FORM 6
FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Report of Foreign Private Issuer
Pursuant to Rule 13a - 16 or 15d - 16
of
the Securities Exchange Act of 1934
For the month of August
HSBC Holdings plc
42nd Floor, 8 Canada Square, London
E14 5HQ, England
(Indicate by check mark whether the registrant
files or will file annual reports under cover of Form 20-F or Form 40-F).
Form 20-F X
Form 40-F
......
(Indicate by check mark whether the registrant
by furnishing the information contained in this Form is also thereby furnishing the
information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act
of 1934).
Yes.......
No X
(If "Yes" is marked, indicate below the file
number assigned to the registrant in connection with Rule 12g3-2(b): 82-
..............).
UNITED STATES SECURITIES AND
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X
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended June 30, 2009
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period from
to
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Commission file number 1-8198
(Exact name of registrant as specified in its charter)
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(State of
Incorporation
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26525 North Riverwoods Boulevard
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(I.R.S. Employer Identification No.)
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(Address of principal executive offices)
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Registrant's telephone number, including area code
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 whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File required to
be submitted and posted pursuant to Rule 405 of Regulation S-T during the
preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files). Yes
No
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See the
definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated
filer
Accelerated filer
Non-accelerated filer
X
Smaller reporting company
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes
No X
As of July 31, 2009, there were 64 shares of the registrant's common
stock outstanding, all of which are owned by HSBC Investments (
North America
) Inc.
Part
I.
FINANCIAL INFORMATION
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Consolidated Statement of Loss
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Consolidated Balance Sheet
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Consolidated Statement of Changes in Shareholders' Equity
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Consolidated Statement of Cash Flows
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Notes to Consolidated Financial Statements
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Management's Discussion and Analysis of Financial Condition and Results
of Operations
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Forward-Looking Statements
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Segment Results - IFRS Management Basis
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Liquidity and Capital Resources
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Reconciliations to
U.S.
GAAP Financial Measures
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Quantitative and Qualitative Disclosures about Market Risk
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Part II OTHER INFORMATION
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Part
I.
FINANCIAL INFORMATION
Item 1.
Financial Statements
CONSOLIDATED STATEMENT OF LOSS (UNAUDITED)
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Finance and other interest income
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Interest expense on debt held by:
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Provision for credit losses
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Net interest income (loss) after provision for credit
losses
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Gain (loss) on debt designated at fair value and related
derivatives
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Enhancement services revenue
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Taxpayer financial services income
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Gain on bulk receivable sales to HSBC affiliates
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Gain on receivable sales to HSBC affiliates
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Servicing and other fees from HSBC affiliates
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Lower of cost or fair value adjustment on receivables held for
sale
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Salaries and employee benefits
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Occupancy and equipment expenses
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Real estate owned expenses
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Other servicing and administrative expenses
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Support services from HSBC affiliates
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Amortization of intangibles
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Goodwill and other intangible asset impairment charges
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Loss from continuing operations before income tax benefit
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Loss from continuing operations
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Discontinued Operations (Note 2):
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Income from discontinued operations before income tax expense
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Income from discontinued operations
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The accompanying notes are an integral part of the consolidated financial
statements.
CONSOLIDATED BALANCE SHEET (UNAUDITED)
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Interest bearing deposits with banks
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Securities purchased under agreements to resell
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Securities available for sale
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Receivables held for sale
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Properties and equipment, net
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Derivative financial assets
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Deferred income taxes, net
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Long term debt (including $25.9 billion at June 30, 2009 and
$28.3 billion at December 31, 2008 carried at fair
value)
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Insurance policy and claim reserves
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Derivative related liabilities
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Liability for post-retirement benefits
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Redeemable preferred stock, 1,501,100 shares authorized,
Series B, $0.01 par value, 575,000 shares issued
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Common shareholder's equity:
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Common stock, $0.01 par value, 100 shares authorized,
64 shares issued at June 30, 2009 and 60 shares issued
at December 31, 2008
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Additional paid-in capital
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Accumulated other comprehensive loss
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Total common shareholder's equity
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Total liabilities and shareholders' equity
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The accompanying notes are an integral part of the consolidated financial
statements.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
Six Months Ended June 30,
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Balance at beginning and end of period
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Common shareholder's equity
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Additional paid-in capital
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Balance at beginning of period
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Excess of book value over consideration received on sale of
U.K.
operations to an HSBC affiliate
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Capital contribution from parent company
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Return of capital to parent company
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Employee benefit plans, including transfers and other
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Balance at beginning of period
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Dividend equivalents on HSBC's Restricted Share Plan
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Accumulated other comprehensive loss
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Balance at beginning of period
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Net change in unrealized gains (losses), net of tax, on:
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Derivatives classified as cash flow hedges
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Securities available for sale and interest-only strip receivables
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Postretirement benefit plan adjustment, net of tax
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Foreign currency translation adjustments
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Other comprehensive income (loss), net of tax
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Reclassification of foreign currency translation and pension
adjustments to additional paid-in capital resulting from sale of
U.K.
operations
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Total common shareholder's equity
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Comprehensive income (loss)
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Other comprehensive income (loss)
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Comprehensive income (loss)
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The accompanying notes are an integral part of the consolidated financial
statements
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
Six Months Ended June 30,
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Cash flows from operating activities
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Loss from discontinued operations
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Loss from continuing operations
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Adjustments to reconcile net income to net cash provided by operating
activities:
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Provision for credit losses
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Gain on bulk sale of receivables to HSBC Bank
USA
, National Association ("HSBC Bank
USA
")
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Gain on receivable sales to HSBC affiliates
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Goodwill and other intangible impairment
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Loss on sale of real estate owned, including lower of cost or market
adjustments
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Insurance policy and claim reserves
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Depreciation and amortization
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Mark-to-market on debt designated at fair value and related
derivatives
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Gain on sale of Visa Class B shares
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Net change in other assets
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Net change in other liabilities
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Originations of loans held for sale
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Sales and collections on loans held for sale
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Foreign exchange and FAS 133 movements on long term debt and net
change in non-FVO related derivative assets and liabilities
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Other-than-temporary impairment on securities
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Lower of cost or fair value on receivables held for sale
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Cash provided by operating activities - continuing
operations
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Cash provided by operating activities - discontinued
operations
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Net cash provided by operating activities
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Cash flows from investing activities
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Net change in short-term securities available for sale
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Net change in securities purchased under agreements to resell
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Net change in interest bearing deposits with banks
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Cash from sale of Visa Class B shares
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Proceeds from sale of affiliate preferred stock shares to HSBC
Plc
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Net (originations) collections
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Purchases and related premiums
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Proceeds from sales of real estate owned
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Cash received on sales of real estate secured receivables held in
portfolio to a third party
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Net cash received in sale of U.K. Operations to an affiliate
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Cash received from bulk sales of receivables to HSBC Bank
USA
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Purchases of properties and equipment
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Cash provided by investing activities - continuing
operations
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Cash provided by investing activities - discontinued
operations
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Net cash provided by investing activities
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The accompanying notes are an integral part of the consolidated financial
statements
Six Months Ended June 30,
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Cash flows from financing activities
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Net change in short-term debt
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Net change in due to affiliates
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Policyholders' benefits paid
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Cash received from policyholders
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Capital contribution from parent
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Return of capital to parent
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Preferred shareholders' dividends
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Cash used in financing activities - continuing operations
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Cash used in financing activities - discontinued operations
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Net cash used in financing activities
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Effect of exchange rate changes on cash
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Cash at beginning of period^
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Supplemental Noncash Investing and Capital Activities
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Fair value of properties added to real estate owned
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Transfer of receivables to held for sale
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Transfer of receivables to held for investment
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Assumption of indebtedness by HSBC Bank
USA
related to the bulk receivable sale
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Redemption of the junior subordinated notes underlying the mandatorily
redeemable preferred securities of the Household Capital
Trust VIII for common stock
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^ Cash includes $171 million and $43 million for discontinued
operations at January 1, 2008 and June 30, 2008.
The accompanying notes are an integral part of the consolidated financial
statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Basis of Presentation
HSBC Finance Corporation is an indirect wholly owned subsidiary of HSBC North
America Holdings Inc. ("HSBC North America"), which is an indirect wholly owned
subsidiary of HSBC Holdings plc ("HSBC"). The accompanying unaudited interim
consolidated financial statements of HSBC Finance Corporation and its subsidiaries
have been prepared in accordance with accounting principles generally accepted in
the
United States of America
("U.S. GAAP") for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. In the
opinion of management, all normal and recurring adjustments considered necessary
for a fair presentation of financial position, results of operations and cash flows
for the interim periods have been made. HSBC Finance Corporation and its
subsidiaries may also be referred to in this Form 10-Q as "we," "us" or "our."
These unaudited interim consolidated financial statements should be read in
conjunction with our Annual Report on Form 10-K for the year ended
December 31, 2008 (the "2008 Form 10-K"). Certain reclassifications have
been made to prior period amounts to conform to the current period presentation.
Subsequent events have been evaluated through August 3, 2009, the date this
Form 10-Q was issued and filed with the U.S. Securities and Exchange
Commission.
The consolidated financial statements have been prepared on the basis that we will
continue as a going concern. Such assertion contemplates the significant losses
recognized in recent years and the challenges we anticipate with respect to a
sustainable return to profitability under prevailing and forecasted economic
conditions. HSBC continues to be fully committed and has the capacity to continue
to provide the necessary capital and liquidity to fund continuing operations.
The preparation of financial statements in conformity with U.S. GAAP requires
the use of estimates and assumptions that affect reported amounts and disclosures.
Actual results could differ from those estimates. Interim results should not be
considered indicative of results in future periods.
During the first quarter of 2009, we adopted Statement of Financial Accounting
Standards No. 161, "Disclosures about Derivative Instruments and Hedging
Activities - an amendment of FASB Statement No. 133," and FASB Staff
Position ("FSP") FAS 107-1 and APB 28-1, "Interim Disclosures about Fair Value
of Financial Instruments." In addition, we early adopted FSP FAS 115-2 and
124-2, "Recognition and Presentation of Other-Than-Temporary Impairments," as well
as FSP FAS 157-4, "Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying
Transactions That Are Not Orderly," effective January 1, 2009. See
Note 19, "New Accounting Pronouncements," for further details and related
impact.
2. Discontinued Operations
United Kingdom
In May 2008, we sold all of the common stock of Household International Europe, the
holding company for our
United Kingdom
operations ("U.K. Operations") to HSBC Overseas Holdings (UK) Limited
("HOHU"), a subsidiary of HSBC. The sales price was GBP 181 million
(equivalent to approximately $359 million). At the time of the sale, the
assets of the U.K. Operations consisted primarily of net receivables of
$4.6 billion and the liabilities consisted primarily of amounts due to HSBC
affiliates of $3.6 billion. As a result of this transaction, HOHU assumed the
liabilities of our U.K. Operations outstanding at the time of the sale. Because the
sale was between affiliates under common control, the book value of the investment
in our U.K. Operations in excess of the consideration received at the time of sale
which totaled $576 million was recorded as a decrease to common shareholder's
equity. Of this amount, $196 million was reflected as a decrease to additional
paid in capital and $380 million was reflected as a decrease to other
comprehensive income (loss), primarily related to foreign currency translation
adjustments. There was no tax benefit recorded as a result of this transaction. Our
U.K. Operations were previously reported in the International Segment.
The following summarizes the operating results of our U.K. Operations for the
periods presented:
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Net interest income and other revenues
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Provision for credit losses
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Loss before income tax (expense) benefit
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Income tax (expense) benefit
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Loss from discontinued operations
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Amounts shown for 2008 represent totals from the beginning of the
period through the date of the sale.
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Canada
On November 30, 2008, we sold the common stock of HSBC Financial Corporation
Limited, the holding company for our Canadian business ("Canadian Operations") to
HSBC Bank
Canada
. The sales price was approximately $279 million (based on the exchange rate
on the date of sale). At the time of the sale, the assets of the Canadian
Operations consisted primarily of net receivables of $3.1 billion,
available-for-sale securities of $98 million and goodwill of $65 million.
Liabilities at the time of the sale consisted primarily of long term debt of
$3.1 billion. As a result of this transaction, HSBC Bank
Canada
assumed the liabilities of our Canadian Operations outstanding at the time of
the sale. However, we continue to guarantee the long-term and medium-term notes
issued by our Canadian business prior to the sale. As of June 30, 2009, the
outstanding balance of the guaranteed notes was $2.1 billion and the latest
scheduled maturity of the notes is May 2012. Because the sale was between
affiliates under common control, the book value of the investment in our Canadian
Operations in excess of the consideration received at the time of sale which
totaled $40 million was recorded as a decrease to common shareholder's equity.
Of this amount, $46 million was reflected as a decrease to additional paid in
capital and $6 million was reflected as an increase to other comprehensive
income (loss), primarily related to foreign currency translation adjustments. There
was no tax benefit recorded as a result of this transaction. Our Canadian
Operations were previously reported in the International Segment.
The following summarizes the operating results of our Canadian Operations for the
periods presented:
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Net interest income and other revenues
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Provision for credit losses
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Income before income tax (expense) benefit
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Income tax (expense) benefit
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Income from discontinued operations
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3. Receivable Portfolio Sales to HSBC Bank
USA
and Adoption of FFIEC
Policies
General Motors and AFL-CIO Union Plus Credit Card Receivable
Portfolios
In January 2009 upon receipt of regulatory approval, we sold our General Motors
MasterCard receivable portfolio ("GM Portfolio") and our AFL-CIO Union Plus
MasterCard/Visa receivable portfolio ("UP Portfolio") with an aggregate outstanding
principal balance of $6.3 billion and $6.1 billion, respectively, to HSBC
Bank USA. At December 31, 2008, the GM and UP Portfolios were included in
receivables held for sale with a lower of cost or fair value of $6.2 billion
and $5.9 billion, respectively. The aggregate sales price for the GM and UP
Portfolios was $12.2 billion which included the transfer of approximately
$6.1 billion of indebtedness, resulting in net cash proceeds of
$6.1 billion. As a result, in the first quarter of 2009 we recorded a gain of
$130 million ($84 million after-tax) on the sale of the GM and UP
Portfolios. This gain was partially offset by a loss of $(80) million
($(51) million after-tax) recorded on the termination of cash flow hedges
associated with the $6.1 billion of indebtedness transferred to HSBC Bank USA
as part of these transactions. The sales price was determined based on independent
valuation opinions. We retained the customer account relationships and the right to
originate new customer account relationships for both the GM and UP Portfolios. By
agreement, we will sell additional volume for new and existing accounts on a daily
basis to HSBC Bank
USA
at fair market value and we will continue to service the receivables sold to
HSBC Bank
USA
for a fee.
Auto Finance Receivable Portfolio
In January 2009 upon receipt of regulatory approval, we also sold certain auto
finance receivables with an aggregate outstanding principal balance of
$3.0 billion to HSBC Bank USA for an aggregate sales price of
$2.8 billion. As a result, in the first quarter of 2009 we recorded a gain of
$7 million ($4 million after-tax) on the sale of these auto finance
receivables. The sales price was based on an independent valuation opinion. We will
continue to service these auto finance receivables for HSBC Bank
USA
for a fee.
Upon receipt of regulatory approval for the sale of the auto finance receivables
discussed above, 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 entire auto finance receivable portfolio immediately prior to
the sale. Under the revised policy, the principal balance of auto loans in excess
of the estimated net realizable value will be charged-off no later than the end of
the month in which the auto loan becomes 120 days contractually delinquent.
Additionally, auto loans subject to a bankruptcy will be charged-off at the earlier
of (i) the end of the month 60 days after notice of filing and
60 days contractually delinquent, or (ii) the end of the month during
which the loan becomes 120 days contractually delinquent. The adoption of
FFIEC charge-off policies for our auto finance portfolio increased our provision
for credit losses and reduced our net income in the first quarter of 2009 as
summarized below:
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Provision for credit losses:
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Charge-offs to comply with FFIEC policies
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Release of credit loss reserves
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Reduction to income from continuing operations before income tax
expense
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Reduction to net income from continuing operations
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As discussed in prior filings, we have been engaged in a continuing, comprehensive
evaluation of the strategies and opportunities of our operations. In light of the
unprecedented developments in the retail credit markets, particularly in the
residential mortgage industry, this evaluation has resulted in decisions to lower
the risk profile of our operations, to reduce our capital and liquidity
requirements by reducing the size of our balance sheet and to rationalize and
maximize the efficiency of our operations. As a result, a number of strategic
actions have been undertaken since mid-2007 and continued into the first half of
2009 which are summarized below:
Facility Closures
During the second quarter of 2009, we announced the decision to exit certain lease
arrangements and consolidate a variety of locations across the
United States
to increase our operating efficiencies and reduce operating expenses. As a
result, over the next 18 to 24 months, we will exit facilities in
Bridgewater
,
New Jersey
;
Minnetonka
,
Minnesota
; Wood Dale,
Illinois
; and
Elmhurst
,
Illinois
. Additionally, we have decided to consolidate our operations in
Virginia Beach
,
Virginia
into our
Chesapeake
,
Virginia
facility. Severance and lease termination costs associated with this decision
have not been material to date. During the three months ended June 30, 2009,
we recorded a non-cash charge of $3 million related to the impairment of fixed
assets. We anticipate additional restructuring costs will be recorded through 2011,
however such costs are not expected to be material.
Consumer Lending Business
In late February 2009, we decided to discontinue new customer account originations
for all products by our Consumer Lending business and close substantially all
branch offices as soon as all commitments to customers were satisfied. We will
continue to service and collect the existing receivable portfolio as it runs off,
while continuing our efforts to reach out and assist mortgage customers utilizing
appropriate modification and other account management programs, potentially
including refinancing a loan with an existing customer in accordance with their
financial needs, to maximize collection and home preservation. The following
summarizes the restructuring liability relating to our Consumer Lending business
recorded through June 30, 2009.
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Restructuring liability at December 31, 2008
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Restructuring costs recorded during the first quarter of 2009
|
|
|
|
|
Restructuring costs paid during the first quarter of 2009
|
|
|
|
|
Restructuring liability at March 31, 2009
|
|
|
|
|
Restructuring costs recorded during the period
|
|
|
|
|
Restructuring costs paid during the period
|
|
|
|
|
Adjustments to restructure liability during the period
|
|
|
|
|
Restructure liability at June 30, 2009
|
|
|
|
|
During the second quarter of 2009, we released $13 million of severance
accruals as we have adjusted a variety of previously estimated severance costs.
During the first quarter of 2009, we also incurred $3 million primarily
relating to the acceleration of stock based compensation expense and non-cash
charges of approximately $29 million relating to the impairment of fixed
assets and other capitalized costs. We also recorded a curtailment gain of
$16 million for other post-retirement benefits related to this decision. As a
result, we have expensed a cumulative total of $158 million in restructuring
costs. We anticipate additional closure costs will be recorded during 2009, however
such remaining costs are not expected to be material. Separately, our information
technology services affiliate recorded approximately $16 million of costs
relating to one-time termination and employee benefit costs and asset write-downs
during the first half of 2009. We currently believe none of these costs will be
billed to us by this affiliate.
In addition, we were required to perform an interim intangible asset impairment
test for our remaining Consumer Lending intangible assets which resulted in an
impairment charge of $14 million during the first quarter of 2009 which
represented all of the remaining intangibles associated with this business. See
Note 9, "Intangible Assets," for additional information related to the
intangible asset impairment.
While our Consumer Lending business is currently operating in a run-off mode, we
have not reported this business as a discontinued operation because of our
continuing involvement in servicing and collecting the receivables.
Card and Retail Services Business
In the third quarter of 2008 we closed our servicing facilities located in
Jacksonville
,
Florida
and White Marsh,
Maryland
(the "Servicing Facilities"). The servicing activities performed in the
Servicing Facilities have been redeployed to other facilities in our Card and
Retail Services businesses. The restructure liability relating to the closure of
the Servicing Facilities was $4 million at both June 30, 2009 and
December 31, 2008. No additional restructuring charges are anticipated to be
incurred related to the closure of the Servicing Facilities. As a result of this
decision, we have expensed a cumulative total of $10 million in restructuring
costs through June 30, 2009.
Additionally, in the fourth quarter of 2008, we decided to further reduce headcount
in our Card and Retail Services business and recorded a total of $5 million in
restructuring costs. The restructure liability related to this reduction in force,
which was $5 million at December 31, 2008, has been fully paid as of
June 30, 2009. We do not anticipate additional restructuring costs associated
with this reduction in force will be recorded in future periods.
Auto Finance Business
In March 2008, we decided to reduce the size of our Auto Finance business, which is
a part of our Consumer Segment that historically purchased retail installment
contracts from active dealer relationships throughout the
U.S.
as part of its business strategy. At that time, we decided to discontinue our
dealer relationships in several select states, primarily in the Northeast, and
discontinued certain other product offerings. As a result of these decisions, we
recorded $3 million in severance costs during the first quarter of 2008 which
were fully paid to employees during the second quarter of 2008.
In July 2008, we decided to discontinue new auto loan originations from our dealer
and direct-to-consumer channels. We will continue to service and collect the
existing auto loan portfolio as it pays down. As a result of this decision, we have
expensed a cumulative total of $32 million in restructuring costs through
June 30, 2009, which includes a $2 million non-cash charge during 2008
relating to the impairment of fixed assets. We anticipate additional restructuring
costs will be recorded during 2009, however such remaining costs are not expected
to be material. The restructure liability relating to this decision was
$4 million and $10 million at June 30, 2009 and
December 31, 2008, respectively. While our Auto Finance business is currently
operating in a run-off mode, we have not reported this business as a discontinued
operation because of our continuing involvement in servicing and collecting the
receivables.
Solstice Capital Group, Inc. Operations
In December 2008, we decided to cease operations of Solstice Capital Group, Inc.
("Solstice"), a subsidiary of our Consumer Lending business which originated real
estate secured receivables for resale. As a result of this decision, we recorded
$1 million of one-time termination and other employee benefit costs during the
fourth quarter of 2008 which was paid to the affected employees during the first
quarter of 2009. No additional restructuring charges are anticipated in future
periods.
The following summarizes the changes in the restructure liability during the three
and six months ended June 30, 2009 and 2008 relating to the actions
implemented during 2008:
|
|
|
|
|
|
Three months ended June 30, 2009:
|
|
|
|
Restructure liability at March 31, 2009
|
|
|
|
Restructuring costs paid during the period
|
|
|
|
Adjustments to restructure liability during the period
|
|
|
|
Restructure liability at June 30, 2009
|
|
|
|
Three months ended June 30, 2008:
|
|
|
|
Restructure liability at March 31, 2008
|
|
|
|
Restructuring costs paid during the period
|
|
|
|
Restructure liability at June 30, 2008
|
|
|
|
|
|
|
|
|
|
Six months ended June 30, 2009:
|
|
|
|
Restructure liability at December 31, 2008
|
|
|
|
Restructuring costs recorded during the period
|
|
|
|
Restructuring costs paid during the period
|
|
|
|
Adjustments to restructure liability during the period
|
|
|
|
Restructure liability at June 30, 2009
|
|
|
|
Six months ended June 30, 2008:
|
|
|
|
Restructure liability at December 31, 2007
|
|
|
|
Restructuring costs recorded during the period
|
|
|
|
Restructuring costs paid during the period
|
|
|
|
Restructuring liability at June 30, 2008
|
|
|
|
Beginning in mid-2007 we undertook a number of actions including the
following:
> Discontinued correspondent channel acquisitions of our Mortgage Services
business;
> Ceased operations of Decision One Mortgage
Company;
> Reduced Consumer Lending branch network to
approximately 1,000 branches at December 31, 2007; and
> Closed our loan underwriting, processing and
collections center in
Carmel
,
Indiana
.
The following summarizes the changes in the restructure liability during the three
and six months ended June 30, 2009 and 2008 relating to the actions
implemented during 2007:
|
|
|
|
|
|
Three months ended June 30, 2009:
|
|
|
|
Restructure liability at March 31, 2009
|
|
|
|
Restructuring costs recorded during the second quarter of 2009
|
|
|
|
Restructuring costs paid during the second quarter of 2009
|
|
|
|
Restructure liability at June 30, 2009
|
|
|
|
Three months ended June 30, 2008:
|
|
|
|
Restructure liability at March 31, 2008
|
|
|
|
Restructuring costs recorded during the period
|
|
|
|
Restructuring costs paid during the period
|
|
|
|
Adjustments to restructure liability during the period
|
|
|
|
Restructure liability at June 30, 2008
|
|
|
|
|
|
|
|
|
|
Six months ended June 30, 2009:
|
|
|
|
Restructure liability at December 31, 2008
|
|
|
|
Restructuring costs paid during 2009
|
|
|
|
Restructure liability at June 30, 2009
|
|
|
|
Six months ended June 30, 2008:
|
|
|
|
Restructure liability at December 31, 2007
|
|
|
|
Restructuring costs recorded during the period
|
|
|
|
Restructuring costs paid during the period
|
|
|
|
Adjustments to restructure liability during the period
|
|
|
|
Restructuring liability at June 30, 2008
|
|
|
|
Summary of Restructuring Activities
The following table summarizes the net cash and non-cash expenses recorded for all
restructuring activities during the six months ended June 30, 2009 and 2008:
|
|
|
|
|
|
|
|
Six months ended June 30, 2009:
|
|
|
|
|
|
Consumer Lending closure(5)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended June 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-time termination and other employee benefits are included as a
component of Salaries and employee benefits in the consolidated
statement of loss.
|
|
|
|
Lease termination and associated costs and fixed assets write-downs are
included as a component of Occupancy and equipment expenses in the
consolidated statement of loss.
|
|
|
|
The other expenses are included as a component of Other servicing and
administrative expenses in the consolidated statement of loss.
|
|
|
|
Includes $29 million and $18 million of fixed asset
write-offs during the six months ended June 30, 2009 and 2008,
respectively, which were recorded as a component of Other servicing and
administrative expenses in the consolidated statement of loss. The six
months ended June 30, 2009 also includes $3 million relating
to stock based compensation and other benefits as well as a curtailment
gain of $16 million which were recorded as a component of Salaries
and employee benefits in the consolidated statement of loss.
|
|
|
|
Excludes intangible asset impairment charges of $14 million
recorded during the six months ended June 30, 2009.
|
Securities consisted of the following available-for-sale investments:
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
government sponsored enterprises(1)
|
|
|
|
|
U.S.
government agency issued or guaranteed
|
|
|
|
|
Obligations of
U.S.
states and political subdivisions
|
|
|
|
|
Asset-backed securities(2)
|
|
|
|
|
U.S.
corporate debt securities(3)
|
|
|
|
|
|
|
|
|
|
Preferred equity securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued investment income
|
|
|
|
|
Total securities available-for-sale
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
government sponsored enterprises(1)
|
|
|
|
|
U.S.
government agency issued or guaranteed
|
|
|
|
|
Obligations of
U.S.
states and political subdivisions
|
|
|
|
|
Asset-backed securities(2)
|
|
|
|
|
U.S.
corporate debt securities(3)
|
|
|
|
|
|
|
|
|
|
Preferred equity securities(4)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued investment income
|
|
|
|
|
Total securities available-for-sale
|
|
|
|
|
|
Includes primarily mortgage-backed securities issued by the Federal
National Mortgage Association and the Federal Home Loan Mortgage
Corporation.
|
|
|
|
At June 30, 2009 and December 31, 2008, the majority of our
asset-backed securities are residential mortgage-backed
securities.
|
|
|
|
At June 30, 2009 and December 31, 2008, the majority of
our
U.S.
corporate debt securities represent investments in the financial
services, consumer products, healthcare and industrials sectors.
|
|
|
|
At December 31, 2008, substantially all of our preferred equity
securities were perpetual preferred equity investments in the utilities
and financial services sectors which were sold in the first half of
2009.
|
A summary of gross unrealized losses and related fair values as of June 30,
2009 and December 31, 2008, classified as to the length of time the losses
have existed follows:
|
|
|
|
|
|
|
|
|
|
|
(dollars are in millions)
|
|
|
|
|
|
|
|
U.S.
government sponsored enterprises
|
|
|
|
|
|
|
U.S.
government agency issued or guaranteed
|
|
|
|
|
|
|
Obligations of
U.S.
states and political subdivisions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
corporate debt securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars are in millions)
|
U.S.
government sponsored enterprises
|
|
|
|
|
|
|
U.S.
government agency issued or guaranteed
|
|
|
|
|
|
|
Obligations of
U.S.
states and political subdivisions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
corporate debt securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred equity securities
|
|
|
|
|
|
|
Gross unrealized losses decreased during the first half of 2009 primarily due to
the impact of lower credit spreads, partially offset by rising interest rates. We
have reviewed our securities for which there is an unrealized loss in accordance
with our accounting policies for other-than-temporary impairment. Our decision in
the first quarter of 2009 to discontinue new customer account originations in our
Consumer Lending business adversely impacted certain insurance subsidiaries that
hold perpetual preferred securities. Therefore, during the first quarter of 2009 we
determined it was more-likely-than-not that we would be required to sell the
portfolio of perpetual preferred securities prior to recovery of amortized cost and
subsequently sold our entire portfolio of perpetual preferred securities during the
second quarter of 2009. There were no impairment losses recorded during the three
months ended June 30, 2009. During the six months ended June 30, 2009, we
recorded $20 million of impairment losses related to perpetual preferred
securities. The entire unrealized loss was recorded in earnings in accordance with
FSP FAS 115-2 and 124-2, which is discussed more fully below, as we determined
it was more-likely-than-not that we would be required to sell the portfolio of
perpetual preferred securities prior to recovery of amortized cost. We do not
consider any other securities to be other-than-temporarily impaired because we
expect to recover the entire amortized cost basis of the securities and we neither
intend to nor expect to be required to sell the securities prior to recovery, even
if that equates to holding securities until their individual maturities. However,
additional other-than-temporary impairments may occur in future periods if the
credit quality of the securities deteriorates.
On-Going Assessment for Other-Than Temporary Impairment
On a quarterly basis, we perform an assessment to determine whether there have been
any events or economic circumstances to indicate that a security with an unrealized
loss has suffered other-than-temporary impairment, pursuant to FASB Staff Position
115-1 and 124-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments," ("FSP FAS 115-1"). A debt security is
considered impaired if the fair value is less than its amortized cost basis at the
reporting date. If impaired, we then assess whether the unrealized loss is
other-than-temporary. Prior to our early adoption of FASB Staff Position
No. 115-2 and FAS 124-2, "Recognition and Presentation of
Other-Than-Temporary Impairments," ("FSP FAS 115-2") on January 1, 2009,
unrealized losses on all securities that were determined to be temporary were
recorded, net of tax, in other comprehensive income and unrealized losses that were
determined to be other-than-temporary were recorded entirely to earnings.
Under FSP FAS 115-2, an unrealized loss is generally deemed to be
other-than-temporary and a credit loss is deemed to exist if the present value of
the expected future cash flows is less than the amortized cost basis of the debt
security. As a result, the credit loss component of an other-than-temporary
impairment write-down for debt securities is recorded in earnings while the
remaining portion of the impairment loss is recognized net of tax in other
comprehensive income (loss) provided we do not intend to sell the underlying debt
security and it is more-likely-than-not that we would not have to sell the debt
security prior to recovery.
For all our debt securities, as of the reporting date we do not have the intention
to sell these securities and believe we will not be required to sell these
securities for contractual, regulatory or liquidity reasons.
We consider the following factors in determining whether a credit loss exists and
the period over which the debt security is expected to recover:
• The length of time and the extent to which the fair value has been less than
the amortized cost basis;
• The level of credit enhancement provided by the structure which includes,
but is not limited to, credit subordination positions, overcollateralization,
protective triggers and financial guarantees provided by monoline wraps;
• Changes in the near term prospects of the issuer or underlying collateral of
a security, such as changes in default rates, loss severities given default and
significant changes in prepayment assumptions;
• The level of excess cash flows generated from the underlying collateral
supporting the principal and interest payments of the debt securities; and
• Any adverse change to the credit conditions of the issuer or the security
such as credit downgrades by the rating agencies.
At June 30, 2009, approximately 91 percent of our corporate debt
securities are rated A- or better. At June 30, 2009, approximately
73 percent of our asset-backed securities, which totaled $106 million,
are rated "AAA." However, without an economic recovery in the near-term, spreads
returning to levels that reflect underlying credit characteristics and liquidity
continuing to return to the markets, additional other-than-temporary impairments
may occur in future periods.
Proceeds from the sale and call of available-for-sale investments totaled
approximately $59 million and $191 million during the six months ended
June 30, 2009 and 2008, respectively. We realized gross gains of
$4 million and $2 million during the six months ended June 30, 2009
and 2008, respectively. We realized gross losses of $3 million and
$1 million during the six months ended June 30, 2009 and 2008,
respectively.
Contractual maturities of and yields on investments in debt securities for those
with set maturities were as follows:
|
|
|
|
|
|
|
|
|
(dollars are in millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
government sponsored enterprises:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
government agency issued or guaranteed:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of
U.S.
states and political subdivisions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
corporate debt securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Computed by dividing annualized interest by the amortized cost of
respective investment securities.
|
Receivables consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
HSBC acquisition purchase accounting fair value adjustments, net
|
|
|
|
|
|
Credit loss reserve for receivables
|
|
|
Unearned credit insurance premiums and claims reserves
|
|
|
|
|
|
|
On a continuing basis, private label receivables consist primarily of
the liquidating retail sales contracts in our Consumer Lending business
with a receivable balance of $28 million as of June 30, 2009.
Beginning in the first quarter of 2009, we began reporting this
liquidating portfolio prospectively within our personal non-credit card
portfolio.
|
Secured financings of $6.6 billion at June 30, 2009 were secured by
$9.9 billion of real estate secured, auto finance and credit card receivables.
Secured financings of $15.0 billion at December 31, 2008 were secured by
$21.4 billion of real estate secured, auto finance, credit card and personal
non-credit card receivables.
HSBC acquisition purchase accounting fair value adjustments represent adjustments
which have been "pushed down" to record our receivables at fair value on
March 28, 2003, the date we were acquired by HSBC.
Purchased Receivable Portfolios:
In November 2006, we acquired $2.5 billion of real estate secured receivables
from Champion Mortgage ("Champion") a division of KeyBank, N.A. These acquired
receivables were subject to the requirements of Statement of Position 03-3,
"Accounting for Certain Loans or Debt Securities Acquired in a Transfer"
("SOP 03-3") to the extent there was evidence of deterioration of credit
quality since origination and for which it was probable, at acquisition, that all
contractually required payments would not be collected and that the associated line
of credit had been closed. The carrying amount of Champion real estate secured
receivables subject to the requirements of SOP 03-3 was $57 million and
$62 million at June 30, 2009 and at December 31, 2008, respectively,
and is included in the real estate secured receivables in the table above. The
outstanding contractual balance of these receivables was $72 million and
$76 million at June 30, 2009 and December 31, 2008, respectively.
Credit loss reserves of $12 million and $6 million as of June 30,
2009 and December 31, 2008, respectively, were held for the acquired Champion
receivables subject to SOP 03-3 due to a decrease in the expected future cash
flows since the acquisition.
As part of our acquisition of Metris Companies Inc. ("Metris") on December 1,
2005, we acquired $5.3 billion of credit card receivables which were also
subject to the requirements of SOP 03-3. The carrying amount of the credit
card receivables acquired from Metris which were subject to SOP 03-3 was
$40 million and $52 million at June 30, 2009 and December 31,
2008, respectively, and is included in the credit card receivables in the table
above. The outstanding contractual balance of these receivables was
$53 million and $77 million at June 30, 2009 and December 31,
2008, respectively. At June 30, 2009 and December 31, 2008, no credit
loss reserve for the acquired Metris receivables subject to SOP 03-3 was
established as there has been no decrease to the expected future cash flows since
the acquisition.
The following summarizes the accretable yield on Metris and Champion receivables at
June 30, 2009 and 2008:
|
|
|
|
|
|
|
|
|
|
Accretable yield at beginning of period
|
|
|
|
|
Accretable yield amortized to interest income during the period
|
|
|
|
|
Reclassification from non-accretable difference(3)
|
|
|
|
|
Accretable yield at end of period
|
|
|
|
|
|
For the Champion portfolio, there were no reclassifications to
accretable yield from non-accretable difference during both the three
and six months ended June 30, 2009. There was a reclassification
to accretable yield from non-accretable difference of $3 million
and $4 million during the three and six months ended June 30,
2008, respectively.
|
|
|
|
For the Metris portfolio, there was a reclassification to accretable
yield from non-accretable difference of $1 million and
$9 million during the three and six months ended June 30,
2009, respectively. There was a reclassification to accretable yield
from non-accretable difference of $7 million and $12 million
during the three and six months ended June 30, 2008,
respectively.
|
|
|
|
Reclassification from non-accretable difference represents an increase
to the estimated cash flows to be collected on the underlying
portfolio.
|
Troubled Debt Restructurings ("TDR"):
The following table presents information about our TDR Loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total real estate secured
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit loss reserves for TDR Loans:
|
|
|
|
|
|
|
|
|
|
|
|
Total real estate secured
|
|
|
|
|
|
|
|
|
|
|
|
Total credit loss reserves for TDR Loans(2)
|
|
|
|
Includes TDR balances reported as receivables held for sale for which
there are no credit loss reserves as they are carried at lower of cost
or fair value. At June 30, 2009, TDR loans include
$14 million and $24 million of credit card and auto finance
receivables held for sale, respectively. At December 31, 2008, TDR
loans include $138 million of credit card receivables held for
sale.
|
|
|
|
Included in credit loss reserves.
|
|
|
|
|
|
|
|
|
|
|
Average balance of TDR Loans
|
|
|
|
|
Interest income recognized on TDR Loans
|
|
|
|
|
Concentrations of Credit Risk:
We have historically served non-conforming and non-prime consumers. Such customers
are individuals who have limited credit histories, modest incomes, high
debt-to-income ratios or have experienced credit problems caused by occasional
delinquencies, prior charge-offs, bankruptcy or other credit related actions. The
majority of our secured receivables and receivables held for sale have high
loan-to-value ratios. Our receivables and receivables held for sale portfolios
includes the following types of loans:
• Interest-only loans - A loan which allows a customer to pay the
interest-only portion of the monthly payment for a period of time which results in
lower payments during the initial loan period. However, subsequent events affecting
a customer's financial position could affect the ability of customers to repay the
loan in the future when the principal payments are required.
• ARM loans - A loan which allows us to adjust pricing on the loan in
line with market movements. A customer's financial situation and the general
interest rate environment at the time of the interest rate reset could affect the
customer's ability to repay or refinance the loan after adjustment.
• Stated income loans - Loans underwritten based upon the loan
applicant's representation of annual income, which is not verified by receipt of
supporting documentation.
The following table summarizes the balances of interest-only, loans and stated
income loans in our receivable portfolios at June 30, 2009 and
December 31, 2008
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At June 30, 2009 and December 31, 2008, $1.6 billion and
$3.3 billion of our ARM loan portfolio will experience their first
interest rate reset during the remainder of 2009 based on original
contractual reset date and the outstanding receivable levels at the end
of each period. ARM loans with initial reset dates after 2009 are not
significant.
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We do not have any option ARM loans in our portfolio.
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At June 30, 2009 and December 31, 2008, interest-only, ARM and stated
income loans comprise 27 percent and 29 percent of real estate secured
receivables, including receivables held for sale, respectively. We no longer
originate or acquire interest-only, ARM or stated-income loans.
An analysis of credit loss reserves was as follows:
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Credit loss reserves at beginning of period
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Provision for credit losses
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Receivables transferred to held for sale
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Release of credit loss reserves related to loan sales
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Credit loss reserves at end of period
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8. Receivables Held for
Sale
Receivables held for sale, which are carried at the lower of cost or fair value,
consisted of the following:
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Total receivables held for sale, net
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(1) Includes the following receivables which were originated with the
intent to sell:
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Real estate secured receivables:
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The following table shows the activity in receivables held for sale during the
first half of 2009:
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Receivables held for sale - December 31, 2008
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Transfers of auto finance receivables into receivables held for sale at
the lower of cost or fair value
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Additional lower of cost or fair value adjustment subsequent to
transfer to receivables held for sale(1)
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Transfer of real estate secured and credit card receivables into
receivables held for investment
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Net change in receivable balance
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Receivables held for sale - June 30, 2009
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(1) Includes $3 million with respect to real estate secured loans
originated with the intent to sell.
In January 2009, we sold our GM and UP Portfolios as well as certain auto finance
receivables to HSBC Bank
USA
. See Note 3, "Receivable Portfolio Sales to HSBC Bank
USA
and Adoption of FFIEC Policies," for details of these transactions.
In March 2009, we transferred real estate secured receivables previously classified
as receivables held for sale to receivables held for investment as we now intend to
hold these receivables for the foreseeable future, generally twelve months for real
estate secured receivables. These receivables were transferred at their current
fair market value of $214 million.
In June 2009, we transferred credit card receivables previously classified as
receivables held for sale to receivables held for investment as we now intend to
hold these receivables for the foreseeable future. These receivables were
transferred at their current fair market value of $590 million. The
outstanding contractual balance of these receivables at June 30, 2009 was
$788 million.
In June 2009, we also identified certain auto finance receivables with a fair value
of $450 million for which we no longer have the intent to hold for the
foreseeable future, generally twelve months for auto finance receivables.
Accordingly, these receivables, which were previously held for investment purposes,
have been transferred to held for sale during the second quarter of 2009. These
receivables are now carried at the lower of cost or fair value which resulted in a
lower of cost or fair value adjustment of $38 million during the three months
ended June 30, 2009. The following summarizes the components of this
adjustment:
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Provision for credit losses(1)
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Lower of cost or fair value adjustment
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(1) The portion of the lower of cost or fair value adjustment
attributable to credit was recorded as a provision for credit losses. This was
determined by giving consideration to the impact of over-the-life credit loss
estimates as compared to the existing credit loss reserves prior to our decision to
transfer to receivables held for sale.
(2) Reflects the impact on value caused by current marketplace
conditions including changes in interest rates and illiquidity.
As a result of the adverse economic conditions in the
U.S.
, we have recorded a valuation allowance associated with receivables held for sale
subsequent to the initial transfer to receivables held for sale. The valuation
allowance related to loans held for sale is presented in the following table:
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Valuation allowance at December 31, 2008
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Increase in allowance for net reductions in market value
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Decreases in valuation allowance for loans sold, charged-off or
transferred to held for investment
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Valuation allowance at June 30, 2009
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Intangible assets consisted of the following:
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Purchased credit card relationships and related programs
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Consumer loan related relationships
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Technology, customer lists and other contracts
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Purchased credit card relationships and related programs
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Consumer loan related relationships
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Technology, customer lists and other contracts
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Our purchased credit card relationships are being amortized to their estimated
residual value of $162 million as of June 30, 2009 and December 31,
2008.
Estimated amortization expense associated with our intangible assets for each of
the following years is as follows:
As a result of the decision to discontinue all new customer account originations
for all receivable products in our Consumer Lending business in late February 2009,
during the first quarter of 2009 we performed an interim impairment test for our
technology, customer list and loan related relationship intangible assets. As a
result of these tests, we concluded that the carrying value of the technology,
customer list and loan related relationship intangible assets exceeded their fair
value and we recorded an impairment charge of $14 million to reduce these
assets to their current fair value.
Changes in estimates of the tax basis in our assets and liabilities or other tax
estimates recorded at the date of our acquisition by HSBC or our acquisition of
Metris have historically been adjusted against goodwill. As a result of the
adoption of new accounting standards involving business combinations in 2009,
changes in such estimates are now recorded in earnings.
Changes in the carrying amount of goodwill are as follows:
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Goodwill impairment related to Insurance Services business
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Goodwill impairment related to Card and Retail Services business
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Change in estimate of the tax basis of assets and liabilities
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We performed an interim goodwill impairment test of our Card and Retail Services
business during both the first and second quarter of 2009 as a result of the
continuing deterioration of the economic conditions in the
United States
. In the interim goodwill impairment test performed during the first quarter of
2009, a review of cost of capital requirements resulted in the use of a higher
discount rate in our discounted cash flow model which, when combined with the
changes in fair value of certain reporting unit assets and liabilities, resulted in
a partial impairment of the goodwill allocated to our Card and Retail Services
reporting unit. As a result, during the first quarter of 2009, we recorded an
impairment charge of $393 million relating to this business. For the interim
impairment test during the second quarter of 2009, the continued deterioration in
economic and credit conditions, including rising unemployment rates, as well as the
consideration of various legislative and regulatory actions, resulted in a
significant reduction in our estimated future cash flows. When combined with the
changes in fair value of certain reporting unit assets and liabilities, these
changes have resulted in the impairment of all of the remaining goodwill allocated
to our Card and Retail Services reporting unit. As a result, during the second
quarter of 2009, we recorded an additional impairment charge of
$1,641 million.
During the first quarter of 2009 we also performed an interim goodwill impairment
test of our Insurance Services business. The discontinuance of Consumer Lending new
customer account originations resulted in a substantial decrease in credit
insurance policies sold which significantly impacted our cash flow forecasts for
the Insurance Services reporting unit. Therefore, during the first quarter of 2009
we recorded an impairment charge of $260 million which represented all of the
goodwill allocated to our Insurance Services business.
11. Derivative Financial Instruments
Our business activities involve analysis, evaluation, acceptance and management of
some degree of risk or combination of risks. Accordingly, we have comprehensive
risk management policies to address potential financial risks, which include credit
risk, liquidity risk, market risk, and operational risks. Our risk management
policy is designed to identify and analyze these risks, to set appropriate limits
and controls, and to monitor the risks and limits continually by means of reliable
and up-to-date administrative and information systems. Our risk management policies
are primarily carried out in accordance with practice and limits set by the HSBC
Group Management Board. The HSBC Finance Corporation Asset Liability Committee
("ALCO") meets regularly to review risks and approve appropriate risk management
strategies within the limits established by the HSBC Group Management Board.
Additionally, our Audit Committee receives regular reports on our liquidity
positions in relation to the established limits. In accordance with the policies
and strategies established by ALCO, in the normal course of business, we enter into
various transactions involving derivative financial instruments. These derivative
financial instruments primarily are used to manage our market risk.
Objectives for Holding Derivative Financial Instruments
Market risk (which includes interest rate and foreign currency exchange risks) is
the possibility that a change in interest rates or foreign exchange rates will
cause a financial instrument to decrease in value or become more costly to settle.
Historically, customer demand for our loan products shifts between fixed rate and
floating rate products, based on market conditions and preferences. These shifts in
loan products resulted in different funding strategies and produced different
interest rate risk exposures. Additionally, the mix of receivables on our balance
sheet and the corresponding market risk is changing as we manage the liquidation of
several of our receivable portfolios. We maintain an overall risk management
strategy that uses a variety of interest rate and currency derivative financial
instruments to mitigate our exposure to fluctuations caused by changes in interest
rates and currency exchange rates related to our debt liabilities. We manage our
exposure to interest rate risk primarily through the use of interest rate swaps,
but also use forwards, futures, options, and other risk management instruments. We
manage our exposure to foreign currency exchange risk primarily through the use of
currency swaps, options and forwards. We do not use leveraged derivative financial
instruments.
Interest rate swaps are contractual agreements between two counterparties for the
exchange of periodic interest payments generally based on a notional principal
amount and agreed-upon fixed or floating rates. The majority of our interest rate
swaps are used to manage our exposure to changes in interest rates by converting
floating rate debt to fixed rate or by converting fixed rate debt to floating rate.
We have also entered into currency swaps to convert both principal and interest
payments on debt issued from one currency to the appropriate functional currency.
Forwards are agreements between two parties, committing one to sell and the other
to buy a specific quantity of an instrument on some future date. The parties agree
to buy or sell at a specified price in the future, and their profit or loss is
determined by the difference between the arranged price and the level of the spot
price when the contract is settled. We use foreign exchange rate forward contracts
to reduce our exposure to foreign currency exchange risk related to our debt
liabilities. Cash requirements for forward contracts include the receipt or payment
of cash upon the sale or purchase of the instrument.
Purchased options grant the purchaser the right, but not the obligation, to either
purchase or sell a financial instrument at a specified price within a specified
period. The seller of the option has written a contract which creates an obligation
to either sell or purchase the financial instrument at the agreed-upon price if,
and when, the purchaser exercises the option. We use caps to limit the risk
associated with an increase in rates and floors to limit the risk associated with a
decrease in rates.
We do not manage credit risk or the changes in fair value due to the changes in
credit risk by entering into derivative financial instruments such as credit
derivatives or credit default swaps.
By utilizing derivative financial instruments, we are exposed to counterparty
credit risk. Counterparty credit risk is our primary exposure on our interest rate
swap portfolio. Counterparty credit risk is the risk that the counterparty to a
transaction fails to perform according to the terms of the contract. We manage the
counterparty credit (or repayment) risk in derivative instruments through
established credit approvals, risk control limits, collateral, and ongoing
monitoring procedures. Our exposure to credit risk for futures is limited as these
contracts are traded on organized exchanges. Each day, changes in futures contract
values are settled in cash. In contrast, swap agreements and forward contracts have
credit risk relating to the performance of the counterparty. We utilize an
affiliate, HSBC Bank
USA
, as the primary provider of domestic derivative products. We have never suffered a
loss due to counterparty failure.
At June 30, 2009, substantially all of our existing derivative contracts are
with HSBC subsidiaries, making them our primary counterparty in derivative
transactions. Most swap agreements require that payments be made to, or received
from, the counterparty when the fair value of the agreement reaches a certain
level. Generally, third-party swap counterparties provide collateral in the form of
cash which is recorded in our balance sheet as derivative related assets or
derivative related liabilities. At June 30, 2009 and December 31, 2008,
we provided third party swap counterparties with $29 million and
$26 million of collateral, respectively. When the fair value of our agreements
with affiliate counterparties requires the posting of collateral, it is provided in
either the form of cash and recorded on the balance sheet, consistent with third
party arrangements, or in the form of securities which are not recorded on our
balance sheet. At June 30, 2009 and December 31, 2008, the fair value of
our agreements with affiliate counterparties required the affiliate to provide
collateral of $2.4 billion and $2.9 billion, respectively, all of which
was provided in cash. These amounts are offset against the fair value amount
recognized for derivative instruments that have been offset under the same master
netting arrangement and recorded in our balance sheet as a component of derivative
related assets or liabilities. At June 30, 2009, we had derivative contracts
with a notional value of approximately $68.7 billion, including
$67.3 billion outstanding with HSBC Bank
USA
. At December 31, 2008, we had derivative contracts with a notional value of
approximately $79.7 billion, including $77.9 billion outstanding with
HSBC Bank
USA
. Derivative financial instruments are generally expressed in terms of notional
principal or contract amounts which are much larger than the amounts potentially at
risk for nonpayment by counterparties.
To manage our exposure to changes in interest rates, we enter into interest rate
swap agreements and currency swaps which have been designated as fair value or cash
flow hedges under derivative accounting principles. We currently utilize the
long-haul method to assess effectiveness of all derivatives designated as hedges.
In the tables that follow below, the fair value disclosed does not include swap
collateral that we either receive or deposit with our interest rate swap
counterparties. Such swap collateral is recorded on our balance sheet at an amount
which approximates fair value and is netted on the balance sheet with the fair
value amount recognized for derivative instruments.
Fair Value Hedges
Fair value hedges include interest rate swaps to convert our fixed rate debt to
variable rate debt and currency swaps to convert debt issued from one currency into
U.S. dollar variable debt. All of our fair value hedges are associated with
debt. We recorded fair value adjustments for fair value hedges which increased the
carrying value of our debt by $98 million and $124 million at
June 30, 2009 and December 31, 2008, respectively. The following table
provides information related to the location of derivative fair values in the
consolidated balance sheet for our fair value hedges.
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Derivative financial assets
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Derivative related liabilities
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Derivative financial assets
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Derivative related liabilities
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The following table presents fair value hedging information, including the gain
(loss) recorded on the derivative and where that gain (loss) is recorded in the
consolidated statement of loss as well as the offsetting gain (loss) on the hedged
item that is recognized in current earnings, the net of which represents hedge
ineffectiveness.
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Three Months Ended June 30,
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Six Months Ended June 30,
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Cash Flow Hedges
Cash flow hedges include interest rate swaps to convert our variable rate debt to
fixed rate debt and currency swaps to convert debt issued from one currency into
pay fixed debt of the appropriate functional currency. Gains and (losses) on
unexpired derivative instruments designated as cash flow hedges are reported in
accumulated other comprehensive income (loss) net of tax and totaled a loss of
$(656) million and $(1,193) million at June 30, 2009 and
December 31, 2008, respectively. We expect $(672) million
($(434) million after tax) of currently unrealized net losses will be
reclassified to earnings within one year, however, these reclassed unrealized
losses will be offset by decreased interest expense associated with the variable
cash flows of the hedged items and will result in no significant net economic
impact to our earnings. The following table provides information related to the
location of derivative fair values in the consolidated balance sheet for our cash
flow hedges.
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Derivative financial assets
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Derivative related liabilities
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Derivative financial assets
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Derivative related liabilities
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The following table provides the gain or loss recorded on our cash flow hedging
relationships.
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Three Months Ended June 30,
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Six Months Ended June 30,
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Gain on bulk receivable
sale to HSBC affiliates
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Non-Qualifying Hedging Activities
We may use interest rate caps, exchange traded options, interest rate and currency
swaps and foreign exchange forwards which are not designated as hedges under
derivative accounting principles. These financial instruments are economic hedges
but do not qualify for hedge accounting and are primarily used to minimize our
exposure to changes in interest rates and currency exchange rates. The following
table provides information related to the location and derivative fair values in
the consolidated balance sheet for our non-qualifying hedges:
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Derivative financial assets
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Derivative related liabilities
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Derivative financial assets
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Derivative related liabilities
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Total non-qualifying hedges
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The following table provides detail of the gain or loss recorded on our
non-qualifying hedges:
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Amount of Gain (Loss) Recognized in
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In addition to the non-qualifying hedges described above, we have elected the fair
value option for certain issuances of our fixed rate debt and have entered into
interest rate and currency swaps related to debt carried at fair value. The
interest rate and currency swaps associated with this debt are considered economic
hedges and realized gains and losses are reported as "Gain on debt designated at
fair value and related derivatives" within other revenues. The derivatives related
to fair value option debt are included in the tables below. See Note 12, "Fair
Value Option," for further discussion.
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Derivative financial assets
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Derivative related liabilities
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Derivative financial assets
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Derivative related liabilities
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Total non-qualifying hedges
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The following table provides the gain or loss recorded on the derivatives related
to fair value option debt due to changes in interest rates:
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Amount of Gain (Loss) Recognized in
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Gain (loss) on debt designated at fair
value and related derivatives
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Gain (loss) on debt designated at fair
value and related derivatives
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Notional Value of Derivative Contracts
The following table summarizes the notional values of derivative contracts:
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Derivatives designated as hedging instruments:
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Non-qualifying economic hedges:
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Derivatives not designated as hedging instruments:
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Derivatives associated with debt carried at fair value:
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We elected fair value option ("FVO") reporting for certain issuances of our fixed
rate debt in order to align our accounting treatment with that of HSBC under
International Financial Reporting Standards ("IFRSs"). To align our U.S. GAAP
and IFRSs accounting treatment, we have adopted FVO reporting only for the fixed
rate debt issuances which also qualify for FVO reporting under IFRSs.
Long term debt at June 30, 2009 of $72.3 billion includes
$25.9 billion of fixed rate debt carried at fair value. At June 30, 2009,
we have not elected FVO for $20.4 billion of fixed rate debt. Fixed rate debt
accounted for under FVO at June 30, 2009 has an aggregate unpaid principal
balance of $26.8 billion which includes a foreign currency translation
adjustment relating to our foreign denominated FVO debt which increased the debt
balance by $405 million. Long term debt at December 31, 2008 of
$90.0 billion includes $28.3 billion of fixed rate debt carried at fair
value. At December 31, 2008, we have not elected FVO for $23.9 billion of
fixed rate debt for the reasons discussed above. Fixed rate debt accounted for
under FVO at December 31, 2008 has an aggregate unpaid principal balance of
$29.8 billion which included a foreign currency translation adjustment
relating to our foreign denominated FVO debt which increased the debt balance by
$413 million.
The components of "Gain on debt designated at fair value and related derivatives"
were as follows:
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Mark-to-market on debt designated at fair value(1):
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Total mark-to-market on debt designated at fair value
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Mark-to-market on the related derivatives(1)
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Net realized gains (losses) on the related derivatives
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(1) Mark-to-market on debt designated at fair value and related
derivatives excludes market value changes due to fluctuations in foreign currency
exchange rates. Foreign currency translation gains (losses) recorded in derivative
income associated with debt designated at fair value was a loss of
$(188) million and a gain of $41 million for the three months ended
June 30, 2009 and 2008, respectively. Foreign currency translation gains
(losses) was a gain of $8 million and a loss of $(305) million for the
six months ended June 30, 2009 and 2008, respectively. Offsetting gains
(losses) recorded in derivative income associated with the related derivatives was
a gain of $188 million and a loss of $(41) million for the three months
ended June 30, 2009 and 2008, respectively, and a loss of $(8) million
and a gain of $305 million for the six months ended June 30, 2009 and
2008, respectively.
The movement in the fair value reflected in
Gain on debt designated at fair value and
related derivatives
includes the effect of credit spread changes and interest rate changes, including
any ineffectiveness in the relationship between the related swaps and our debt.
With respect to the credit component, as credit spreads widen accounting gains are
booked and the reverse is true if credit spreads narrow. Differences arise between
the movement in the fair value of our debt and the fair value of the related swap
due to the different credit characteristics and differences in the calculation of
fair value for debt and derivatives. The size and direction of the accounting
consequences of such changes can be volatile from period to period but do not alter
the cash flows intended as part of the documented interest rate management
strategy. On a cumulative basis, we have recorded fair value option adjustments
which have decreased the value of our debt by $.9 billion and
$1.5 billion at June 30, 2009 and December 31, 2008, respectively.
The changes in the debt interest rate component and the derivative market value
during the first half of 2009 reflect a steepening in the U.S. LIBOR curve.
Since January 1, 2009, interest rates for instruments with terms of one year
or less have remained low while interest rates for instruments with terms of
greater than two years have increased. This resulted in gains in the interest rate
component of the mark-to-market on debt designated at fair value and losses on
mark-to-market on the related derivatives in the current quarter and for the six
months ended June 30, 2009. In the second quarter of 2008, rising long term
U.S. interest rates resulted in a gain in the interest rate component on debt
designated at fair value and a decrease in the value of receive fixed/pay variable
swaps. By the end of the second quarter 2008,
U.S.
interest rates were at approximately the same level as at the start of 2008,
and the gains recorded during the second quarter of 2008 were offset by the losses
recorded during the first quarter of 2008. Changes in the value of the interest
rate component of the debt as compared to the related derivatives are also affected
by the differences in cash flows and valuation methodologies for the debt and
related derivatives. Cash flows on debt are discounted using a single discount rate
from the bond yield curve while derivative cash flows are discounted using rates at
multiple points along the LIBOR yield curve. The impacts of these differences vary
as short-term and long-term interest rates change relative to each other.
Furthermore, certain derivatives have been called by the counterparty resulting in
certain FVO debt having no related derivatives which increases the net difference
between the change in the value of the interest rate component of the debt and the
change in the value of the derivatives.
Our credit spreads, which had widened dramatically in the first quarter of 2009 in
response to general market conditions and credit rating downgrades in early March
2009 as a result of the announcement of the discontinuation of all new customer
account originations in our Consumer Lending business and the closure of all branch
offices, narrowed significantly during the second quarter of 2009. For the six
months ended June 30, 2009, we experienced a net tightening of our credit
spreads. Changes in the credit risk component of the debt during the second quarter
of 2008 were impacted by a tightening of our credit spreads. The tightening of
credit spreads during the second quarter of 2008 was a partial reversal of a
widening experienced in the first quarter of 2008 as new issue and secondary bond
market credit spreads across all domestic bond market sectors narrowed as well as a
general lack of liquidity in the secondary bond market during the period.
Net income volatility, whether based on changes in the interest rate or credit risk
components of the mark-to-market on debt designated at fair value and the related
derivatives, impacts the comparability of our reported results between periods.
Accordingly, gain on debt designated at fair value and related derivatives for the
six months ended June 30, 2009 should not be considered indicative of the
results for any future periods.
Effective tax rates are analyzed as follows.
Three Months Ended June 30,
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(dollars are in millions)
|
Tax expense (benefit) at the U.S. Federal statutory income tax
rate
|
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Increase (decrease) in rate resulting from:
|
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Valuation allowance on deferred tax assets
|
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State and local taxes, net of Federal benefit and state valuation
allowance
|
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|
Low income housing and other tax credits
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Total income tax expense (benefit)
|
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|
Six Months Ended June 30,
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|
(dollars are in millions)
|
Tax expense (benefit) at the U.S. Federal statutory income tax
rate
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Increase (decrease) in rate resulting from:
|
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|
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Valuation allowance on deferred tax assets
|
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Receivable portfolio affiliate sales
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|
|
State and local taxes, net of Federal benefit and state valuation
allowance
|
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|
|
State rate change effect on net deferred taxes
|
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Low income housing and other tax credits
|
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|
|
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Total income tax expense (benefit)
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|
The effective tax rate was significantly impacted by the incremental valuation
allowance on deferred tax assets recorded in 2009 and the non-tax deductible
impairment of goodwill related to our Card and Retail Services business and for the
year-to-date period, the non-tax deductible impairment of goodwill related to our
Insurance Services business. The percentage impact of reconciling items is larger
in the six months ended June 30, 2008 as a result of the significantly lower
level of pre-tax book loss in that period. The effective tax rate for the six
months ended June 30, 2009 was also impacted by a change in estimate in the
state tax rate for jurisdictions where we file combined unitary state tax returns
with other HSBC affiliates.
HSBC
North America
Consolidated Income Taxes
We are included in HSBC North America's Consolidated Federal income tax return and
in various state income tax returns. As such, we have entered into a tax allocation
agreement with HSBC North America and its subsidiary entities ("the HNAH Group")
included in the consolidated returns which govern the current amount of taxes to be
paid or received by the various entities included in the consolidated return
filings. As a result, we have looked at the HNAH Group's consolidated deferred tax
assets and various sources of taxable income, including the impact of HSBC and HNAH
Group tax planning strategies, in reaching conclusions on recoverability of
deferred tax assets. Where a valuation allowance is determined to be necessary at
the HNAH consolidated level, such allowance is allocated to principal subsidiaries
within the HNAH Group as described below in a manner that is systematic, rational
and consistent with the broad principles of accounting for income taxes.
The HNAH Group evaluates deferred tax assets for recoverability using a consistent
approach which considers the relative impact of negative and positive evidence,
including historical financial performance, projections of future taxable income,
future reversals of existing taxable temporary differences, tax planning strategies
and any available carryback capacity.
In evaluating the need for a valuation allowance, the HNAH Group estimates future
taxable income based on management approved business plans, future capital
requirements and ongoing tax planning strategies, including capital support from
HSBC necessary as part of such plans and strategies. This process involves
significant management judgment about assumptions that are subject to change from
period to period.
The HNAH Group has continued to consider the impact of the economic environment on
the North American businesses and the expected growth of the deferred tax assets.
During the second quarter, the current economic environment, and its impact on the
HNAH Group's businesses and strategies, has been incorporated into its revised
business forecasts. In addition, HNAH Group's consideration and evaluation of the
various sources of taxable income supporting realization of the deferred tax
assets, including tax planning strategies, have been updated.
In conjunction with the HNAH Group deferred tax evaluation process, based on our
forecasts of future taxable income, which include assumptions about the depth and
severity of further home price depreciation and the U.S. recession, including
unemployment levels and their related impact on credit losses, we currently
anticipate that our results of future operations will generate sufficient taxable
income to allow us to realize our deferred tax assets. However, since the recent
market conditions have created significant downward pressure and volatility on our
near-term pre-tax book income, our analysis of the realizability of the deferred
tax assets significantly discounts any future taxable income expected from
continuing operations and relies to a greater extent on continued capital support
from our parent, HSBC, including tax planning strategies implemented in relation to
such support. HSBC has indicated they remain fully committed and have the capacity
to provide capital as needed to run operations, maintain sufficient regulatory
capital, and fund certain tax planning strategies.
Only those tax planning strategies that are both prudent and feasible, and for
which management has the ability and intent to implement, are incorporated into our
analysis and assessment. The primary and most significant strategy is HSBC's
commitment to reinvest excess HNAH Group capital which would be maintained to
reduce debt funding or otherwise invest in assets to ensure that it is more likely
than not that the deferred tax assets, including net operating loss carryforwards,
will be utilized.
Currently, the HNAH Group's primary tax planning strategy, in combination with
other tax planning strategies, provides support for the realization of net deferred
tax assets of approximately $5.9 billion for the HNAH Group. Such
determination was based on HSBC's revised business forecasts and updated assessment
in the second quarter of 2009 as to the most efficient and effective deployment of
HSBC capital, most importantly including the length of time such capital will need
to be maintained in the U.S. for purposes of the tax planning strategy. As it
relates to the growth in the HNAH consolidated deferred tax asset, during the
second quarter HSBC decided to limit the level and duration of excess HNAH Group
capital it will reinvest in the
US
operations in future years as part of the primary tax planning strategy.
Therefore, although a significant part of the net deferred tax assets are supported
by the aforementioned tax planning strategies, it has been determined that for the
residual portion of the net deferred tax assets, it is not more-likely-than-not
that the expected benefits to be generated by the various tax planning strategies
are sufficient to ensure full realization. As such, a valuation allowance has been
recorded by the HNAH Group during the second quarter of 2009 relative to growth in
the deferred tax asset in excess of the level discussed above.
The aforementioned HNAH Group valuation allowance recorded during the second
quarter has been allocated to the principal subsidiaries, including HSBC Finance
Corporation. The methodology allocates the valuation allowance to the principal
subsidiaries based primarily on the entity's relative contribution to the growth of
the HNAH consolidated deferred tax asset against which the valuation allowance is
being recorded.
The HNAH Group expects to record significant additional valuation allowances
against further growth in the deferred tax assets through the remainder of 2009 and
2010, and perhaps longer.
If future results differ from the HNAH Group's current forecasts or the primary tax
planning strategy were to change, a valuation allowance against the remaining net
deferred tax assets may need to be established which could have a material adverse
effect on HSBC Finance Corporation's results of operations, financial condition and
capital position. The HNAH Group will continue to update its assumptions and
forecasts of future taxable income, including relevant tax planning strategies, and
assess the need for such incremental valuation allowances.
Absent the capital support from HSBC and implementation of the related tax planning
strategies, the HNAH Group, including us, would be required to record a valuation
allowance against the remaining deferred tax assets.
HSBC Finance Corporation Income Taxes
We recognize deferred tax assets and liabilities for the future tax consequences
related to differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases, and for tax credits and net
operating and other losses. Our net deferred tax assets, including deferred tax
liabilities and valuation allowances, totaled $2.9 billion and
$3.3 billion as of June 30, 2009 and December 31, 2008 respectively.
During the six months ended June 30, 2009, we recorded additional Federal
valuation allowances on deferred tax assets of $549 million. The increase in
the valuation allowance relates primarily to net operating loss carryforwards,
future tax deductions relating to book and tax basis differences and foreign and
other tax credit carryforwards.
We expect to contribute substantially to the growth in the HNAH Group deferred tax
assets in the near term and, in accordance with the allocation methodology, expect
to be allocated and record significant additional valuation allowances in future
periods.
We are currently under audit by the Internal Revenue Service as well as various
state and local tax jurisdictions. Although one or more of these audits may be
concluded within the next 12 months, it is not possible to reasonably estimate
the impact of the results from the audit on our uncertain tax positions at this
time.
14. Pension and Other Post-retirement Benefits
The components of pension expense for the domestic defined benefit pension plan
reflected in our consolidated statement of loss are shown in the table below and
reflect the portion of the pension expense of the combined HSBC North America
pension plan which has been allocated to HSBC Finance Corporation:
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Service cost - benefits earned during the period
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Expected return on assets
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Net periodic benefit cost
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|
Pension expense increased during 2009 due to the amortization of a portion of the
actuarial losses incurred by the plan as a result of the volatile capital markets
that occurred in 2008.
Components of the net periodic benefit cost for our post-retirement benefits other
than pensions are as follows:
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Service cost - benefits earned during the period
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Net periodic post-retirement benefit cost
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During the six months ended June 30, 2009, we recorded a curtailment gain of
$16 million due to a reduction in the number of employees covered by the
postretirement benefit plan as a result of the decision to discontinue new customer
account originations by our Consumer Lending business and to close the Consumer
Lending branch offices.
15. Related Party Transactions
In the normal course of business, we conduct transactions with HSBC and its
subsidiaries. These transactions occur at prevailing market rates and terms and
include funding arrangements, derivative execution, purchases and sales of
receivables, servicing arrangements, information technology services, item and
statement processing services, banking and other miscellaneous services. The
following tables present related party balances and the income and (expense)
generated by related party transactions for continuing operations:
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Assets and (Liabilities):
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Securities purchased under agreements to resell
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Derivative related assets (liability), net
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Affiliate preferred stock received in sale of
U.K.
credit card business
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Interest expense paid to HSBC affiliates(1)
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Interest income from HSBC affiliates
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Net gain on bulk sale of receivables to HSBC Bank
USA
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Gain on receivable sales to HSBC affiliates:
|
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Daily sales of domestic private label receivable originations
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Daily sales of credit card receivables
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Sales of real estate secured receivables
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Total gain on receivable sales to HSBC affiliates
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Loss on sale of affiliate preferred stock
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Servicing and other fees from HSBC affiliates:
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|
HSBC Bank
USA
, National Association ("HSBC Bank
USA
"):
|
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|
|
Real estate secured servicing revenue
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|
Private label and card receivable servicing and related fees
|
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Auto finance receivable servicing and related fees
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Other servicing, processing, origination and support revenues from HSBC
Bank
USA
and other HSBC affiliates
|
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HSBC Technology and Services (
USA
) Inc. ("HTSU")
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Total servicing and other fees from HSBC affiliates
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Taxpayer financial services loan origination and other fees
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Support services from HSBC affiliates:
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HSBC Global Resourcing (
UK
) Ltd.
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Total support services from HSBC affiliates
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Stock based compensation expense with HSBC
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Insurance commission paid to HSBC Bank
Canada
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(1) Includes interest expense paid to HSBC affiliates for debt held by
HSBC affiliates as well as interest paid to HSBC affiliates on risk management
positions related to non-affiliate debt.
Transactions with HSBC Bank
USA
:
• In January 2009, we sold our GM and UP Portfolios to HSBC Bank
USA
with an outstanding principal balance of $12.4 billion at the time of
sale and recorded a gain on the bulk sale of these receivables of
$130 million. This gain was partially offset by a loss of $80 million
recorded on the termination of cash flow hedges associated with the
$6.1 billion of indebtedness transferred to HSBC Bank
USA
as part of these transactions. We retained the customer account relationships
and by agreement will sell on a daily basis all new credit card receivable
originations for the GM and UP Portfolios to HSBC Bank
USA
. We sold $4.7 billion and $8.9 billion of new GM and UP receivable
originations to HSBC Bank
USA
during the three and six months ended June 30, 2009, respectively. We
continue to service the sold GM and UP Portfolios and receive servicing and related
fee income from HSBC Bank
USA
. At June 30, 2009, we were servicing $11.6 billion of GM and UP credit
card receivables for HSBC Bank
USA
. The servicing and related fee income received from HSBC Bank
USA
as well as the gains recorded on the daily sales of new GM and UP credit card
receivable originations are reflected in the table above.
• In January 2009, we also sold certain auto finance receivables with an
outstanding principal balance of $3.0 billion to HSBC Bank
USA
at the time of sale and recorded a gain on the bulk sale of these receivables
of $7 million. We continue to service these auto finance receivables for HSBC
Bank
USA
for a fee which is reflected in the table above. At June 30, 2009, we
were servicing $2.5 billion of auto finance receivables for HSBC Bank
USA
.
• In the second quarter of 2008, our Consumer Lending business launched a new
program with HSBC Bank
USA
to sell real estate secured receivables to the Federal Home Loan Mortgage
Corporation ("Freddie Mac"). Our Consumer Lending business originated the loans in
accordance with Freddie Mac's underwriting criteria. The loans were then sold to
HSBC Bank
USA
, generally within 30 days. HSBC Bank
USA
repackaged the loans and sold them to Freddie Mac under their existing
Freddie Mac program. During the three months ended March 31, 2009, we sold
$51 million of real estate secured loans to HSBC Bank
USA
for a gain on sale of $2 million. This program was discontinued in late
February 2009 as a result of our decision to discontinue new customer account
originations in our Consumer Lending business.
• In July 2004 we purchased the account relationships associated with
$970 million of credit card receivables from HSBC Bank
USA
and in December 2004, we sold HSBC Bank
USA
our domestic private label receivable portfolio (excluding retail sales
contracts at our Consumer Lending business). We continue to service the sold
domestic private label and credit card receivables and receive servicing and
related fee income from HSBC Bank
USA
. We retained the customer account relationships and by agreement sell on a daily
basis substantially all new private label receivable originations and new
originations on these credit card receivables to HSBC Bank USA. The servicing and
related fee income received from HSBC Bank
USA
as well as the gains recorded on the sale of domestic private label and
credit card receivables are reflected in the table above. Related to the private
label receivables and for the account relationships purchased from HSBC Bank
USA
, the following table summarizes the receivables we are servicing at June 30,
2009 and December 31, 2008 and the receivables sold during the three and six
months ended June 30, 2009 and 2008:
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Receivables serviced for HSBC Bank
USA
:
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Receivables sold to HSBC Bank
USA
during the three months ended:
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Receivables sold to HSBC Bank
USA
during the six months ended:
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• As of June 30, 2009 and December 31, 2008, we were servicing
$1.9 billion and $2.1 billion, respectively, of real estate secured
receivables for HSBC Bank
USA
. The fee revenue associated with these receivables totaled $2 million and
$3 million during the three and six months ended June 30, 2009,
respectively, is recorded in
Servicing and other fees from HSBC affiliates
in the consolidated statement of loss. Fee revenue associated with these
receivables totaled $2 million and $4 million during the three and six
months ended June 30, 2008, respectively.
• HSBC Bank USA services a portfolio of real estate secured receivables for us
with an outstanding principal balance of $1.7 billion and $2.0 billion at
June 30, 2009 and December 31, 2008, respectively. Fees paid relating to
the servicing of this portfolio totaled $3 million and $5 million during
the three and six months ended June 30, 2009, respectively, and are reported
in
Support
services from HSBC affiliates
. Fees paid for servicing this portfolio totaled $3 million and
$7 million during the three and six months ended June 30, 2008,
respectively.
• HSBC Bank USA and HSBC Trust Company (
Delaware
), N.A. ("HTCD") are the originating lenders for loans initiated by our Taxpayer
Financial Services business for clients of various third party tax preparers. We
purchase the loans originated by HSBC Bank
USA
and HTCD daily for a fee. Origination fees paid for these loans totaled
$1 million and $11 million during the three months and six months ended
June 30, 2009, respectively. Origination fees for the three and six months
ended June 30, 2008 totaled $1 million and $13 million,
respectively. These origination fees are included as an offset to taxpayer
financial services revenue and are reflected as
Taxpayer
financial services loan origination and other fees
in the above table.
• Under multiple service level agreements, we also provide various services to
HSBC Bank
USA
, including real estate and credit card servicing and processing activities, auto
finance loan servicing and other operational and administrative support. Fees
received for these services are reported as
Servicing and other fees from HSBC
affiliates
.
• We have extended revolving lines of credit to subsidiaries of HSBC
Bank
USA
for an aggregate total of $1.0 billion. No balances were outstanding
under any of these lines of credit at either June 30, 2009 or
December 31, 2008.
• HSBC Bank USA extended a secured $1.5 billion uncommitted credit
facility to certain of our subsidiaries in December 2008. This is a 364 day
credit facility and there were no balances outstanding at June 30, 2009 or
December 31, 2008.
• HSBC Bank USA extended a $1.0 billion committed credit facility to HSBC
Bank
Nevada
("HOBN"), a subsidiary of HSBC Finance Corporation, in December 2008. This is
a 364 day credit facility and there were no balances outstanding at
June 30, 2009 or December 31, 2008.
Transactions with HSBC Holdings plc:
• During the second quarter of 2009, we sold to HSBC $248 million of
affiliate preferred stock which we had received on the sale of our
U.K.
credit card business. As a result, we recorded a loss on sale of
$6 million which is included as a component of other income.
• At June 30, 2009 and December 31, 2008, a commercial paper
back-stop credit facility of $2.5 billion from HSBC supported our domestic
issuances of commercial paper. No balances were outstanding under this credit
facility at June 30, 2009 or December 31, 2008. The annual commitment fee
requirement to support availability of this line is included as a component
of
Interest expense -
HSBC affiliates
in the consolidated statement of loss.
• In late February 2009, we effectively converted $275 million of
mandatorily redeemable preferred securities of the Household Capital
Trust VIII which had been issued during 2003 to common stock by redeeming the
junior subordinated notes underlying the preferred securities and then issuing
common stock to HSBC Investments (North America) Inc. ("HINO"). Interest expense
recorded on the underlying junior subordinated notes totaled $3 million and
$9 million during the six months ended June 30, 2009 and 2008,
respectively, and $5 million in the three months ended June 30, 2008.
This interest expense is included in
Interest expense -
HSBC affiliates
in the consolidated statement of loss.
• Employees of HSBC Finance Corporation participate in one or more stock
compensation plans sponsored by HSBC. These expenses are recorded in
Salary and employee benefits
and are reflected in the above table as
Stock based compensation
expense with HSBC
. As of June 30, 2009, our share of future compensation cost related to grants
which have not yet fully vested is approximately $54 million. This amount is
expected to be recognized over a weighted-average period of 1.8 years.
• We had extended a revolving line of credit to HTSU which was terminated in
May 2008 and replaced by a line of credit from another affiliate. Interest income
associated with this line of credit was recorded in interest income and reflected
as
Interest income from HSBC affiliates
in the table above.
• Technology and some centralized operational services and beginning in
January 2009, human resources, corporate affairs and other shared services in
North America
are centralized within HTSU. Technology related assets and software purchased
subsequent to January 1, 2004 are generally purchased and owned by HTSU. HTSU
also provides certain item processing and statement processing activities which are
included in
Support services from HSBC affiliates.
We also receive revenue from HTSU for rent on certain office space, which has
been recorded as a reduction of occupancy and equipment expenses, and for certain
administrative costs, which has been recorded as a component of servicing and other
fees from HSBC affiliates. Rental revenue from HTSU recorded as a reduction of
occupancy and equipment expense was $14 million and $25 million during
the three and six months ended June 30, 2009, respectively. Rental revenue
from HTSU was $12 million and $24 million during the three and six months
ended June 30, 2008, respectively.
• During the fourth quarter of 2008, we sold miscellaneous assets to HTSU for
a purchase price equal to the book value of these assets of $41 million.
Transactions with other HSBC affiliates:
• The notional value of derivative contracts outstanding with HSBC
subsidiaries totaled $67.3 billion and $77.9 billion at June 30,
2009 and December 31, 2008, respectively. When the fair value of our
agreements with affiliate counterparties requires the posting of collateral, it is
provided in either the form of cash and recorded on the balance sheet or in the
form of securities which are not recorded on our balance sheet. The fair value of
our agreements with affiliate counterparties required the affiliate to provide
collateral of $2.4 billion and $2.9 billion at June 30, 2009 and
December 31, 2008, respectively, all of which was received in cash. These
amounts are offset against the fair value amount recognized for derivative
instruments that have been offset under the same master netting arrangement in
accordance with FASB Staff Position No. FIN 39-1, "Amendment of FASB
Interpretation No. 39," ("FSP 39-1").
•
Due to affiliates
includes amounts owed to subsidiaries of HSBC as a result of direct debt issuances
(other than preferred stock).
• In September 2008, we borrowed $1.0 billion from an existing
uncommitted credit facility with HSBC Bank plc ("HBEU"). The borrowing was for
60 days and matured in November 2008. We renewed this borrowing for an
additional 95 days. The borrowing matured in February 2009 and we chose not to
renew it at that time.
• In October 2008, we borrowed $1.2 billion from an uncommitted money
market facility with a subsidiary of HSBC Asia Pacific ("HBAP"). The borrowing was
for six months, matured in April 2009 and we chose not to renew it at that time.
• We purchase from HSBC Securities (USA) Inc. ("HSI") securities under an
agreement to resell. Interest income recognized on these securities totaled
$1 million and $3 million during the three and six months ended
June 30, 2009, respectively, and is reflected as
Interest income from HSBC affiliates
in the table above. Interest income recognized on these securities totaled
$5 million and $11 million during the three and six months ended
June 30, 2008, respectively.
• We use HSBC Global Resourcing (UK) Ltd., an HSBC affiliate located outside
of the
United States
, to provide various support services to our operations including among other
areas, customer service, systems, collection and accounting functions. The expenses
related to these services of $43 million and $87 million during the three
and six months ended June 30, 2009, respectively are included as a component
of
Support services from HSBC affiliates
in the table above. Expenses related to these services totaled $43 million and
$85 million during the three and six months ended June 30, 2008,
respectively.
•
Support services from HSBC affiliates
also includes banking services and other miscellaneous services provided by other
subsidiaries of HSBC, including HSBC Bank
USA
.
• We utilize HSBC Markets (USA) Inc., an affiliated HSBC entity, to lead
manage the underwriting of a majority of our debt issuances. There were no fees
paid to the affiliate for such services during the three or six months ended
June 30, 2009 or 2008. For debt not accounted for under the fair value option,
fees paid for such services are amortized over the life of the related debt.
• Domestic employees of HSBC Finance Corporation participate in a defined
benefit pension plan and other post-retirement benefit plans sponsored by HSBC
North America. See Note 14, "Pension and Other Post-retirement Benefits," for
additional information on this pension plan.
• As previously discussed in Note 2, "Discontinued Operations," in May
2008 we sold all of the common stock of the holding company of our U.K. Operations
to HOHU for GBP 181 million (equivalent to approximately $359 million).
The results of operations for our U.K. Operations have been reclassified as
Income from
discontinued operations
for all periods presented.
• As previously discussed in Note 2, "Discontinued Operations," in
November 2008 we sold all of the common stock of the holding company of our
Canadian Operations to HSBC Bank
Canada
for approximately $279 million (based on the exchange rate on the date
of sale). While HSBC Bank
Canada
assumed the liabilities of our Canadian Operations as a result of this
transaction, we continue to guarantee the long-term and medium-term notes issued by
our Canadian business prior to the sale for a fee. During the three and six months
ended June 30, 2009, we recorded $2 million and $3 million,
respectively, for providing this guarantee. As of June 30, 2009, the
outstanding balance of the guaranteed notes was $2.1 billion and the latest
scheduled maturity of the notes is May 2012. The sale agreement with HSBC
Bank
Canada
allows us to continue to distribute various insurance products through the
branch network for a fee. Fees paid to HSBC Bank
Canada
for distributing insurance products through this network during the three and
six months ended June 30, 2009 were $5 million and $10 million,
respectively, and are included in
Insurance Commission paid
to HSBC Bank
Canada
.
The results of operations for our Canadian Operations have been reclassified
as
Income from
discontinued operations
for all periods presented.
We have two reportable segments: Card and Retail Services and Consumer. Our
segments are managed separately and are characterized by different middle-market
consumer lending products, origination processes, and locations. Our segment
results are reported on a continuing operations basis.
Our Card and Retail Services segment includes our MasterCard, Visa, private label
and other credit card operations. The Card and Retail Services segment offers these
products throughout the
United States
primarily via strategic affinity and co-branding relationships, merchant
relationships and direct mail. Products are also offered and customers serviced
through the Internet.
Our Consumer segment consists of our run-off Consumer Lending, Mortgage Services
and Auto Finance businesses. The Consumer segment provided real estate secured,
auto finance and personal non-credit card loans. Loans were offered with both
revolving and closed-end terms and with fixed or variable interest rates. Loans
were originated through branch locations and direct mail. Products were also
offered and customers serviced through the Internet. Prior to the first quarter of
2007, we acquired loans through correspondent channels and prior to September 2007
we also originated loans through mortgage brokers.
The All Other caption includes our Insurance, Taxpayer Financial Services and
Commercial businesses, each of which falls below the quantitative threshold tests
under segment reporting accounting principles, for determining reportable segments,
as well as our corporate and treasury activities, which includes the impact of FVO
debt. Certain fair value adjustments related to purchase accounting resulting from
our acquisition by HSBC and related amortization have been allocated to Corporate,
including goodwill arising from our acquisition by HSBC, which is included in the
"All Other" caption within our segment disclosure.
In the first quarter of 2009, we began allocating the majority of the costs of our
corporate and treasury activities to our reportable segments. These allocated costs
had previously not been considered in determining segment profit (loss) and are now
reported as intersegment revenues in the "All Other" caption and operating expenses
for our reportable segments. There have been no other changes in our measurement of
segment profit (loss) and there have been no changes in the basis of segmentation
as compared with the presentation in our 2008 Form 10-K.
We report results to our parent, HSBC, in accordance with its reporting basis,
IFRSs. Our segment results are presented on an IFRS Management Basis (a
non-U.S. GAAP financial measure) as operating results are monitored and
reviewed, trends are evaluated and decisions about allocating resources such as
employees are made almost exclusively on an IFRS Management Basis. IFRS Management
Basis results are IFRSs results which assume that the GM and UP credit card, auto
finance, private label and real estate secured receivables transferred to HSBC Bank
USA have not been sold and remain on our balance sheet and the revenues and
expenses related to these receivables remain on our income statement. IFRS
Management Basis also assumes that the purchase accounting fair value adjustments
relating to our acquisition by HSBC have been "pushed down" to HSBC Finance
Corporation. Operations are monitored and trends are evaluated on an IFRS
Management Basis because the receivable sales to HSBC Bank
USA
were conducted primarily to fund prime customer loans more efficiently
through bank deposits and such receivables continue to be managed and serviced by
us without regard to ownership. However, we continue to monitor capital adequacy,
establish dividend policy and report to regulatory agencies on a U.S. GAAP
legal entity basis.
Reconciliation of our IFRS Management Basis segment results to the U.S. GAAP
consolidated totals are as follows:
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Three months ended June 30, 2009
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Other operating income (Total other revenues)
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Loan impairment charges (Provision for credit losses)
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Operating expenses (Total costs and expenses)
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Customer loans (Receivables)
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Three months ended June 30, 2008
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Other operating income (Total other revenues)
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Loan impairment charges (Provision for credit losses)
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Operating expenses (Total costs and expenses)
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Customer loans (Receivables)
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Six months ended June 30, 2009
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Other operating income (Total other revenues)
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Loan impairment charges (Provision for credit losses)
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Operating expenses (Total costs and expenses)
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Six months ended June 30, 2008
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Other operating income (Total other revenues)
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Loan impairment charges (Provision for credit losses)
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Operating expenses (Total costs and expenses)
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Eliminates intersegment revenues.
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Management Basis Adjustments represent the GM and UP credit card
Portfolios and the auto finance, private label and real estate secured
receivables transferred to HSBC Bank
USA
.
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IFRS Adjustments consist of the accounting differences between U.S.
GAAP and IFRSs which have been described more fully below.
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Represents differences in balance sheet and income statement
presentation between IFRSs and U.S. GAAP.
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At June 30, 2009, all of our goodwill has been fully
written-off.
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A summary of the significant differences between U.S. GAAP and IFRSs as they
impact our results are presented below:
Effective interest rate
- The calculation of effective interest rates under IFRS 39 requires an estimate of
"all fees and points paid or recovered between parties to the contract" that are an
integral part of the effective interest rate be included. U.S. GAAP generally
prohibits recognition of interest income to the extent the net interest in the loan
would increase to an amount greater than the amount at which the borrower could
settle the obligation. Under U.S. GAAP, prepayment penalties are generally
recognized as received. U.S. GAAP also includes interest income on loans held
for resale which is included in other revenues for IFRSs.
Deferred loan origination costs and fees
- Loan origination cost deferrals under IFRSs are more stringent and result in
lower costs being deferred than permitted under U.S. GAAP. In addition, all
deferred loan origination fees, costs and loan premiums must be recognized based on
the expected life of the receivables under IFRSs as part of the effective interest
calculation while under U.S. GAAP they may be recognized on either a
contractual or expected life basis.
Derivative interest expense
- Under IFRSs, net interest income includes the interest element for derivatives
which correspond to debt designated at fair value. For U.S. GAAP, this is
included in
Gain (loss) on debt designated at fair value and
related derivatives
which is a component of other revenues. Additionally, under IFRSs, insurance
investment income is included in net interest income instead of as a component of
other revenues under U.S. GAAP.
Other operating income (Total other revenues)
Present value of long-term insurance business
- Under IFRSs, the present value of an in-force ("PVIF") long-term insurance
business is determined by discounting future cash flows expected to emerge from
business currently in force using appropriate assumptions in assessing factors such
as future mortality, lapse rates and levels of expenses, and a discount rate that
reflects the risk premium attributable to the respective long-term insurance
business. Movements in the PVIF long-term insurance business are included in other
operating income. Under U.S. GAAP, revenue is recognized over the life
insurance policy term.
During the second quarter of 2009, we refined the income recognition methodology in
respect of long-term insurance contracts. This resulted in the recognition of a
revenue item on an IFRSs basis of $66 million ($43 million after-tax).
Approximately $43 million ($28 million after-tax) would have been
recorded prior to January 1, 2009 if the refinement in respect of income
recognition had been applied at that date.
Policyholder benefits
- Other revenues under IFRSs includes policyholder benefits expense which is
classified as other expense under U.S. GAAP.
Loans held for sale
- IFRSs requires loans designated as held for resale at the time of origination to
be treated as trading assets and recorded at their fair market value. Under
U.S. GAAP, loans designated as held for resale are reflected as loans and
recorded at the lower of amortized cost or fair value. Under IFRSs, the income and
expenses related to receivables held for sale are reported in other operating
income. Under U.S. GAAP, the income and expenses related to receivables held
for sale are reported similarly to loans held for investment.
For receivables transferred to held for sale subsequent to origination, IFRSs
requires these receivables to be reported separately on the balance sheet but does
not change the recognition and measurement criteria. Accordingly, for IFRSs
purposes such loans continue to be accounted for in accordance with IAS 39 with any
gain or loss recorded at the time of sale. U.S. GAAP requires loans that
management intends to sell to be transferred to a held for sale category at the
lower of cost or fair value. Under U.S. GAAP, the component of the lower of
cost or fair value adjustment related to credit risk is recorded in the statement
of loss as provision for credit losses while the component related to interest
rates and liquidity factors is reported in the statement of loss in other revenues.
Securities
- Under IFRSs, securities include HSBC shares held for stock plans at fair
value. These shares are recorded at fair value through other comprehensive income.
If it is determined these shares have become impaired, the fair value loss is
recognized in profit and loss and any fair value loss recorded in other
comprehensive income is reversed. There is no similar requirement under
U.S. GAAP.
During the second quarter of 2009, under IFRSs we recorded income for the value of
additional shares attributed to HSBC shares held for stock plans as a result of
HSBC's rights offering earlier in 2009. The additional shares are not recorded
under U.S. GAAP.
Other-than-temporary impairments
- As a result of the guidance issued by the SEC in October 2008, under
U.S. GAAP we are allowed to evaluate perpetual preferred securities for
potential other-than-temporary impairment similar to a debt security provided there
has been no evidence of deterioration in the credit of the issuer and record the
unrealized losses as a component of other comprehensive income. There are no
similar provisions under IFRSs as all perpetual preferred securities are evaluated
for other-than-temporary impairment as equity securities.
Effective January 1, 2009 under U.S. GAAP, the credit loss component of
an other-than-temporary impairment of a debt security is recognized in earnings
while the remaining portion of the impairment loss is recognized in other
comprehensive income provided a company concludes it neither intends to sell the
security nor concludes that it is more-likely-than-not that it will have to sell
the security prior to recovery. Under IFRSs, there is no bifurcation of
other-than-temporary impairment and the entire decline in value is recognized in
earnings.
Loan impairment charges (Provision for credit losses)
IFRSs requires a discounted cash flow methodology for estimating impairment on
pools of homogeneous customer loans which requires the incorporation of the time
value of money relating to recovery estimates. Also under IFRSs, future recoveries
on charged-off loans are accrued for on a discounted basis and a recovery asset is
recorded. Subsequent recoveries are recorded to earnings under U.S. GAAP, but
are adjusted against the recovery asset under IFRSs. Interest is recorded based on
collectibility under IFRSs.
As discussed above, under U.S. GAAP the credit risk component of the lower of
cost or fair value adjustment related to the transfer of receivables to held for
sale is recorded in the statement of loss as provision for credit losses. There is
no similar requirement under IFRSs.
Goodwill impairment under IFRSs is higher than that under U.S. GAAP due to
higher levels of goodwill established under IFRSs as well as differences in how
impairment is measured as U.S. GAAP requires a two-step impairment test which
requires the fair value of goodwill to be determined in the same manner as the
amount of goodwill recognized in a business combination. However, operating
expenses under IFRSs are lower as policyholder benefits expenses are reported as an
offset to other revenues as discussed above. There are other less significant
differences between IFRSs and U.S. GAAP relating to pension expense and prior
to 2009, changes in tax estimates.
Customer loans (Receivables)
- On an IFRSs basis loans designated as held for sale at the time of origination
and accrued interest are classified in other assets. However, the accounting
requirements governing when receivables previously held for investment are
transferred to a held for sale category are more stringent under IFRS than under
U.S. GAAP. Unearned insurance premiums are reported as a reduction to
receivables on a U.S. GAAP basis but are reported as insurance reserves for
IFRSs.
Other
- In addition to the differences discussed above, there are higher derivative
related assets under IFRSs compared to U.S. GAAP due to more stringent netting
requirements under U.S. GAAP.
17. Fair Value Measurements
FAS No. 157, "Fair Value Measurements," provides a framework for
measuring fair value and focuses on an exit price in the principal (or
alternatively, the most advantageous) market accessible in an orderly transaction
between willing market participants. FAS 157 establishes a three-tiered fair
value hierarchy with Level 1 representing quoted prices (unadjusted) in active
markets for identical assets or liabilities. Fair values determined by Level 2
inputs are inputs that are observable for the asset or liability, either directly
or indirectly. Level 2 inputs include quoted prices for similar assets or
liabilities in active markets, quoted prices for identical or similar assets or
liabilities in markets that are disorderly, and inputs other than quoted prices
that are observable for the asset or liability, such as interest rates and yield
curves that are observable at commonly quoted intervals. Level 3 inputs are
unobservable inputs for the asset or liability and include situations where there
is little, if any, market activity for the asset or liability.
Assets and Liabilities Recorded at Fair Value on a Recurring
Basis
The following table presents information about our assets and liabilities measured
at fair value on a recurring basis as of June 30, 2009 and December 31,
2008, and indicates the fair value hierarchy of the valuation techniques utilized
to determine such fair value.
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Derivative related assets(1)
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Available for sale securities:
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U.S.
government sponsored enterprises
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U.S.
government agency issued or guaranteed
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Obligations of
U.S.
states and political subdivisions
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U.S.
corporate debt securities
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Preferred equity securities
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Total available-for-sale securities
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Long term debt carried at fair value
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Derivative related liabilities
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Derivative related assets(1)
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Available for sale securities:
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U.S.
government sponsored enterprises
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U.S.
government agency issued or guaranteed
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Obligations of
U.S.
states and political subdivisions
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U.S.
corporate debt securities
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Preferred equity securities
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Total available-for-sale securities
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Long term debt carried at fair value
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Derivative related liabilities
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The fair value disclosed does not include swap collateral which was a
net liability of $2.3 billion and $2.9 billion at
June 30, 2009 and December 31, 2008, respectively, and that
we either received or deposited with our interest rate swap
counterparties. Such swap collateral is recorded on our balance sheet
at an amount which "approximates fair value" as discussed in FASB Staff
Position No. FIN 39-1, "Amendment of FASB Interpretation No.
39" and is netted on the balance sheet with the fair value amount
recognized for derivative instruments.
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The table below reconciles the beginning and ending balances for assets recorded at
fair value using significant unobservable inputs (Level 3) during the
three and six months ended June 30, 2009 and 2008.
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Beginning balance at beginning of period
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Transfers in (out) of Level 3, net
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Purchases, sales, issuances and settlements (net)
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Total gains or losses (realized/unrealized):
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Included in income from continuing operations
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Included in other comprehensive income
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Net change in accrued interest
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Ending balance at end of period
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The changes in unrealized losses relate to assets no longer held on our
balance sheet at either June 30, 2009 or 2008.
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Assets recorded at fair value on a recurring basis at June 30, 2009 and
December 31, 2008 which have been classified as using Level 3
measurements include certain U.S. corporate debt securities and
mortgage-backed securities and at December 31, 2008, our entire portfolio of
perpetual preferred equity securities which was sold during the first half of 2009.
Securities are classified as using Level 3 measurements when one or both of
the following conditions are met:
• An asset-backed security is downgraded below a AAA credit rating; or
• An individual security fails the quarterly pricing comparison test, which is
described more fully below, with a variance greater than 5 percent.
During the three months ended June 30, 2009, transfers out of Level 3
classifications, net, represents changes in the mix of individual securities that
meet one or both of the above conditions. During the three months ended
June 30, 2009, we transferred $49 million from Level 2 to
Level 3 of individual corporate debt securities and mortgage-backed securities
which met one or both of the conditions described above, which was partially offset
by the transfer of $28 million of individual corporate debt securities and
mortgage-backed securities from Level 3 to Level 2 as they no longer met
one or both of the conditions described above.
Assets and Liabilities Recorded at Fair Value on a Non-recurring
Basis
The following table presents information about our assets and liabilities measured
at fair value on a non-recurring basis as of June 30, 2009 and June 30,
2008, and indicates the fair value hierarchy of the valuation techniques utilized
to determine such fair value.
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Non-Recurring Fair Value Measurements as
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Total receivables held for sale at fair value(1)
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Non-Recurring Fair Value Measurements as
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Total receivables held for sale at fair value(1)
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Excludes $5 million and $6,323 million of receivables held
for sale at June 30, 2009 and June 30, 2008 for which the
fair value exceeds carrying value and therefore not recorded at fair
value.
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The fair value disclosed is unadjusted for transaction costs as
required by FAS 157. The amounts recorded in the consolidated
balance sheet are recorded net of transaction costs as required by
FAS 144.
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In accordance with the provisions of FAS 142, goodwill with a
carrying amount of $260 million allocated to our Insurance
Services business and $2,034 million allocated to our Card and
Retail Services businesses was written down to its implied fair value
of $0 million and $1,641 million, respectively, during the
three months ended March 31, 2009. Additionally, technology,
customer lists and customer loan related relationship intangible assets
totaling $34 million were written down to their implied fair value
of $20 million during the three months ended March 31, 2009.
No write down of goodwill or intangible assets occurred during the
three and six months ended June 30, 2008. During three months
ended June 30, 2009, goodwill with a carrying amount of
$1,641 million allocated to our Card and Retail Services business
was written down to its implied fair value of $0 million.
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Repossessed vehicles are typically sold within two months of
repossession. As a result, fair value adjustments subsequent to
repossession are not significant.
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Fair Value of Financial Instruments
In accordance with Statement of Financial Accounting Standards No. 107,
"Disclosures about Fair Value of Financial Instruments," as amended,
("FAS 107") on a quarterly basis we report the fair value of all financial
instruments in our consolidated balance sheet, including those financial
instruments carried at cost. The fair value estimates, methods and assumptions set
forth below for our financial instruments are made solely to comply with the
requirements of FAS 107 and should be read in conjunction with the financial
statements and notes included in this quarterly report. The following table
summarizes the carrying values and estimated fair value of our financial
instruments at June 30, 2009 and December 31, 2008.
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Interest bearing deposits with banks
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Securities purchased under agreements to resell
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Total Consumer Lending real estate secured receivables
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Non-real estate secured receivables
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Total consumer receivables
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Receivables held for sale
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Derivative financial assets
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Commercial paper, bank and other borrowings
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Long term debt carried at fair value
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Long term debt not carried at fair value
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Insurance policy and claim reserves
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Derivative financial liabilities
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Receivable values presented in the table above were determined using the framework
for measuring fair value as prescribed by FAS 157, which is based on our best
estimate of the amount within a range of value we believe would be received in a
sale as of the balance sheet date (i.e. exit price). The unprecedented developments
in the mortgage lending industry and the current economic conditions have resulted
in a significant reduction in the secondary market demand for assets not guaranteed
or eligible for guarantee by the Federal government or a governmental agency. The
estimated fair values at June 30, 2009 and December 31, 2008 for our
receivables reflect these market conditions. For consumer receivables, potential
investors often assume a significantly higher charge-off level than what we, as the
servicer of these receivables, believe will ultimately be the case, and the asset
value reflects a significant pricing discount resulting from the lack of liquidity
available to most buyers of whole loan assets. This resulting value may be
substantially lower than would otherwise be reported under more normal marketplace
conditions.
Valuation Techniques
The following summarizes the valuation methodology used to determine the estimated
fair values for financial instruments reflected in the tables above.
Cash:
Carrying value approximates fair value due to cash's liquid nature.
Interest bearing deposits with banks:
Carrying value approximates fair value due to the asset's liquid nature.
Securities purchased under agreements to resell:
The fair value of securities purchased under agreements to resell
approximates carrying value due to the short-term maturity of the agreements.
Securities:
Fair value for our available-for-sale securities is generally determined by a
third party valuation source. The pricing services generally source fair value
measurements from quoted market prices and if not available, the security is valued
based on quotes from similar securities using broker quotes and other information
obtained from dealers and market participants. For securities which do not trade in
active markets, such as fixed income securities, the pricing services generally
utilize various pricing applications, including models, to measure fair value. The
pricing applications are based on market convention and use inputs that are derived
principally from or corroborated by observable market data by correlation or other
means. The following summarizes the valuation methodology used for our major
security types:
• U.S. Treasury,
U.S.
government agency issued or guaranteed and Obligations of U.S. States
and political subdivisions - As these securities transact in an active market,
the pricing services source fair value measurements from quoted prices for the
identical security or quoted prices for similar securities with adjustments as
necessary made using observable inputs which are market corroborated.
• U.S. government sponsored enterprises - For certain government
sponsored mortgage-backed securities which transact in an active market, the
pricing services source fair value measurements from quoted prices for the
identical security or quoted prices for similar securities with adjustments as
necessary made using observable inputs which are market corroborated. For
government sponsored mortgage-backed securities which do not transact in an active
market, fair value is determined using discounted cash flow models and inputs
related to interest rates, prepayment speeds, loss curves and market discount rates
that would be required by investors in the current market given the specific
characteristics and inherent credit risk of the underlying collateral.
• Asset-backed securities - Fair value is determined using discounted
cash flow models and inputs related to interest rates, prepayment speeds, loss
curves and market discount rates that would be required by investors in the current
market given the specific characteristics and inherent credit risk of the
underlying collateral.
•
U.S.
corporate and foreign debt securities - For non-callable corporate
securities, a credit spread scale is created for each issuer. These spreads are
then added to the equivalent maturity U.S. Treasury yield to determine current
pricing. Credit spreads are obtained from the new issue market, secondary trading
levels and dealer quotes. For securities with early redemption features, an option
adjusted spread ("OAS") model is incorporated to adjust the spreads determined
above. Additionally, the pricing services will survey the broker/dealer community
to obtain relevant trade data including benchmark quotes and updated spreads.
• Preferred equity securities - In general, for perpetual preferred
securities, fair value is calculated using an appropriate spread over a comparable
US Treasury security for each issue. These spreads represent the additional yield
required to account for risk including credit, refunding and liquidity. The inputs
are derived principally from or corroborated by observable market data.
• Money market funds - Carrying value approximates fair value due to the
asset's liquid nature.
We perform validations of the fair values sourced from the independent pricing
services at least quarterly. Such validation principally includes sourcing security
prices from other independent pricing services or broker quotes. The validation
process provides us with information as to whether the volume and level of activity
for a security has significantly decreased and assists in identifying transactions
that are not orderly. Depending on the results of the validation, additional
information may be gathered from other market participants to support the fair
value measurements. A determination will be made as to whether adjustments to the
observable inputs are necessary as a result of investigations and inquiries about
the reasonableness of the inputs used and the methodologies employed by the
independent pricing services.
Receivables:
The estimated fair value of our receivables was determined by developing an
estimated range of value from a mix of various sources as appropriate for the
respective pool of assets. These sources include,
inter alia
, value estimates from an HSBC affiliate which reflect current estimated rating
agency credit tranching levels with the associated benchmark credit spreads,
forward looking discounted cash flow models using assumptions we believe are
consistent with those which would be used by market participants in valuing such
receivables, trading input from market participants which includes observed primary
and secondary trades, and general discussions held directly with potential
investors.
Model inputs relate to interest rates, prepayment speeds, default and loss curves,
and market discount rates reflecting management's estimate of the rate of return
that would be required by investors in the current market given the specific
characteristics and inherent credit risk of the receivables. Some of these inputs
are influenced by home price changes and unemployment rates. To the extent
available, such inputs are derived principally from or corroborated by observable
market data by correlation and other means. We perform periodic validations of our
valuation methodologies and assumptions based on the results of actual sales of
such receivables. In addition, from time to time, we will engage a third party
valuation specialist to measure the fair value of a pool of receivables. Portfolio
risk management personnel provide further validation through discussions with third
party brokers and other market participants. Since an active market for these
receivables does not exist, the fair value measurement process uses unobservable
significant inputs which are specific to the performance characteristics of the
various receivable portfolios.
Real estate owned:
Fair value is determined based on third party appraisals obtained at the time
we take title to the property and, if less than the carrying value of the loan, the
carrying value of the loan is adjusted to the fair value. After three months on the
market, the carrying value is further reduced, if necessary, to reflect observable
local market data, including local area sales data.
Repossessed vehicles:
Fair value is determined based on current Black Book values, which represent
current observable prices in the wholesale auto auction market.
Due from affiliates:
Carrying value approximates fair value because the interest rates on these
receivables adjust with changing market interest rates.
Commercial paper and short-term borrowings:
The fair value of these instruments approximates existing carrying
value because interest rates on these instruments adjust with changes in market
interest rates due to their short-term maturity or repricing characteristics.
Due to affiliates:
The estimated fair value of our fixed rate and floating rate debt due to
affiliates was determined using discounted future expected cash flows at current
interest rates and credit spreads offered for similar types of debt instruments.
Long term debt:
Fair value was primarily determined by a third party valuation source. The
pricing services source fair value from quoted market prices and, if not available,
expected cash flows are discounted using the appropriate interest rate for the
applicable duration of the instrument adjusted for our own credit risk (spread).
The credit spreads applied to these instruments were derived from the spreads
recognized in the secondary market for similar debt as of the measurement date.
Where available, relevant trade data is also considered as part of our validation
process.
Insurance policy and claim reserves:
The fair value of insurance reserves for periodic payment annuities was
estimated by discounting future expected cash flows at estimated market interest
rates.
Derivative related assets and liabilities:
Derivative values are defined as the amount we would receive or pay to
extinguish the contract using a market participant as of the reporting date. The
values are determined by management using a pricing system maintained by HSBC
Bank
USA
. In determining these values, HSBC Bank
USA
uses quoted market prices, when available, principally for exchange-traded
options. For non-exchange traded contracts, such as interest rate swaps, fair value
is determined using discounted cash flow modeling techniques. Valuation models
calculate the present value of expected future cash flows based on models that
utilize independently-sourced market parameters, including interest rate yield
curves, option volatilities, and currency rates. Valuations may be adjusted in
order to ensure that those values represent appropriate estimates of fair value.
These adjustments, which are applied consistently over time, are generally required
to reflect factors such as market liquidity and counterparty credit risk that can
affect prices in arms-length transactions with unrelated third parties. Finally,
other transaction specific factors such as the variety of valuation models
available, the range of unobservable model inputs and other model assumptions can
affect estimates of fair value. Imprecision in estimating these factors can impact
the amount of revenue or loss recorded for a particular position.
Counterparty credit risk is considered in determining the fair value of a financial
asset. FAS 157 specifies that the fair value of a liability should reflect the
entity's non-performance risk and accordingly, the effect of our own credit risk
(spread) has been factored into the determination of the fair value of our
financial liabilities, including derivative instruments. In estimating the credit
risk adjustment to the derivative assets and liabilities, we take into account the
impact of netting and/or collateral arrangements that are designed to mitigate
counterparty credit risk.
18. 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. Certain of these activities are or purport to be class actions seeking
damages in very large amounts. These actions include assertions concerning
violations of laws and/or unfair treatment of consumers.
We accrue for litigation-related liabilities when it is probable that such a
liability has been incurred and the amount of the loss can be reasonably estimated.
While the outcome of litigation is inherently uncertain, we believe, in light of
all information known to us at June 30, 2009, that our litigation reserves are
adequate at such date. We review litigation reserves at least quarterly, and the
reserves may be increased or decreased in the future to reflect further relevant
developments. We believe that our defenses to the claims asserted against us in our
currently active litigation have merit and any adverse decision should not
materially affect our consolidated financial condition. However, losses may be
material to our results of operations for any particular future periods depending
on our income level for that period.
On May 7, 2009, the jury in the class action
Jaffe v. Household International
Inc., et. al
returned a verdict partially in favor of the plaintiffs with respect to Household
International and three former officers for certain of the claims arising out of
alleged false and misleading statements made in connection with certain activities
of Household International, Inc. between July 30, 1999 and October 11, 2002.
Despite the verdict at the District Court level, we continue to believe, after
consultation with counsel, that neither Household nor its former officers committed
any wrongdoing and that we will either prevail on our outstanding motions or that
the Seventh Circuit will reverse the trial Court verdict upon appeal. As such, it
is not probable a loss has been incurred as of June 30, 2009 and, therefore,
no loss accrual resulting from this verdict has been established.
19. New Accounting Pronouncements
In December 2007, the FASB issued Statement of Financial Accounting Standards
No. 141 (Revised), "Business Combinations" ("FAS 141(R)").
FAS 141(R) requires an acquirer to recognize all assets acquired, liabilities
assumed and any noncontrolling interest in the acquiree at fair value as of the
date of acquisition. FAS 141(R) also changes the recognition and measurement
criteria for certain assets and liabilities including those arising from
contingencies, contingent consideration, and bargain purchases. In addition, it
requires the expensing of acquisition related structuring and transaction costs.
FAS 141(R) is effective for business combinations with an effective date in
2009.
In December 2007, the FASB issued Statement of Financial Accounting Standards
No. 160, "Noncontrolling Interests in Consolidated Financial Statements"
("FAS 160"). FAS 160 amends ARB 51 and requires entities to report
noncontrolling interests in subsidiaries as equity in the consolidated financial
statements and to account for the transactions with noncontrolling interest owners
as equity transactions provided the parent retains controlling interests in the
subsidiary. FAS 160 requires disclosure of the amounts of consolidated net
income attributable to the parent and to the noncontrolling interest on the face of
the consolidated statement of loss. FAS 160 also requires expanded disclosures
that identify and distinguish between parent and noncontrolling interests.
FAS 160 is effective from fiscal years beginning on or after December 15,
2008. The adoption of FAS 160 did not have a material impact on our financial
position or results of operations.
In February 2008, the FASB issued FASB Staff Position FAS No. 140-3,
"Accounting for Transfers of Financial Assets and Repurchase Financing
Transactions" ("FSP FAS 140-3"). Under FSP FAS 140-3, the initial
transfer of a financial asset and a repurchase financing involving the same asset
that is entered into contemporaneously with, or in contemplation of the initial
transfer, is presumptively linked and are considered part of the same arrangement
under FAS 140. The initial transfer and subsequent financing transaction will
be considered separate transactions under FAS 140 if certain conditions are
met. FSP FAS 140-3 is effective for new transactions entered into in fiscal
years beginning after November 15, 2008. The adoption of FSP FAS 140-3
did not have any material impact on our financial position or results of
operations.
In March 2008, the FASB issued Statement of Financial Accounting Standards
No. 161, "Disclosures about Derivative Instruments and Hedging
Activities - an amendment of FASB Statement No. 133" ("FAS 161").
FAS 161 requires enhanced disclosures about an entity's derivative and hedging
activities and improves transparency in financial reporting. FAS 161 requires
entities to provide enhanced disclosures about (a) how and why an entity uses
derivative instruments; (b) how derivative instruments and related hedged
items are accounted for under FAS 133 and its related interpretations; and
(c) how derivative instruments and related hedge items affect an entity's
financial position, financial performance and cash flows. It is effective for
fiscal years beginning after November 15, 2008 with early adoption encouraged.
We adopted FAS 161 effective January 1, 2009. See Note 11,
"Derivative Financial Instruments," in these consolidated financial statements.
In May 2008, the FASB issued Statement of Financial Accounting Standards
No. 163, "Accounting for Financial Guarantee Insurance Contracts - an
interpretation of FASB Statement No. 60" ("FAS 163"). FAS 163
applies to financial guarantee insurance (and reinsurance) contracts issued by
enterprises that are included within the scope of paragraph 6 of Statement 60
and that are not accounted for as derivative instruments. It clarifies how
Statement 60 applies to financial guarantee insurance contracts, including the
recognition and measurement of premium revenue and claim liabilities. This
statement requires expanded disclosures about financial guarantee insurance
contracts. FAS 163 is effective for financial statements issued for fiscal
years beginning after December 15, 2008, and all interim periods within those
fiscal years. The adoption of FAS 163 did not have an impact on our financial
position or our results of operations as we do not have any contracts within the
scope of FAS 163.
In December 2008, the FASB issued FSP FAS 132(R)-1, "Employers' Disclosures
about Post-retirement Benefit Plan Assets" ("FSP FAS 132(R)-1"). FSP
FAS 132(R)-1 applies to an employer that is subject to the disclosure
requirements of Statement 132(R). It requires entities to provide disclosures about
employer's defined benefit plans and other post-retirement plans that would help
users of the financial statements to understand how investment allocation decisions
are made, the major categories of plan assets, the inputs and the valuation
techniques used to measure the fair value of plan assets, the effect of fair value
measurements using significant unobservable inputs (Level 3) on changes
in plan assets for the period and significant concentrations of risk within plan
assets. FSP FAS 132(R)-1 is applicable for the first fiscal year ending after
December 15, 2009.
In April 2009, the FASB amended FASB Statement No. 107, "Disclosures about
Fair Value of Financial Instruments," and APB Opinion No. 28, "Interim
Financial Reporting," by issuing FASB Staff Position FAS 107-1 and APB 28-1,
"Interim Disclosures about Fair Value of Financial Instruments" ("FSP
FAS 107-1 and APB 28-1"). FSP FAS 107-1 and APB 28-1 require entities to
disclose fair value of financial instruments for all the interim reporting periods
ending after June 15, 2009 with earlier application permitted. We have adopted
the disclosure requirements of FSP FAS 107-1 and APB 28-1 effective
January 1, 2009. See Note 17, "Fair Value Measurements," in these
consolidated financial statements.
In April 2009, the FASB issued FASB Staff Position FAS 157-4, "Determining
Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That are not Orderly," ("FSP
FAS 157-4") to provide additional guidance for estimating fair value in
accordance with FASB Statement No. 157, "Fair Value Measurements"
("FAS 157"). FSP FAS 157-4 provides additional guidance in determining
fair value when the volume and level of activity for the asset and liability have
significantly decreased and also on identifying circumstances that indicate a
transaction is not orderly. It also amends FAS 157 to require enhanced
disclosures about the inputs and valuation techniques for measuring fair value
along with changes in the valuation methodologies and related inputs and to present
further disclosures for debt and equity securities. This FSP is effective for
reporting periods ending after June 15, 2009 with earlier adoption permitted.
We have adopted this FSP effective January 1, 2009. See Note 17, "Fair
Value Measurements," in these consolidated financial statements for the expanded
disclosure.
In April 2009, the FASB issued FASB Staff Position FAS 115-2 and 124-2,
"Recognition and Presentation of Other-Than-Temporary Impairments," ("FSP
FAS 115-2 and 124-2") to amend the recognition and presentation of
other-than-temporary impairments of debt securities. Under this guidance, if we do
not have the intention to sell and it is more-likely-than-not we will not be
required to sell the debt security, FSP FAS 115-2 and 124-2 requires
segregating the difference between fair value and amortized cost into credit loss
and other losses with only the credit loss recognized in earnings with other losses
recorded to other comprehensive income. Where our intent is to sell the debt
security or where it is more-likely-than-not that we will be required to sell the
debt security, the entire difference between the fair value and the amortized cost
basis is recognized in earnings. FSP FAS 115-2 and 124-2 also requires
disclosure of the reasons for recognizing a portion of impairment in other
comprehensive income and the methodology and significant inputs used to calculate
the credit loss component. FSP FAS 115-2 and 124-2 is effective for all the
reporting periods ending after June 15, 2009, with earlier adoption permitted.
We have adopted FSP FAS 115-2 and 124-2 effective January 1, 2009. The
adoption of FSP FAS 115-2 and 124-2 did not have an impact on our financial
position or results of operations. See Note 5, "Securities," in these
consolidated financial statements for the expanded disclosure.
In May 2009, the FASB issued Statement of Financial Accounting Standards
No. 165 ("FAS 165"), "Subsequent Events." It provides guidance for the
recognition and disclosure of subsequent events not addressed in other applicable
generally accepted accounting principles ("GAAP"). This Statement is effective for
interim or annual financial periods ending after June 15, 2009, and shall be
applied prospectively. The adoption of FAS 165 did not have an impact on our
financial position or results of operations.
In June 2009, the FASB issued Statement of Financial Accounting Standard
No. 166, "Accounting for Transfers of Financial Assets, an amendment of FASB
Statement No. 140" ("FAS 166"). This statement amends FAS 140 by
removing the concept of a qualifying special-purpose entity ("QSPE"). It also
modifies the financial-components approach and limits the circumstances in which a
transferor derecognizes a portion or component of a financial asset, establishes
conditions for reporting a transfer of a portion(s) of financial asset as a sale,
defines "participating interest" and removes the special provisions for guaranteed
mortgage securitizations and requires them to be treated in the same way as the
transfer of other financial assets within the scope of FAS 140. It also
requires enhanced disclosures about the transfers of financial assets and the
transferor's continuing involvement with transfers of financial assets accounted
for as sales. The statement is effective for all interim and annual periods
beginning after November 15, 2009. Earlier application is prohibited. The
recognition and measurement provisions of this statement shall be applied to
transfers that occur on or after January 1, 2010. We are currently evaluating
the impact of the adoption of FAS 166 on our financial position and results of
operations.
In June 2009, the FASB issued Statement of Financial Accounting Standards
No. 167, "Amendments to FASB Interpretation No. 46(R)" ("FAS 167").
This standard changes the requirement from using quantitative analysis to
qualitative analysis when determining if an enterprise has a controlling financial
interest in a variable interest entity ("VIE") for the purpose of determining the
primary beneficiary. It also changes the timing of assessment to determine if an
enterprise is the primary beneficiary of a VIE from "when specific events occur" to
"ongoing re-assessment", eliminates the exception related to troubled debt
restructuring which is now considered to be an event that requires reconsideration
of whether an entity is a VIE, requires enhanced disclosures and nullifies FSP
FAS 140-4 and FIN 46(R)-8, "Disclosures by Public Entities (Enterprises)
about Transfers of Financial Assets and Interests in Variable Interest Entities."
The statement is effective for all interim and annual periods beginning after
November 15, 2009. Earlier application is prohibited. On the effective date,
certain VIEs which are not consolidated currently may be required to be
consolidated. We are currently evaluating the impact of FAS 167 on our
financial position and results of operations.
In July 2009, the FASB, in an effort to codify all authoritative accounting
guidance related to a particular topic in a single place, issued Statement of
Financial Account Standards No. 168 ("FAS 168"), "The FASB Accounting
Standard Codification and the Hierarchy of Generally Accepted Accounting
Principles, a replacement of FASB Statement No. 162." It replaces the
U.S. GAAP hierarchy created by Statement of Financial Accounting Standards
No. 162, "The Hierarchy of Generally Accepted Accounting Principles," by
establishing only two levels of generally accepted accounting principles:
authoritative and nonauthoritative. All authoritative guidance will carry the same
level of authority. The statement is effective for financial statements issued for
interim and annual periods ending after September 15, 2009. The adoption of
FAS 168 will not have an impact on our financial position or results of
operations.
Item 2. Management's Discussion and Analysis of Financial
Condition and
Results of Operations
Forward-Looking Statements
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") should be read in conjunction with the consolidated
financial statements, notes and tables included elsewhere in this report and with
our Annual Report on Form 10-K for the year ended December 31, 2008 (the
"2008 Form 10-K"). MD&A may contain certain statements that may be
forward-looking in nature 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 "may",
"will", "should", "would", "could", "intend", "believe", "expect", "estimate",
"target", "plan", "anticipate", "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.
HSBC Finance Corporation is an indirect wholly owned subsidiary of HSBC Holdings
plc ("HSBC"). HSBC Finance Corporation may also be referred to in MD&A as "we",
"us", or "our".
During the first half of 2009, economic conditions in the
U.S.
continued to deteriorate as a result of continued declines in the housing
market, rising unemployment, tighter credit conditions and reduced economic growth.
While the on-going financial market disruptions continued to impact credit spreads
and liquidity during the period, we have seen improvement in marketplace liquidity
during the second quarter of 2009 and credit spreads have narrowed considerably due
to increased market confidence stemming largely from various government actions
taken to restore faith in the capital markets.
U.S.
unemployment rates, which have become a major factor in the deterioration of
credit quality in the
U.S.
, increased to 9.5 percent in June 2009, an increase of 100 basis points
during the quarter and 230 basis points since December 2008. Unemployment
rates in 15 states are greater than the
U.S.
national average and have unemployment rates above 10 percent.
Additionally, personal bankruptcy filings in the
U.S.
have continued to increase throughout the year. Concerns about the future of
the
U.S.
economy, including the length and depth of the current economic recession,
consumer confidence, volatility in energy prices, adverse developments in the
credit markets and mixed corporate earnings continue to negatively impact the
U.S.
economy and the capital markets.
During the first half of 2009, mortgage lending industry trends continued to
deteriorate, including:
> Mortgage loan originations from 2005 to 2008 continue to perform worse than
originations from prior periods;
> Real estate markets in a large portion of the
United States
continue to be affected by stagnation or decline in property values;
> Increases in the period of time properties remain unsold in most markets;
> Increased loss severities on homes that are foreclosed and remarketed due to
the increasing inventory of homes for sale and the declining property values in
certain markets as discussed above;
> Low secondary market demand for subprime loans resulting in reduced liquidity
for subprime mortgages; and
> Continued tightening of lending standards by mortgage lenders which impacts
borrowers' ability to refinance existing mortgage loans.
The combination of the above factors, including the previous closure or merger of a
number of mortgage lenders, has further reduced the ability of many of our real
estate loan customers to make payments on or to refinance their loans. Accessing
any equity in their homes is no longer an option as either there is no equity in
their homes or if there is, few institutions are willing to finance its withdrawal.
It is generally believed that the slowdown in the housing market will continue to
impact housing prices into 2010 and possibly beyond.
Improvement in unemployment rates and a recovery of the housing market, including
stabilization in home prices, continue to remain critical components for a
broader
U.S.
economic recovery. Further weakening in these components as well as in
consumer confidence may result in additional deterioration in consumer payment
patterns and increased delinquencies and charge-off rates in loan portfolios across
the industry, including our own.
The U.S. Federal government and banking regulators continued their efforts to
stabilize the
U.S.
economy during the quarter. On June 17, 2009, the Administration
unveiled its proposal for a sweeping overhaul of the financial regulatory system.
The Financial Regulatory Reform proposals are comprehensive and include the
creation of an inter-agency Financial Services Oversight council to, among other
things, identify emerging risks and advise the Federal Reserve Board regarding
institutions whose failure could pose a threat to financial stability; expand the
Federal Reserve Board's powers to regulate these systemically-important
institutions and impose more stringent capital and risk management requirements;
create a Consumer Financial Protection Agency as a single primary federal consumer
protection supervisor, which will regulate credit, savings, payment and other
consumer financial products and services and providers of those products and
services; and impose comprehensive regulation of over-the-counter ("OTC")
derivatives markets, including credit default swaps, and prudent supervision of OTC
derivatives dealers. Draft legislation for strengthening consumer and investor
protection, including the creation of the Consumer Financial Protection Agency, has
been released and additional proposed legislation in support of the broader
financial regulatory restructuring is expected in the near term. It is likely that
significant reform of the financial regulatory system will be adopted and that
reform is expected to have a significant impact on the operations of financial
institutions in the
U.S.
, including us and our affiliates. It is not possible to assess the impact of
financial regulatory reform, however, until final legislation has been enacted and
related regulations have been adopted.
As discussed in prior filings, we have been engaged in a continuing, comprehensive
evaluation of the strategies and opportunities for our operations. In light of the
unprecedented developments in the retail credit markets, particularly in the
residential mortgage industry and the continued deterioration of U.S. economic
conditions, we are focused on the things we can control and, beginning in mid-2007
and continuing through 2008, we made strategic decisions designed to lower the risk
profile and reduce the capital and liquidity requirements of our operations by
reducing the size of the balance sheet while maximizing efficiencies.
As previously disclosed, this evaluation continued into 2009, and resulted in the
discontinuation of new customer account originations for all products by our
Consumer Lending business, the closure of our Consumer Lending branch offices as
well as the decision in the second quarter of 2009 to close or consolidate other
back office and collection facilities in Bridgewater, New Jersey; Minnetonka,
Minnesota; Wood Dale, Illinois; Elmhurst, Illinois and Virginia Beach, Virginia. As
a result of these decisions, during the six months ended June 30, 2009, we
recorded closure costs, predominately related to one-time termination and other
employee benefit costs. In addition, during the six months ended June 30,
2009, we incurred related non-cash charges for the impairment of fixed assets and
other capitalized costs. See Note 4, "Strategic Initiatives" for additional
detail regarding these costs. We continue to service and collect the existing Auto
Finance, Consumer Lending and Mortgage Services receivable portfolios as they run
off and continue our efforts to reach out and assist mortgage customers utilizing
appropriate modification and other account management programs, potentially
including refinancing a loan with an existing customer in accordance with their
financial needs, to maximize collection and home preservation.
As a result of these decisions as well as those made from mid-2007 and through
2008, our lending products currently include MasterCard, Visa, American Express and
Discover credit card receivables as well as private label receivables. A portion of
new credit card and all new private label receivable originations are sold on a
daily basis to HSBC Bank
USA
, National Association ("HSBC Bank
USA
"). We also offer specialty insurance products in the
United States
and
Canada
as well as tax refund anticipation loans and other related products in
the
United States
. However, the closure of our Consumer Lending loan origination operations has and
will continue to significantly decrease the credit insurance policies sold by our
Insurance Services business.
As previously reported, in January 2009, we sold our General Motors MasterCard
receivable portfolio ("GM Portfolio") and our AFL-CIO Union Plus MasterCard/Visa
receivable portfolio ("UP Portfolio") to HSBC Bank
USA
at fair value in order to maximize the efficient use of liquidity at each
entity. We continue to evaluate our operations as we seek to optimize our risk
profile as well as our liquidity, capital and funding requirements and review
opportunities in the subprime lending industry as the credit markets stabilize.
This could result in further strategic actions that may include changes to our
legal structure, additional asset sales and further alterations or refinement of
product offerings as we work to reposition our businesses for long-term success.
Although nothing is currently contemplated, we continue to evaluate our
relationship with HSBC Bank
USA
to identify additional ways to leverage liquidity and identify funding
opportunities, subject to regulatory approval.
As a result of the strategic changes in our business focus since mid-2007, our real
estate secured, auto finance and personal non-credit card receivable portfolios,
which totaled $86.1 billion at June 30, 2009 are currently liquidating.
The timeframe in which these portfolios will liquidate is dependent upon numerous
factors which are beyond our control. The rate at which receivables pay off prior
to their maturity date due to loan prepayments fluctuates for a variety of reasons
such as interest rates, availability of refinancing, home values as well as the
individual borrower's employment and credit history. In light of the current
economic conditions and mortgage industry trends described above, loan prepayment
rates continue to slow even though interest rates remain low. Additionally, our
modification programs which are designed to maximize cash collections and avoid
foreclosure or repossession if economically expedient, are contributing to the
slowing in loan prepayment rates.
While difficult to project both loan prepayment rates and net charge-off rates,
based on current experience we expect receivables in our run-off real estate
secured, auto finance and personal non-credit card receivable portfolios to decline
between 40 percent and 60 percent over the next four to five years and be
comprised primarily of real estate secured receivables. Attrition will not be
linear during this period. Over the next two years, receivable run-off is expected
to accelerate as charge-offs are expected to grow to a level consistent with
current delinquencies. Run-off will later slow as a high percentage of the
remaining real estate secured receivables stay on the balance sheet longer due to
the impact of modifications and/or the lack of re-financing alternatives.
Performance, Developments and Trends
Net loss from continuing operations was $(6.0) billion and $(5.1) billion
during the three and six months ended June 30, 2009, respectively, compared to
$(1.4) billion and $(1.2) billion during the three and six months ended
June 30, 2008, respectively. Loss from continuing operations before income tax
was $(7.5) billion and $(5.7) billion during the three and six months
ended June 30, 2009, respectively, compared to $(2.2) billion and
$(1.8) billion during the three and six months ended June 30, 2008,
respectively. Our results in both periods were significantly impacted by the change
in the fair value and related derivatives of debt for which we have elected fair
value option reporting and, during the 2009 periods, goodwill and other intangible
asset impairment charges which distort the underlying performance trends of our
business. The following table summarizes the collective impact of these items on
our loss before income tax for all periods presented:
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Loss from continuing operations before income tax, as reported
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Change in value of fair value option debt
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Goodwill and other intangible asset impairment charges
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Loss from continuing operations before income tax, excluding above
items
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Excluding the impact of these items, our 2009 results were impacted by lower net
interest income and lower other revenues, partially offset by lower provision for
credit losses and lower operating expenses. Should economic conditions continue to
deteriorate in line with our current forecasts, we would expect to continue to
generate losses through 2010 and likely longer.
The decrease in net interest income in the three and six months ended June 30,
2009 was due to lower average receivables, lower origination volumes due to risk
mitigation efforts, including our decision to stop all new account originations in
our auto finance and consumer lending businesses, as well as lower consumer
spending levels, lower levels of performing receivables and lower overall yields on
our receivable portfolios, partially offset by lower interest expense. Overall
yields decreased due to the impact of deterioration in credit quality including
growth in non-performing assets, increased levels of loan modifications, lower
amortization of net deferred fees due to lower loan prepayments and lower loan
origination volumes as well as decreases in rates on variable rate products which
reflect market rate movements, partially offset by the impact of interest rate
floors in portions of our credit card receivable portfolio. Overall yields were
also negatively impacted by a shift in receivable mix to higher levels of real
estate secured receivables as a result of the sale of the $12.4 billion of
credit card receivables and $3.0 billion of auto finance receivables in
January 2009 as credit card and auto finance receivables generally have higher
yields than real estate secured receivables. We also experienced lower yields on
our non-insurance investment portfolio reflecting lower rates on overnight
investments. Lower interest expense was due to lower average rates for floating
rate borrowings on lower average borrowings. Our net interest margin decreased to
5.70 percent for the three months ended June 30, 2009 compared to
6.47 percent in the prior year quarter. Net interest margin decreased to
5.79 percent for the six months ended June 30, 2009 compared to
6.39 percent for the year-ago period. The decrease in both periods was due to
the lower overall yields on our receivable portfolio discussed above, partially
offset by lower funding costs due to lower average interest rates for short-term
borrowings which reflect actions taken by the Federal Reserve Bank which decreased
Federal Fund Rates by 175 basis points since June 30, 2008.
Other revenues, which decreased in both periods, was significantly impacted by the
loss on debt designated at fair value and related derivatives. The loss on debt
designated at fair value and related derivatives increased significantly during the
three months ended June 30, 2009 due to a significant narrowing of our credit
spreads since March 31, 2009. Credit spreads had widened significantly during
the first quarter of 2009 in response to general market conditions and credit
rating downgrades by two of the three primary rating agencies as a result of the
decision to discontinue new customer account originations in our Consumer Lending
business and close substantially all Consumer Lending branches. Changes in the
credit component of fair value optioned debt decreased other revenues by
$5.1 billion during the three months ended June 30, 2009 compared to
$969 million in the prior year quarter. During the six months ended
June 30, 2009, changes in the credit component of fair value optioned debt
decreased other revenues by $1.3 billion compared to increasing other revenues
by $320 million in the year-ago period. Excluding the loss on fair value
optioned debt and related derivatives, other revenues remained lower in both
periods primarily due to the following:
• Lower fee income and enhancement services revenues on our credit card
receivable portfolio due to lower receivable levels and changes in customer
behavior; and
• Lower taxpayer financial services revenue due to discontinuing all partner
relationships except for H&R Block as well as a shift in mix to lower revenue
and lower risk products.
These decreases in other revenues were partially offset by:
• A decrease in the lower of cost or fair market value adjustments for
receivables held for sale during the second quarter of 2009;
• Higher gains on daily sales of receivables to HSBC Bank
USA
and higher servicing and other fees from HSBC affiliates due to higher
volumes as a result of the sale of the GM and UP Portfolios as previously
discussed;
• For the year-to-date period, a gain of $57 million on the bulk sale to
an HSBC affiliate of the credit card and auto finance receivables as previously
discussed; and
• Higher derivative income due to an increase in economic hedge positions
designed to offset the interest rate risk associated with slower mortgage loan
repayment rates as discussed above.
The provision for credit losses decreased during the three and six months ended
June 30, 2009 as a result of lower provision for credit losses in all of our
receivable portfolios with the exception of receivables in our Consumer Lending
business. The lower provision for credit losses in our Mortgage Services business
as well as in our credit card and auto finance portfolios was due to the following:
• Provision for credit losses in our Mortgage Services business decreased as
compared to the year-ago periods as the portfolio continues to become more fully
seasoned and runs off, resulting in lower charge-off levels. While loss severities
have continued to increase as discussed above, we have experienced a shift in the
mix of charge-offs to first lien loans which generally have lower loss severities
than second lien loans.
• Provision for credit losses in our credit card receivable portfolio
decreased significantly in both periods due to lower receivable levels driven by
the impact of the sale of the GM and UP Portfolios to HSBC Bank
USA
in January 2009. However, excluding the impact of these transferred
portfolios, our provision for credit losses still remained lower due to lower
non-prime receivable levels as a result of actions taken throughout 2008 and into
2009 to reduce credit appetite and to slow receivable growth as well as lower
consumer spending levels. The transfer of $2.0 billion of non-prime
receivables to held for sale in June 2008 also contributed to lower provisions as
these portfolios were written down through other revenue. These lower credit loss
estimates have been partially offset by lower recovery rates on defaulted
receivables.
• Provision for credit losses in our auto finance receivable portfolio
decreased in both periods as a result of lower receivable levels reflecting the
discontinuation of auto finance originations as well as the sale of
$3.0 billion of auto finance receivables to HSBC Bank
USA
in January 2009. Additionally, we have experienced lower loss severities
driven by improvements in prices on repossessed vehicles. The year-to-date period
was also impacted by the adoption of FFIEC charge-off policies during the first
quarter of 2009 which increased the provision for credit losses by
$36 million.
The provision for credit losses in our Consumer Lending business increased during
both periods primarily in our first lien, real estate secured receivable portfolio
driven by an accelerated deterioration which began in the second half of 2007 for
portions of that portfolio. Charge-off and delinquency, including early stage
delinquency, continued to increase due to the marketplace deterioration as
previously discussed. Lower receivable prepayments and higher loss severities also
resulted in a higher real estate secured credit loss provision. Credit loss
estimates for Consumer Lending's personal non-credit card portfolio also increased
during the first half of 2009 due to higher levels of charge-off resulting from
deterioration in the 2006 and 2007 vintages which was more pronounced in certain
geographic regions.
The provision for credit losses for all products was negatively impacted by rising
unemployment rates in an increasing number of markets and continued deterioration
in the
U.S.
economy and housing markets, higher levels of personal bankruptcy filings and
portfolio seasoning. See "Results of Operations" for a more detailed discussion of
our provision for credit losses.
During the three months ended June 30, 2009, the provision for credit losses
was $82 million lower than net charge-offs compared to provision in excess of
net charge-offs of $535 million in the prior year quarter. During the six
months ended June 30, 2009, we recorded provision in excess of net charge-offs
of $475 million compared to $998 million during the year-ago period.
Consequently, while our credit loss reserve levels have increased during the first
half of 2009, they have decreased slightly during the second quarter as the rate of
deterioration in credit quality slowed and receivable balances have declined.
Reserve levels for real estate secured receivables at our Mortgage Services and
Consumer Lending businesses as well as for our credit card receivables can be
further analyzed as follows:
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Real Estate Secured Receivables
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Three Months Ended June 30,
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Credit loss reserves at beginning of period
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Provision for credit losses
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Reserves on receivables transferred to held for sale
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Release of credit loss reserves related to loan sales
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Credit loss reserves at end of period
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Real Estate Secured Receivables
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Six Months Ended June 30,
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Credit loss reserves at beginning of period
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Provision for credit losses
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Reserves on receivables transferred to held for sale
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Release of credit loss reserves related to loan sales
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Credit loss reserves at end of period
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Total operating expenses in the first half of 2009 were negatively impacted by the
following:
• Restructuring charges totaling $158 million, primarily recorded during
the first quarter of 2009, related to the decision to discontinue all new customer
account originations for our Consumer Lending business and to close the Consumer
Lending branch offices. See Note 4, "Strategic Initiatives," in the
accompanying consolidated financial statements for additional information related
to this decision.
• Goodwill impairment charges of $1.6 billion during the three months
ended June 30, 2009 related to our Card and Retail Services business and
$2.3 billion during the year-to-date period related to our Card and Retail
Services and Insurance Services businesses. All of our goodwill has now been fully
written off.
• Impairment charges of $14 million during the first quarter of 2009
relating to technology, customer lists and loan related relationships resulting
from the discontinuation of originations for our Consumer Lending business.
Excluding these items, total operating expenses decreased $411 million, or
31 percent, and $687 million, or 25 percent, during the three and
six months ended June 30, 2009, respectively, due to lower salary expense,
lower marketing expenses, lower sales incentives and the impact of entity-wide
initiatives to reduce costs, partially offset by higher collection costs.
The financial information set forth below summarizes selected financial highlights
for continuing operations of HSBC Finance Corporation as of June 30, 2009 and
2008 and for the three and six month periods ended June 30, 2009 and 2008.
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(dollars are in millions)
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Loss from continuing operations
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Return on average owned assets
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Return on average common shareholder's equity
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Consumer net charge-off ratio, annualized
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Two-month-and-over contractual delinquency ratio
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Ratio of total costs and expenses less policyholders' benefits to net
interest income and other revenues less policyholders' benefits.
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Excludes receivables held for sale.
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Our efficiency ratio from continuing operations was (96.80) percent for the three
months ended June 30, 2009 compared to 57.23 percent in the prior year
quarter. Our efficiency ratio from continuing operations was 109.1 percent for
the six months ended June 30, 2009 compared to 38.36 percent in the prior
year period. Our efficiency ratio in both periods was significantly impacted by the
change in the fair value of debt for which we have elected fair value option
reporting and the related derivatives and the goodwill and intangible asset
impairment charges recorded during the three and six months ended June 30,
2009, as discussed above. Excluding these items in the quarters, our efficiency
ratio improved 319 points during the second quarter of 2009 as a result of lower
salary expense, marketing expense and sales incentives as well as the impact of
entity-wide initiatives to reduce costs which resulted in operating expenses
decreasing more rapidly than net interest income and fee income. Excluding these
items in the year-to-date periods, our efficiency ratio deteriorated 423 points
during the six months ended June 30, 2009 primarily as a result of the
restructuring charges recorded in the first quarter of 2009 as previously
discussed. Additionally, deterioration in the year-to-date period reflects net
interest income and fee income decreasing at a more rapid pace than operating
expenses prior to the discontinuation of Consumer Lending new customer account
originations and branch closures.
Our return on average common shareholder's equity ("ROE") was (191.13) percent and
(44.19) percent, for the three months ended June 30, 2009 and 2008,
respectively. ROE was (80.07) percent and (19.11) percent for the six months ended
June 30, 2009 and 2008, respectively. Our return on average assets ("ROA") was
(22.11) percent and (3.90) percent for the three months ended June 30, 2009
and 2008, respectively. ROA was (9.02) percent and (1.60) percent for the six
months ended June 30, 2009 and 2008, respectively. ROE and ROA were
significantly impacted in all periods by the change in the fair value of debt for
which we have elected fair value option reporting and the related derivatives and
by the goodwill and other intangible asset impairment charges. Excluding these
items, ROE decreased 1,245 basis points and ROA decreased 218 basis
points as compared to prior year quarter. As compared to the year-ago periods,
excluding these items ROE decreased 1,516 basis points and ROA decreased
233 basis points. The decrease for all periods was a result of the lower net
interest income, including lower overall yields on our receivable portfolios due to
changes in mix, lower other revenues and for ROE, higher average common
shareholder's equity, partially offset by lower provisions for credit losses and
the impact of restructuring charges as previously discussed. ROA for both periods
was also negatively impacted by lower average assets as a result of the decision to
reduce the size of our balance sheet and lower our risk profile as previously
discussed.
Our effective tax rate was (20.3) percent and (11.5) percent during the three and
six months ended June 30, 2009 compared to (35.6) percent and (33.7) percent
during the year-ago periods. The effective tax rate was significantly impacted by
the incremental valuation allowance recorded in 2009 and the non-tax deductible
impairment of goodwill related to our Card and Retail Services business and for the
year-to-date period, the non-tax deductible impairment of goodwill related to our
Insurance Services business. The percentage impact of reconciling items is larger
in the six months ended June 30, 2008 as a result of the significantly lower
level of pre-tax book loss in that period. The effective tax rate for the six
months ended June 30, 2009 was also impacted by a change in estimate in the
state tax rate for jurisdictions where we file combined unitary state tax returns
with other HSBC affiliates.
Receivables were $98.1 billion at June 30, 2009, $103.1 billion at
March 31, 2009 and $126.6 billion at June 30, 2008. The decrease is
a result of our decision to reduce the size of our balance sheet and lower our risk
profile as previously discussed. We have made significant changes to our product
offerings and implemented other risk mitigation efforts since mid-2007 which have
resulted in lower originations throughout 2008 and continuing into 2009, including
the recent decision in late February 2009 to discontinue new customer account
originations of all products in our Consumer Lending business. Lower receivable
balances at June 30, 2009 also reflect the transfer of $9.6 billion of
credit card and auto finance receivables into receivables held for sale since
June 30, 2008 (of which $9.1 billion was subsequently sold in January
2009). Decreases in credit card receivable balances also reflect lower consumer
spending as a result of the current economic conditions, partially offset by the
transfer in the second quarter of 2009 of $590 million of receivables
previously held for sale to receivables held for investment as we now have the
intent to hold these receivables for the foreseeable future. Decreases in real
estate secured receivable balances at June 30, 2009 have been partially offset
by a decline in loan prepayments resulting from fewer refinancing opportunities for
our customers due to the previously discussed trends impacting the mortgage lending
industry. See "Receivables Review" for a more detailed discussion of the decreases
in receivable balances.
Receivables held for sale were $1.1 billion at June 30, 2009,
$1.4 billion at March 31, 2009 and $9.1 billion at June 30,
2008. As compared to the prior year quarter, the decrease largely reflects the sale
of our GM credit card portfolio and other real estate secured receivables which
were classified as held for sale. As compared to the prior quarter, the decrease
reflects $590 million of credit card receivables transferred from receivables
held for sale to receivables held for investment at fair value, partially offset by
the transfer of auto finance receivables with a fair value of $450 million to
receivables held for sale in the second quarter of 2009 as we no longer have the
intent to hold these receivables for the foreseeable future.
Our two-months-and-over contractual delinquency ratio increased as compared to both
the prior quarter and prior year quarter due to lower receivable levels for all
products as discussed above and, compared to the prior year quarter, higher dollars
of delinquency. Dollars of contractual delinquency decreased compared to the prior
quarter driven by lower delinquency levels in our Mortgage Services real estate
secured receivable portfolio due to continued maturation and seasoning of a run-off
portfolio, as well as lower delinquency levels in our credit card and personal
non-credit card receivable portfolios. Lower delinquency dollars in our credit card
and personal non-credit card receivable portfolios reflect the lower receivable
levels discussed above, an extended seasonal benefit of increased cash available to
consumers as a result of various government economic stimulus actions and lower
energy costs, as well as for our credit card receivables, higher levels of personal
bankruptcy filings during the first half of 2009 which results in accounts
migrating to charge-off more quickly. In addition, we believe the decrease in
dollars of delinquency in both portfolios is a result of the risk mitigation
actions we have taken since 2007 to tighten underwriting and reduce the risk
profile of these portfolios. These decreases in dollars of delinquency were
partially offset by increases in delinquency levels in the first lien portion of
our Consumer Lending real estate secured receivable portfolio reflecting continued
weakening in the housing and mortgage industry as well as continuing delays in
processing foreclosures due to backlogs in foreclosure proceedings as a result of
actions by local governments and actions of certain states which have lengthened
the foreclosure process. As compared to both the prior quarter and prior year
quarter, delinquency for all products was negatively impacted by the continued
deterioration in the
U.S.
economy, including significantly higher unemployment rates and portfolio
seasoning. See "Credit Quality-Delinquency" for a more detailed discussion of
two-months-and-over contractual delinquency ratios.
Net charge-offs as a percentage of average consumer receivables for the quarter
increased compared to both the prior year quarter and prior quarter. As compared to
the prior year quarter, the increase was due to lower average consumer receivables,
partially offset by lower dollars of net charge-off. The decrease in average
consumer receivables reflects changes in product offerings, lower origination
volumes, lower consumer spending levels and the sale of real estate secured, credit
card and auto finance receivables as previously discussed, partially offset by a
decline in loan prepayments for our real estate secured receivables. Lower dollars
of net charge-off when compared to the prior year quarter was driven by our
Mortgage Services business as the portfolio continues to become more fully seasoned
and run-off, including lower charge-off of second lien loans which generally have
higher loss severities. As compared to the prior quarter, the increase reflects
higher dollars of charge-offs in our real estate secured, credit card and personal
non-credit card receivable portfolios and lower average consumer receivables as
discussed above. The higher charge-offs reflect the migration of delinquent
receivables to charge-off. For our credit card and personal non-credit card
portfolios, the higher charge-offs also reflect a higher percentage of loans which
progress to later stages of delinquency ("higher roll rates"). Additionally, both
periods were negatively impacted by the continued deterioration in the
U.S.
economy and housing markets, significantly higher unemployment rates, higher
levels of personal bankruptcy filings, portfolio seasoning and lower recovery rates
on credit card receivables. See "Credit Quality- Net Charge-offs of Consumer
Receivables" for a more detailed discussion of net charge-offs as a percentage of
average consumer receivables.
Funding and Capital
During the first half of 2009, HSBC Investments (
North America
) Inc. ("HINO") made three capital contributions to us totaling $2.0 billion.
Additionally, in late February 2009 we effectively converted $275 million of
mandatorily redeemable preferred securities of the Household Capital
Trust VIII to common stock by redeeming the junior subordinated notes
underlying the preferred securities and then issuing common stock to HINO. These
transactions serve to support ongoing operations and to maintain capital at levels
we believe are prudent in the current market conditions. These capital
contributions occurred subsequent to the dividend of $1.0 billion paid to HINO
in January 2009 relating to the capital associated with the receivables sold to
HSBC Bank
USA
. Until we return to profitability, we are dependent upon the continued capital
support of HSBC to continue our business operations and maintain selected capital
ratios.
As discussed previously, in February 2009 we decided to discontinue new customer
account originations for all products offered by our Consumer Lending business and
close substantially all branch offices as soon as all commitments to customers were
satisfied. This action resulted in two of the three primary credit rating agencies
electing to lower the ratings on our senior debt, commercial paper and
Series B preferred stock. Prior to our February 2009 decision, these agencies
had designated HSBC Finance Corporation as a "core" business within the HSBC Group.
Following this decision, these agencies felt that we had diminished strategic
importance to the overall HSBC Group, resulting in the lower ratings as described
above. HSBC remains fully committed to providing the capital support, and has the
capacity to provide such support, to ensure our remaining business operations
continue and selected capital ratios are maintained. See "Liquidity and Capital
Resources" in this MD&A for a schedule showing our credit ratings as of
June 30, 2009 and December 31, 2008.
The balance sheet and corresponding credit dynamics described above will have a
significant impact on our liquidity and risk management processes. Lower cash flow
as a result of declining receivable balances as well as "cashless" attrition due to
charge-offs, will not fully cover maturing debt through 2013. Absent asset sales
and financial support from HSBC, we may face additional funding requirements from
time to time. Funding requirements will be covered primarily through a combination
of capital infusions from HSBC, a robust cash management process and potential
opportunistic portfolio sales. HSBC has indicated it remains fully committed and
has the capacity to continue to provide such support. We believe a portion of this
gap could also be met through potential issuances of unsecured term debt. These
issuances would better match the projected cash flows of the remaining real estate
secured receivable portfolio and partly reduce reliance on direct HSBC support.
On October 3, 2008, the United States Congress enacted the Emergency Economic
Stabilization Act of 2008 (the "EESA") with the stated purpose of providing
stability to and preventing disruption in the economy and financial system and
protecting taxpayers. Pursuant to or in conjunction with the EESA, in 2008 and
continuing into 2009 the U.S. Department of the Treasury and the federal
banking and thrift regulatory agencies have announced a series of initiatives
intended to strengthen market stability, improve the strength of financial
institutions and enhance market liquidity. As of June 30, 2009, the only
program under the EESA in which we are participating is the Commercial Paper
Funding Facility ("CPFF") which provides a liquidity backstop to
U.S.
issuers of commercial paper. See "Liquidity and Capital Resources" in this
MD&A for a further discussion of our participation in the CPFF. We will
continue to evaluate additional initiatives to enhance liquidity and provide other
market support as the details of the various programs become available.
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 a continuing
operations basis of reporting. Certain reclassifications have been made to prior
year amounts to conform to the current year presentation.
In addition to the U.S. GAAP financial results reported in our consolidated
financial statements, MD&A includes reference to the following information
which is presented on a non-U.S. GAAP basis:
Equity Ratios
Tangible shareholders' equity plus owned loss reserves to tangible managed assets
("TETMA + Owned Reserves") and tangible common equity to tangible managed assets
are non-U.S. GAAP financial measures that are used by HSBC Finance Corporation
management and certain rating agencies to evaluate capital adequacy. These ratios
exclude the equity impact of Statement of Financial Accounting Standards
No. 115, "Accounting for Certain Investments in Debt and Equity Securities,"
the equity impact of Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities," Statement of
Financial Accounting Standards No. 158, "Employers' Accounting for Defined
Benefit Pension and Other Post-retirement Plans - an amendment of FASB
statement Nos. 87, 88, 106, and 132(R)," and the impact of Statement of Financial
Accounting Standards No. 159, "The Fair Value Option for Financial Assets and
Financial Liabilities - including an amendment of FASB statement
No. 115," including the subsequent changes in fair value recognized in
earnings associated with debt for which we elected the fair value option. Preferred
securities issued by certain non-consolidated trusts are also considered equity in
the TETMA + Owned Reserves calculations because of their long-term subordinated
nature and our ability to defer dividends. Managed assets include owned assets plus
any loans which we may have sold and service with limited recourse. These ratios
may differ from similarly named measures presented by other companies. The most
directly comparable U.S. GAAP financial measure is the common and preferred
equity to owned assets ratio. For a quantitative reconciliation of these
non-U.S. GAAP financial measures to our common and preferred equity to owned
assets ratio, see "Reconciliations to U.S. GAAP Financial Measures."
International Financial Reporting Standards
Because HSBC reports results in accordance with International Financial Reporting
Standards ("IFRSs") and IFRSs results are used in measuring and rewarding
performance of employees, our management also separately monitors net income under
IFRSs (a non-U.S. GAAP financial measure). All purchase accounting fair value
adjustments relating to our acquisition by HSBC have been "pushed down" to HSBC
Finance Corporation for both U.S. GAAP and IFRSs consistent with our IFRS
Management Basis presentation. The following table reconciles our net income on a
U.S. GAAP basis to net income on an IFRSs basis:
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Net loss - U.S. GAAP basis
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Derivatives and hedge accounting (including fair value
adjustments)
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Other-than-temporary impairments on available-for-sale securities
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Present value of long term insurance business
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Goodwill and intangible asset impairment charges
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Loss on sale of U.K. Operations to an affiliate
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Tax benefit - IFRSs basis
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Loss before tax - IFRSs basis
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A summary of the significant differences between U.S. GAAP and IFRSs as they
impact our results are presented below:
Derivatives and hedge accounting (including fair value
adjustments)
- The historical use of the "shortcut" and "long haul" hedge accounting
methods for U.S. GAAP resulted in different cumulative adjustments to the
hedged item for both fair value and cash flow hedges. These differences are
recognized in earnings over the remaining term of the hedged items. All of the
hedged relationships which previously qualified under the shortcut method
provisions of FAS 133 have been redesignated and are now either hedges under
the long-haul method of hedge accounting or included in the fair value option
election.
Intangible assets
- Intangible assets under IFRSs are significantly lower than those under
U.S. GAAP as the newly created intangibles associated with our acquisition by
HSBC were reflected in goodwill for IFRSs. As a result, amortization of intangible
assets is lower under IFRSs.
Deferred loan origination costs and fees
- Under IFRSs, loan origination cost deferrals are more stringent and result
in lower costs being deferred than permitted under U.S. GAAP. In addition, all
deferred loan origination fees, costs and loan premiums must be recognized based on
the expected life of the receivables under IFRSs as part of the effective interest
calculation while under U.S. GAAP they may be recognized on either a
contractual or expected life basis. As a result, in years with higher levels of
receivable originations, net income is higher under U.S. GAAP as more expenses
are deferred. In years with lower levels of receivable originations, net income is
lower under U.S. GAAP as the higher costs deferred in prior periods are
amortized into income without the benefit of similar levels of cost deferrals for
current period originations.
Loan impairment provisioning
- IFRSs requires a discounted cash flow methodology for estimating impairment
on pools of homogeneous customer loans which requires the incorporation of the time
value of money relating to recovery estimates. Also under IFRSs, future recoveries
on charged-off loans are accrued for on a discounted basis and a recovery asset is
recorded. Subsequent recoveries are recorded to earnings under U.S. GAAP, but
are adjusted against the recovery asset under IFRSs. Interest is recorded based on
collectibility under IFRSs.
Loans held for sale
- IFRSs requires loans designated as held for sale at the time of origination
to be treated as trading assets and recorded at their fair market value. Under
U.S. GAAP, loans designated as held for sale are reflected as loans and
recorded at the lower of amortized cost or fair value. Under U.S. GAAP, the
income and expenses related to receivables held for sale are reported similarly to
loans held for investment. Under IFRSs, the income and expenses related to
receivables held for sale are reported in other operating income.
For receivables transferred to held for sale subsequent to origination, IFRSs
requires these receivables to be reported separately on the balance sheet but does
not change the recognition and measurement criteria. Accordingly for IFRSs
purposes, such loans continue to be accounted for in accordance with IAS 39 with
any gain or loss recorded at the time of sale. U.S. GAAP requires loans that
management intends to sell to be transferred to a held for sale category at the
lower of cost or fair value.
Interest recognition
- The calculation of effective interest rates under IAS 39 requires an
estimate of "all fees and points paid or recovered between parties to the contract"
that are an integral part of the effective interest rate be included.
U.S. GAAP generally prohibits recognition of interest income to the extent the
net interest in the loan would increase to an amount greater than the amount at
which the borrower could settle the obligation. Also under U.S. GAAP,
prepayment penalties are generally recognized as received.
Securities
- Under IFRSs, securities include HSBC shares held for stock plans at fair
value. These shares are recorded at fair value through other comprehensive income.
If it is determined these shares have become impaired, the fair value loss is
recognized in profit and loss and any fair value loss recorded in other
comprehensive income is reversed. There is no similar requirement under
U.S. GAAP.
During the second quarter of 2009, under IFRSs we recorded income for the value of
additional shares attributed to HSBC shares held for stock plans as a result of
HSBC's rights offering earlier in 2009. The additional shares are not recorded
under U.S. GAAP.
Other-than-temporary impairment on available-for-sale
securities
- As a result of the guidance issued by the SEC in October 2008, under
U.S. GAAP we are allowed to evaluate perpetual preferred securities for
potential other-than-temporary impairment similar to a debt security provided there
has been no evidence of deterioration in the credit of the issuer and record the
unrealized losses as a component of other comprehensive income. There are no
similar provisions under IFRSs as all perpetual preferred securities are evaluated
for other-than-temporary impairment as equity securities. Under IFRSs all
impairments are reported in other operating income.
Effective January 1, 2009 under U.S. GAAP, the credit loss component of
an other-than-temporary impairment of a debt security is recognized in earnings
while the remaining portion of the impairment loss is recognized in other
comprehensive income provided a company concludes it neither intends to sell the
security nor concludes that it is more-likely-than-not that it will have to sell
the security prior to recovery. Under IFRSs, there is no bifurcation of
other-than-temporary impairment and the entire decline in value is recognized in
earnings.
Present value of long term insurance business
- Under IFRSs, the present value of an in-force ("PVIF") long-term insurance
business is determined by discounting future cash flows expected to emerge from
business currently in force using appropriate assumptions in assessing factors such
as future mortality, lapse rates and levels of expenses, and a discount rate that
reflects the risk premium attributable to the respective long-term insurance
business. Movements in the PVIF long-term insurance business are included in other
operating income. Under U.S. GAAP, revenue is recognized over the life
insurance policy term.
During the second quarter of 2009, we refined the income recognition methodology in
respect of long-term insurance contracts. This resulted in the recognition of a
revenue item on an IFRSs basis of $66 million ($43 million after-tax).
Approximately $43 million ($28 million after-tax) would have been
recorded prior to January 1, 2009 if the refinement in respect of income
recognition had been applied at that date.
Goodwill and other intangible asset impairment charges
- Goodwill levels established as a result of our acquisition by HSBC were
higher under IFRSs than U.S. GAAP as the HSBC purchase accounting adjustments
reflected higher levels of intangibles under U.S. GAAP. Consequently, the
amount of goodwill allocated to our Card and Retail Services and Insurance Services
businesses and written off during 2009 is greater under IFRSs. In addition,
U.S. GAAP requires a two-step impairment test which requires an analysis of
the reporting units' implied fair value of goodwill to be determined in the same
manner as the amount of goodwill recognized in a business combination. In the
second quarter of 2009, the Card and Retail Services goodwill written off was
higher under U.S. GAAP as a greater proportion of goodwill was written off under
IFRSs in the first quarter of 2009 due to the two-step process described above
resulting in the cash flows supporting a higher amount of goodwill under U.S. GAAP
than under IFRSs. Additionally, the intangible assets allocated to our Consumer
Lending business and written off during the first quarter of 2009 were higher under
U.S. GAAP. There are also differences in the valuation of assets and
liabilities under IFRSs and U.S. GAAP resulting from the Metris acquisition in
December 2005.
Other
- There are other differences between IFRSs and U.S. GAAP including
pension expense, changes in tax estimates prior to 2009, securitized receivables,
purchase accounting and other miscellaneous items as well as a curtailment gain
related to post-retirement benefits during the first quarter of 2009.
IFRS Management Basis Reporting
As previously discussed, corporate goals and individual goals of executives are
currently calculated in accordance with IFRSs under which HSBC prepares its
consolidated financial statements. As a result, operating results are being
monitored and reviewed, trends are being evaluated and decisions about allocating
resources, such as employees, are being made almost exclusively on an IFRS
Management Basis. IFRS Management Basis results are IFRSs results which assume that
the GM and UP Portfolios and the auto finance, private label and real estate
secured receivables transferred to HSBC Bank USA have not been sold and remain on
our balance sheet and the revenues and expenses related to these receivables remain
on our income statement. Additionally, IFRS Management Basis assumes that all
purchase accounting fair value adjustments relating to our acquisition by HSBC have
been "pushed down" to HSBC Finance Corporation. Operations are monitored and trends
are evaluated on an IFRS Management Basis because the receivable sales to HSBC
Bank
USA
were conducted primarily to appropriately fund prime customer loans more
efficiently through bank deposits and such receivables continue to be managed and
serviced by us without regard to ownership. Accordingly, our segment reporting is
on an IFRS Management Basis. However, we continue to monitor capital adequacy,
establish dividend policy and report to regulatory agencies on an U.S. GAAP
legal entity basis. A summary of the significant differences between U.S. GAAP
and IFRSs as they impact our results are summarized in Note 16, "Business
Segments," in the accompanying consolidated financial statements.
Quantitative Reconciliations of Non-U.S. GAAP Financial Measures
to
U.S.
GAAP Financial Measure
For quantitative reconciliations of non-U.S. GAAP financial measures presented
herein to the equivalent GAAP basis financial measures, see "Reconciliations to
U.S. GAAP Financial Measures."
The following table summarizes receivables and receivables held for sale at
June 30, 2009 and increases (decreases) over prior periods:
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Increases (Decreases) From
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(dollars are in millions)
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Real estate secured(1)(3)
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Personal non-credit card(2)
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Receivables held for sale:
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Total receivables held for sale
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Total receivables and receivables held for sale:
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Personal non-credit card(2)
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Total receivables and receivables held for sale
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(1) Real estate secured receivables are comprised of the
following:
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Increases (Decreases) From
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(dollars are in millions)
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Total real estate secured
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On a continuing basis, private label receivables consist primarily of
the liquidating retail sales contracts in our Consumer Lending business
with a receivable balance of $28 million and $37 million as
of June 30, 2009 and March 31, 2009. Beginning in the first
quarter of 2009, we began reporting this liquidating portfolio
prospectively within our personal non-credit card portfolio.
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During the first quarter of 2009, $214 million of Consumer Lending
real estate secured receivables held for sale were reclassified to held
for investment.
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During the second quarter of 2009, $590 million of credit card
receivables held for sale were reclassified to held for
investment.
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Real estate secured receivables can be further analyzed as follows:
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Increases (Decreases) From
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(dollars are in millions)
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Total real estate secured(2)
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Receivable classification between fixed rate, adjustable rate, and
interest-only receivables is based on the classification at the time of
receivable origination and does not reflect any changes in the
classification that may have occurred as a result of any loan
modifications.
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Excludes receivables held for sale. Real estate secured receivables
held for sale included $41 million, $49 million and
$1.2 billion primarily of closed-end, first lien receivables at
June 30, 2009, March 31, 2009 and June 30, 2008,
respectively. During the first quarter of 2009, $214 million of
Consumer Lending real estate secured receivables held for sale were
reclassified to held for investment.
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The following table summarizes various real estate secured receivables information
(excluding receivables held for sale) for our Mortgage Services and Consumer
Lending businesses:
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Includes fixed rate interest-only receivables of $318 million,
$331 million and $376 million at June 30, 2009,
March 31, 2009 and June 30, 2008, respectively.
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Includes fixed rate interest-only receivables of $41 million,
$43 million and $47 million at June 30, 2009,
March 31, 2009 and June 30, 2008, respectively.
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Receivable classification between fixed rate, adjustable rate, and
interest-only receivables is based on the classification at the time of
receivable origination and does not reflect any changes in the
classification that may have occurred as a result of any loan
modifications which may have occurred.
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Receivable decreases since June 30, 2008
Real estate secured receivables decreased from the year-ago period. Lower
receivable balances in our Mortgage Services business reflect the continuing
liquidation of the portfolio. The lower real estate secured receivable levels in
our Consumer Lending business resulted from the actions taken since mid-2007 to
reduce risk going forward as well as the decision in late February 2009 to
discontinue new originations for all loan products in our Consumer Lending
operations. The balance of this portfolio will continue to decline going forward as
the receivable balances liquidate. The decreases in real estate secured receivables
were slowed in both our Mortgage Services and Consumer Lending businesses by a
decline in loan prepayments due to fewer refinancing opportunities for our
customers due to the previously discussed trends impacting the mortgage lending
industry.
Auto finance receivables decreased as a result of our decision to discontinue auto
loan originations in July 2008 as well as the transfer of $3.0 billion of
non-delinquent auto finance receivables to receivables held for sale during the
third quarter of 2008 which were subsequently sold to HSBC Bank
USA
. Additionally, during the second quarter of 2009, we transferred auto finance
receivables with a fair value of $450 million to receivables held for sale
because we no longer had the intent to hold them for the foreseeable future. The
balance of the auto finance portfolio will continue to decline going forward as the
receivable balances liquidate. Credit card receivables decreased due to the
transfer of the UP Portfolio to receivables held for sale during the fourth quarter
of 2008 which were subsequently sold to HSBC Bank USA, numerous actions taken to
slow receivable growth throughout 2008 and into 2009, including tightening initial
credit line sales authorization criteria, closing inactive accounts, decreasing
credit lines, tightening underwriting criteria, tightening cash access and reducing
marketing expenditures as well as lower consumer spending levels. We continue
limited direct marketing mailings and new customer account originations in portions
of our portfolio to maintain the value and functionality of our receivable
origination platform as well as to collect marketplace knowledge. However, we have
also identified certain segments of our credit card portfolio which have been the
most impacted by the current housing and economic conditions and have stopped all
new account originations in these market segments. As credit performance improves,
we will re-evaluate whether to resume direct marketing mailings and new customer
account originations for portions of our credit card receivable portfolio. These
actions have resulted in an on-going decline in our credit card receivable
portfolio. These decreases were partially offset by the transfer of
$590 million of credit card receivables previously held for sale to
receivables held for investment during the second quarter of 2009. Personal
non-credit card receivables decreased as a result of the actions taken throughout
2008 to reduce risk as well as the decision in late February 2009 to cease new
customer account originations for all products in our Consumer Lending business.
Receivable decreases since March 31, 2009
Real estate secured receivables have decreased since March 31, 2009. Our
Mortgage Services real estate secured portfolio and our auto finance receivable
portfolio have continued to liquidate during the second quarter of 2009. Lower real
estate secured receivables in our Consumer Lending business and personal non-credit
card receivables reflect the decision to discontinue new originations for all loan
products in late February 2009, as discussed above. The decreases in the real
estate secured portfolio were slowed by a decline in loan prepayments which has
continued during the second quarter of 2009. Decreases in our credit card
receivables were due to the aforementioned actions taken to reduce risk and lower
consumer spending levels, partially offset by the transfer of $590 million of
credit card receivables previously held for sale to receivables held for
investment.
Receivables Held for
Sale
As compared to the prior year quarter, the decrease largely reflects the sale of
our GM credit card portfolio and other real estate secured receivables which
were classified as held for sale. As compared to the prior quarter the decrease
reflects $590 million of credit card receivables transferred from receivables
held for sale to receivables held for investment at fair value, partially offset by
auto finance receivables with a fair value of $450 million which were
transferred to receivables held for sale in the second quarter of 2009 as we no
longer have the intent to hold these receivables for the foreseeable future.
We currently have no intent to execute bulk sales of our run-off receivables
portfolio beyond the auto finance receivables that we have classified as held for
sale. Market pricing continues to value the cash flows associated with these
receivables in the currently distressed market environment at amounts which are
significantly lower than what we as servicer believe will ultimately be realized
and we see no return to pricing that would typically be seen under more normal
marketplace conditions for the foreseeable future. Therefore, we have decided to
hold these run-off receivables for investment. However, should market pricing
improve in the future, our intent may change, which could result in the
reclassification of a significant portion of the run-off receivables into
receivables held for sale.
We obtain real estate by taking possession of the collateral pledged as security
for real estate secured receivables ("REO"). REO properties are made available for
sale in an orderly fashion with the proceeds used to reduce or repay the
outstanding receivable balance. The following table provides quarterly information
regarding our REO properties:
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Number of REO properties at end of period
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Number of properties added to REO inventory in the period
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Average loss on sale of REO properties(1)
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Average total loss on foreclosed properties(2)
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Average time to sell REO properties (in days)
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The average loss on sale of foreclosed properties is calculated based
on cash proceeds, after deducting selling costs, minus the unpaid loan
principal balance and any other ancillary amounts owed (e.g., real
estate tax advances). This amount is divided by the unpaid loan
principal balance plus any other ancillary amounts.
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The average total loss on foreclosed properties sold each quarter
includes both the loss on sale and the cumulative write-downs
recognized on the loans up to and upon classification as "Real Estate
Owned." This average total loss on foreclosed properties is expressed
as a percentage of the unpaid loan principal balance plus any other
ancillary amounts owed (e.g., real estate tax advances).
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The number of REO properties at June 30, 2009 decreased as compared to
March 31, 2009 due to continuing delays in processing foreclosures due to
backlogs in foreclosure proceedings as a result of actions by local governments and
actions of certain states that have lengthened the foreclosure process. The average
loss on sale of REO properties declined during the current quarter as the local
government delays in foreclosure have resulted in the receivables remaining on our
balance sheet longer and additional write-downs occurring prior to foreclosure. The
average total loss on foreclosed properties was essentially flat during the second
quarter as a result of some stabilization of home prices during the quarter.
Unless noted otherwise, the following discusses amounts reported in our
consolidated statement of loss for continuing operations.
Net interest income
The following table summarizes net interest income:
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(dollars are in millions)
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Three months ended June 30,
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Finance and other interest income
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Six months ended June 30,
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Finance and other interest income
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% Columns: comparison to average interest-earning assets.
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The decrease in net interest income during the quarter and year-to-date periods
were due to lower average receivables, lower origination volumes due to risk
mitigation efforts as well as lower consumer spending levels, lower levels of
performing receivables and lower overall yields on our receivable portfolio,
partially offset by lower interest expense. With the exception of credit card
receivables, yields on our receivable portfolio decreased for all products due to
increased levels of loan modifications, the impact of deterioration in credit
quality, including growth in non-performing assets, lower amortization of net
deferred fees due to lower loan prepayments and lower loan origination volumes as
well as decreases in rates on variable rate products which reflect market rate
movements, partially offset by the impact of interest rate floors in portions of
our credit card receivable portfolio. Overall yields were also negatively impacted
by a shift in mix to higher levels of real estate secured receivables as a result
of the sale of $12.4 billion and $3.0 billion of credit card and auto
finance receivables, respectively, in January 2009 as credit card and auto finance
receivables generally have higher yields than real estate secured receivables. The
higher yields on our credit card receivable portfolio during 2009 were due to a
significant shift in mix to higher levels of non-prime receivables which carry
higher rates as a result of the sale of GM and UP Portfolios. We also experienced
lower yields on our non-insurance investment portfolio reflecting lower rates on
overnight investments. The lower interest expense was due to lower average rates
for floating rate borrowings on lower average borrowings. The lower average rates
for floating rate borrowings reflect actions taken by the Federal Reserve Bank
which decreased short-term interest rates by 175 basis points since
June 30, 2008.
Net interest margin was 5.70 percent during the three months ended
June 30, 2009 compared to 6.47 percent in the prior year quarter. Net
interest margin was 5.79 percent during the six months ended June 30,
2009 compared to 6.39 percent in the prior year period. Net interest margin
decreased during both periods due to lower overall yields on our receivable
portfolio as discussed above, partially offset by lower funding costs. The
following table shows the impact of these items on net interest margin for the
three and six month periods:
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Net interest margin - Three months ended June 30, 2008 and
2007, respectively
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Impact to net interest margin resulting from:
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Impact of non-performing assets
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Non-insurance investment income
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Net interest margin - Three months ended June 30, 2009 and
2008, respectively
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Net interest margin - Six months ended June 30, 2008 and
2007, respectively
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Impact to net interest margin resulting from:
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Impact of non-performing assets
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Non-insurance investment income
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Net interest margin - Six months ended June 30, 2009 and
2008, respectively
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The varying maturities and repricing frequencies of both our assets and liabilities
expose us to interest rate risk. When the various risks inherent in both the asset
and the debt do not meet our desired risk profile, we use derivative financial
instruments to manage these risks to acceptable interest rate risk levels. See
"Risk Management" for additional information regarding interest rate risk and
derivative financial instruments.
Provision for credit losses
The following table summarizes provision for credit losses:
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(dollars are in millions)
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Three months ended June 30,
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Six months ended June 30,
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Our provision for credit losses decreased in both periods as a result of lower
provisions for credit losses in our Mortgage Services business as well as in our
credit card and auto finance receivable portfolios due to the following:
• Provision for credit losses in our Mortgage Services business decreased as
compared to the year-ago periods as the portfolio continues to become more fully
seasoned and run-off, resulting in lower charge-off levels. Additionally, there has
been a shift in the mix of charge-offs to first lien loans which generally have
lower loss severities than second lien loans. However, loss severities have
continued to increase due to declines in real estate values. Rising unemployment
rates in an increasing number of markets and continued deterioration in the
U.S.
economy were also significant factors partially offsetting the lower credit
loss provision.
• Provision for credit losses in our credit card receivable portfolio
decreased significantly in both periods due to lower receivable levels driven by
the impact of the sale of the GM and UP Portfolios to HSBC Bank
USA
in January 2009. However, excluding the impact of these transferred
portfolios, our provision for credit losses still remained lower due to lower
non-prime receivable levels as a result of actions taken throughout 2008 and into
2009 to reduce credit appetite and to slow receivable growth as well as lower
consumer spending levels. The transfer of $2.0 billion of non-prime
receivables to held for sale in June 2008 also contributed to lower provisions as
these portfolios were written down through other revenue. These lower credit loss
estimates have been partially offset by the continued deterioration in the
U.S.
economy and housing markets, portfolio seasoning, higher levels of personal
bankruptcy filings and lower recovery rates on defaulted receivables.
• Provision for credit losses in our auto finance receivable portfolio
decreased in both periods as a result of lower receivable levels reflecting the
discontinuation of auto finance originations as well as the sale of
$3.0 billion of non-delinquent auto finance receivables in January 2009 to
HSBC Bank
USA
as discussed above. Additionally, we have experienced lower loss severities
driven by improvements in prices on repossessed vehicles. The year-to-date period
was also impacted by the adoption of FFIEC charge-off policies during the first
quarter of 2009 which increased the provision for credit losses by
$36 million. The improvement was partially offset by continued deterioration
in the
U.S.
economy, including significantly higher unemployment rates.
The provision for credit losses in our Consumer Lending business increased during
both periods primarily in our first lien, real estate secured receivable portfolio
driven by an accelerated deterioration which began in the second half of 2007 for
portions of that portfolio. Charge-off and delinquency, including early stage
delinquency, continued to increase due to the marketplace deterioration as
previously discussed. Lower receivable prepayments, portfolio seasoning and higher
loss severities due to continued deterioration in real estate values also resulted
in a higher real estate secured credit loss provision, as did rising unemployment
rates in an increasing number of markets and continued deterioration in the
U.S.
economy. The higher delinquency trends continued to increase during the
second quarter of 2009, particularly in the first lien portions of Consumer
Lending's 2006 and 2007 real estate secured receivable originations and to a lesser
extent the real estate secured originations in the first half of 2008 due to the
current economic conditions, including higher early stage delinquency levels. As a
result, dollars of delinquency in our Consumer Lending real estate secured
receivable portfolio at June 30, 2009 were $6.5 billion, an increase of
135 percent, compared to $2.8 billion at June 30, 2008. Credit loss
estimates for Consumer Lending's personal non-credit card portfolio also increased
during the first half of 2009 due to higher levels of charge-off resulting from
deterioration in the 2006 and 2007 vintages which was more pronounced in certain
geographic regions and continued deterioration in the
U.S.
economy.
Net charge-off dollars totaled $2,518 million and $4,906 million during
the three and six months ended June 30, 2009, respectively, as compared to
$2,654 million and $5,019 million in the year-ago periods. Dollars of net
charge-offs in both periods were essentially flat as increases in net charge-offs
due to continued deterioration in the U.S. economy and housing markets, rising
unemployment rates, higher levels of personal bankruptcy filings and portfolio
seasoning were offset by the impact of lower receivable levels, a shift in mix to
higher levels of first lien loans which generally have lower loss severities than
second lien loans and local government delays in processing foreclosures. We
continue to experience delays in processing foreclosures due to backlogs in
foreclosure proceedings as a result of actions by local governments and actions of
certain states that have lengthened the foreclosure process. For further discussion
see "Credit Quality" in this Form 10-Q.
We anticipate delinquency will deteriorate and charge-off will increase during the
remainder of 2009. However, the magnitude of these negative trends in 2009 will
largely be dependent on the length and depth of the
U.S.
economic recession, including unemployment rates and to some extent will be
offset by the impact of actions we have already taken to reduce risk in these
portfolios.
Other revenue
The following table summarizes other revenues:
Three Months Ended June 30,
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(dollars are in millions)
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Gain (loss) on debt designated at fair value and related
derivatives
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Enhancement services revenue
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Taxpayer financial services revenue
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Gain on bulk sale of receivables to HSBC Bank
USA
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Gain on receivable sales to HSBC affiliates
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Servicing and other fees from HSBC affiliates
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Lower of cost or fair value adjustment on receivables held for
sale
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Six Months Ended June 30,
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(dollars are in millions)
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Gain (loss) on debt designated at fair value and related
derivatives
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Enhancement services revenue
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Taxpayer financial services revenue
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Gain on bulk sale of receivables to HSBC Bank
USA
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Gain on receivable sales to HSBC affiliates
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Servicing and other fees from HSBC affiliates
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Lower of cost or fair value adjustment on receivables held for
sale
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Insurance revenue
decreased during both periods as a result of lower credit related premiums due to
the decision in late February 2009 to discontinue all new customer account
originations in our Consumer Lending business. As a result of this decision, we
will no longer issue credit insurance policies in this business segment but will
continue to collect premiums on existing policies. The decreases in insurance
revenue were partially offset by growth in the simplified issue term life insurance
product that was introduced in 2007.
Investment income
includes income on securities available for sale in our insurance business,
realized gains and losses from the sale of securities and the recording of
other-than temporary impairment charges, as required. Other-than-temporary
impairment charges totaled $0 million and $20 million during the three
and six months ended June 30, 2009, respectively, as compared to
$9 million and $15 million in the year-ago periods. Excluding the impact
of other-than-temporary impairment charges from all periods, investment income
decreased in both periods due to lower yields and lower average investment
balances.
Derivative income
includes realized and unrealized gains and losses on derivatives which do not
qualify as effective hedges under derivative accounting principles as well as the
ineffectiveness on derivatives which are qualifying hedges. Derivative income is
summarized in the table below:
Three Months Ended June 30,
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Net realized gains (losses)
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Mark-to-market on derivatives which do not qualify as effective
hedges
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Six Months Ended June 30,
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Net realized gains (losses)
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Mark-to-market on derivatives which do not qualify as effective
hedges
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As previously discussed, the deterioration in marketplace and economic conditions
has resulted in our Consumer Lending and Mortgage Services real estate secured
receivables remaining on the balance sheet longer due to lower prepayment rates and
higher delinquency levels. To offset the increase in duration of these receivables
and the corresponding increase in interest rate risk as measured by the present
value of a basis point ("PVBP") we had $6.2 billion of non-qualifying pay
fixed, receive variable rate interest rate swaps outstanding during the current
quarter. While these hedge positions lowered our overall interest rate risk, they
did not qualify as effective hedges under derivative accounting principles. The
mark-to-market on derivatives which do not qualify as effective hedges were
positively impacted by rising long-term
U.S.
interest rates in the second quarter of 2009. The results of these
non-qualifying hedges in the first six months of 2009 did, however, negatively
impact net realized losses as short-term interest rates fell. The increase in
ineffectiveness is primarily driven by changes in the market value of our cross
currency cash flow hedges due to the increase in
U.S.
and foreign interest rates in the second quarter of 2009.
Designation of swaps as effective hedges reduces the volatility that would
otherwise result from mark-to-market accounting. All derivatives are economic
hedges of the underlying debt instruments regardless of the accounting treatment.
Net income volatility, whether based on changes in interest rates for swaps which
do not qualify for hedge accounting or ineffectiveness recorded on our qualifying
hedges under the long haul method of accounting, impacts the comparability of our
reported results between periods. Accordingly, derivative income for the six months
ended June 30, 2009 should not be considered indicative of the results for any
future periods.
Gain (loss) on debt designated at fair value and related derivatives
reflects fair value changes on our fixed rate debt accounted for under FVO as well
as the fair value changes and realized gains (losses) on the related derivatives
associated with debt designated at fair value. These components are summarized in
the table below:
Three Months Ended June 30,
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Mark-to-market on debt designated at fair value(1):
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Total mark-to-market on debt designated at fair value
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Mark-to-market on the related derivatives
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Net realized gains on the related derivatives
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Six Months Ended June 30,
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Mark-to-market on debt designated at fair value(1):
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Total mark-to-market on debt designated at fair value
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Mark-to-market on the related derivatives
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Net realized gains on the related derivatives
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Mark-to-market on debt designated at fair value and related derivatives
excludes market value changes due to fluctuations in foreign currency
exchange rates. Foreign currency translation gains (losses) recorded in
derivative income associated with debt designated at fair value was a
loss of $(188) million and a gain of $41 million for the
three months ended June 30, 2009 and 2008, respectively. Foreign
currency translation gains (losses) was a gain of $8 million and a
loss of $(305) million for the six months ended June 30, 2009
and 2008, respectively. Offsetting gains (losses) recorded in
derivative income associated with the related derivatives was a gain of
$188 million and a loss of $(41) million for the three months
ended June 30, 2009 and 2008, respectively, and a loss of
$(8) million and a gain of $305 million for the six months
ended June 30, 2009 and 2008, respectively.
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The change in the fair value of the debt and the change in value of the related
derivatives reflect the following:
•
Interest rate curve -
In the second quarter of 2009, the U.S. LIBOR curve continued to steepen as
interest rates with one year terms or less remained low while interest rates for
terms greater than two years increased. This resulted in gains in the interest rate
component of the mark-to-market on debt designated at fair value and losses on
mark-to-market on the related derivatives in the current quarter and for the
year-to-date period. In the second quarter of 2008, rising long term
U.S. interest rates resulted in a gain in the interest rate component on debt
designated at fair value and a decrease in the value of receive fixed/pay variable
swaps. By the end of the second quarter of 2008,
U.S.
interest rates were at approximately the same level as at the start of 2008,
and the gains recorded during the second quarter of 2008 were offset by the losses
recorded during the first quarter of 2008. Changes in the value of the interest
rate component of the debt as compared to the related derivative are also affected
by the differences in cash flows and valuation methodologies for the debt and
related derivative. Cash flows on debt are discounted using a single discount rate
from the bond yield curve while derivative cash flows are discounted using rates at
multiple points along the LIBOR yield curve. The impacts of these differences vary
as short-term and long-term interest rates change relative to each other.
Furthermore, certain derivatives have been called by the counterparty resulting in
certain FVO debt having no related derivatives which increases the net difference
between the change in the value of the interest rate component of the debt and the
change in the value of the derivatives. Income from net realized gains increased
due to reduced short term
U.S.
interest rates.
•
Credit -
Our credit spreads tightened significantly in the second quarter of 2009. This
tightening exceeded the widening that was experienced in the first quarter of 2009
due to general market conditions and credit rating downgrades in early March 2009
following the announcement of the discontinuation of all new customer account
originations in our Consumer Lending business and closure of the Consumer Lending
branch offices. Changes in the credit risk component of the debt during the second
quarter of 2008 were impacted by a tightening of our credit spreads. The tightening
of credit spreads during the second quarter of 2008 was a partial reversal of a
general widening of credit spreads experienced in the first quarter of 2008 as new
issue and secondary bond market credit spreads across all domestic bond market
sectors narrowed as well as a general lack of liquidity in the secondary bond
market during the period. The fair value benefit from the change of our credit
spreads is a result of having historically raised debt at credit spreads which are
not available under today's market conditions.
Net income volatility, whether based on changes in either the interest rate or
credit risk components of the mark-to market on debt designated at fair value and
the related derivatives, impacts the comparability of our reported results between
periods. Accordingly, gain on debt designated at fair value and related derivatives
for the six months ended June 30, 2009 should not be considered indicative of
the results for any future periods.
Fee income,
which includes revenues from fee-based products such as credit cards, decreased in
both periods primarily as a result of the sale of the GM and UP Portfolios as
previously discussed, higher fee charge-offs due to increased loan defaults and
lower late, overlimit and interchange fees due to lower volumes and customer
behavior changes.
Enhancement services revenue,
which consists of ancillary credit card revenue from products such as Account
Secure Plus (debt protection) and Identity Protection Plan, decreased in both
periods primarily as a result of the sale of the GM and UP Portfolios as previously
discussed as well as the impact of lower new origination volumes.
Taxpayer financial services ("TFS") revenue
decreased in both periods as H&R Block was the only third-party preparer during
the 2009 tax season with whom we had an on-going relationship and a shift in mix to
lower revenue and lower risk products.
Gain on bulk sale of receivables to HSBC Bank USA
for the six months ended June 30, 2009 reflects the gain on sale of the GM and
UP Portfolios, with an outstanding receivable balance of $12.4 billion, at the
time of sale, and $3.0 billion of auto finance receivables to HSBC Bank
USA
in January 2009. This gain was partially offset by a loss recorded on the
termination of cash flow swaps associated with $6.1 billion of indebtedness
transferred to HSBC Bank
USA
as part of these transactions.
Gain on receivable sales to HSBC affiliates
consists primarily of daily sales of private label receivable originations and
certain credit card account originations to HSBC Bank
USA
. The increase in both periods is primarily a result of higher sales volumes as a
result of the sales of new receivable originations in the GM and UP Portfolios
beginning in January 2009.
Servicing and other fees from HSBC affiliates
represents revenue received under service level agreements under which we service
credit card and private label receivables as well as real estate secured and auto
finance receivables for HSBC affiliates. The increases in both periods primarily
relate to higher levels of receivables being serviced on behalf of HSBC Bank
USA
as a result of the sale of the GM and UP Portfolios as well as certain auto
finance receivables in January 2009 which we continue to service.
Lower of cost or fair value adjustment on receivables held for sale
for the three months ended June 30, 2009 includes a lower of cost or fair
value adjustment of $10 million resulting from the transfer of auto finance
receivables with a fair value of $450 million previously held for investment
to receivables held for sale. Additionally, the current year periods also reflect
the impact of current market conditions on pricing for credit card receivables held
for sale which resulted in additional lower of cost or fair value adjustments of
$163 million and $333 million during the three months and six months
ended June 30, 2009, respectively. During the second quarter of 2008, we
transferred $9,042 million of real estate secured and credit card receivables
previously held for investment to receivables held for sale, resulting in a lower
of cost or fair value adjustment of $194 million.
Other income
decreased during the three months ended June 30, 2009 as a result of lower
gains on miscellaneous asset sales, including real estate investments. In addition,
the year-ago period included a gain of $11 million related to the sale of a
portion of our Visa Class B shares as well as higher securitization related
revenue as we repaid the remaining securitized credit card receivable trust in
February 2008.
The following table summarizes total costs and expenses:
Three Months Ended June 30,
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(dollars are in millions)
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Salaries and employee benefits
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Occupancy and equipment expenses
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Real estate owned expenses
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Other servicing and administrative expenses
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Support services from HSBC affiliates
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Amortization of intangibles
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Goodwill and other intangible asset impairment charges
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Six Months Ended June 30,
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(dollars are in millions)
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Salaries and employee benefits
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Occupancy and equipment expenses
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Real estate owned expenses
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Other servicing and administrative expenses
|
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Support services from HSBC affiliates
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Amortization of intangibles
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Goodwill and other intangible asset impairment charges
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Salaries and employee benefits
for the year-to-date period included severance costs of $74 million and
$3 million relating to accelerated stock based compensation and other
benefits, partially offset by a $16 million curtailment gain related to
post-retirement benefit, primarily related to the decision in late February 2009 to
discontinue all new customer account originations in our Consumer Lending business
and close the Consumer Lending branch offices. Excluding the severance costs
related to this decision from the year-to-date period, salaries and employee
benefits were even lower reflecting the reduced scope of our business operations,
including the change in headcount from the strategic decisions implemented
throughout 2008, the impact of entity-wide initiatives to reduce costs as well as
lower salary costs derived from an increase in customer service, systems,
collections and accounting services provided by an HSBC affiliate located outside
the U.S. Partially offsetting these decreases were higher salary expense
resulting from increased collection capacity.
Sales incentives
decreased in both periods due to lower origination volumes in our Consumer Lending
business resulting from the changes in product offerings and the tightening of
underwriting criteria throughout 2008, the economic and market conditions described
above and the decision in late February 2009 to discontinue all new customer
account originations in our Consumer Lending business.
Occupancy and equipment expenses
for the year-to-date period included lease termination and associated costs of
$54 million and write-offs of fixed asset and other capitalized costs of
$29 million related to the decision in late February 2009 to close
substantially all of the Consumer Lending branch offices. Excluding the impact of
these items, occupancy and equipment expenses were lower in both periods as a
result of the reduction of the scope of our business operations since June 2008.
Other marketing expenses
include payments for advertising, direct mail programs and other marketing
expenditures. The decrease in marketing expense in both periods reflects the
decision to continue to reduce credit card and personal non-credit card receivable
marketing expenses in an effort to reduce risk and slow receivable growth in these
portfolios as well as the decision in late February 2009 to discontinue
originations of personal non-credit card receivables.
Real estate owned expenses
decreased in three and six months ended June 30, 2009 as a result of lower
levels of real estate owned due to local government delays in foreclosure
proceedings as certain states and municipalities have implemented new rules which
lengthen the foreclosure process, partially offset by higher average loss on sale
of REO properties.
Other servicing and administrative expenses
decreased during both periods primarily as a result of the reduction of the scope
of our business operations since June 2008. These decreases were partially offset
by lower origination cost deferrals due to lower origination volumes, higher third
party collection costs and for the year-to-date period, the write-off of
miscellaneous assets related to the decision in late February 2009 to close
substantially all of the Consumer Lending branch offices.
Support services from HSBC affiliates
includes technology and some centralized operational services and beginning in
January 2009, human resources, corporate affairs and other shared services charged
to us by HTSU which were previously recorded in salaries and employee benefits.
Support services from HSBC affiliates also includes services charged to us by an
HSBC affiliate located outside of the United States which provides operational
support to our businesses, including among other areas, customer service, systems,
collection and accounting functions. Support services from HSBC affiliates
increased during the three months and six months ended June 30, 2009 as a
result of the human resources, corporate affairs and other shared services which
began being provided by HTSU in January 2009, partially offset by a reduction in
support services due to reducing the scope of our business operations.
Amortization of intangibles
decreased in both periods due to lower amortization for technology and customer
lists due to the write off of a portion of these intangibles as a result of the
decision in late February 2009 to discontinue all new customer account originations
for all products in our Consumer Lending business. Additionally, lower amortization
of intangibles in the year-to-date period reflects amortization on retail sales
merchant agreements which became fully amortized during the first quarter of 2008.
Policyholders' benefits
decreased during the three months ended June 30, 2009 due to lower life and
disability claims on credit insurance policies as a result of fewer life and
disability polices as we are no longer issuing these policies in the Consumer
Lending business as discussed above. The decreases were partially offset by higher
unemployment claims due to rising unemployment rates during the quarter and higher
claims incurred on the simplified issue term life product due to growth in this
product offering as discussed above. Policyholders' benefits were flat during the
six months ended June 30, 2009 as decreases during the year-to-date period in
life and disability policies discussed above were offset by the impact of rising
unemployment rates and growth in the simplified issue term life insurance product.
Goodwill and other intangible asset impairment charges
for the six months ended June 30, 2009 includes goodwill impairment charges of
$2.3 billion representing all of the goodwill previously allocated to our Card
and Retail Services and Insurance Services businesses. Of this amount,
$1.6 billion of goodwill impairment charges were recorded during the second
quarter of 2009 due to a significant reduction in estimated future cash flows in
our Card and Retail Services business as a result of continued deterioration in
economic and credit conditions, including rising unemployment rates, as well as the
consideration of various legislation and regulatory actions. See Note 10,
"Goodwill," in the accompanying consolidated financial statements for further
discussion of the goodwill impairment. Additionally during the first quarter of
2009, we recorded impairment charges of $14 million for intangible assets
associated with our Consumer Lending business as a result of our decision to
discontinue new customer account originations for all products. See Note 4,
"Strategic Initiatives," and Note 9, "Intangible Assets," in the accompanying
consolidated financial statements for further discussion of the impairment.
Efficiency ratio
The following table summarizes our efficiency ratio:
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Three months ended June 30,
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Six months ended June 30,
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Our efficiency ratio in both periods was significantly impacted by the change in
the fair value of debt for which we have elected fair value option reporting and
the related derivatives and the goodwill and intangible asset impairment charges
recorded during the three and six months ended June 30, 2009, as discussed
above. Excluding these items in the quarters, our efficiency ratio improved 319
points during the second quarter of 2009 as a result of lower salary expense,
marketing expense and sales incentives as well as the impact of entity-wide
initiatives to reduce costs which resulted in operating expenses decreasing more
rapidly than net interest income and fee income. Excluding these items in the
year-to-date periods, our efficiency ratio deteriorated 423 points during the six
months ended June 30, 2009 primarily as a result of the restructuring charges
recorded in the first quarter of 2009 as previously discussed. Additionally,
deterioration in the year-to-date period reflects net interest income and fee
income decreasing at a more rapid pace than operating expenses prior to the
discontinuation of Consumer Lending new customer account originations and branch
closures.
Segment Results - IFRS Management Basis
We have two reportable segments: Card and Retail Services and Consumer. Our
segments are managed separately and are characterized by different middle-market
consumer lending products, origination processes and locations. Our segment results
are reported on a continuing operations basis.
Our Card and Retail Services segment includes our MasterCard, Visa, private label
and other credit card operations. The Card and Retail Services segment offers these
products throughout the
United States
primarily via strategic affinity and co-branding relationships, merchant
relationships and direct mail. Products are also offered and customers serviced
through the Internet.
Our Consumer segment consists of our run-off Consumer Lending, Mortgage Services
and Auto Finance businesses. The Consumer segment provided real estate secured,
auto finance and personal non-credit card loans. Loans were offered with both
revolving and closed-end terms and with fixed or variable interest rates. Loans
were originated through branch locations and direct mail. Products were also
offered and customers serviced through the Internet. Prior to the first quarter of
2007, we acquired loans through correspondent channels and prior to September 2007
we also originated loans sourced through mortgage brokers.
The "All Other" caption includes our Insurance, Taxpayer Financial Services and
Commercial businesses, each of which falls below the quantitative threshold tests
under segment reporting rules, for determining reportable segments, as well as our
corporate and treasury activities, which includes the impact of FVO debt. Certain
fair value adjustments related to purchase accounting resulting from our
acquisition by HSBC and related amortization have been allocated to Corporate,
including goodwill arising from our acquisition by HSBC, which is included in the
"All Other" caption within our segment disclosure.
In the first quarter of 2009, we began allocating a majority of the costs of our
corporate and treasury activities to our reportable segments. These allocated costs
had previously not been considered in determining segment profit (loss) and are now
reported as intersegment revenues in the "All Other" caption and operating expenses
for our reportable segments. There have been no other changes in our measurement of
segment profit (loss) and there have been no changes in the basis of segmentation
as compared with the presentation in our 2008 Form 10-K.
We report results to our parent, HSBC, in accordance with its reporting basis,
IFRSs. Our segment results are presented on an IFRS Management Basis (a
non-U.S. GAAP financial measure) as operating results are monitored and
reviewed, trends are evaluated and decisions about allocating resources such as
employees are made almost exclusively on an IFRS Management Basis. IFRS Management
Basis results are IFRSs results which assume that the GM and UP credit card
Portfolios and the auto finance, private label, real estate secured receivables
transferred to HSBC Bank USA have not been sold and remain on our balance sheet and
the revenues and expenses related to these receivables remain on our income
statement. IFRS Management Basis also assumes that the purchase accounting fair
value adjustments relating to our acquisition by HSBC have been "pushed down" to
HSBC Finance Corporation. Operations are monitored and trends are evaluated on an
IFRS Management Basis because the receivable sales to HSBC Bank
USA
were conducted primarily to fund prime customer loans more efficiently
through bank deposits and such receivables continue to be managed and serviced by
us without regard to ownership. However, we continue to monitor capital adequacy,
establish dividend policy and report to regulatory agencies on a U.S. GAAP
legal entity basis. A summary of the significant differences between U.S. GAAP
and IFRSs as they impact our results are summarized in Note 16, "Business
Segments," in the accompanying consolidated financial statements.
Card and Retail Services Segment
The following table summarizes the IFRS Management Basis results for our Card and
Retail Services segment:
Three Months Ended June 30,
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(dollars are in millions)
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Operating expenses, excluding goodwill impairment charges
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Profit (loss) before tax and goodwill impairment charges
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Goodwill impairment charges(1)
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Net interest margin, annualized
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Six Months Ended June 30,
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(dollars are in millions)
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Operating expenses, excluding goodwill impairment charges
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Profit (loss) before tax and goodwill impairment charges
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Goodwill impairment charges(1)
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Net interest margin, annualized
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Goodwill impairment charges of $530 million recorded during the
three months ended June 30, 2009 were not deductible for tax
purposes.
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Our Card and Retail Services segment reported a net loss for the three and six
months ended June 30, 2009 as compared to net income for the year-ago periods.
The net loss in 2009 was significantly impacted by goodwill impairment charges of
$530 million (after-tax) during the three months ended June 30, 2009
relating to goodwill which had been established subsequent to our acquisition by
HSBC in 2003 and was recorded directly to the balance sheet of our Card and Retail
Service segment. Additional goodwill impairment charges of $770 million
(after-tax) and $2.4 billion (after-tax) during the three and six months ended
June 30, 2009, respectively, related to our acquisition by HSBC in 2003 was
recorded in the "All Other" caption as this goodwill was recorded at corporate and
was allocated to our businesses only for purposes of goodwill impairment testing.
Excluding the goodwill impairment charges, net income was lower in both periods due
to lower other operating income, partially offset by lower operating expenses,
higher net interest income and for the three months ended June 30, 2009, lower
loan impairment charges. For the six months ended June 30, 2009, loan
impairment charges were higher as compared to the year-ago period.
Loan impairment charges were higher during the six months ended June 30, 2009
due to higher delinquency and charge-off levels as a result of portfolio seasoning,
increased levels of personal bankruptcy filings, continued deterioration in
the
U.S.
economy including rising unemployment rates and lower recovery rates on
defaulted loans. The higher credit loss estimates in the year-to-date period were
partially offset by lower customer loan levels as a result of actions taken
throughout 2008 and into 2009 to reduce credit appetite and to slow receivable
growth and lower consumer spending levels. Lower loan impairment charges during the
three months ended June 30, 2009 were driven by the lower customer loan levels
discussed above as well as declines in delinquency levels during the quarter. Lower
delinquency levels reflect lower loan levels, an extended seasonal benefit of
increased cash available to consumers as a result of various government economic
stimulus actions and lower energy costs, as well as higher levels of personal
bankruptcy filings during the first half of 2009 which results in accounts
migrating to charge-off more quickly. During the first half of 2009, we decreased
credit loss reserves to $4.3 billion as loan impairment charges were
$59 million lower than net charge-offs. During the first half of 2008, we
increased credit loss reserves to $3.6 billion as loan impairment charges were
$249 million greater than net charge-offs.
Net interest income increased in both periods due to lower interest expense,
partially offset by lower interest income. The lower interest income reflects the
impact of lower overall loan levels partially offset in the three month period by
higher yields. Yields were higher during the three months ended June 30, 2009
as a result of repricing initiatives as well as the impact of interest rate floors
in portions of the loan portfolio. Loan yields during the year-to-date period were
essentially flat as the impact of repricing initiatives and interest rate floors
during the first half of 2009 was offset by the impact of deterioration in credit
quality. Net interest margin increased during both periods primarily due to a lower
cost of funds and repricing initiatives as well as the impact of interest rate
floors in portions of the loan portfolio during the first half of 2009, partially
offset by the impact of deterioration in credit quality. The decrease in other
operating income in both periods was primarily due to lower cash advance,
interchange fees, late fees and enhancement services revenue due to lower volumes
and changes in customer behavior. Excluding the goodwill impairment charge
discussed above, operating expenses decreased in both periods due to lower
marketing expenses in our effort to slow receivable growth in our credit card
receivable portfolio as well as lower salary expenses. These decreases were
partially offset by $8 million in restructuring costs recorded as a result of
our decision in the second quarter of 2009 to close and consolidate additional
facilities. See Note 4, "Strategic Initiatives," in the accompanying
consolidated financial statements for additional information on this decision.
ROA decreased during both periods primarily due to the goodwill impairment charge
and for the six months ended June 30, 2009, higher loan impairment charges as
discussed above, partially offset by lower average assets.
On May 22, 2009, the Credit Card Accountability Responsibility and Disclosure
Act of 2009 (the "CARD Act") was signed into law. The CARD Act modifies and expands
upon the amendments to Regulation AA (Unfair or Deceptive Acts or Practices)
("UDAP") and Regulation Z (Truth in Lending) adopted by the Federal Reserve in
December 2008, which among other things, place restrictions on applying interest
rate increases on new and existing balances, require changes to deferred interest
plans, prescribe the manner in which payments in excess of the minimum payment may
be allocated to amounts due and penalty rates may be charged on past due balances,
and limits certain fees. Most of the requirements of the CARD Act become effective
in February 2010, however, some provisions will become effective in August 2009 and
a few will not become effective until August 2010. New restrictions introduced by
the CARD Act include requiring customers to opt-in to over limit fee assessments
and requiring re-priced accounts be evaluated for interest rate decreases every six
months. The CARD Act also requires the Federal Reserve to conduct rulemaking to
ensure penalty fees are reasonable and requires other government agencies to
conduct studies on interchange, debt cancellation agreements and credit insurance
products and present reports to Congress on these topics. Although we are already
compliant with some provisions, other provisions such as those addressing
limitations on interest rate increases, over limit fees and payment allocation will
require us to make changes to our business practices. This may require us and our
competitors to manage risk differently than has historically been the case.
Potential pricing, underwriting and product changes in response to the new
legislation are under analysis. We are currently in the process of making changes
to processes and systems to comply with the new rules and will be fully compliant
by the applicable effective dates. Although we currently believe the implementation
of these new rules is likely to have a material adverse financial impact to us, the
full impact of the CARD Act on us at this time is uncertain as it ultimately
depends upon the Federal Reserve and other government agencies interpretations of
some of the provisions discussed above, successful implementation of our
strategies, consumer behavior and the actions of our competitors.
In July 2009, the Office of the Comptroller of the Currency ("OCC") advised HSBC
Bank
Nevada
, N.A. that it issued Examiner Guidance for Appropriate Minimum Payment
Requirements in Credit Card Lending. The guidance sets forth the requirements that
national bank credit card issuers should require a minimum payment from the
borrower for all credit card programs, thereby no longer allowing "no payment"
promotional financing. We currently are in discussions with the OCC to determine
the scope and effective date of this guidance. However, if adopted in its broadest
terms, our preliminary analysis indicates that the impact of the guidance could be
material to the Retail Services business.
On June 1, 2009, General Motors announced its plan to restructure, filing for
bankruptcy protection under the Chapter 11 reorganization provisions. While we
provide credit under the GM Card Program, GM owns and operates the Earnings/Rewards
Program. Concurrently with its bankruptcy filing, GM filed a motion with the
bankruptcy court requesting authority to honor the GM Card Program in the ordinary
course of business, including allowing the continued redemption of earned rewards
points as well as authorizing the continued performance by GM under the card
agreements. The court approved this motion on June 2, 2009. We have been
advised that GM intends to continue the GM Card program and have asked the court to
approve the assignment and assumption of the GM Card Agreement to the New GM. In
July 2009, the bankruptcy court approved GM's plan to transfer substantially all of
GM's assets to New GM, and GM was granted permission to exit from bankruptcy.
Customer loans for our Card and Retail Services segment can be analyzed as follows:
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Compared to June 30, 2008, customer loans decreased 12 percent due to the
actions taken throughout 2008 to slow receivable growth, including tightening
initial credit line sales authorization criteria, closing inactive accounts,
decreasing credit lines, tightening underwriting criteria, tightening cash access
and reducing marketing expenditures as well as lower consumer spending levels. We
continue limited direct marketing mailings and new customer account originations in
portions of our non-prime portfolio to maintain the value and functionality of our
receivable origination platform as well as to collect marketplace knowledge.
However, we have also identified certain segments of our credit card portfolio
which have been the most impacted by the current housing and economic conditions
and have stopped all new account originations in these market segments. As credit
performance improves, we will re-evaluate whether to resume direct marketing
mailings and new customer account originations for portions of our credit card
receivable portfolio. These actions have resulted in an on-going decline in our
non-prime credit card receivable portfolio. Lower private label receivable levels
also reflect the termination of unprofitable retail partners.
Customer loans decreased 4 percent to $41.0 billion at June 30, 2009
compared to $42.9 billion at March 31, 2009, primarily due to the actions
taken to reduce receivable growth and lower consumer spending levels as discussed
above.
The following is additional key performance data related to our Card and Retail
Services portfolios. The information is based on IFRS Management Basis results.
Our Cards and Retail Services portfolios consist of three key segments. The
non-prime portfolios are primarily originated through direct mail channels (the
"Non-prime Portfolio"). The prime portfolio consists of General Motors, Union
Privilege and Retail Services receivables (the "Prime Portfolio"). These
receivables are primarily considered prime at origination, however the credit
profile of some customers will subsequently change due to changes in customer
circumstances. The other portfolio is comprised of several run-off portfolios and
alternative marketing programs such as third party turndown programs (the "Other
Portfolio"). The Other Portfolio includes certain adjustments not allocated to
either the Non-prime or Prime Portfolios. The Other Portfolio contains both prime
and non-prime receivables.
The following table includes key financial metrics for our Card and Retail Services
business:
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As previously discussed, customer loans have decreased by 12 percent as
compared to the prior year quarter. The Prime Portfolio has decreased at a slower
rate than the Non-prime Portfolio due to the need to maintain approval rates as a
result of merchant obligations and absolute levels of charge-offs.
Net interest margin for both the Non-prime and Prime Portfolios remains strong,
primarily due to lower cost of funds, lower promotional balances, incremental
pricing actions and the impact of interest rate floors in portions of the loan
portfolio.
While we have seen deterioration in performance across the Cards and Retail
Services segment as compared to the prior year quarter, the Non-prime Portfolio
performance has deteriorated to a lesser degree through this stage of the economic
cycle. Delinquency in the Non-prime Portfolio has deteriorated at a lower rate than
our Prime Portfolio as non-prime customers typically have lower home ownership,
smaller credit lines which have lower minimum payment requirements and lower
incidences of interest rate increases and credit line decreases. Dollars of net
charge-offs in the Non-prime Portfolio have also deteriorated at a lower rate than
our Prime Portfolio. However, due to the more rapid decrease in the average loan
balance in the Non-prime Portfolio as compared to the Prime Portfolio, the
deterioration in the net charge-off ratio has been similar.
The trends discussed above are at a point in time. Given the volatile economic
conditions, there can be no certainty such trends will continue in the future.
Consumer Segment
The following table summarizes the IFRS Management Basis results for our Consumer
segment:
Three Months Ended June 30,
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Net interest margin, annualized
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Six Months Ended June 30,
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Net interest margin, annualized
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Our Consumer segment reported a higher net loss during the three and six months
ended June 30, 2009 due to lower net interest income and higher loan
impairment charges, partially offset by lower operating expenses and higher other
operating income.
Loan impairment charges in both periods reflect higher credit loss estimates in our
Consumer Lending loan portfolios, partially offset by lower loan impairment charges
in our Mortgage Services loan portfolio as this portfolio continues to become more
fully seasoned and run-off as we discontinued originations in this portfolio in
2007. Additionally, there has been a shift in mix of charge-offs in our Mortgage
Services loan portfolio to first lien loans which generally have lower loss
severities than second lien loans. Loan impairment charges in our Consumer Lending
business increased during both periods primarily in our first lien, real estate
secured loan portfolio driven by an accelerated deterioration which began in the
second half of 2007 for portions of that portfolio. Charge-off and delinquency,
including early stage delinquency, continued to increase due to the marketplace
deterioration as previously discussed. Credit loss estimates for Consumer Lending's
personal non-credit card portfolio also increased during the first half of 2009 due
to higher levels of charge-off resulting from deterioration in the 2006 and 2007
vintages which was more pronounced in certain geographic regions and continued
deterioration in the
U.S.
economy. Both our Consumer Lending and Mortgage Services loan portfolios were
negatively impacted by portfolio seasoning, rising unemployment rates and continued
deterioration in the
U.S.
economy as well as lower loan prepayments and higher loss severities due to
continued deterioration in real estate values in our real estate secured loan
portfolios. During the first half of 2009, credit loss reserves increased as loan
impairment charges were $603 million greater than net charge-offs. During the
first half of 2008, credit loss reserves increased as loan impairment charges were
$755 million greater than net charge-offs.
The decrease in net interest income was due to lower average customer loans, lower
origination volumes, lower levels of performing receivables and lower overall
yields partially offset by lower interest expense. Overall yields decreased due to
the impact of deterioration in credit quality, including growth in non-performing
assets, increased levels of loan modifications, and lower amortization of net
deferred fees due to lower loan prepayments and lower origination volumes. The
decrease in net interest margin was primarily a result of lower overall yields as
discussed above. Other operating income increased primarily due to lower losses on
sales of REO properties, partially offset by lower credit insurance commissions.
Operating expenses for the six months ended June 30, 2009 also included
$139 million of costs, net of a curtailment gain of $34 million related
to other post-retirement benefits, related to the decision to discontinue new
originations for all products in our Consumer Lending business and close the
Consumer Lending branch offices. In addition, we were required to perform an
interim intangible asset impairment test for our remaining Consumer Lending
intangible asset which resulted in an impairment charge of $5 million during
the six months ended June 30, 2009. See Note 4, "Strategic Initiatives,"
in the accompanying consolidated financial statements for additional information.
Operating expenses decreased during both periods due to the reductions in the scope
of our business operations as well as other cost containment measures, and lower
REO expenses for the six months ended June 30, 2009.
The decrease in the ROA ratio during the three and six months ended June 30,
2009 was primarily due to lower net interest income and for the year-to-date
period, higher loan impairment charges as discussed above, partially offset by
lower average assets.
Government sponsored programs in the mortgage lending environment have recently
been introduced which are focused on reducing the number of foreclosures and making
it easier for customers to refinance loans. One such program intends to help
certain at-risk homeowners avoid foreclosure by reducing monthly mortgage payments.
This program provides certain incentives to lenders to modify all eligible loans
that fall under the guidelines of the program. Another program focuses on
homeowners who have a proven payment history on an existing mortgage owned by
Fannie Mae or Freddie Mac and provides assistance to eligible homeowners to
refinance their mortgage loans to take advantage of current lower mortgage rates or
to refinance adjustable rate mortgages into more stable fixed rate mortgages. We
continue to evaluate whether we will help our customers address financial
challenges through these government programs or through our own home preservation
programs.
Customer loans for our Consumer segment can be analyzed as follows:
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Real estate secured receivables are comprised of the following:
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Total real estate secured
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Private label receivables consisted primarily of the liquidating retail
sales contracts in our Consumer Lending business with a receivable
balance of $28 million and $37 million as of June 30,
2009 and March 31, 2009. Beginning in the first quarter of 2009,
we began reporting this liquidating portfolio prospectively within our
personal non-credit card portfolio.
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Customer loans decreased 18 percent to $90.2 billion at June 30,
2009 as compared to $109.8 billion at June 30, 2008. Real estate secured
receivables decreased from the year-ago period. Lower receivable balances in our
Mortgage Services business reflect the continuing liquidation of the portfolio. The
lower real estate secured receivable levels in our Consumer Lending business
resulted from the actions taken throughout 2008 to reduce risk going forward as
well as the decision in late February 2009 to discontinue all new originations for
all loan products in our Consumer Lending operations. The decrease in real estate
secured receivables was partially offset by a continued decline in loan prepayments
due to fewer refinancing opportunities for our customers due to the trends
impacting the mortgage lending industry. Our auto finance portfolio decreased as a
result of the transfer of $833 million to receivables held for sale as we no
longer have the intent to hold these receivables for the foreseeable future as well
as decisions made in 2008 to reduce and ultimately discontinue new auto loan
originations. Personal non-credit card receivables decreased as a result of the
actions taken throughout 2008 to reduce risk and limit growth going forward.
Additionally as previously discussed, originations of personal non-credit card
receivables have been terminated as a result of the decision in late February 2009
to discontinue originations of all products in our Consumer Lending business.
Customer loans decreased 6 percent at June 30, 2009 as compared to
$95.7 billion at March 31, 2009. Real estate secured receivables have
decreased since March 31, 2009. As discussed above, our Mortgage Services real
estate secured portfolio has continued to liquidate. Lower real estate secured and
personal non-credit card receivables in our Consumer Lending business reflect the
decision to discontinue new originations for all loan products in late February
2009, as discussed above. These decreases in the real estate secured portfolio were
partially offset by a decline in loan prepayments as discussed above. Decreases in
our auto finance portfolio reflect the decision to terminate new auto loan
originations as previously discussed.
See "Receivables Review" for a more detail discussion of the decreases in our
receivable portfolios.
We maintain credit loss reserves to cover probable losses of principal, interest
and fees, including late, overlimit and annual fees. Credit loss reserves are based
on a range of estimates and are intended to be adequate but not excessive. We
estimate probable losses for consumer receivables using a roll rate migration
analysis that estimates the likelihood that a loan will progress through the
various stages of delinquency, or buckets, and ultimately charge-off based upon
recent historical performance experience of other loans in our portfolio. This
analysis considers delinquency status, loss experience and severity and takes into
account whether loans are in bankruptcy, have been re-aged or rewritten, or are
subject to forbearance, an external debt management plan, hardship, modification,
extension or deferment. Our credit loss reserves take into consideration the loss
severity expected based on the underlying collateral, if any, for the loan in the
event of default. Delinquency status may be affected by customer account management
policies and practices, such as the re-age of accounts, forbearance agreements,
extended payment plans, modification arrangements, external debt management
programs and deferments. When customer account management policies or changes
thereto, shift loans from a "higher" delinquency bucket to a "lower" delinquency
bucket, this will be reflected in our roll rate statistics. To the extent that
re-aged or modified accounts have a greater propensity to roll to higher
delinquency buckets, this will be captured in the roll rates. Since the loss
reserve is computed based on the composite of all of these calculations, this
increase in roll rate will be applied to receivables in all respective delinquency
buckets, which will increase the overall reserve level. In addition, loss reserves
on consumer receivables are maintained to reflect our judgment of portfolio risk
factors that may not be fully reflected in the statistical roll rate calculation or
when historical trends are not reflective of current inherent losses in the
portfolio. Risk factors considered in establishing loss reserves on consumer
receivables include product mix, unemployment rates, bankruptcy trends, geographic
concentrations, loan product features such as adjustable rate loans, economic
conditions, such as national and local trends in housing markets and interest
rates, portfolio seasoning, account management policies and practices, current
levels of charge-offs and delinquencies, changes in laws and regulations and other
items which can affect consumer payment patterns on outstanding receivables, such
as natural disasters and global pandemics.
While our credit loss reserves are available to absorb losses in the entire
portfolio, we specifically consider the credit quality and other risk factors for
each of our products. We recognize the different inherent loss characteristics in
each of our products as well as customer account management policies and practices
and risk management/collection practices. Charge-off policies are also considered
when establishing loss reserve requirements to ensure the appropriate reserves
exist for products with longer charge-off periods. We also consider key ratios such
as reserves to nonperforming loans, reserves as a percentage of net charge-offs,
reserves as a percentage of two-months-and-over contractual delinquency and months
coverage ratios in developing our loss reserve estimate. Loss reserve estimates are
reviewed periodically and adjustments are reported in earnings when they become
known. As these estimates are influenced by factors outside of our control such as
consumer payment patterns and economic conditions, there is uncertainty inherent in
these estimates, making it reasonably possible that they could change.
The following table sets forth credit loss reserves for the periods
indicated:
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Reserves as a percent of:
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Net charge-offs for the quarter, annualized, as a percentage of average
consumer receivables for the quarter.
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Ratio excludes nonperforming receivables and charge-offs associated
with receivable portfolios which are considered held for sale as these
receivables are carried at the lower of cost or fair value with no
corresponding credit loss reserves.
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Credit loss reserves at June 30, 2009 decreased as compared to March 31,
2009 as the provision for credit losses was $82 million lower than net
charge-offs primarily as a result of lower receivable levels for all products and
lower overall dollars of delinquency as discussed more fully below. The lower
receivable levels are due to lower origination volumes as a result of changes in
our product offerings, actions taken beginning in 2007 to slow credit card
receivable growth as well as lower consumer spending. The decrease in credit loss
reserves was partially offset by a combination of the following factors:
• Higher late stage delinquency since March 31, 2009 which has resulted
in higher credit loss estimates for our Consumer Lending real estate secured
receivable portfolios;
• Higher roll rates for credit card and personal non-credit card receivables;
• Higher loss severities for real estate secured receivables;
• Continued deterioration of the
U.S.
economy and housing markets;
• Significantly higher unemployment rates;
• Higher levels of personal bankruptcy filings;
• Portfolio seasoning; and
• Continuing local government delays in processing foreclosures for real
estate secured receivables due to backlogs in foreclosure proceedings as a result
of actions by local governments and actions of certain states that have lengthened
the foreclosure process.
At June 30, 2009 and going forward, credit loss estimates for our credit card
receivable portfolio relate primarily to non-prime credit card receivables as a
result of the sale of the GM and UP Portfolios to HSBC Bank USA in January 2009.
Our non-prime credit card receivable portfolio is structured for customers with
lower credit scores. The products have lower credit lines and are priced for higher
risk. The credit quality of the non-prime credit card portfolio has deteriorated at
a lower rate relative to our GM and UP Portfolios which were sold to HSBC
Bank
USA
in January 2009. The continued deterioration of the housing markets in
the
U.S.
has affected the credit performance of our entire credit card portfolio,
particularly in states which previously had experienced the greatest home price
appreciation. Our non-prime credit card receivable portfolio concentration in these
states is approximately proportional to the
U.S.
population, but a substantial majority of our non-prime customers are renters
who are, on the whole, demonstrating a better payment history on their loans than
homeowners. Furthermore, our lower credit scoring customers within our non-prime
portfolio, which have an even lower home ownership rate, have shown the least
deterioration through this stage of the economic cycle. In addition, through
June 30, 2009 unemployment has resulted in less credit deterioration in the
non-prime portfolios as compared to prime portfolios. However, there can be no
certainty that these trends will continue.
In establishing reserve levels, given the current housing market trends in
the
U.S.
, we anticipate that losses in our real estate secured receivable portfolios will
be incurred with greater frequency and severity than historically experienced.
There is currently little secondary market liquidity for subprime mortgages. As a
result, lenders have significantly tightened underwriting standards, substantially
limiting the availability of alternative and subprime mortgages. As fewer financing
options currently exist in the marketplace for home buyers, properties in certain
markets are remaining on the market for longer periods of time which contributes to
home price depreciation. For some of our customers, the ability to refinance and
access equity in their homes is no longer an option as home prices remain stagnant
in many markets and have depreciated in others. The current housing market trends
are exacerbated by the current economic recession, including rising levels of
unemployment. As a result, the impact of these industry trends on our portfolio has
worsened, resulting in higher charge-off in our receivable portfolio. It is
generally believed that recovery of the housing market, as well as unemployment
rates, is not expected to begin to occur until at least 2010. We have considered
these factors in establishing our credit loss reserve levels, as appropriate.
Reserves as a percentage of receivables at June 30, 2009 was higher than at
March 31, 2009 and June 30, 2008 due to the impact of additional reserve
requirements in our Consumer Lending business as discussed above and lower
receivable levels. Additionally, as compared to the prior year quarter, reserves as
a percentage of receivables was higher as a result of a shift in mix to higher
levels of non-prime receivables which have deteriorated at a lower rate as
previously discussed.
Reserves as a percentage of net charge-offs was lower at June 30, 2009 as
compared to March 31, 2009 as reserves decreased due to lower receivable
levels and lower overall delinquency levels while charge-off increased as
delinquent accounts have migrated to charge-off. As compared to June 30, 2008,
reserves as a percentage of net charge-offs increased as the increase in reserve
levels outpaced charge-offs as the growing late stage delinquency in our real
estate secured receivable portfolios due to the current economic conditions and
actions by local government which has resulted in delays in processing
foreclosures, will migrate to charge-off in future periods.
Reserves as a percentage of nonperforming loans (excluding nonperforming loans held
for sale) was higher at June 30, 2009 as compared to March 31, 2009. As
compared to the prior quarter, the decrease in nonperforming loans due to lower
receivable levels, higher levels of personal bankruptcy filings and an extended
seasonal benefit as discussed above outpaced the decrease in reserve levels as the
decreases in reserve levels were partially offset by the increase in reserve
requirements for our Consumer Lending business. Reserves as a percentage of
nonperforming loans (excluding nonperforming loans held for sale) was lower as
compared to the prior year quarter as the majority of the increase in nonperforming
loans was from the first lien real estate secured receivable portfolios in our
Consumer Lending and Mortgage Services businesses which typically carry lower
reserve requirements than second lien real estate secured and unsecured
receivables.
The following table summarizes dollars of two-months-and-over contractual
delinquency and two-months-and-over contractual delinquency as a percent of
consumer receivables and receivables held for sale ("delinquency ratio"):
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Dollars of Contractual Delinquency:
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Total consumer - continuing operations(2)
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Total consumer - continuing operations(2)
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Real estate secured two-months-and-over contractual delinquency and as
a percentage of consumer receivables and receivables held for sale for
our Mortgage Services and Consumer Lending businesses are comprised of
the following:
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(dollars are in millions)
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Dollars of Contractual Delinquency:
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The trend in dollars of contractual delinquency and the delinquency
ratio for our credit card and auto finance portfolios as of
June 30, 2009 and March 31, 2009 as compared to the year-ago
period was significantly impacted by the sale of our GM and UP
Portfolios as well as the sale of certain non-delinquent auto finance
receivables to HSBC Bank USA in January 2009. The following table
presents on a proforma basis, the delinquency dollars and delinquency
ratios for the credit card and auto finance portfolios and for total
consumer-continuing operations excluding these receivables from all
periods presented:
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(dollars are in millions)
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Dollars of contractual delinquency excluding the sold credit card
and auto finance receivables from all periods:
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Total consumer - continuing operations
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Delinquency ratio excluding the sold credit card and auto finance
receivables from all periods:
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Total consumer - continuing operations
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On a continuing operations basis, private label receivables consisted
primarily of the retail sales contracts in our Consumer Lending
business which are liquidating. In the first quarter of 2009, we began
reporting this liquidating portfolio on a prospective basis within our
personal non-credit card portfolio.
|
The delinquency ratio for continuing operations increased 50 basis points
compared to the prior quarter primarily due to lower receivable levels for all
products as a result of lower origination volumes due to changes in our product
offerings, including the discontinuation of auto finance originations and the
cessation of all Consumer Lending originations, as well as lower consumer spending
levels, while dollars of delinquency declined at a slower pace. Decreases in real
estate secured receivable levels were partially offset by a decline in loan
prepayments.
Although the delinquency ratio has increased, dollars of contractual delinquency
for continuing operations decreased $275 million during the three months ended
June 30, 2009 as compared to March 31, 2009 driven by lower delinquency
levels in our Mortgage Services real estate secured, credit card and personal
non-credit card receivable portfolios. Lower delinquency levels in our Mortgage
Services real estate secured receivable portfolio primarily reflect the continued
maturation and seasoning of a liquidating portfolio. Lower dollars of delinquency
in our credit card and personal non-credit card receivable portfolios reflect the
lower receivable levels discussed above, an extended seasonal benefit of increased
cash available to customers as a result of various government economic stimulus
actions and lower energy costs as well as for our credit card receivables higher
levels of personal bankruptcy filings during the first half of 2009 which resulted
in accounts migrating to charge-off more quickly. In addition, we believe the
decrease in dollars of delinquency in both portfolios is a result of the risk
mitigation actions we have taken since 2007 to tighten underwriting and reduce the
risk profile of these portfolios. To date, delinquency levels in our personal
non-credit card receivables, which may have been impacted by the closure of our
Consumer Lending branch offices, continue to perform within our expectations.
These decreases in dollars of delinquency were partially offset by increases in
delinquency levels in the first lien portion of our Consumer Lending real estate
secured receivable portfolio reflecting continued weakening in the housing and
mortgage industry, particularly in the 2006 and 2007 real estate secured receivable
originations and to a lesser extent real estate secured receivable originations in
the first half of 2008 due to current economic conditions. Also contributing to the
increase were continuing local government delays in processing foreclosures due to
backlogs in foreclosure proceedings as a result of actions by local governments and
actions of certain states which have lengthened the foreclosure process. To date,
delinquency levels in our Consumer Lending real estate secured receivables, which
may have been impacted by the closure of our Consumer Lending branch offices,
continue to perform within our expectations. As a result, contractually delinquent
receivables which would have normally proceeded to foreclosure and reported as real
estate owned continue to be reported as contractually delinquent. Higher dollars of
delinquency for auto finance receivables reflect portfolio seasoning.
While overall dollars of delinquency decreased, delinquency for all receivable
products was negatively impacted by the following:
• Continued deterioration in the
U.S.
economy;
• Significantly higher unemployment rates during the quarter; and
Compared to June 30, 2008, our delinquency ratio from continuing operations
increased 651 basis points at June 30, 2009 for the reasons discussed
above. As compared to the prior year quarter, the trend in dollars of contractual
delinquency and delinquency ratios for our credit card receivable portfolio was
also significantly impacted by the sale of the GM and UP Portfolios and certain
auto finance receivables to HSBC Bank
USA
in January 2009 as discussed in Note 2 to the table above.
Net Charge-offs of Consumer Receivables
The following table summarizes net charge-off of consumer receivables for the
quarter, annualized, as a percent of average consumer receivables ("net charge-off
ratio"). During a quarter that receivables are transferred to receivables held for
sale, those receivables continue to be included in the average consumer receivable
balances prior to such transfer and any charge-offs related to those receivables
prior to such transfer remain in our net charge-off totals. However, for periods
following the transfer to the held for sale classification, the receivables are no
longer included in average consumer receivable balance as such loans are carried at
the lower of cost or fair value and there are no longer any charge-offs reported
associated with these receivables.
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(dollars are in millions)
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Total consumer - continuing operations(2)
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Total consumer - continuing operations(2)
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Real estate secured net charge-offs and REO expense as a percent of
average real estate secured receivables
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Real estate secured net charge-off dollars, annualized, as a percentage
of average consumer receivables for our Mortgage Services and Consumer
Lending businesses are comprised of the following:
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(dollars are in millions)
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The trend in net charge-off dollars and the net charge-off ratio for
our credit card and auto finance portfolios as of June 30, 2009
and March 31, 2009 as compared to the year-ago period was
significantly impacted by the sale of our GM and UP Portfolios as well
as the sale of certain non-delinquent auto finance receivables to HSBC
Bank USA in January 2009. The following table presents on a proforma
basis, the net charge-off dollars and the net charge-off ratio for the
credit card and auto finance portfolios and for total
consumer-continuing operations excluding these receivables from all
periods presented:
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(dollars are in millions)
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Net charge-off dollars excluding the sold credit card and auto
finance receivables from all periods:
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Total consumer - continuing operations
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Net charge-off ratio excluding the sold credit card and auto finance
receivables from all periods:
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Total consumer - continuing operations
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On a continuing operations basis, private label receivables consisted
primarily of the retail sales contracts in our Consumer Lending
business which are liquidating. In the first quarter of 2009, we began
reporting this liquidating portfolio on a prospective basis within our
personal non-credit card portfolio
|
Our net charge-off ratio for continuing operations increased 99 basis points
compared to the prior quarter primarily due to higher dollars of charge-offs in our
real estate secured, credit card and personal non-credit card receivable portfolios
as the higher delinquency levels we have been experiencing are migrating to
charge-off and lower average consumer receivables. The decrease in average consumer
receivables reflects reductions in credit appetite, changes in product offerings,
lower origination volumes, lower consumer spending levels and the sale of real
estate secured, credit card and auto finance receivables as previously discussed,
partially offset by a decline in loan prepayments for our real estate secured
receivables.
Dollars of net charge-offs for all products were negatively impacted by the
following:
• Continued deterioration in the
U.S.
economy and housing markets;
• Significantly higher unemployment rates;
• Higher levels of personal bankruptcy filings; and
Charge-off dollars and ratios increased in our real estate secured receivable
portfolio reflecting continued weakening in the housing and mortgage industry,
including decreases in home values in certain markets, rising unemployment rates
and seasoning in our Consumer Lending real estate secured receivable portfolio.
Charge-off dollars and ratios increased in our credit card receivable portfolio as
higher delinquency levels in late 2008 are migrating to charge-off and lower
recovery rates on credit card receivables as well as higher levels of personal
bankruptcy filings during the first half of the year which resulted in accounts
migrating to charge-off more quickly. Lower net charge-offs in our auto finance
receivable portfolio reflects the adoption of FFIEC charge-off policies during the
prior quarter which resulted in an acceleration of auto finance charge-offs of
$87 million, portfolio run-off and improvements in loss severities resulting
from continuing improvement in pricing for used vehicles, partially offset by the
economic conditions described above. Charge-off dollars and ratios in our personal
non-credit card receivable portfolio reflect a deterioration in the 2006 and 2007
vintages which was more pronounced in certain geographic regions as well has higher
levels of personal bankruptcy filings during the first half of the year which
resulted in accounts migrating to charge-off more quickly.
Our net charge-off ratio for continuing operations increased 235 basis points
compared to the prior year quarter as a result of the lower average consumer
receivables discussed above, partially offset by lower dollars of net charge-off.
Lower dollars of net charge-off was driven by our Mortgage Services business as the
portfolio continues to become more fully seasoned and run-off including lower
charge-off of second lien loans which generally have higher loss severities than
first lien loans. Dollars of net charge-offs of real estate secured receivables in
both our Mortgage Services and Consumer Lending business were also impacted by
increases in the volume of receivable re-ages and modifications as well as
continuing delays in processing foreclosures as discussed above. Lower dollars of
net charge-offs for our auto finance receivable portfolio reflect lower receivable
levels as well as improvements in loss severities as discussed above. Net
charge-off dollars and ratios for our credit card receivable portfolio was impacted
by the sale of the GM and UP Portfolios in January 2009 as discussed in Note 2
to the table above. Excluding the impact of the GM and UP Portfolios from the prior
year quarter, dollars of net charge-off in our credit card receivable portfolio
increased as a result of higher levels of personal bankruptcy filings during the
first half of the year which resulted in accounts migrating to charge-off more
quickly and lower recovery rates for defaulted receivables. Charge-off dollars and
ratios in our personal non-credit card receivable portfolio reflect the continuing
deterioration in the 2006 and 2007 vintages which was more pronounced in certain
geographic regions as well the impact of higher levels of personal bankruptcy
filings previously discussed. Dollars of net charge-offs for all products were
negatively impacted by the continued weakening in the
U.S.
economy, including rising unemployment rates and continued home price
depreciation in certain markets. For our credit card portfolio, the impact has been
the highest for non-prime customers who are also homeowners and typically carry
higher balances.
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(dollars are in millions)
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Nonaccrual receivables(1)
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Nonaccrual receivables held for sale
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Accruing credit card receivables 90 or more days delinquent(2)
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Accruing credit card receivables 90 or more days delinquent held for
sale(2)
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Total nonperforming receivables
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Total nonperforming assets - continuing operations
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Total nonperforming assets
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Credit loss reserves as a percent of nonperforming
receivables - continuing operations(3)
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Nonaccrual receivables are comprised of the following:
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Total real estate secured
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Total nonaccrual receivables
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Consistent with industry practice, accruing credit card receivables 90
or more days delinquent includes credit card receivables.
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Ratio excludes nonperforming receivables associated with receivable
portfolios which are considered held for sale as these receivables are
carried at the lower of cost or fair value with no corresponding credit
loss reserves.
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Compared to March 31, 2009, the decrease in total nonperforming receivables is
primarily due to the lower receivable levels as discussed above as well as the
lower dollars of delinquency in our Mortgage Services, credit card and personal
non-credit card receivable portfolios. As compared to June 30, 2008, the
increase in total nonperforming receivables is largely due to higher levels of real
estate secured nonaccrual receivables at our Consumer Lending business, partially
offset by lower levels of accruing credit card receivables 90 or more days
delinquent primarily resulting from the sale of the GM and UP Portfolios in January
2009. Total nonperforming real estate secured receivables and real estate owned at
June 30, 2009 has also been impacted by the continuing local government delays
in foreclosure activities as previously discussed. Real estate secured nonaccrual
loans includes stated income loans at our Mortgage Services business of
$1.1 billion, $1.2 billion and $1.3 billion at June 30, 2009,
March 31, 2009 and June 30, 2008, respectively.
As discussed more fully below, we have numerous account management policies and
practices to assist our customers in accordance with their individual needs,
including either temporarily or permanently modifying loan terms. Loans which have
been granted a permanent modification, a twelve-month or longer modification, or
two or more consecutive six-month modifications are considered troubled debt
restructurings for purposes of determining loss reserve estimates under Statement
of Financial Accounting Standards No. 114, "Accounting by Creditors for
Impairment of a Loan," ("TDR Loans").
The following table summarizes TDR Loans which are shown as nonperforming assets
for continuing operations in the table above:
For additional information related to our troubled debt restructurings, see
Note 6, "Receivables," to our accompanying consolidated financial statements.
Customer Account Management Policies and Practices
Our policies and practices for the collection of consumer receivables, including
our customer account management policies and practices, permit us to modify the
terms of loans, either temporarily or permanently, and/or to reset the contractual
delinquency status of an account to current, based on indicia or criteria which, in
our judgment, evidence continued payment probability. Such policies and practices
vary by product and are designed to manage customer relationships, maximize
collection opportunities and avoid foreclosure or repossession if economically
expedient. If a re-aged account subsequently experiences payment defaults, it will
again become contractually delinquent.
As a result of the marketplace conditions previously described, in the fourth
quarter of 2006 we began performing extensive reviews of our account management
policies and practices and, in the first quarter of 2008, conducted a further
strategic review of our receivable collection efforts. As more fully discussed
below, these reviews have resulted in changes in our strategies for contacting
customers as well as expanding existing modification programs to enable us to
assist more customers in accordance with their needs.
Beginning late in the first quarter of 2008, we expanded our customer contact
strategies in an effort to reach more customers. We have increased collection
staffing particularly during the morning and evening hours when our customers are
more likely to be available. We continue to work with advocacy groups in select
markets to assist in encouraging our customers with financial needs to contact us.
We have also implemented new training programs to ensure that our customer service
representatives are focused on helping the customer through difficulties, are
knowledgeable about the re-aging and modification programs available and are able
to advise each customer of the best solutions for their individual circumstance. In
the past, the majority of our customers were best served by re-aging their loan
either with or without a modification of the loan terms. In the current
marketplace, we have determined that certain customers may be better served by a
modification of the loan terms, which may or may not also include a re-aging of the
account. As a result, during 2008 and during the first half of 2009, we have
assisted more customers through the use of account modification than in prior
years.
The following describes the primary programs we currently utilize to provide
assistance to our customers with the goal to keep more customers in their homes,
while maximizing future cash flows.
•
Proactive ARM Reset Modification Program:
As part of our risk mitigation efforts relating to the affected components of
the Mortgage Services portfolio, in October 2006 we established a program
specifically designed to meet the needs of select customers with ARMs nearing their
first interest rate and payment reset that we expect will be the most impacted by a
rate adjustment. We proactively contact these customers and, through a variety of
means, we assess their ability to make the adjusted payment with a focus on the
customer's debt service capability. As appropriate and in accordance with defined
policies, we modify the loans, allowing time for the customer to seek alternative
financing or improve their individual situation. Through the first quarter of 2008,
these loan modifications primarily involved a twelve-month temporary interest rate
relief by either maintaining the current interest rate for the entire twelve-month
period or resetting the interest rate for the twelve-month period to a rate lower
than originally required at the first reset date. At the end of the modification
period, the interest rate on the loan will reset in accordance with the original
loan terms unless the borrower qualifies for and is granted a new modification.
We anticipate approximately $73 million of ARM loans modified under this
program since October 2006 will reach a reset date during the remainder of 2009.
Prior to a loan reaching that reset date, we will re-evaluate the loan to determine
if an extension of the modification term is warranted. If the loan is less than
30-days delinquent and has not received assistance under any other risk mitigation
program, typically the modification may be extended for an additional twelve-month
period at a time provided the customer demonstrates an ongoing need for assistance.
Loans modified as part of this specific risk mitigation effort are not considered
to have been re-aged as these loans were not contractually delinquent at the time
of the modification. However, if the loan had been re-aged in the past for other
reasons or qualified for a re-age subsequent to the modification, it is included in
the re-aging statistics table ("Re-age Table") below.
We modified approximately 240 loans for the first time under the Proactive ARM
Reset Modification Program during the six months ended June 30, 2009 with an
outstanding receivable balance of $41 million at the time of the modification.
Since the inception of the Proactive ARM Reset Modification program in October
2006, we have modified approximately 13,200 loans with an aggregate outstanding
principal balance of $2.1 billion at the time of the modification. The
following provides information about the post-modification performance of loans
granted modifications under this program since October 2006:
Status as of June 30, 2009
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Current or less than 30-days delinquent
|
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30- to 59-days delinquent
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60-days or more delinquent
|
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Charged-off, transferred to real estate owned or sold
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Of the loans modified under this program since October 2006 which remain
outstanding at June 30, 2009, approximately 5,300 loans have subsequently
qualified for assistance under other risk mitigation programs. Approximately 3,100
loans have reached the end of the modification period but did not qualify for other
risk modification programs. Approximately 2,400 of those loans have had the
interest rate reset in accordance with the original contractual terms.
•
Foreclosure Avoidance/Account Modification
Programs:
Since the fourth quarter of 2006, we have significantly increased our use of
modifications in response to what we expect will be a longer term need of
assistance by our customers due to the weak housing market and U.S. economy.
In these instances, at our Mortgage Services and Consumer Lending businesses we are
actively using account modifications to modify the rate and/or payment on a number
of qualifying loans and re-age certain of these accounts upon receipt of two or
more modified payments and other criteria being met. This account management
practice is designed to assist borrowers who may have purchased a home with an
expectation of continued real estate appreciation or whose income has subsequently
declined. We also expanded the use of a Foreclosure Avoidance Program for
delinquent Consumer Lending customers designed to provide relief to qualifying
homeowners through loan modification and/or re-aging.
Based on the economic environment and expected slow recovery of housing values,
during 2008 we developed additional analytical review tools leveraging off best
practices in our Mortgage Services business to assist us in identifying customers
who are willing to pay, but are expected to have longer term disruptions in their
ability to pay. Using these analytical review tools, we have expanded our
foreclosure avoidance/account modification programs to assist customers who did not
qualify for assistance under prior program requirements or who required greater
assistance than available under the programs. The expanded program includes certain
documentation requirements as well as receipt of two qualifying payments before the
account may be re-aged. For Consumer Lending customers, prior to July 2008, receipt
of one qualifying payment was required for a modified account before the account
would be re-aged. During the first quarter of 2008, we began to offer this expanded
program to customers who had contacted us and requested payment relief as well as
for customers who had not qualified for assistance under one of the existing
programs. For selected customer segments, this expanded program lowers the interest
rate on fixed rate loans and for ARM loans the expanded program modifies the loan
to a lower interest rate than scheduled at the first interest rate reset date. The
eligibility requirements for this expanded program allow more customers to qualify
for payment relief and in certain cases can result in a lower interest rate than
allowed under other existing programs. In the second quarter of 2008, we
established a pre-approved payment relief program for customers who may not yet
have requested payment relief. In February 2009, we temporarily suspended this
proactive relief program as we attempt to better understand and evaluate the
U.S. Treasury sponsored debt relief programs. As of the date of this filing,
we continue to evaluate this proactive relief program and the Federal debt relief
programs. As a result of the current marketplace conditions and our outlook for a
slow return to more normal marketplace conditions, we have increased the use of
longer term modifications as we believe they provide the most benefit to our
customers and stakeholders as the economy recovers. A loan modified under these
programs is only included in the Re-age Table if the delinquency status of the
loan was reset as a part of the modification or was re-aged in the past for other
reasons. Not all loans modified under these programs have the delinquency status
reset and, therefore, are not considered to have been re-aged.
The following table summarizes loans modified under the Foreclosure
Avoidance/Account Modification programs during the six months ended June 30,
2009, some of which may have also been re-aged:
Six Months Ended June 30, 2009
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Foreclosure Avoidance/Account Modification Programs(1)(2)
|
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(1) Includes all loans modified under these programs during the
first half of 2009 regardless of whether the loan was also re-aged.
(2) If qualification criteria are met, customer modification may occur on
more than one occasion for the same account. For purposes of the table above, an
account is only included in modification totals once in an annual period and not
for each separate modification.
(3) Prior to June 30, 2009, the modification totals we reported for our
Consumer Lending business excluded any modifications related to the Consumer
Lending purchased receivable portfolios. Beginning in the second quarter of 2009,
the table above includes modifications related to these purchased receivable
portfolios. During the three months ended June 30, 2009, approximately 40
loans in the Consumer Lending purchased receivable portfolios were modified with an
outstanding receivable balance of $6 million at the time of the modification.
We also support a variety of national and local efforts in homeownership
preservation and foreclosure avoidance.
As a result of the expansion of our modification and re-age programs in response to
the marketplace conditions previously described, modification and re-age volumes
since January 2007 for real estate secured receivables have significantly increased
and we anticipate this trend of higher modification and re-age volumes will
continue in the foreseeable future. Since January 2007, we have cumulatively
modified and/or re-aged approximately 291,200 real estate secured loans with an
aggregate outstanding principal balance of $34.8 billion at the time of
modification and/or re-age under the Proactive ARM Modification and the Foreclosure
Avoidance/Account Modification Programs described above. These totals include
approximately 37,400 real estate secured loans with an outstanding principal
balance of $5.9 billion that received two or more modifications since January
2007. The following provides information about the post-modification performance of
all real estate secured loans granted a modification and/or re-age since January
2007:
|
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Current or less than 30-days delinquent
|
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30- to 59-days delinquent
|
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60-days or more delinquent
|
|
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|
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Transferred to real estate owned or sold
|
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|
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The following table shows the number of real estate secured accounts as well as the
outstanding receivable balance of these accounts as of the period indicated for
loans that were either re-aged only, modified only or modified and re-aged:
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(accounts are in thousands)
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(dollars are in millions)
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Loans modified and re-aged
|
|
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Total loans modified and/or re-aged(3)
|
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|
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Loans modified and re-aged
|
|
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Total loans modified and/or re-aged(3)
|
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Loans modified and re-aged
|
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Total loans modified and/or re-aged
|
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Loans which have been granted a permanent modification, a twelve-month
or longer modification, or two or more consecutive six-month
modifications are considered troubled debt restructurings for purposes
of determining loss reserve estimates under Statement of Financial
Accounting Standards No. 114, "Accounting by Creditors for
Impairment of a Loan." For additional information related to our
troubled debt restructurings, see Note 6, "Receivables," to our
accompanying consolidated financial statements.
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Includes loans that have been modified under the Proactive ARM
Modification program described above.
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The following table provides information at June 30, 2009
regarding the delinquency status of loans granted modifications of loan
terms and/or re-ages of the account:
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Current or less than 30-days delinquent
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30- to 59-days delinquent
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60-days or more delinquent
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The outstanding receivable balance included in this table reflects the
principal amount outstanding on the loan excluding any basis
adjustments to the loan such as unearned income, unamortized deferred
fees and costs on originated loans, purchase accounting fair value
adjustments and premiums or discounts on purchased loans.
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Prior to June 30, 2009, the modification and re-age totals we
reported for our Consumer Lending business excluded any modifications
or re-ages related to the Consumer Lending purchased receivable
portfolios. Beginning in the second quarter of 2009, the table above
includes modifications and re-ages related to these purchased
receivable portfolios. At June 30, 2009, 140 loans in the Consumer
Lending purchased receivable portfolios have been modified and/or
re-aged with an outstanding receivable balance of $18 million at
June 30, 2009.
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Prior to July 2008, for Consumer Lending customers receipt of one
qualifying payment was required before an account would be re-aged.
Beginning in July 2008, receipt of two qualifying payments was required
before an account would be re-aged.
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Although we have shifted our customer assistance programs to include more loan
modifications, we continue to monitor and track information related to accounts
that have been re-aged. Currently, approximately 80 percent of all re-aged
receivables are real estate secured products, which in general have less loss
severity exposure because of the underlying collateral. Credit loss reserves take
into account whether loans have been re-aged, rewritten or are subject to
forbearance, an external debt management plan, modification, extension or
deferment. Our credit loss reserves also take into consideration the loss severity
expected based on the underlying collateral, if any, for the loan.
As previously reported, in prior periods we used certain assumptions and estimates
to compile our re-aging statistics. The systemic counters used to compile the
information presented below exclude from the reported statistics loans that have
been reported as contractually delinquent but have been reset to a current status
because we have determined that the loans should not have been considered
delinquent (e.g., payment application processing errors). When comparing re-aging
statistics from different periods, the fact that our re-age policies and practices
will change over time, that exceptions are made to those policies and practices,
and that our data capture methodologies have been enhanced, should be taken into
account.
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(dollars are in millions)
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Re-aged in the last 6 months
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Re-aged in the last 7-12 months
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Previously re-aged beyond 12 months
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Total Re-aged by Product(1)(3)
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(As a percent of receivables and receivables held for sale)
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Excludes commercial and other.
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The Mortgage Services and Consumer Lending businesses real estate
secured re-ages are as shown in the following table:
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Total real estate secured
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The outstanding receivable balance included in the Re-age Table
reflects the principal amount outstanding on the loan net of unearned
income, unamortized deferred fees and costs on originated loans,
purchase accounting fair value adjustments and premiums or discounts on
purchased loans.
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The increase in re-aged loans during the second quarter of 2009 was primarily
attributable to higher contractual delinquency in our real estate secured portfolio
as we continue to work with our customers who, in our judgment, evidence continued
payment probability as well as changes to our collection strategies as described
above. As we expect economic conditions, particularly unemployment, to worsen in
2009, we anticipate re-aged loans will continue to increase during the second half
of 2009. At June 30, 2009, March 31, 2009 and June 30, 2008,
$8.7 billion (25 percent of total re-aged loans in the
Re-age Table), $8.2 billion (25 percent of total re-aged loans in
the Re-age Table) and $4.8 billion (18 percent of total re-aged
loans in the Re-age Table), respectively, of re-aged receivable balances have
subsequently experienced payment defaults and are included in our
two-months-and-over contractual delinquency at the period indicated.
In addition to our modification and re-aging policies and practices, we employ
other customer account management techniques in respect of delinquent accounts that
are similarly designed to manage customer relationships, maximize collection
opportunities and avoid foreclosure or repossession if commercially sensible and
reasonably possible. These additional customer account management techniques
include, at our discretion, actions such as extended payment arrangements, approved
external debt management plans, forbearance, loan rewrites and/or deferment pending
a change in circumstances. We typically use these customer account management
techniques with individual borrowers in transitional situations, usually involving
borrower hardship circumstances or temporary setbacks that are expected to affect
the borrower's ability to pay the contractually specified amount for some period of
time. For example, under a forbearance agreement, we may agree not to take certain
collection or credit agency reporting actions with respect to missed payments,
often in return for the borrower's agreement to pay us an additional amount with
future required payments. In some cases, these additional customer account
management techniques may involve us agreeing to lower the contractual payment
amount and/or reduce the periodic interest rate.
When we use a customer account management technique, we may treat the account as
being contractually current and will not reflect it as a delinquent account in our
delinquency statistics. However, if the account subsequently experiences payment
defaults, it will again become contractually delinquent. Reserves are maintained
specifically for re-aged accounts. We generally consider loan rewrites to involve
an extension of a new loan, and such new loans are not reflected in our delinquency
or re-aging statistics. Our account management actions vary by product and are
under continual review and assessment to determine that they meet the goals
outlined above.
The amount of receivables subject to forbearance, non-real estate secured
receivable modification, rewrites or other customer account management techniques
for which we have reset delinquency and that is not included in the re-aged or
delinquency statistics was approximately $159 million or .2 percent of
receivables and receivables held for sale at June 30, 2009 and
$141 million or .1 percent at December 31, 2008.
Geographic Concentrations
The following table reflects the percentage of consumer receivables and receivables
held for sale in states which individually account for 5 percent or greater of
our portfolio as of June 30, 2009 as well as the unemployment rate for these
states as of June 30, 2009.
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The
U.S.
national unemployment rate as of June 30, 2009 was
9.5 percent.
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Liquidity and Capital Resources
HSBC Related Funding
Debt due to affiliates and other HSBC related funding are summarized in the
following table:
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Debt issued to HSBC subsidiaries:
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Preferred securities issued by Household Capital Trust VIII to
HSBC
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Total debt outstanding to HSBC subsidiaries
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Debt outstanding to HSBC clients:
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Total debt outstanding to HSBC clients
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Cash received on bulk and subsequent sales of credit card receivables
to HSBC Bank
USA
, net (cumulative)
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Cash received on bulk sales of auto finance receivables to HSBC
Bank
USA
, net (cumulative)
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Cash received on bulk and subsequent sales of private label credit card
receivables to HSBC Bank
USA
, net (cumulative)
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Real estate secured receivable activity with HSBC Bank
USA
:
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Cash received on sales (cumulative)
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Direct purchases from correspondents (cumulative)
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Reductions in real estate secured receivables sold to HSBC Bank
USA
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Total real estate secured receivable activity with HSBC Bank
USA
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Cash received from sale of U.K. Operations to HOHU
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Cash received from sale of Canadian Operations to HSBC Bank
Canada
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Cash received from sale of
U.K.
credit card business to HBEU
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Capital contribution by HSBC Investments (
North America
) Inc. (cumulative)
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Total HSBC related funding
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At June 30, 2009 and December 31, 2008, funding from HSBC, including debt
issuances to HSBC subsidiaries and clients, represented 12 percent of our
total debt and preferred stock funding.
Cash proceeds received from the sale of our Canadian Operations to HSBC Bank
Canada, the sale of our U.K. Operations to HOHU, the sale of our European
Operations to an HBEU affiliate and the sale of our U.K. credit card business to
HBEU were used to pay down short-term domestic borrowings, including outstanding
commercial paper balances, and draws on bank lines from HBEU. Proceeds received
from the bulk sale and subsequent daily sales of private label and credit card
receivables to HSBC Bank USA of $28.4 billion and the proceeds from the bulk
sale of certain auto finance receivables of $2.6 billion were used to pay down
short-term domestic borrowings, including outstanding commercial paper balances,
and during the first half of 2009, to pay down maturing long-term debt. Proceeds
from each of these transactions were also used to fund ongoing operations.
At December 31, 2008, we had $1.0 billion and $1.2 billion in
outstanding short-term debt drawn under previously uncommitted money market
facilities from HBEU and a subsidiary of HSBC Asia Pacific ("HBAP"), respectively.
The HBEU borrowing matured in February 2009 and we chose not to renew it at that
time. The HBAP borrowing matured in April 2009 and we chose not to renew it at that
time. We also have a $1.5 billion uncommitted credit facility and a
$1.0 billion committed credit facility from HSBC Bank
USA
. In May 2009, we borrowed $500 million under the $1.5 billion
uncommitted credit facility and repaid the amount in June 2009. At June 30,
2009 and December 31, 2008, there were no balances outstanding under either of
these lines.
We had derivative contracts with a notional value of $67.3 billion, or
approximately 98 percent of total derivative contracts, outstanding with HSBC
affiliates at June 30, 2009 and $77.9 billion, or approximately
98 percent at December 31, 2008.
Interest bearing deposits with banks and other short-term investments
Interest bearing deposits with banks totaled $33 million and
$25 million at June 30, 2009 and December 31, 2008, respectively.
Securities purchased under agreements to resell totaled $2.6 billion and
$1.0 billion at June 30, 2009 and December 31, 2008, respectively.
The increase in the amount of securities purchased under agreements to resell is
due to the generation of additional liquidity as a result of the receivable
portfolio sales to HSBC Bank
USA
.
Commercial paper
totaled $5.8 billion and $9.6 billion at June 30, 2009 and
December 31, 2008, respectively. Included in this total was outstanding Euro
commercial paper sold to customers of HSBC of $664 million and
$353 million at June 30, 2009 and December 31, 2008, respectively.
Commercial paper balances were higher at December 31, 2008 as a result of
higher short term funding requirements until the completion of the sale of the
credit card and auto finance receivables to HSBC Bank
USA
in January 2009 as discussed above. Euro commercial paper balances were
higher at June 30, 2009 due to improved pricing and expanded foreign currency
offerings. Our funding strategies are structured such that committed bank credit
facilities exceed 100 percent of outstanding commercial paper.
On October 7, 2008, the Federal Reserve Board announced the Commercial Paper
Funding Facility to provide a liquidity backstop to
U.S.
issuers of commercial paper. Under the CPFF, the Federal Reserve Bank
of
New York
will finance the purchase of highly-rated, U.S. dollar-denominated,
unsecured and asset-backed three-month commercial paper from eligible issuers
through its primary dealers. The program will terminate on February 1, 2010
unless extended by the Federal Reserve Board. On October 28, 2008, we became
eligible to participate in the program in an amount of up to $12.0 billion. At
June 30, 2009, there were no balances outstanding under this program. At
December 31, 2008, we had $520 million outstanding under this program.
We had committed back-up lines of credit totaling $7.8 billion at
June 30, 2009 and $9.8 billion at December 31, 2008, of which
$2.5 billion was with HSBC affiliates, to support our issuance of commercial
paper. During April 2009, $3.8 billion in third party lines matured. During
May 2009, we replaced $1.8 billion of these matured facilities. A substantial
portion of our committed back-up lines mature during the next two years. The
$2.5 billion credit facility with an HSBC affiliate is scheduled to mature in
September 2009 and $4.3 billion in back-up lines with third parties are
scheduled to mature during 2010. Based on current market conditions, we do not
anticipate renewing all of our third party back-up lines in 2010. Given the overall
reduction in our balance sheet, we expect the lower level of back-up lines will
support a commercial paper issuance program that is consistent with our reduced
funding requirements.
Long-term debt
decreased to $72.3 billion at June 30, 2009 from $90.0 billion
at December 31, 2008 as we have reduced the size of our balance sheet due to
the sale of $15.4 billion of receivables to HSBC Bank
USA
, lower origination volumes and receivable run-off during the first half of 2009.
We have been focused on achieving the most effective cost of funding for HSBC's
assets across
North America
. The following table summarizes issuances and retirements of long term debt during
the six months ended June 30, 2009 and 2008:
Six Months Ended June 30,
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Long-term debt retired(1)
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Net long term debt retired
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Additionally, during the six months ended June 30, 2009, long term
debt of $6.1 billion was assumed by HSBC Bank
USA
in connection with their purchase of the GM and UP Portfolios, as
discussed previously.
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Issuances of long term debt during the first half of 2009 consisted of
$1.6 billion of securities backed by personal non-credit card receivables. For
accounting purposes, these transactions were structured as secured
financings.
Common Equity
During the first half of 2009, HINO made three capital contributions to us
totaling $2.0 billion. Additionally, in late February 2009 we effectively
converted $275 million of mandatorily redeemable preferred securities of the
Household Capital Trust VIII, which were included as a component of due to
affiliates, to common stock by redeeming the junior subordinated notes underlying
the preferred securities and then issuing common stock to HINO. These transactions
serve to support ongoing operations and to maintain capital at levels we believe
are prudent in the current market conditions. These capital contributions occurred
subsequent to the dividend of $1.0 billion paid to HINO in January 2009
relating to the capital associated with the receivables sold to HSBC Bank
USA
. Until we return to profitability, we are dependent upon the continued capital
support of HSBC to continue our business operations and maintain selected capital
ratios. HSBC has provided significant capital in support of our operations in the
last two years and has indicated that they remain fully committed and have the
capacity to continue that support.
Selected capital ratios
In managing capital, we develop targets for tangible shareholders' equity
plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves") and
tangible common equity to tangible managed assets. These ratio targets are based on
discussions with HSBC and rating agencies, risks inherent in the portfolio and the
projected operating environment and related risks. These ratios also exclude the
equity impact of Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," the equity
impact of Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities," Statement of Financial Accounting
Standards No. 158, "Accounting for Defined Benefit Pension and other
Post-retirement Plans - as amendment of FASB Statement Nos. 87, 88, 106,
and 132(R)," and the impact of Statement of Financial Accounting Standards
No. 159, "The Fair Value Option for Financial Assets and Liabilities,"
including the subsequent changes in fair value recognized in earnings associated
with debt for which we elected the fair value option and the related derivatives.
Preferred securities issued by certain non-consolidated trusts are also considered
equity in the TETMA + Owned Reserves calculations because of their long-term
subordinated nature and our ability to defer dividends. Managed assets include
owned assets plus any loans which we may have sold and service with limited
recourse. Our targets may change from time to time to accommodate changes in the
operating environment or other considerations such as those listed above.
Selected capital ratios are summarized in the following table:
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TETMA + Owned Reserves(1)
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Tangible common equity to tangible managed assets(1)
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Common and preferred equity to owned assets
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TETMA + Owned Reserves and tangible common equity to tangible managed
assets represent non-U.S. GAAP financial ratios that are used by HSBC
Finance Corporation management and applicable rating agencies to
evaluate capital adequacy and may differ from similarly named measures
presented by other companies. See "Basis of Reporting" for additional
discussion on the use of non-U.S. GAAP financial measures and
"Reconciliations to U.S. GAAP Financial Measures" for quantitative
reconciliations to the equivalent U.S. GAAP basis financial
measure.
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As previously discussed, subsequent to the announcement of our discontinuation of
all new customer account originations in our Consumer Lending business and the
closure of substantially all Consumer Lending branch offices two of the three
primary credit rating agencies elected to lower the ratings on our senior debt,
commercial paper and Series B preferred stock. The following summarizes our
credit ratings at June 30, 2009 and December 31, 2008:
Secured financings
Secured financings (collateralized funding transactions which do not receive sale
treatment under Statement of Financial Accounting Standards No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities, a Replacement of FASB Statement No. 125," ("FAS 140")) of
consumer receivables have been a source of funding and liquidity for us.
Collateralized funding transactions have been used to limit our reliance on the
unsecured debt markets and can be a more cost-effective source of alternative
funds. There were no secured financings during either of the three month periods
ended June 30, 2009 or 2008. Secured financings are summarized in the
following table for the six months ended June 30, 2009 and 2008:
Six Months Ended June 30,
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Secured financings of $6.6 billion at June 30, 2009 were secured by
$9.9 billion of real estate secured, auto finance and credit card receivables.
Secured financings of $15.0 billion at December 31, 2008 were secured by
$21.4 billion of real estate secured, auto finance, credit card and personal
non-credit card receivables. Secured financings, including conduit credit
facilities, represented 7 percent of the funding associated with our managed
funding portfolio at June 30, 2009 and 13 percent at December 31,
2008.
The following table shows by product type the receivables which secure our secured
financings:
At June 30, 2009 and December 31, 2008, we had conduit credit facilities
with commercial banks under which we may issue securities backed with up to
$.4 billion and $8.2 billion of receivables, respectively. Of the amounts
available under these facilities, $.4 billion and $5.8 billion were
utilized at June 30, 2009 and December 31, 2008, respectively. The
decrease in availability of these facilities in the first half of 2009 reflects the
transfer of conduit credit facilities totaling $4.1 billion to HSBC Bank
USA
in conjunction with its purchase of the GM and UP Portfolios as previously
discussed, as well as the expiration and reduction of conduit credit facilities
totaling $3.7 billion. The facilities are renewable at the banks' option.
Commitments
We enter into commitments to meet the financing needs of our customers. In most
cases, we have the ability to reduce or eliminate these open lines of credit. As a
result, the amounts below do not necessarily represent future cash requirements.
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Private label and credit cards(1)
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Other consumer lines of credit
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These totals include open lines of credit related to private label
credit cards and the GM and UP Portfolios which we sell all new
receivable originations to HSBC Bank
USA
on a daily basis.
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Includes an estimate for acceptance of credit offers mailed to
potential customers prior to June 30, 2009 and December 31,
2008, respectively.
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In January 2009, we extended a line of credit to H&R Block for up to
$2.5 billion to fund the purchase of a participation interest in refund
anticipation loans. In April 2009, no balances were outstanding under this line and
the line was closed.
2009 Funding Strategy
Our current range of estimates for funding needs and sources for 2009 are
summarized in the table that follows.
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Net asset growth/(attrition)
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Commercial paper maturities
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Secured financings, including conduit facility maturities
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Commercial paper issuances(1)
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Asset transfers and loan sales
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Secured financings, including conduit facility renewals
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HSBC and HSBC subsidiaries, including capital infusions
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For the period January 1 through June 30, 2009, domestic and Euro
commercial paper outstandings were $5.8 billion offset by
$2.6 billion in short-term liquid investments.
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Includes proceeds of $15.0 billion from the sale of credit card
and auto finance receivables to HSBC Bank
USA
, which included the transfer of approximately $6.1 billion of
indebtedness.
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As previously discussed, we have experienced deterioration in the performance of
all of our receivable portfolios as a result of the current mortgage lending
industry trends and economic conditions. As a result, since mid-2007 and through
the first half of 2009 we have taken numerous actions which, when combined with
normal portfolio attrition, have and will continue to result in a reduction in our
aggregate portfolio.
For the remainder of 2009, portfolio attrition will again provide a key source of
liquidity. The combination of attrition, proceeds received from the sale of credit
card and certain auto finance receivables to HSBC Bank
USA
in the first quarter of 2009, cash generated from operations and planned
capital infusions from HSBC will generate the liquidity necessary to meet our
maturing debt obligations. These sources of liquidity may be supplemented with HSBC
affiliate funding and opportunistic sales of selected receivable portfolios to meet
our 2009 funding requirements. Additionally, should credit market conditions
continue to improve, a portion of this funding requirement could be met through the
potential issuance of unsecured term debt.
Commercial paper outstanding for the remainder of 2009 is expected to be lower than
2008 balances. The majority of outstanding commercial paper is expected to be
directly placed, domestic commercial paper. Euro commercial paper will continue to
be marketed predominately to HSBC clients.
On January 1, 2007, we adopted FAS 157, "Fair Value "Measurements" and
FAS 159, "The Fair Value Option for Financial Assets and Financial
Liabilities", ("FAS 159"). Net income volatility arising from changes in
either interest rate or credit components of the mark-to-market on debt designated
at fair value and related derivatives affects the comparability of reported results
between periods. Accordingly, gain on debt designated at fair value and related
derivatives for the six months ended June 30, 2009 should not be considered
indicative of the results for any future period.
Control Over Valuation Process and Procedures
A control framework has been established which is designed to ensure that fair
values are either determined or validated by a function independent of the
risk-taker. To that end, the ultimate responsibility for the determination of fair
values rests with Treasury finance. Treasury finance establishes policies and
procedures to ensure appropriate valuations. Fair values for debt securities and
long-term debt for which we have elected fair value option are determined by a
third-party valuation source (pricing service) by reference to external quotations
on the identical or similar instruments. An independent price validation process is
also utilized. For price validation purposes, we obtain quotations from at least
one other independent pricing source for each financial instrument, where possible.
We consider the following factors in determining fair values:
• similarities between the asset or the liability under consideration and the
asset or liability for which quotation is received;
• whether the security is traded in an active or inactive market;
• consistency among different pricing sources;
• the valuation approach and the methodologies used by the independent pricing
sources in determining fair value;
• the elapsed time between the date to which the market data relates and the
measurement date; and
• the manner in which the fair value information is sourced.
Greater weight is given to quotations of instruments with recent market
transactions, pricing quotes from dealers who stand ready to transact, quotations
provided by market-makers who originally underwrote such instruments, and market
consensus pricing based on inputs from a large number of participants. Any
significant discrepancies among the external quotations are reviewed by management
and adjustments to fair values are recorded where appropriate.
Fair values for derivatives are determined by management using valuation
techniques, valuation models and inputs that are developed, reviewed, validated and
approved by the Derivative Model Review Group of an affiliate, HSBC Bank
USA
. These valuation models utilize discounted cash flows or an option pricing model
adjusted for counterparty credit risk and market liquidity. The models used apply
appropriate control processes and procedures to ensure that the derived inputs are
used to value only those instruments that share similar risk to the relevant
benchmark indexes and therefore demonstrate a similar response to market factors.
In addition, a validation process is followed which includes participation in peer
group consensus pricing surveys, to ensure that valuation inputs incorporate market
participants' risk expectations and risk premium.
We have various controls over our valuation process and procedures for receivables
held for sale. As these fair values are generally determined using modeling
techniques, the controls may include independent development or validation of the
logic within the valuation models, the inputs to those models, and adjustments
required to outside valuation models. The inputs and adjustments to valuation
models are reviewed with management and reconciled to inputs and assumptions used
in other internal valuation processes.
FAS 157 establishes a fair value hierarchy structure that prioritizes the
inputs to valuation techniques used to determine the fair value of an asset or
liability. FAS 157 distinguishes between inputs that are based on observed
market data and unobservable inputs that reflect market participants' assumptions.
It emphasizes the use of valuation methodologies that maximize market inputs. For
financial instruments carried at fair value, the best evidence of fair value is a
quoted price in an actively traded market (Level 1). Where the market for a
financial instrument is not active, valuation techniques are used. The majority of
valuation techniques use market inputs that are either observable or indirectly
derived from and corroborated by observable market data for substantially the full
term of the financial instrument (Level 2). Because Level 1 and
Level 2 instruments are determined by observable inputs, less judgment is
applied in determining their fair values. In the absence of observable market
inputs, the financial instrument is valued based on valuation techniques that
feature one or more significant unobservable inputs (Level 3). The
determination of the level of fair value hierarchy within which the fair value
measurement of an asset or a liability is classified often requires judgment. We
consider the following factors in developing the fair value hierarchy:
• whether the asset or liability is transacted in an active market with a
quoted market price that is readily available;
• the size of transactions occurring in an active market;
• the level of bid-ask spreads;
• a lack of pricing transparency due to, among other things, the complexity of
the product structure and market liquidity;
• whether only a few transactions are observed over a significant period of
time;
• whether the pricing quotations vary substantially among independent pricing
services;
• whether the inputs to the valuation techniques can be derived from or
corroborated with market data; and
• whether significant adjustments are made to the observed pricing information
or model output to determine the fair value.
Level 1 inputs are unadjusted quoted prices in active markets that the
reporting entity has the ability to access for the identical assets or liabilities.
A financial instrument is classified as a Level 1 measurement if it is listed
on an exchange or is an instrument actively traded in the OTC market where
transactions occur with sufficient frequency and volume. We regard financial
instruments such as equity securities and derivative contracts listed on the
primary exchanges of a country to be actively traded. Non-exchange-traded
instruments classified as Level 1 assets include securities issued by the
U.S. Treasury.
Level 2 inputs are inputs that are observable either directly or indirectly
but do not qualify as Level 1 inputs. We generally classify derivative
contracts, corporate debt including asset-backed securities as well as our own debt
issuance for which we have elected fair value option which are not traded in active
markets, as Level 2 measurements. Currently, substantially all such items
qualify as Level 2 measurements. These valuations are typically obtained from
a third party valuation source which, in the case of derivatives, includes
valuations provided by an affiliate, HSBC Bank
USA
.
Level 3 inputs are unobservable inputs for the asset or liability and include
situations where there is little, if any, market activity for the asset or
liability. Level 3 inputs incorporate market participants' assumptions about
risk and the risk premium required by market participants in order to bear that
risk. We develop Level 3 inputs based on the best information available in the
circumstances. As of June 30, 2009 and December 31, 2008, our
Level 3 instruments recorded at fair value on a recurring basis include
$95 million and $175 million, respectively, of
U.S.
corporate debt, mortgage-backed and perpetual preferred securities. As of
June 30, 2009 and December 31, 2008, our Level 3 instruments
recorded at fair value on a non-recurring basis included the following:
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Receivables held for sale
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Card and Retail Services goodwill
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Transfers Into (Out of) Level 3 Measurements
Assets recorded at fair value on a recurring basis at June 30, 2009 and
December 31, 2008 which have been classified as using Level 3
measurements include certain U.S. corporate debt securities and
mortgage-backed securities and at December 31, 2009, our entire portfolio of
perpetual preferred equity securities which was sold during the first half of 2009.
Securities are classified as using Level 3 measurements when one or both of
the following conditions are met:
• An asset-backed security is downgraded below a AAA credit rating; or
• An individual security fails the quarterly pricing comparison test with a
variance greater than 5 percent.
During the six months ended June 30, 2009, transfers out of Level 3
classifications, net, represents changes in the mix of individual securities that
meet one or both of the above conditions. During the three months ended
June 30, 2009, we transferred $49 million from Level 2 to
Level 3 of individual corporate debt securities and mortgage-backed securities
which met one or both of the conditions described above during the quarter, which
was partially offset by the transfer of $28 million of individual corporate
debt securities and mortgage-backed securities from Level 3 to Level 2 as
they no longer met one or both of the conditions described above. During the six
months ended June 30, 2009, we transferred $119 million of individual
corporate debt securities and mortgage-backed securities from Level 3 to
Level 2 as they no longer met one or both of the conditions described above,
which was partially offset by the transfer of $85 million from Level 2 to
Level 3 of individual corporate debt securities and mortgage-backed securities
which met one or both of the conditions described above during the year-to-date
period. As a result, we reported a total of $95 million and $175 million
of available-for-sale securities, or approximately 3 percent and
6 percent of our securities portfolio as Level 3 at June 30, 2009
and December 31, 2008, respectively. At June 30, 2009 and
December 31, 2008, total Level 3 assets as a percentage of total assets
measured at fair value on a recurring basis was 2 percent and 3 percent,
respectively.
Valuation Techniques for Major Assets and Liabilities Carried at Fair
Value
Securities:
Fair value for our available-for-sale securities is generally determined by a
third party valuation source. The pricing services generally source fair value
measurements from quoted market prices and if not available, the security is valued
based on quotes from similar securities using broker quotes and other information
obtained from dealers and market participants. For securities which do not trade in
active markets, such as fixed income securities, the pricing services generally
utilize various pricing applications, including models, to measure fair value. The
pricing applications are based on market convention and use inputs that are derived
principally from or corroborated by observable market data by correlation or other
means. The following summarizes the valuation methodology used for our major
security types:
• U.S. Treasury,
U.S.
government agency issued or guaranteed and Obligations of U.S. States
and political subdivisions - As these securities transact in an active
market, the pricing services source fair value measurements from quoted prices for
the identical security or quoted prices for similar securities with adjustments as
necessary made using observable inputs which are market corroborated.
• U.S. government sponsored enterprises - For certain
government sponsored mortgage-backed securities which transact in an active market,
the pricing services source fair value measurements from quoted prices for the
identical security or quoted prices for similar securities with adjustments as
necessary made using observable inputs which are market corroborated. For
government sponsored mortgage-backed securities which do not transact in an active
market, fair value is determined using discounted cash flow models and inputs
related to interest rates, prepayment speeds, loss curves and market discount rates
that would be required by investors in the current market given the specific
characteristics and inherent credit risk of the underlying collateral.
• Asset-backed securities - Fair value is determined using
discounted cash flow models and inputs related to interest rates, prepayment
speeds, loss curves and market discount rates that would be required by investors
in the current market given the specific characteristics and inherent credit risk
of the underlying collateral.
•
U.S.
corporate and foreign debt securities - For non-callable corporate
securities, a credit spread scale is created for each issuer. These spreads are
then added to the equivalent maturity U.S. Treasury yield to determine current
pricing. Credit spreads are obtained from the new issue market, secondary trading
levels and dealer quotes. For securities with early redemption features, an option
adjusted spread ("OAS") model is incorporated to adjust the spreads determined
above. Additionally, the pricing services will survey the broker/dealer community
to obtain relevant trade data including benchmark quotes and updated spreads.
• Preferred equity securities - In general, for perpetual preferred
securities fair value is calculated using an appropriate spread over a comparable
US Treasury security for each issue. These spreads represent the additional yield
required to account for risk including credit, refunding and liquidity. The inputs
are derived principally from or corroborated by observable market data.
• Money market funds - Carrying value approximates fair value due to
the asset's liquid nature.
We perform validations of the fair values sourced from the independent pricing
services at least quarterly. Such validation principally includes sourcing security
prices from other independent pricing services or broker quotes. The validation
process provides us with information as to whether the volume and level of activity
for a security has significantly decreased and assists in identifying transactions
that are not orderly. Depending on the results of the validation, additional
information may be gathered from other market participants to support the fair
value measurements. A determination will be made as to whether adjustments to the
observable inputs are necessary as a result of investigations and inquiries about
the reasonableness of the inputs used and the methodologies employed by the
independent pricing services.
Debt securities, including mortgage-backed securities and other asset-backed
securities represented approximately 80 percent and 76 percent of our
total investment securities portfolio at June 30, 2009 and December 31,
2008, respectively.
Derivatives
Derivative values are defined as the amount we would receive or pay to
extinguish the contract using a market participant as of the reporting date. The
values are determined by Treasury finance using a pricing system maintained by HSBC
Bank
USA
. In determining these values, HSBC Bank
USA
uses quoted market prices, when available, principally for exchange-traded
options. For non-exchange traded contracts, such as interest rate swaps, fair value
is determined using discounted cash flow modeling techniques. Valuation models
calculate the present value of expected future cash flows based on models that
utilize independently-sourced market parameters, including interest rate yield
curves, option volatilities, and currency rates. Valuations may be adjusted in
order to ensure that those values represent appropriate estimates of fair value.
These adjustments, which are applied consistently over time, are generally required
to reflect factors such as market liquidity and counterparty credit risk that can
affect prices in arms-length transactions with unrelated third parties. Finally,
other transaction specific factors such as the variety of valuation models
available, the range of unobservable model inputs and other model assumptions can
affect estimates of fair value. Imprecision in estimating these factors can impact
the amount of revenue or loss recorded for a particular position.
Counterparty credit risk is considered in determining the fair value of a financial
asset. FAS 157 specifies that the fair value of a liability should reflect the
entity's non-performance risk and accordingly, the effect of our own credit risk
(spread) has been factored into the determination of the fair value of our
financial liabilities, including derivative instruments. In estimating the credit
risk adjustment to the derivative assets and liabilities, we take into account the
impact of netting and/or collateral arrangements that are designed to mitigate
counterparty credit risk.
Long-Term Debt Carried at Fair Value
Fair value was primarily determined by a third party valuation source. The
pricing services source fair value from quoted market prices and, if not available,
expected cash flows are discounted using the appropriate interest rate for the
applicable duration of the instrument adjusted for our own credit risk (spread).
The credit spreads applied to these instruments were derived from the spreads
recognized in the secondary market for similar debt as of the measurement date.
Where available, relevant trade data is also considered as part of our validation
process.
Receivables Held for
Sale
Receivables held for sale are carried at the lower of amortized cost or fair
value. Accordingly, fair value for such receivables must be estimated to determine
any required write down to fair value when the amortized cost of the receivables
exceeds their current fair value. Where available, quoted market prices are used to
estimate the fair value of these receivables. Where market quotes are not
available, fair value is estimated using observable market prices of similar
instruments, including bonds, credit derivatives, and receivables with similar
characteristics. Where quoted market prices and observable market parameters are
not available, the fair value of receivables held for sale is based on contractual
cash flows adjusted for management's estimates of prepayments, defaults, and
recoveries, discounted at management's estimate of the rate of return that would be
required by investors in the current market given the specific characteristics and
inherent credit risk of the receivables. Continued lack of liquidity in credit
markets has resulted in a significant decrease in the availability of observable
market data, which has, in turn, resulted in an increased level of management
judgment required to estimate fair value for receivables held for sale. In certain
cases, an independent third party is utilized to substantiate management's estimate
of fair value.
We review and update our fair value hierarchy classifications quarterly. Changes
from one quarter to the next related to the observability of inputs to a fair value
measurement may result in a reclassification between hierarchy levels. Imprecision
in estimating unobservable market inputs can impact the amount of revenue, loss or
changes in common shareholder's equity recorded for a particular financial
instrument. Furthermore, while we believe our valuation methods are appropriate,
the use of different methodologies or assumptions to determine the fair value of
certain financial assets and liabilities could result in a different estimate of
fair value at the reporting date.
See Note 17, "Fair Value Measurements" in the accompanying consolidated
financial statements for further details including the classification hierarchy
associated with assets and liabilities measured at fair value.
In the first half of 2009 significant steps were undertaken to further strengthen
our risk management organization, including the appointment of a Chief Risk Officer
and the creation of a distinct, cross-disciplinary risk organization, representing
a shift from a business unit driven approach to an independent and integrated risk
function.
Credit Risk
Day-to-day management of credit risk is administered by Chief Credit Officers for
each business who report to the Chief Risk Officer. The Chief Risk Officer reports
to our Chief Executive Officer and to the Group Managing Director and Chief Risk
Officer of HSBC. Although our product offerings have been significantly reduced as
a result of our decision to discontinue all new customer account originations in
our Consumer Lending business, there have been no other significant changes in our
approach to credit risk management since December 31, 2008.
Currently the majority of our existing derivative contracts are with HSBC
subsidiaries, making them our primary counterparty in derivative transactions. Most
swap agreements, both with unaffiliated and affiliated third parties, require that
payments be made to, or received from, the counterparty when the fair value of the
agreement reaches a certain level. Generally, third-party swap counterparties
provide collateral in the form of cash which is recorded in our balance sheet as
derivative related assets or derivative related liabilities. We provided third
party swap counterparties with collateral totaling $29 million and
$26 million at June 30, 2009 and December 31, 2008, respectively.
The fair value of our agreements with affiliate counterparties required the
affiliate to provide cash collateral of $2.4 billion and $2.9 billion at
June 30, 2009 and December 31, 2008, respectively. These amounts are
offset against the fair value amount recognized for derivative instruments that
have been offset under the same master netting arrangement in accordance with FASB
Staff Position No. FIN 39-1, "Amendment of FASB Interpretation
No. 39," ("FSP 39-1").
Liquidity Risk
The balance sheet and corresponding credit dynamics described above will have a
significant impact on our liquidity risk management processes. Lower cash flow as a
result of declining receivable balances as well as "cashless" attrition due to
charge-offs, will not fully cover maturing debt through 2013. Absent asset sales
and financial support from HSBC, we may face additional funding requirements from
time to time. Funding requirements will be covered primarily through a combination
of capital infusions from HSBC, a robust cash management process and potential
opportunistic portfolio sales. HSBC has indicated it remains fully committed and
has the capacity to continue to provide such support. We believe a portion of this
gap could also be met through potential issuances of unsecured term debt. These
issuances would better match the projected cash flows of the remaining real estate
secured receivable portfolio and partly reduce reliance on direct HSBC support.
During 2007 and 2008 and continuing into the first half of 2009, the capital
markets have been severely disrupted, highly risk averse and reactionary. Until
very recently, institutional fixed income investors for the most part remained
reluctant to commit significant levels of liquidity to the financial sector of the
market unless the corresponding debt issuance was in conjunction with a government
guarantee program. Traditional providers of credit to the subprime market have
either continued to reduce their exposure to this asset class or have markedly
tightened the credit standards necessary to receive financing for subprime assets.
This has reduced the availability of third party liquidity while increasing the
cost of this liquidity.
Other conditions that could negatively affect our liquidity include unforeseen cash
or capital requirements, a continued strengthening of the U.S. dollar, a
slowdown in the rate of attrition of our balance sheet and an inability to obtain
expected funding from HSBC, its subsidiaries and clients.
Lastly, maintaining our credit ratings is an important part of maintaining our
overall liquidity profile. A credit ratings downgrade could potentially increase
borrowing costs, and depending on its severity, substantially limit access to
capital markets, require cash payments or collateral posting and permit termination
of certain contracts material to us.
Following our decision in late February 2009 to discontinue new customer account
originations for all products offered by our Consumer Lending business and to close
substantially all branch offices, two of the three primary credit rating agencies
elected to lower the ratings on our senior debt, commercial paper and Series B
preferred stock. While we continue to access short term funding through the
commercial paper market at competitive rates, we have identified several investors
that have placed a hold on any additional purchases of our commercial paper. We do
not anticipate this will have a significant impact on our ability to meet our
projected short term funding needs at competitive rates.
The rating actions discussed above initially resulted in a widening of the credit
spreads quoted on our senior debt trading in the secondary market and a reduction
in the number of potential institutional investors willing to purchase this debt.
Consistent with the experience of most other financial sector issuers, the quoted
spread on our secondary market debt has tightened significantly during the second
quarter. Should our 2009 funding plans change and we elect to issue new
institutionally-placed senior debt, we would likely experience a reduction in the
amount of new debt that could be issued and an increase in the corresponding
interest rate and credit spread when compared with our historical issuances.
There have been no significant changes in our approach to liquidity risk since
December 31, 2008.
Market Risk
Our exposure to interest rate risk is also changing as the balance sheet
declines. Prior to the credit crisis, our real estate portfolio was assumed to have
a duration (average life) of approximately 3 years. While the loans had
original maturities of 30 years, active customer refinancing resulted in the
shorter duration assumption used in the risk management process. Debt was typically
issued in intermediate and longer term maturities to maximize the liquidity
benefit. The interest rate risk created by combining short duration assets with
long duration liabilities was reduced by entering into hedge positions that reduced
the duration of the liabilities portfolio.
The progression of the credit crisis over the last 2 years is impacting this
risk profile. Originally modeled as 3 years, the duration assumption for our
real estate portfolio is extending as a higher percentage of the remaining loans
stay on the books longer due to the impact of modification programs and/or lack of
refinancings alternatives. At the same time, the duration of our liability
portfolio is declining due to the passage of time and the absence of new term debt
issuance. To reduce the interest rate risk arising from this changing balance sheet
profile, we have and will continue to enter into economic hedge positions that
effectively extend the duration of our floating rate liabilities.
HSBC has certain limits and benchmarks that serve as additional guidelines in
determining the appropriate levels of interest rate risk. One such limit is
expressed in terms of the Present Value of a Basis Point, which reflects the change
in value of the balance sheet for a one basis point movement in all interest rates
without considering other correlation factors or assumptions. Our absolute PVBP
limit was $2.35 million at June 30, 2009 and December 31, 2008 which
includes the risk associated with hedging instruments. Thus, for a one basis point
change in interest rates, the policy dictates that the value of the balance sheet
for June 30, 2009 and December 31, 2008 shall not increase or decrease by
more than $2.35 million. At June 30, 2009 and December 31, 2008 we
had an absolute PVBP position of $.855 million and $2.396 million,
respectively. Although the PVBP was above the limits as of December 31, 2008,
our ALCO elected not to take immediate action as the sale of the credit card and
auto finance receivables to HSBC Bank USA which occurred in January 2009 brought
this risk measure back within established limits. As described above, we have
executed additional economic hedge positions in the second quarter of 2009 to
further reduce our PVBP position and our corresponding exposure to rising interest
rates. The following table shows the components of absolute PVBP at June 30,
2009 and December 31, 2008 broken down by currency risk:
We also monitor the impact that an immediate hypothetical increase or decrease in
interest rates of 25 basis points applied at the beginning of each quarter
over a 12 month period would have on our net interest income assuming for 2009
and 2008 a declining balance sheet and the current interest rate risk profile. Our
December 31, 2008 estimate included assumptions for the sale of the GM
Portfolio, UP Portfolio and Auto Finance receivables to HSBC Bank
USA
in early January 2009 and the discontinuation of all new customer account
originations for all products by our Consumer Lending business all occurred prior
to December 31, 2008. These estimates also assume we would not take any
corrective actions in response to interest rate movements and, therefore, exceed
what most likely would occur if rates were to change by the amount indicated. The
following table summarizes such estimated impact:
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Decrease in net interest income following a hypothetical 25 basis
points rise in interest rates applied at the beginning of each quarter
over the next 12 months
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Increase in net interest income following a hypothetical 25 basis
points fall in interest rates applied at the beginning of each quarter
over the next 12 months
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A principal consideration supporting both of these analyses is the projected
prepayment of loan balances for a given economic scenario. Individual loan
underwriting standards in combination with housing valuations, loan modification
program and macroeconomic factors related to available mortgage credit are the key
assumptions driving these prepayment projections. While we have utilized a number
of sources to refine these projections, we cannot currently project precise
prepayment rates with a high degree of certainty in all economic environments given
recent, significant changes in both subprime mortgage underwriting standards and
property valuations across the country.
Operational Risk
There has been no significant change in our approach to operational risk
management since December 31, 2008.
Compliance Risk
There has been no significant change in our approach to compliance risk
management since December 31, 2008.
Reputational Risk
There has been no significant change in our approach to reputational risk
management since December 31, 2008.
RECONCILIATIONS TO
U.S.
GAAP FINANCIAL MEASURES
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(dollars are in millions)
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Common shareholder's equity
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Fair value option adjustment
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Unrealized (gains) losses on cash flow hedging instruments
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Postretirement benefit plan adjustments, net of tax
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Unrealized gains on investments and interest-only strip
receivables
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Tangible shareholders' equity:
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Mandatorily redeemable preferred securities of Household Capital
Trusts
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Tangible shareholders' equity
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Tangible shareholder's(s') equity plus owned loss reserves:
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Tangible shareholders' equity
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Tangible shareholders' equity plus owned loss reserves
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Derivative financial assets
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Common and preferred equity to owned assets
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Tangible common equity to tangible managed assets
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Tangible shareholders' equity to tangible managed assets
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Tangible shareholders' equity plus owned loss reserves to tangible
managed assets
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
See Item 2, "Management's Discussion and Analysis of Financial Condition and
Results of Operations," under the caption "Risk Management - Market Risk" of
this Form 10-Q.
Item 4. Controls and Procedures
We maintain a system of internal and disclosure controls and procedures designed to
ensure that information required to be disclosed by HSBC Finance Corporation in the
reports we file or submit under the Securities Exchange Act of 1934, as amended,
(the "Exchange Act"), is recorded, processed, summarized and reported on a timely
basis. Our Board of Directors, operating through its audit committee, which is
composed entirely of independent outside directors, provides oversight to our
financial reporting process.
We conducted an evaluation, with the participation of the Chief Executive Officer
and Chief Financial Officer, of the effectiveness of our disclosure controls and
procedures as of the end of the period covered by this report. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded that
our disclosure controls and procedures were effective as of the end of the period
covered by this report so as to alert them in a timely fashion to material
information required to be disclosed in reports we file under the Exchange Act.
There has been no significant change in our internal control over financial
reporting that occurred during the three months ended June 30, 2009 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are party 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. However, losses may be material to our results of
operations for any particular future period depending on our income level for that
period.
During the past several years, the press has widely reported certain industry
related concerns, including rising delinquencies, the tightening of credit and more
recently, increasing litigation. Some of the litigation instituted against lenders
is being brought in the form of purported class actions by individuals or by state
or federal regulators or state attorneys general. Like other companies in this
industry, we are involved in litigation regarding our practices. The cases
generally allege inadequate disclosure or misrepresentation during the loan
origination process. In some suits, other parties are also named as defendants.
Unspecified compensatory and punitive damages are sought. The judicial climate in
many states is such that the outcome of these cases is unpredictable. Although we
believe we have substantive legal defenses to these claims and are prepared to
defend each case vigorously, a number of such cases have been settled or otherwise
resolved for amounts that in the aggregate are not material to our operations.
Insurance carriers have been notified as appropriate.
Loan Discrimination Litigation
Since July of 2007, HSBC Finance Corporation and/or one or more of its subsidiaries
has been named as a defendant in five class actions filed in the federal courts in
the Northern District of Illinois, the Central District of California and the
District of Massachusetts:
Zamudio v. HSBC North America Holdings and HSBC
Finance Corporation d/b/a Beneficial,
(N.D. Ill. 07CV5413)
, National Association for the Advancement of Colored People
("NAACP") v. Ameriquest Mortgage Company, et al. including HSBC Finance
Corporation
(C.D. Ca., No. SACV07-0794AG)
, Toruno v. HSBC Finance
Corporation and Decision One Mortgage Company, LLC
(C.D. Ca., No. CV07-05998JSL),
Suyapa Allen v. Decision One Mortgage Company, LLC,
HSBC Finance Corporation, et al.
(D. Mass., C.A. 07-11669)
and Doiron, et
al. v. HSBC Mortgage Services Inc., et al.,
(E.D. Ca., 2:08-CV-00605- FCD). Each suit alleges that the named entities racially
discriminated against their customers by using loan pricing policies and procedures
that have resulted in a disparate impact against minority customers. Violations of
various federal statutes, including the Fair Housing Act and the Equal Credit
Opportunity Act, are claimed. The
Zamudio
case was voluntarily dismissed by the plaintiff on July 7, 2008 and may
not be reinitiated. In the NAACP case, the Court granted HSBC Finance Corporation's
motion to dismiss for lack of personal jurisdiction on January 9, 2009. At
this time, we are unable to quantify the potential impact from the remaining
actions, if any.
City of
Cleveland
Litigation
On January 10, 2008, a suit captioned,
City of Cleveland v. Deutsche Bank
Trust Company, et al.
(No. 1:08-CV-00139)
,
was filed in the
Cuyahoga County Common Pleas Court
against numerous financial services entities. HSBC Finance Corporation is a
defendant. The City of
Cleveland
("City") seeks damages it allegedly incurred as a result of defendants'
creation of a public nuisance in the City through their respective involvement as
lenders and/or securitizers of sub-prime mortgages on properties located in
Cleveland
. On January 16, 2008, the case was removed to the United States District
Court for the Northern District of Ohio. On August 22, 2008, the City filed a
new complaint,
City of
Cleveland v. JP Morgan Chase Bank, NA et al
, in the Court of Common Pleas, Cuyahoga County Ohio (No. CV 08 668608), in
which it made virtually identical allegations as in the Federal Court complaint,
alleges violations of the Ohio Corrupt Practices Act and named additional
defendants. The two courts have now approved the parties' agreements regarding the
defendants in these two actions. HSBC Finance Corporation was dismissed with
prejudice from the Federal Court action. The City appealed this order. Subsidiaries
of HSBC Finance Corporation, namely Household Realty Corporation and HSBC Mortgage
Services Inc. are defendants in the State Court action. All the defendants filed
motions to sever in the State Court action.
Since June 2005, HSBC Finance Corporation, HSBC North America, and HSBC, as well as
other banks and Visa Inc. and Master Card Incorporated, were named as defendants in
four class actions filed in Connecticut and the Eastern District of New York;
Photos
Etc.
Corp. et al. v. Visa U.S.A., Inc., et al.
(D. Conn. No. 3:05-CV-01007 (WWE)):
National Association of Convenience Stores, et
al. v. Visa U.S.A., Inc., et al.
(E.D.N.Y. No. 05-CV 4520 (JG));
Jethro
Holdings, Inc., et al. v. Visa U.S.A., Inc. et al.
(E.D.N.Y. No. 05-CV-4521 (JG)); and
American Booksellers Ass'n v. Visa U.S.A.,
Inc. et al.
(E.D.N.Y. No. 05-CV-5391 (JG)). Numerous other complaints containing similar
allegations (in which no HSBC entity is named) were filed across the country
against Visa Inc., MasterCard Incorporated and other banks. These actions
principally allege that the imposition of a no-surcharge rule by the associations
and/or the establishment of the interchange fee charged for credit card
transactions causes the merchant discount fee paid by retailers to be set at
supracompetitive levels in violation of the Federal antitrust laws. These suits
have been consolidated and transferred to the Eastern District of New York. The
consolidated case is:
In re Payment Card Interchange Fee and Merchant Discount
Antitrust Litigation, MDL 1720, E.D.N.Y.
A consolidated, amended complaint was filed by the plaintiffs on April 24,
2006 and a second consolidated amended complaint was filed on January 29,
2009. The parties are engaged in discovery and motion practice. At this time, we
are unable to quantify the potential impact from this action, if any.
In August 2002, we restated previously reported consolidated financial statements
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 Card Services operations. As a result
of the restatement and other corporate events, including, e.g., the 2002 settlement
with 46 states and the District of Columbia relating to real estate lending
practices, Household International and certain former officers were named as
defendants in a class action lawsuit,
Jaffe v. Household International,
Inc., et al.
, No. 02 C 5893 (N.D. Ill., filed August 19, 2002).
The complaint, as narrowed by Court rulings, asserted claims under § 10
and § 20 of the Securities Exchange Act of 1934, on behalf of all persons
who acquired and disposed of Household International common stock between
July 30, 1999 and October 11, 2002. The claims alleged that the
defendants knowingly or recklessly made false and misleading statements of material
facts relating to Household's Consumer Lending operations, including collections,
sales and lending practices, some of which ultimately led to the 2002 state
settlement agreement, and facts relating to accounting practices evidenced by the
restatement. The plaintiffs claim that these statements were made in conjunction
with the purchase or sale of securities, that they justifiably relied on one or
more of those statements, that the false statement(s) caused the plaintiffs'
damages, and that some or all of the defendants should be liable for those damages.
A jury trial began on March 30, 2009 and closing arguments concluded on
April 30, 2009. The jury deliberated over the course of four days before
rendering a verdict on May 7 partially in favor of the plaintiffs with respect to
Household International and three former officers. The jury found 17 of 40 alleged
misstatements actionable and that the first actionable statement occurred on
March 23, 2001. This effectively excludes claims for purchases made prior to
that date. We filed a motion requesting that the Court set aside the jury's verdict
and enter a verdict in favor of all defendants on all claims and a motion for a new
trial. Pleadings supporting the motions were filed with the Court by July 20,
2009.
Concurrent with the briefing on the motion to set aside the jury verdict, a second
phase of the case will proceed to determine the actual damages, if any, due to the
plaintiff class. Although the jury determined that the loss per common share
attributable to the alleged misstatements varied by day and ranged from -$4.60 (no
loss) to $23.94, how this stage of the case will proceed has not been determined by
the Court. Matters to be determined include, but are not limited to, whether there
will be discovery to determine if shareholders actually relied upon statements
found to be misleading, the process for determining which shareholders purchased
securities on or after March 23, 2001 and sold during the relevant period (the
sale window potentially extending up to 90 days after October 11, 2002),
as well as other procedural matters and eligibility criteria. The plaintiffs and
defendants each filed proposals on how to conduct this damages phase. Given the
complexity associated with this phase of the case, it is impossible at this time to
determine whether any damages will eventually be awarded, or the amount of any such
award.
There are also several motions pending that would dispose of the case prior to a
determination of actual damages, including defendants' motion for summary judgment
as filed in May 2008 and motions to direct a verdict made at the close of both the
plaintiffs' and defendants' cases. When any final judgment is entered by the
District Court at the conclusion of the damages phase of the case, the parties have
30 days in which to appeal the verdict to the Seventh Circuit Court of
Appeals.
Despite the verdict at the District Court level, we continue to believe, after
consultation with counsel, that neither Household nor its former officers engaged
in any wrongdoing and that we will either prevail on our outstanding motions or
that the Seventh Circuit will reverse the trial Court verdict upon appeal.
Exhibits included in this Report:
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Statement of Computation of Ratio of Earnings to Fixed Charges and to
Combined Fixed Charges and Preferred Stock Dividends
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Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
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Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
Senior Executive Vice President and
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Statement of Computation of Ratio of Earnings to Fixed Charges and to
Combined Fixed Charges and Preferred Stock Dividends
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Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
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Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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COMPUTATION OF RATIO OF LOSS TO FIXED CHARGES AND TO
COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
Six Months Ended June 30,
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Loss from continuing operations
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Loss before income tax benefit
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Interest portion of rentals(1)
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Total earnings (loss) from continuing operations as defined
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Ratio of earnings (loss) to fixed charges
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Preferred stock dividends(2)
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Ratio of earnings (loss) to combined fixed charges and preferred stock
dividends
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Represents one-third of rentals, which approximates the portion
representing interest.
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Preferred stock dividends are grossed up to their pretax
equivalents.
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CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
Certification of Chief Executive Officer
I, Niall S.K. Booker, Chief Executive Officer of HSBC Finance Corporation, certify
that:
1. I have reviewed this report on Form 10-Q of HSBC Finance Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of,
and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a - 15(f) and
15d - 15(f)) for the registrant and we have:
a) designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision, to
provide reasonable assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;
c) evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness of
the disclosure controls and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent fiscal
quarter that has materially affected, or is reasonably likely to materially affect,
the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal controls over financial reporting which are reasonably likely
to adversely affect the registrant's ability to record, process, summarize and
report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Certification of Chief Financial Officer
I, Iain J. Mackay, Senior Executive Vice President and Chief Financial Officer of
HSBC Finance Corporation, certify that:
1. I have reviewed this report on Form 10-Q of HSBC Finance Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of,
and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a - 15(f) and
15d - 15(f)) for the registrant and we have:
a) designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision, to
provide reasonable assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;
c) evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness of
the disclosure controls and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent fiscal
quarter that has materially affected, or is reasonably likely to materially affect,
the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal controls over financial reporting which are reasonably likely
to adversely affect the registrant's ability to record, process, summarize and
report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Senior Executive Vice President
and Chief Financial Officer
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to
Section 906 of the Sarbanes-Oxley Act of 2002
The certification set forth below is being submitted in connection with the HSBC
Finance Corporation (the "Company") Quarterly Report on Form 10-Q for the
period ending June 30, 2009 as filed with the Securities and Exchange
Commission on the date hereof (the "Report") for the purpose of complying with
Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934
(the "Exchange Act") and Section 1350 of Chapter 63 of Title 18 of
the United States Code.
I, Niall S.K. Booker, Chief Executive Officer of the Company, certify that:
1. the Report fully complies with the requirements of Section 13(a) or
15(d) of the Exchange Act; and
2. the information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of HSBC Finance
Corporation.
Certification Pursuant to 18 U.S.C. Section 1350,
As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
The certification set forth below is being submitted in connection with the HSBC
Finance Corporation (the "Company") Quarterly Report on Form 10-Q for the
period ending June 30, 2009 as filed with the Securities and Exchange
Commission on the date hereof (the "Report") for the purpose of complying with
Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934
(the "Exchange Act") and Section 1350 of Chapter 63 of Title 18 of
the United States Code.
I, Iain J. Mackay, Senior Executive Vice President and Chief Financial Officer of
the Company, certify that:
1. the Report fully complies with the requirements of Section 13(a) or
15(d) of the Exchange Act; and
2. the information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of HSBC Finance
Corporation.
Senior Executive Vice President
and Chief Financial Officer
This certification accompanies each Report pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the
Sarbanes-Oxley Act of 2002, be deemed filed by HSBC Finance Corporation for
purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
Signed originals of these written statements required by Section 906 of the
Sarbanes-Oxley Act of 2002 have been provided to HSBC Finance Corporation and will
be retained by HSBC Finance Corporation and furnished to the Securities and
Exchange Commission or its staff upon request.
SIGNATURE
Pursuant to the requirements of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
HSBC Holdings plc
By:
Name: P A Stafford
Title: Assistant Group Secretary
Date:
03 August, 2009