HSBC Finance Corp 10-Q Part 3
HSBC Holdings PLC
14 November 2007
HSBC Finance Corporation
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LIQUIDITY AND CAPITAL RESOURCES
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Debt due to affiliates and other HSBC related funding are summarized in the
following table:
SEPTEMBER 30, DECEMBER 31,
2007 2006
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(IN BILLIONS)
Debt issued to HSBC subsidiaries:
Drawings on bank lines in the U.K. and Europe........... $ 3.9 $ 4.3
Term debt............................................... 10.4 10.6
Preferred securities issued by Household Capital Trust
VIII to HSBC......................................... .3 .3
----- -----
Total debt outstanding to HSBC subsidiaries............. 14.6 15.2
----- -----
Debt outstanding to HSBC clients:
Euro commercial paper................................... 2.6 3.0
Term debt............................................... .9 1.2
----- -----
Total debt outstanding to HSBC clients.................. 3.5 4.2
Cash received on bulk and subsequent sales of domestic
private label credit card receivables to HSBC Bank USA,
net (cumulative)........................................ 18.0 17.9
Real estate secured receivable activity with HSBC Bank
USA:
Cash received on sales (cumulative)..................... 3.7 3.7
Direct purchases from correspondents (cumulative)....... 4.2 4.2
Reductions in real estate secured receivables sold to
HSBC Bank USA........................................ (5.3) (4.7)
----- -----
Total real estate secured receivable activity with HSBC
Bank USA................................................ 2.6 3.2
----- -----
Cash received from sale of European Operations to HBEU
affiliate............................................... -(1) -(1)
Cash received from sale of U.K. credit card business to
HBEU.................................................... 2.7 2.7
Capital contribution by HSBC Investments (North America)
Inc. ("HINO") (cumulative).............................. 1.6 1.4
----- -----
Total HSBC related funding................................ $43.0 $44.6
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(1) Less than $100 million.
Funding from HSBC, including debt issuances to HSBC subsidiaries and clients,
represented 12 percent of our total and preferred stock funding at September 30,
2007 and 13 percent at December 31, 2006.
At September 30, 2007, we had a commercial paper back stop credit facility of
$2.5 billion from HSBC supporting domestic issuances and a revolving credit
facility of $5.7 billion from HBEU to fund our operations in the U.K. At
September 30, 2007, $3.9 billion was outstanding under the HBEU lines for the
U.K. and no balances were outstanding under the domestic lines. At September 30,
2007, we had derivative contracts with a notional value of $92.4 billion, or
approximately 96 percent of total derivative contracts, outstanding with HSBC
affiliates. At December 31, 2006, we had derivative contracts with a notional
value of $82.8 billion, or approximately 88 percent of total derivative
contracts, outstanding with HSBC affiliates.
SECURITIES AND OTHER SHORT-TERM INVESTMENTS Securities totaled $3.2 billion at
September 30, 2007 and $4.7 billion at December 31, 2006. Securities purchased
under agreements to resell totaled $1.5 billion at September 30, 2007 and $171
million at December 31, 2006. Interest bearing deposits with banks totaled $511
million at September 30, 2007 and $424 million at December 31, 2006. The
decrease in securities is due to the reclassification of the assets of the U.K.
Insurance Operations which at September 30, 2007 are classified as "Held for
Sale" and included within other assets as well as the use of money market funds
to pay down secured financings during 2007. The increase in
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securities purchased under agreements to resell and interest bearing deposits
with banks is due to the generation of additional liquidity.
COMMERCIAL PAPER, BANK AND OTHER BORROWINGS totaled $9.5 billion at September
30, 2007 and $11.1 billion at December 31, 2006. Included in this total was
outstanding Euro commercial paper sold to customers of HSBC of $2.6 billion at
September 30, 2007 and $3.0 billion at December 31, 2006. Commercial paper
balances were lower at September 30, 2007 as a result of lower short term
funding requirements during the quarter. Our funding strategy requires that
committed bank credit facilities will at all times exceed 80 percent of
outstanding commercial paper and that the combination of bank credit facilities
and undrawn committed conduit facilities will, at all times, exceed 115 percent
of outstanding commercial paper.
LONG TERM DEBT (with original maturities over one year) decreased to $125.4
billion at September 30, 2007 from $127.6 billion at December 31, 2006. The
decrease is due to lower funding requirements resulting from the lower asset
levels during the third quarter of 2007. Significant issuances during the nine
months ended September 30, 2007 included the following:
- $.4 billion of domestic and foreign medium-term notes
- $2.4 billion of foreign currency-denominated bonds
- $.9 billion of InterNotes(SM) (retail-oriented medium-term notes)
- $4.0 billion of global debt
- $8.5 billion of securities backed by real estate secured, auto finance,
credit card and personal non-credit card receivables. For accounting
purposes, these transactions were structured as secured financings.
In the first quarter of 2006, we redeemed the junior subordinated notes, issued
to Household Capital Trust VI with an outstanding principal balance of $206
million. In the fourth quarter of 2006 we redeemed the junior subordinated
notes, issued to Household Capital Trust VII with an outstanding principal
balance of $206 million.
COMMON EQUITY In the first quarter of 2007, HINO made a capital contribution of
$200 million. On November 8, 2007, HINO made an additional capital contribution
of $750 million in exchange for one share of common stock. These capital
contributions were to support ongoing operations and to maintain capital at
levels we believe are prudent in the current market conditions.
SELECTED CAPITAL RATIOS In managing capital, we develop targets for tangible
shareholder's(s') equity to tangible managed assets ("TETMA"), tangible
shareholder's(s') equity plus owned loss reserves to tangible managed assets
("TETMA + Owned Reserves") and tangible common equity to tangible managed
assets. These ratio targets are based on discussions with HSBC and rating
agencies, risks inherent in the portfolio, the projected operating environment
and related risks, and any acquisition objectives. These ratios exclude the
equity impact of SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," the equity impact of SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," and the impact of the adoption
of SFAS No. 159, "The Fair Value Option for Financial Assets and Liabilities,"
including the subsequent changes in fair value recognized in earnings associated
with credit risk on debt for which we elected the fair value option. Preferred
securities issued by certain non-consolidated trusts are also considered equity
in the TETMA and TETMA + Owned Reserves calculations because of their long-term
subordinated nature and our ability to defer dividends. Managed assets include
owned assets plus loans which we have sold and service with limited recourse. We
and certain rating agencies also monitor our equity ratios excluding the impact
of the HSBC acquisition purchase accounting adjustments. We do so because we
believe that the HSBC acquisition purchase accounting adjustments represent non-
cash transactions which do not affect our business operations, cash flows or
ability to meet our debt obligations. Our targets may change from time to time
to accommodate changes in the operating environment or other considerations such
as those listed above. On October 2, 2007, Fitch changed the total outlook on
our issuer default rating to "stable outlook" from "positive outlook".
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SELECTED CAPITAL RATIOS are summarized in the following table:
SEPTEMBER 30, DECEMBER 31,
2007 2006
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TETMA(1).................................................. 7.33%(2) 7.16%
TETMA + Owned Reserves(1)................................. 12.57 11.02
Tangible common equity to tangible managed assets(1)...... 6.20 6.08
Common and preferred equity to owned assets............... 10.60 11.21
Excluding purchase accounting adjustments:
TETMA(1)................................................ 7.87 7.81%
TETMA + Owned Reserves(1)............................... 13.11 11.67
Tangible common equity to tangible managed assets(1).... 6.75 6.72
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(1) TETMA, TETMA + Owned Reserves and tangible common equity to tangible managed
assets represent non-U.S.GAAP financial ratios that are used by HSBC Finance
Corporation management and certain rating agencies to evaluate capital
adequacy and may differ from similarly named measures presented by other
companies. See "Basis of Reporting" for additional discussion on the use of
non-U.S.GAAP financial measures and "Reconciliations to U.S. GAAP Financial
Measures" for quantitative reconciliations to the equivalent U.S.GAAP basis
financial measure.
(2) On a proforma basis, if the capital contribution on November 8, 2007 of $750
million had instead been received on September 30, 2007, the TETMA ratio
would have been 7.78 percent.
SECURITIZATIONS AND SECURED FINANCINGS Securitizations (collateralized funding
transactions structured to receive sale treatment under Statement of Financial
Accounting Standards No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, a Replacement of FASB
Statement No. 125," ("SFAS No. 140")) and secured financings (collateralized
funding transactions which do not receive sale treatment under SFAS No. 140) of
consumer receivables have been a source of funding and liquidity for us.
Securitizations and secured financings have been used to limit our reliance on
the unsecured debt markets and often are more cost-effective than alternative
funding sources.
Securitizations are treated as secured financings under both IFRS and U.K. GAAP.
In order to align our accounting treatment with that of HSBC initially under
U.K. GAAP and now under IFRS, we began to structure all new collateralized
funding transactions as secured financings in the third quarter of 2004.
However, because existing public credit card transactions were structured as
sales to revolving trusts that require replenishments of receivables to support
previously issued securities, receivables will continue to be sold to these
trusts and the resulting replenishment gains recorded until the revolving
periods end, the last of which is currently projected to occur in the fourth
quarter of 2007. The termination of sale treatment on new collateralized funding
activity reduced our reported net income under U.S. GAAP. There was no impact,
however, on cash received from operations. Because we believe the market for
securities backed by receivables is a reliable, efficient and cost-effective
source of funds, we will continue to use secured financings of consumer
receivables as a source of our funding and liquidity.
There were no securitizations (excluding replenishments of certificateholder
interests) during the first nine months of 2007 or 2006. Secured financings are
summarized in the following table:
THREE MONTHS ENDED SEPTEMBER 30 2007 2006
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(IN MILLIONS)
SECURED FINANCINGS:
Real estate secured............................................. $ 950 $2,304
Credit card..................................................... 678 2,640
Auto finance.................................................... - 1,060
Personal non-credit card........................................ 1,200 -
------ ------
Total........................................................... $2,828 $6,004
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NINE MONTHS ENDED SEPTEMBER 30 2007 2006
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(IN MILLIONS)
SECURED FINANCINGS:
Real estate secured............................................ $2,545 $ 2,654
Credit card.................................................... 3,568 4,745
Auto finance................................................... 1,069 2,004
Personal non-credit card....................................... 1,310 2,500
------ -------
Total.......................................................... $8,492 $11,903
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Our securitized receivables totaled $579 million at September 30, 2007 compared
to $949 million at December 31, 2006. As of September 30, 2007, outstanding
secured financings of $22.9 billion were secured by $30.7 billion of real estate
secured, auto finance, credit card and personal non-credit card receivables.
Secured financings of $21.8 billion at December 31, 2006 were secured by $28.1
billion of real estate secured, auto finance, credit card and personal non-
credit card receivables. At September 30, 2007, securitizations structured as
sales represented less than 1 percent and secured financings represented 15
percent of the funding associated with our managed funding portfolio. At
December 31, 2006, securitizations structured as sales represented 1 percent and
secured financings represented 14 percent of the funding associated with our
managed funding portfolio.
COMMITMENTS We also enter into commitments to meet the financing needs of our
customers. In most cases, we have the ability to reduce or eliminate these open
lines of credit. As a result, the amounts below do not necessarily represent
future cash requirements.
SEPTEMBER 30, DECEMBER 31,
2007 2006
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(IN BILLIONS)
Private label, and credit cards........................... $188 $186
Other consumer lines of credit............................ 9 7
---- ----
Open lines of credit(1)................................... $197 $193
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(1) Includes an estimate for acceptance of credit offers mailed to potential
customers prior to September 30, 2007 and December 31, 2006, respectively.
At September 30, 2007, our Mortgage Services business had outstanding forward
sales commitments relating to real estate secured loans totaling $185 million
and unused commitments to extend credit relating to real estate secured loans to
customers (as long as certain conditions are met), totaling less than $1
million.
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2007 FUNDING STRATEGY Our current estimated domestic funding needs and sources
for 2007 are summarized in the table that follows:
ACTUAL ESTIMATED
JANUARY 1 OCTOBER 1
THROUGH THROUGH ESTIMATED
SEPTEMBER 30, DECEMBER 31, FULL YEAR
2007 2007 2007
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(IN BILLIONS)
FUNDING NEEDS:
Net asset growth............................... $(5) $ (5) - 2 $(10) - (3)
Commercial paper, term debt and securitization
maturities.................................. 30 2 - 6 32 - 36
Other.......................................... (2) (1) - 3 (3) - 1
--- --------- -----------
Total funding needs............................ $23 $(4) - 11 $ 19 - 34
=== ========= ===========
FUNDING SOURCES:
External funding, including commercial paper
and portfolio sales......................... $23 $ (5) - 8 $ 18 - 31
HSBC and HSBC subsidiaries..................... - 1 - 3 1 - 3
--- --------- -----------
Total funding sources.......................... $23 $(4) - 11 $ 19 - 34
=== ========= ===========
As previously discussed, we have experienced deterioration in the performance of
mortgage loan originations in our Mortgage Services business and in March 2007
decided to discontinue new correspondent channel acquisitions by that business
subject to fulfilling earlier commitments, which were immaterial. However, the
recent turmoil in the mortgage lending industry, as previously discussed, has
caused us to re-evaluate our strategy. These actions, combined with normal
portfolio attrition and risk mitigation efforts we began in the second half of
2006, will result in negative growth in our aggregate portfolio in 2007. As
opportunities arise, we may also choose to sell selected portfolios, similar to
the $2.2 billion sale of real estate secured receivables completed during the
second quarter of 2007. Future decisions to constrain growth in additional
portfolios as well as decisions to sell selected portfolios would also result in
negative year over year growth in the balance sheet.
RISK MANAGEMENT
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CREDIT RISK Credit risk is the risk that financial loss arises from the failure
of a customer or counterparty to meet its obligations under a contract. Our
credit risk arises primarily from lending and treasury activities.
Day-to-day management of credit risk is administered by Chief Credit Officers in
each business line who have solid reporting lines to both the business line
Chief Executive Officer and the Chief Retail Credit Officer. Oversight is
provided by a corporate Chief Retail Credit Officer who reports to our Chief
Operating Officer and indirectly to the Group General Manager, Head of Credit
and Risk for HSBC. We have established detailed policies to address the credit
risk that arises from our lending activities. Our credit and portfolio
management procedures focus on sound underwriting, effective collections and
customer account management efforts for each loan. Our lending guidelines, which
delineate the credit risk we are willing to take and the related terms, are
specific not only for each product, but also take into consideration various
other factors including borrower characteristics. We also have specific policies
to ensure the establishment of appropriate credit loss reserves on a timely
basis to cover probable losses of principal, interest and fees. See "Credit
Quality" for a detailed description of our policies regarding the establishment
of credit loss reserves, our delinquency and charge-off policies and practices
and our customer account management policies and practices. Also see Note 2,
"Summary of Significant Accounting Policies," in our 2006 Form 10-K for further
discussion of our policies surrounding credit loss reserves. While we develop
our own policies and procedures for all of our lending activities, they are
consistent with HSBC standards and are regularly reviewed and updated both on an
HSBC Finance Corporation and HSBC level.
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At September 30, 2007, we had derivative contracts with a notional value of
approximately $96.4 billion, including $92.4 billion outstanding with HSBC
affiliates. Most swap agreements, both with unaffiliated and affiliated third
parties, require that payments be made to, or received from, the counterparty
when the fair value of the agreement reaches a certain level. Generally, third-
party swap counterparties provide collateral in the form of cash which is
recorded in our balance sheet as other assets or derivative related liabilities.
At September 30, 2007, we provided third party swap counterparties with $44
million collateral. At December 31, 2006, third party counterparties had
provided $158 million in collateral to us. Beginning with the second quarter of
2006, when the fair value of our agreements with affiliate counterparties
require the posting of collateral by the affiliate, it is provided in the form
of cash and recorded on the balance sheet, consistent with third party
arrangements. At September 30, 2007, the fair value of our agreements with
affiliate counterparties required the affiliate to provide cash collateral of
$2.8 billion which is 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. At December 31, 2006, the fair value of our agreements with
affiliate counterparties required the affiliate to provide cash collateral of
$1.0 billion which is 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.
LIQUIDITY RISK There have not been significant changes in our approach to
liquidity risk since December 31, 2006. We continue to focus on ensuring a well
diversified funding base. We constantly monitor market conditions and focus on
our ability to fund maturing liabilities. During the third quarter of 2007, we
continued to access the commercial paper market and all other funding sources
consistent with our funding plans.
MARKET RISK HSBC has certain limits and benchmarks that serve as guidelines in
determining the appropriate levels of interest rate risk. One such limit is
expressed in terms of the Present Value of a Basis Point ("PVBP"), which
reflects the change in value of the balance sheet for a one basis point movement
in all interest rates. Our PVBP limit as of September 30, 2007 was $2 million,
which includes the risk associated with hedging instruments. Thus, for a one
basis point change in interest rates, the policy dictates that the value of the
balance sheet shall not increase or decrease by more than $2 million. As of
September 30, 2007, we had a PVBP position of less than $1 million reflecting
the impact of a one basis point increase in interest rates. As of December 31,
2006, we had a PVBP position of $1.1 million.
The total PVBP position will not change as a result of the early adoption of
SFAS No. 159, however instruments previously accounted for on an accrual basis
will now be accounted for under the fair value option election. As a result, the
PVBP risk for September 30, 2007, summarized in the table below, reflects a
realignment of instruments from December 31, 2006, between accrual and mark-to-
market. Total PVBP risk is lower as a result of normal risk management actions.
The following table shows the components of PVBP:
SEPTEMBER 30, DECEMBER 31,
2007 2006
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(IN MILLIONS)
Risk related to our portfolio of balance sheet items
marked-to-market........................................ $.1 $(1.8)
Risk for all other remaining assets and liabilities....... - 2.9
--- -----
Total PVBP risk........................................... $.1 $ 1.1
=== =====
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We also monitor the impact that an immediate hypothetical increase or decrease
in interest rates of 25 basis points applied at the beginning of each quarter
over a 12 month period would have on our net interest income assuming a growing
balance sheet and the current interest rate risk profile. The following table
summarizes such estimated impact:
SEPTEMBER 30, DECEMBER 31,
2007 2006
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(IN MILLIONS)
Decrease in net interest income following a hypothetical
25 basis points rise in interest rates applied at the
beginning of each quarter over the next 12 months....... $169 $180
Increase in net interest income following a hypothetical
25 basis points fall in interest rates applied at the
beginning of each quarter over the next 12 months....... $128 $ 54
In the September 2007 scenario, as compared to December 2006, the timing of the
repricing of the ARM portfolio is occurring earlier in the scenario, thus having
a greater impact on the results of the analysis for the twelve-month period.
Further, a greater volume of ARMs will reset to higher rates and is expected to
remain on book as a result of fewer refinancing options to subprime customers.
As a result even in the declining rate scenario, the total benefit to net
interest income has increased significantly.
These estimates include the impact of debt and the corresponding derivative
instruments accounted for using the fair value option under SFAS No. 159. These
estimates also assume we would not take any corrective actions in response to
interest rate movements and, therefore, exceed what most likely would occur if
rates were to change by the amount indicated. A principal consideration
supporting this analysis is the projected prepayment of loan balances for a
given economic scenario. Individual loan underwriting standards in combination
with housing valuations 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 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, 2006.
COMPLIANCE RISK There has been no significant change in our approach to
compliance risk management since December 31, 2006.
REPUTATIONAL RISK There has been no significant change in our approach to
reputational risk management since December 31, 2006. We are committed to
offering products that maintain high brand standards and provide value to our
customers. Consistent with this approach, we have taken a number of actions as
discussed elsewhere in this Form 10-Q.
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RECONCILIATIONS TO U.S. GAAP FINANCIAL MEASURES
SEPTEMBER 30, DECEMBER 31,
2007 2006
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(DOLLARS ARE IN MILLIONS)
TANGIBLE COMMON EQUITY:
Common shareholder's equity............................... $ 17,737 $ 19,515
Exclude:
Fair value option adjustment............................ 168 -
Unrealized (gains) losses on cash flow hedging
instruments.......................................... 354 61
Minimum pension liability............................... 1 1
Unrealized gains on investments and interest-only strip
receivables.......................................... 26 23
Intangible assets....................................... (2,029) (2,218)
Goodwill................................................ (6,036) (7,010)
-------- --------
Tangible common equity.................................... 10,221 10,372
HSBC acquisition purchase accounting adjustments.......... 900 1,105
-------- --------
Tangible common equity, excluding HSBC acquisition
purchase accounting adjustments......................... $ 11,121 $ 11,477
======== ========
TANGIBLE SHAREHOLDER'S(S') EQUITY:
Tangible common equity.................................... $ 10,221 $ 10,372
Preferred stock........................................... 575 575
Mandatorily redeemable preferred securities of Household
Capital Trusts.......................................... 1,275 1,275
-------- --------
Tangible shareholder's(s') equity......................... 12,071 12,222
HSBC acquisition purchase accounting adjustments.......... 900 1,105
-------- --------
Tangible shareholder's(s') equity, excluding HSBC
acquisition purchase accounting adjustments............. $ 12,971 $ 13,327
======== ========
TANGIBLE SHAREHOLDER'S(S') EQUITY PLUS OWNED LOSS
RESERVES:
Tangible shareholder's(s') equity......................... $ 12,071 $ 12,222
Owned loss reserves....................................... 8,634 6,587
-------- --------
Tangible shareholder's(s') equity plus owned loss
reserves................................................ 20,705 18,809
HSBC acquisition purchase accounting adjustments.......... 900 1,105
-------- --------
Tangible shareholder's(s') equity plus owned loss
reserves, excluding HSBC acquisition purchase accounting
adjustments............................................. $ 21,605 $ 19,914
======== ========
TANGIBLE MANAGED ASSETS:
Owned assets.............................................. $172,737 $179,218
Receivables serviced with limited recourse................ 579 949
-------- --------
Managed assets............................................ 173,316 180,167
Exclude:
Intangible assets....................................... (2,029) (2,218)
Goodwill................................................ (6,036) (7,010)
Derivative financial assets............................. (502) (298)
-------- --------
Tangible managed assets................................... 164,749 170,641
HSBC acquisition purchase accounting adjustments.......... (7) 64
-------- --------
Tangible managed assets, excluding HSBC acquisition
purchase accounting adjustments......................... $164,742 $170,705
======== ========
EQUITY RATIOS:
Common and preferred equity to owned assets............... 10.60% 11.21%
Tangible common equity to tangible managed assets......... 6.20 6.08
Tangible shareholder's(s') equity to tangible managed
assets ("TETMA")........................................ 7.33 7.16
Tangible shareholder's(s') equity plus owned loss reserves
to tangible managed assets ("TETMA + Owned Reserves")... 12.57 11.02
Excluding HSBC acquisition purchase accounting
adjustments:
Tangible common equity to tangible managed assets....... 6.75 6.72
TETMA................................................... 7.87 7.81
TETMA + Owned Reserves.................................. 13.11 11.67
======== ========
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ITEM 4. CONTROLS AND PROCEDURES
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We maintain a system of internal and disclosure controls and procedures designed
to ensure that information required to be disclosed by HSBC Finance Corporation
in the reports we file or submit under the Securities Exchange Act of 1934, as
amended, (the "Exchange Act"), is recorded, processed, summarized and reported
on a timely basis. Our Board of Directors, operating through its audit
committee, which is composed entirely of independent outside directors, provides
oversight to our financial reporting process.
We conducted an evaluation, with the participation of the Chief Executive
Officer and Chief Financial Officer, of the effectiveness of our disclosure
controls and procedures as of the end of the period covered by this report.
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures were effective as
of the end of the period covered by this report so as to alert them in a timely
fashion to material information required to be disclosed in reports we file
under the Exchange Act.
There have been no significant changes in our internal and disclosure controls
or in other factors which could significantly affect internal and disclosure
controls subsequent to the date that we carried out our evaluation.
HSBC Finance Corporation continues the process to complete a thorough review of
its internal controls as part of its preparation for compliance with the
requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Section 404
requires our management to report on, and our external auditors to attest to,
the effectiveness of our internal control structure and procedures for financial
reporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act, our
first report under Section 404 will be contained in our Form 10-K for the period
ended December 31, 2007.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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GENERAL
We are parties to various legal proceedings resulting from ordinary business
activities relating to our current and/or former operations. Certain of these
actions are or purport to be class actions seeking damages in very large
amounts. These actions assert violations of laws and/or unfair treatment of
consumers. Due to the uncertainties in litigation and other factors, we cannot
be certain that we will ultimately prevail in each instance. We believe that our
defenses to these actions have merit and any adverse decision should not
materially affect our consolidated financial condition.
CONSUMER LITIGATION
During the past several years, the press has widely reported certain industry
related concerns that may impact us. Some of these involve the amount of
litigation instituted against lenders and insurance companies operating in
certain states and the large awards obtained from juries in those states. Like
other companies in this industry, some of our subsidiaries are involved in
lawsuits pending against them in these states. The cases, in particular,
generally allege inadequate disclosure or misrepresentation of financing terms.
In some suits, other parties are also named as defendants. Unspecified
compensatory and punitive damages are sought. Several of these suits purport to
be class actions or have multiple plaintiffs. The judicial climate in these
states is such that the outcome of all of these cases is unpredictable. Although
our subsidiaries believe they have substantive legal defenses to these claims
and are prepared to defend each case vigorously, a number of such cases have
been settled or otherwise resolved for amounts that in the aggregate are not
material to our operations. Insurance carriers have been notified as
appropriate, and from time to time reservations of rights letters have been
received.
DISCRIMINATION LITIGATION
Since July of 2007, HSBC Finance Corporation and/or one or more of its
subsidiaries has been named as a defendant in three class actions filed in the
Central District of California and the District of Massachusetts: 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(ANx)), Toruno v. HSBC Finance Corporation and Decision One
Mortgage Company, LLC (C.D. Ca., No. CV07-05998JSL(RCx) and Suyapa Allen v.
Decision One Mortgage Company, LLC, HSBC Finance Corporation, et al. (D. Mass.,
C.A. 07-11669). Each suit alleges that the named entities racially discriminated
against their customers by using loan pricing policies
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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 NAACP suit has not
yet been served, and responsive pleadings are not yet due in the other suits. At
this time, we are unable to quantify the potential impact from these actions, if
any.
CREDIT CARD SERVICES LITIGATION
Since June 2005, HSBC Finance Corporation, HSBC North America, and HSBC, as well
as other banks and the Visa and Master Card associations, were named as
defendants in four class actions filed in Connecticut and the Eastern District
of New York; Photos Etc. Corp. et al. v. Visa U.S.A., Inc., et al. (D. Conn. No.
3:05-CV-01007 (WWE)): National Association of Convenience Stores, et al. v. Visa
U.S.A., Inc., et al. (E.D.N.Y. No. 05-CV 4520 (JG)); Jethro Holdings, Inc., et
al. v. Visa U.S.A., Inc. et al. (E.D.N.Y. No. 05-CV-4521 (JG)); and American
Booksellers Ass'n v. Visa U.S.A., Inc. et al. (E.D.N.Y. No. 05-CV-5391 (JG)).
Numerous other complaints containing similar allegations (in which no HSBC
entity is named) were filed across the country against Visa, MasterCard and
other banks. These actions principally allege that the imposition of a no-
surcharge rule by the associations and/or the establishment of the interchange
fee charged for credit card transactions causes the merchant discount fee paid
by retailers to be set at supracompetitive levels in violation of the Federal
antitrust laws. In response to motions of the plaintiffs on October 19, 2005,
the Judicial Panel on Multidistrict Litigation (the "MDL Panel") issued an order
consolidating these suits and transferred all of the cases to the Eastern
District of New York. The consolidated case is: In re Payment Card Interchange
Fee and Merchant Discount Antitrust Litigation, MDL 1720, E.D.N.Y. A
consolidated, amended complaint was filed by the plaintiffs on April 24, 2006.
Discovery has begun. At this time, we are unable to quantify the potential
impact from this action, if any.
SECURITIES LITIGATION
In August 2002, we restated previously reported consolidated financial
statements. The restatement related to certain MasterCard and Visa co-branding
and affinity credit card relationships and a third party marketing agreement,
which were entered into between 1992 and 1999. All were part of our Credit Card
Services segment. In consultation with our prior auditors, Arthur Andersen LLP,
we treated payments made in connection with these agreements as prepaid assets
and amortized them in accordance with the underlying economics of the
agreements. Our current auditor, KPMG LLP, advised us that, in its view, these
payments should have either been charged against earnings at the time they were
made or amortized over a shorter period of time. The restatement resulted in a
$155.8 million, after-tax, retroactive reduction to retained earnings at
December 31, 1998. As a result of the restatement, and other corporate events,
including, e.g., the 2002 settlement with 50 states and the District of Columbia
relating to real estate lending practices, HSBC Finance Corporation, and its
directors, certain officers and former auditors, have been involved in various
legal proceedings, some of which purport to be class actions. A number of these
actions allege violations of Federal securities laws, were filed between August
and October 2002, and seek to recover damages in respect of allegedly false and
misleading statements about our common stock. These legal actions have been
consolidated into a single purported class action, Jaffe v. Household
International, Inc., et al., No. 02 C 5893 (N.D. Ill., filed August 19, 2002),
and a consolidated and amended complaint was filed on March 7, 2003. On December
3, 2004, the court signed the parties' stipulation to certify a class with
respect to the claims brought under sec. 10 and sec. 20 of the Securities
Exchange Act of 1934. The parties stipulated that plaintiffs will not seek to
certify a class with respect to the claims brought under sec. 11 and sec. 15 of
the Securities Act of 1933 in this action or otherwise.
The amended complaint purports to assert claims under the Federal securities
laws, on behalf of all persons who purchased or otherwise acquired our
securities between October 23, 1997 and October 11, 2002, arising out of alleged
false and misleading statements in connection with our collection, sales and
lending practices, the 2002 state settlement agreement referred to above, the
restatement and the HSBC merger. The amended complaint, which also names as
defendants Arthur Andersen LLP, Goldman, Sachs & Co., and Merrill Lynch, Pierce,
Fenner & Smith, Inc., fails to specify the amount of damages sought. In May
2003, we, and other defendants, filed a motion to dismiss the complaint. On
March 19, 2004, the Court granted in part, and denied in part the defendants'
motion to dismiss the complaint. The Court dismissed all claims against Merrill
Lynch, Pierce, Fenner & Smith, Inc. and Goldman Sachs & Co. The Court also
dismissed certain claims alleging strict liability for alleged misrepresentation
of material facts based on statute of limitations grounds. The claims that
remain against some or all of the defendants essentially allege the defendants
knowingly made a false statement of a material fact in conjunction with the
purchase or sale of securities, that the
82
HSBC Finance Corporation
--------------------------------------------------------------------------------
plaintiffs justifiably relied on such statement, the false statement(s) caused
the plaintiffs' damages, and that some or all of the defendants should be liable
for those alleged statements. On February 28, 2006, the Court also dismissed all
alleged sec. 10 claims that arose prior to July 30, 1999, shortening the class
period by 22 months. The bulk of fact discovery concluded on January 31, 2007.
Expert discovery is expected to conclude on December 21, 2007. Separately, one
of the defendants, Arthur Andersen LLP, entered into a settlement of the claims
against Arthur Andersen. This settlement received Court approval in April 2006.
At this time we are unable to quantify the potential impact from this action, if
any.
With respect to this securities litigation, we believe that we have not, and our
officers and directors have not, committed any wrongdoing and there will be no
finding of improper activities that may result in a material liability to us or
any of our officers or directors.
ITEM 6. EXHIBITS
--------------------------------------------------------------------------------
Exhibits included in this Report:
12 Statement of Computation of Ratio of Earnings to Fixed Charges and
to Combined Fixed Charges and Preferred Stock Dividends
31 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1 Debt and Preferred Stock Securities Ratings
83
HSBC Finance Corporation
--------------------------------------------------------------------------------
SIGNATURE
--------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 14, 2007
HSBC FINANCE CORPORATION
(Registrant)
/s/ Beverley A. Sibblies
----------------------------------------
Beverley A. Sibblies
Senior Vice President and
Chief Financial Officer
84
HSBC Finance Corporation
--------------------------------------------------------------------------------
EXHIBIT INDEX
--------------------------------------------------------------------------------
12 Statement of Computation of Ratio of Earnings to Fixed Charges and to
Combined Fixed Charges and Preferred Stock Dividends
31 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1 Debt and Preferred Stock Securities Ratings
85
HSBC Finance Corporation
--------------------------------------------------------------------------------
EXHIBIT 12
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND TO
COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
NINE MONTHS ENDED SEPTEMBER 30, 2007 2006
--------------------------------------------------------------------------------
(DOLLARS ARE IN
MILLIONS)
Net income.................................................... $ (498) $2,007
Income tax expense............................................ 166 1,167
------ ------
Income before income tax expense.............................. (332) 3,174
------ ------
Fixed charges:
Interest expense............................................ 6,131 5,318
Interest portion of rentals(1).............................. 42 44
------ ------
Total fixed charges........................................... 6,173 5,362
------ ------
Total earnings as defined..................................... $5,841 $8,536
====== ======
Ratio of earnings to fixed charges............................ .95 1.59
Preferred stock dividends(2).................................. 44 43
Ratio of earnings to combined fixed charges and preferred
stock dividends............................................. .94 1.58
--------
(1) Represents one-third of rentals, which approximates the portion representing
interest.
(2) Preferred stock dividends are grossed up to their pretax equivalents.
HSBC Finance Corporation
--------------------------------------------------------------------------------
EXHIBIT 31
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Brendan P. McDonagh, Chief Executive Officer of HSBC Finance Corporation,
certify that:
1. I have reviewed this report on Form 10-Q of HSBC Finance Corporation;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter that has materially affected, or is reasonably likely
to materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal controls over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 14, 2007
/s/ BRENDAN P. MCDONAGH
----------------------------------------
Brendan P. McDonagh
Chief Executive Officer
HSBC Finance Corporation
--------------------------------------------------------------------------------
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer of
HSBC Finance Corporation, certify that:
1. I have reviewed this report on Form 10-Q of HSBC Finance Corporation;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter that has materially affected, or is reasonably likely
to materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal controls over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 14, 2007
/s/ BEVERLEY A. SIBBLIES
----------------------------------------
Beverley A. Sibblies
Senior Vice President
and Chief Financial Officer
HSBC Finance Corporation
--------------------------------------------------------------------------------
EXHIBIT 32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The certification set forth below is being submitted in connection with the HSBC
Finance Corporation (the "Company") Quarterly Report on Form 10-Q for the period
ending September 30, 2007 as filed with the Securities and Exchange Commission
on the date hereof (the "Report") for the purpose of complying with Rule 13a-
14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "Exchange
Act") and Section 1350 of Chapter 63 of Title 18 of the United States Code.
I, Brendan P. McDonagh, Chief Executive Officer of the Company, certify that:
1. the Report fully complies with the requirements of Section 13(a) or
15(d) of the Exchange Act; and
2. the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
HSBC Finance Corporation.
November 14, 2007
/s/ BRENDAN P. MCDONAGH
----------------------------------------
Brendan P. McDonagh
Chief Executive Officer
HSBC Finance Corporation
--------------------------------------------------------------------------------
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The certification set forth below is being submitted in connection with the HSBC
Finance Corporation (the "Company") Quarterly Report on Form 10-Q for the period
ending September 30, 2007 as filed with the Securities and Exchange Commission
on the date hereof (the "Report") for the purpose of complying with Rule 13a-
14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the "Exchange
Act") and Section 1350 of Chapter 63 of Title 18 of the United States Code.
I, Beverley A. Sibblies, Senior Vice President and Chief Financial Officer of
the Company, certify that:
1. the Report fully complies with the requirements of Section 13(a) or
15(d) of the Exchange Act; and
2. the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
HSBC Finance Corporation.
November 14, 2007
/s/ BEVERLEY A. SIBBLIES
----------------------------------------
Beverley A. Sibblies
Senior Vice President
and Chief Financial Officer
This certification accompanies each Report pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the
Sarbanes-Oxley Act of 2002, be deemed filed by HSBC Finance Corporation for
purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
Signed originals of these written statements required by Section 906 of the
Sarbanes-Oxley Act of 2002 have been provided to HSBC Finance Corporation and
will be retained by HSBC Finance Corporation and furnished to the Securities and
Exchange Commission or its staff upon request.
HSBC Finance Corporation
--------------------------------------------------------------------------------
EXHIBIT 99.1
DEBT AND PREFERRED STOCK SECURITIES RATINGS
STANDARD & MOODY'S
POOR'S INVESTORS
CORPORATION SERVICE FITCH, INC. DBRS, INC.
-------------------------------------------------------------------------------------------------
AS OF SEPTEMBER 30, 2007
HSBC Finance Corporation
Senior debt............................... AA- Aa3 AA- AA (low)
Senior subordinated debt.................. A+ A1 * *
Commercial paper.......................... A-1+ P-1 F1+ R-1 (middle)
Series B preferred stock.................. A A2 A+ *
HFC Bank Limited
Senior debt............................... AA- Aa3 AA- *
Commercial paper.......................... A-1+ P-1 F1+ *
HSBC Financial Corporation Limited
Senior notes and term loans............... AA- Aa3 AA- AA (low)
Commercial paper.......................... * * * R-1 (middle)
--------
(*) Not rated by this agency.
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