HSBC FinCorp Restated 10Q1 Q3

HSBC Holdings PLC 31 March 2005 PART 1 -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to________ COMMISSION FILE NUMBER 1-8198 HSBC FINANCE CORPORATION (FORMERLY KNOWN AS HOUSEHOLD INTERNATIONAL, INC.) (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 86-1052062 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) 2700 SANDERS ROAD, PROSPECT HEIGHTS, ILLINOIS 60070 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (847) 564-5000 REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE 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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X) At October 31, 2004, there were 50 shares of the registrant's common stock outstanding, all of which were indirectly owned by HSBC Holdings plc. THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q WITH THE REDUCED DISCLOSURE FORMAT. -------------------------------------------------------------------------------- HOUSEHOLD INTERNATIONAL, INC. FORM 10-Q/A TABLE OF CONTENTS PART I. FINANCIAL INFORMATION ----------------------------------------------------------------------------------- Item 1. Consolidated Financial Statements: Statement of Income......................................... 4 Balance Sheet............................................... 5 Statement of Changes in Shareholder's(s') Equity............ 6 Statement of Cash Flows..................................... 7 Notes to Consolidated Financial Statements.................. 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations: Forward-Looking Statements.................................. 21 Restatement................................................. 21 Executive Overview.......................................... 22 Basis of Reporting.......................................... 27 Receivables Review.......................................... 33 Results of Operations....................................... 34 Segment Results - Managed Basis............................. 40 Credit Quality.............................................. 47 Liquidity and Capital Resources............................. 52 Risk Management............................................. 56 Reconciliations to GAAP Financial Measures.................. 58 Item 4. Controls and Procedures..................................... 62 PART II. OTHER INFORMATION ----------------------------------------------------------------------------------- Item 1. Legal Proceedings........................................... 62 Item 5. Other Information........................................... 64 Item 6. Exhibits and Reports on Form 8-K............................ 65 Signature.................................................................... 66 2 EXPLANATORY NOTE HSBC Finance Corporation (formerly known as Household International, Inc.) is filing this amended Quarterly Report on Form 10-Q/A to reflect the restatement of its unaudited consolidated financial statements for the periods covered by this report. Please see Note 2 to the Consolidated Financial Statements and the "Restatement" section included in Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations below for a detailed discussion of the restatement. As more fully described therein, we have restated all reported periods since our acquisition by HSBC Holdings plc on March 28, 2003 to eliminate hedge accounting on all hedging relationships outstanding on that date and certain fair value swaps entered into after that date. This restatement is solely the result of the failure to satisfy certain technical requirements of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." This amended Quarterly Report on Form 10-Q/A restates the Quarterly Report on Form 10-Q for the quarter ended September 30, 2004. We have not modified or updated the disclosures in the original Quarterly Report on Form 10-Q except as required to give effect to the restatement. As a result, this amended Quarterly Report on Form 10-Q/A contains forward-looking information that has not been updated for events subsequent to the date of the original filing, and all information contained in this amended Quarterly Report on Form 10-Q/A and the original Quarterly Report on Form 10-Q is subject to updating and supplementing as provided in the periodic reports that we have filed and will file with the Securities and Exchange Commission after the original filing date of the Quarterly Report on Form 10-Q. 3 PART I. FINANCIAL INFORMATION -------------------------------------------------------------------------------- ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS Household International, Inc. -------------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF INCOME THREE MONTHS ENDED NINE MONTHS MARCH 29 JANUARY 1 SEPTEMBER 30, ENDED THROUGH THROUGH ------------------------- SEPTEMBER 30, SEPTEMBER 30, MARCH 28, 2004 2003 2004 2003 2003 ----------------------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (RESTATED) (RESTATED) (RESTATED) (RESTATED) (IN MILLIONS) Finance and other interest income........................ $2,779 $2,570 $7,944 $5,148 $2,469 Interest expense................ 810 654 2,225 1,362 897 ------ ------ ------ ------ ------ NET INTEREST INCOME............. 1,969 1,916 5,719 3,786 1,572 Provision for credit losses..... 1,123 1,001 3,048 2,074 976 ------ ------ ------ ------ ------ NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES... 846 915 2,671 1,712 596 ------ ------ ------ ------ ------ Other revenues: Securitization revenue........ 267 387 881 680 434 Insurance revenue............. 203 193 618 382 171 Investment income............. 36 37 107 71 80 Derivative income (expense)... 72 (612) 248 177 2 Fee income.................... 302 266 809 503 280 Taxpayer financial services (expense) income........... (3) 2 209 5 181 Other income.................. 163 68 443 159 64 ------ ------ ------ ------ ------ TOTAL OTHER REVENUES............ 1,040 341 3,315 1,977 1,212 ------ ------ ------ ------ ------ Costs and expenses: Salaries and employee benefits................... 472 493 1,414 1,000 491 Sales incentives.............. 91 77 259 162 37 Occupancy and equipment expenses................... 77 95 237 198 98 Other marketing expenses...... 174 128 437 267 139 Other servicing and administrative expenses.... 235 282 659 555 314 Support services from HSBC affiliates................. 183 - 556 - - Amortization of intangibles... 83 82 278 162 12 Policyholders' benefits....... 93 95 299 196 91 HSBC acquisition related costs incurred by Household...... - - - - 198 ------ ------ ------ ------ ------ TOTAL COSTS AND EXPENSES........ 1,408 1,252 4,139 2,540 1,380 ------ ------ ------ ------ ------ Income before income tax expense....................... 478 4 1,847 1,149 428 Income tax expense (benefit).... 153 (18) 619 384 182 ------ ------ ------ ------ ------ NET INCOME...................... $ 325 $ 22 $1,228 $ 765 $ 246 ====== ====== ====== ====== ====== The accompanying notes are an integral part of the consolidated financial statements. 4 Household International, Inc. -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEET SEPTEMBER 30, DECEMBER 31, 2004 2003 ---------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (RESTATED) (IN MILLIONS, EXCEPT SHARE DATA) ASSETS Cash........................................................ $ 274 $ 463 Securities.................................................. 6,916 11,073 Receivables, net............................................ 104,225 91,027 Intangible assets, net...................................... 2,684 2,856 Goodwill.................................................... 6,811 6,697 Properties and equipment, net............................... 476 527 Real estate owned........................................... 601 631 Derivative financial assets................................. 3,001 3,016 Other assets................................................ 2,740 2,762 -------- -------- TOTAL ASSETS................................................ $127,728 $119,052 ======== ======== LIABILITIES Debt: Deposits.................................................. $ 51 $ 232 Commercial paper, bank and other borrowings............... 14,507 9,122 Due to affiliates, net.................................... 11,371 7,589 Long term debt (with original maturities over one year)... 78,781 79,632 -------- -------- Total debt.................................................. 104,710 96,575 -------- -------- Insurance policy and claim reserves......................... 1,299 1,258 Derivative related liabilities.............................. 346 597 Other liabilities........................................... 3,546 3,131 -------- -------- TOTAL LIABILITIES......................................... 109,901 101,561 -------- -------- SHAREHOLDER'S EQUITY Preferred stock held by HNAH (held by HSBC at December 31, 2003)..................................................... 1,100 1,100 Common shareholder's equity: Common stock, $0.01 par value, 100 shares authorized, 50 shares issued...................................... - - Additional paid-in capital............................. 14,635 14,645 Retained earnings...................................... 1,627 1,303 Accumulated other comprehensive income................. 465 443 -------- -------- TOTAL COMMON SHAREHOLDER'S EQUITY........................... 16,727 16,391 -------- -------- TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY.................. $127,728 $119,052 ======== ======== The accompanying notes are an integral part of the consolidated financial statements. 5 Household International, Inc. -------------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDER'S(S') EQUITY NINE MONTHS MARCH 29 JANUARY 1 ENDED THROUGH THROUGH SEPTEMBER 30, SEPTEMBER 30, MARCH 28, 2004 2003 2003 ----------------------------------------------------------------------------------------------------------- SUCCESSOR SUCCESSOR (PREDECESSOR) (RESTATED) (RESTATED) (IN MILLIONS) PREFERRED STOCK Balance at beginning of period............................ $ 1,100 $ 1,100 $ 1,193 Reclassification of preferred stock issuance costs........ - - 21 Redemption of preferred stock............................. - - (114) ------- ------- ------- Balance at end of period.................................. $ 1,100 $ 1,100 $ 1,100 ======= ======= ======= COMMON SHAREHOLDER'S(S') EQUITY COMMON STOCK Balance at beginning of period.......................... - - $ 552 Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - (552) ------- ------- ------- Balance at end of period................................ - - $ - ------- ------- ------- ADDITIONAL PAID-IN CAPITAL Balance at beginning of period.......................... $14,645 $14,661 $ 1,911 Return of capital to HSBC............................... (31) (18) - Employee benefit plans and other........................ 21 14 10 Reclassification of preferred stock issuance costs...... - - (21) Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - 12,761 ------- ------- ------- Balance at end of period................................ $14,635 $14,657 $14,661 ------- ------- ------- RETAINED EARNINGS Balance at beginning of period.......................... $ 1,303 $ - $ 9,885 Net income.............................................. 1,228 765 246 Dividends: Preferred stock....................................... (54) (36) (22) Common stock.......................................... (850) - (412) Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - (9,697) ------- ------- ------- Balance at end of period................................ $ 1,627 $ 729 $ - ------- ------- ------- ACCUMULATED OTHER COMPREHENSIVE INCOME Balance at beginning of period.......................... $ 443 $ - $ (695) Net change in unrealized gains (losses) on: Derivatives classified as cash flow hedges.......... 44 - 101 Securities available for sale and interest-only strip receivables................................. (38) 114 (25) Foreign currency translation adjustment............... 16 81 (24) ------- ------- ------- Other comprehensive income, net of tax.................. 22 195 52 Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - 643 ------- ------- ------- Balance at end of period................................ $ 465 $ 195 $ - ------- ------- ------- COMMON STOCK IN TREASURY Balance at beginning of period.......................... - - $(2,431) Exercise of stock options............................... - - 12 Issuance of common stock for employee benefit plans..... - - 12 Purchase of treasury stock.............................. - - (164) Effect of push-down accounting of HSBC's purchase price on net assets......................................... - - 2,571 ------- ------- ------- Balance at end of period................................ - - $ - ------- ------- ------- TOTAL COMMON SHAREHOLDER'S(S') EQUITY....................... $16,727 $15,581 $14,661 ======= ======= ======= COMPREHENSIVE INCOME Net income.................................................. $ 1,228 $ 765 $ 246 Other comprehensive income.................................. 22 195 52 ------- ------- ------- COMPREHENSIVE INCOME........................................ $ 1,250 $ 960 $ 298 ======= ======= ======= The accompanying notes are an integral part of the consolidated financial statements. 6 Household International, Inc. -------------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF CASH FLOWS NINE MONTHS MARCH 29 JANUARY 1 ENDED THROUGH THROUGH SEPTEMBER 30, SEPTEMBER 30, MARCH 28, 2004 2003 2003 ----------------------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (RESTATED) (RESTATED) (IN MILLIONS) CASH FLOWS FROM OPERATING ACTIVITIES Net income.................................................. $ 1,228 $ 765 $ 246 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for credit losses............................... 3,048 2,074 976 Insurance policy and claim reserves....................... (138) (123) 47 Depreciation and amortization............................. 367 232 53 Net change in interest-only strip receivables............. 410 259 30 Net change in other assets................................ 49 781 (593) Net change in other liabilities........................... 182 (771) 616 Other, net................................................ (520) (73) 84 -------- -------- ------- Net cash provided by (used in) operating activities......... 4,626 3,144 1,459 -------- -------- ------- CASH FLOWS FROM INVESTING ACTIVITIES Securities: Purchased................................................. (1,152) (2,771) (1,047) Matured................................................... 1,179 2,107 584 Sold...................................................... 790 470 768 Net change in short-term securities available for sale...... 3,323 960 (375) Receivables: Originations, net of collections.......................... (42,123) (27,386) (8,255) Purchases and related premiums............................ (597) (2,070) (129) Initial and fill-up securitizations....................... 24,250 18,320 7,300 Sales to affiliates....................................... 1,371 - - Properties and equipment: Purchases................................................. (55) (70) (21) Sales..................................................... 2 5 - -------- -------- ------- Net cash provided by (used in) investing activities......... (13,012) (10,435) (1,175) -------- -------- ------- CASH FLOWS FROM FINANCING ACTIVITIES Debt: Net change in short-term debt and deposits................ 5,343 3,024 (514) Net change in time certificates........................... (155) 97 150 Net change in due to affiliates, net...................... 3,760 5,818 - Long term debt issued..................................... 12,603 9,558 4,361 Long term debt retired.................................... (12,581) (11,337) (4,030) Issuance of company obligated mandatorily redeemable preferred securities of subsidiary trusts to HSBC....... - 275 - Redemption of company obligated mandatorily redeemable preferred securities of subsidiary trusts............... - (275) - Insurance: Policyholders' benefits paid.............................. (124) (106) (36) Cash received from policyholders.......................... 194 84 33 Shareholder's(s') dividends................................. (850) (293) (141) Redemption of preferred stock............................... - - (114) Purchase of treasury stock.................................. - - (164) Issuance of common stock for employee benefit plans......... - - 62 -------- -------- ------- Net cash provided by (used in) financing activities......... 8,190 6,845 (393) -------- -------- ------- Effect of exchange rate changes on cash..................... 7 41 (15) -------- -------- ------- Net change in cash.......................................... (189) (405) (124) Cash at beginning of period................................. 463 674 798 -------- -------- ------- CASH AT END OF PERIOD....................................... $ 274 $ 269 $ 674 ======== ======== ======= The accompanying notes are an integral part of the consolidated financial statements. 7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND BASIS OF PRESENTATION -------------------------------------------------------------------------------- The accompanying unaudited interim consolidated financial statements of Household International, Inc. and its subsidiaries (collectively, "Household") 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. Household may also be referred to in this Form 10-Q/A as "we," "us" or "our." These unaudited interim consolidated financial statements should be read in conjunction with the 2003 financial information included in our Annual Report on Form 10-K for the year ended December 31, 2004 (the "2004 Form 10-K"). Household International, Inc. is an indirect wholly owned subsidiary of HSBC Holdings plc ("HSBC"). Household was acquired by HSBC on March 28, 2003 in a purchase business combination recorded under the "push-down" method of accounting, which resulted in a new basis of accounting for the "successor" period beginning March 29, 2003. Information relating to all "predecessor" periods prior to the acquisition is presented using our historical basis of accounting, which impacts comparability to our successor period. 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. Interim financial statement disclosures required by U.S. GAAP regarding segments are included in the Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") section of this Form 10-Q/A. Certain reclassifications have been made to prior period amounts to conform to the current period presentation. Immaterial adjustments have been made to decrease finance income and increase securitization revenue as reported in prior periods. These adjustments reflect corrections after discovery of a system programming error in the posting of finance income between owned receivables and receivables serviced with limited recourse. Reported net income for all prior periods was not affected. 2. RESTATEMENT -------------------------------------------------------------------------------- We have restated our consolidated financial statements for the previously reported period March 29, 2003 through December 31, 2003, the previously reported quarterly periods ended June 30, 2004 and March 31, 2004 and the three and nine month periods ended September 30, 2004. This amended Quarterly Report on Form 10-Q/A and the exhibits included herewith include all adjustments relating to the restatement for the periods covered by this report. During the fourth quarter of 2004, as part of our preparation for the implementation of International Financial Reporting Standards ("IFRS") by HSBC from January 1, 2005, we undertook a review of our hedging activities to confirm conformity with the accounting requirements of IFRS, which differ in several respects from the hedge accounting requirements under U.S. GAAP as set out in Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS 133"). As a result of this review, management determined that there were some deficiencies in the documentation required to support hedge accounting under U.S. GAAP. These documentation deficiencies arose following our acquisition by HSBC. As a consequence of the acquisition, pre-existing hedging relationships, including hedging relationships that had previously qualified under the "shortcut" method of accounting pursuant to SFAS 133, were required to be reestablished. At that time there was some debate in the accounting profession regarding the detailed technical requirements resulting from a business combination. We consulted with our independent accountants, KPMG LLP, in reaching a determination of 8 what was required in order to comply with SFAS 133. Following this, we took the actions we believed were necessary to maintain hedge accounting for all of our historical hedging relationships in our consolidated financial statements for the period ended December 31, 2003 and those consolidated financial statements received an unqualified audit opinion. Management, having determined during the fourth quarter of 2004 that there were certain documentation deficiencies, engaged independent expert consultants to advise on the continuing effectiveness of the identified hedging relationships. As a result of this assessment, we concluded that a substantial number of our hedges met the correlation effectiveness requirements of SFAS 133 throughout the period following our acquisition by HSBC. However, we also determined in conjunction with KPMG LLP that, although a substantial number of the impacted hedges satisfied the correlation effectiveness requirement of SFAS 133, there were technical deficiencies in the documentation that could not be corrected retroactively or disregarded notwithstanding the proven effectiveness of the hedging relationships in place and, consequently, that the requirements of SFAS 133 were not met and that hedge accounting was not appropriate during the period these documentation deficiencies existed. We have therefore determined that we should restate all the reported periods since our acquisition by HSBC to eliminate hedge accounting on all hedging relationships outstanding at March 29, 2003 and certain fair value swaps entered into after that date. This was accomplished primarily by reclassifying the mark to market of the changes in fair market value of the affected derivative financial instruments previously classified in either debt or other comprehensive income into current period earnings. The period to period changes in the fair value of these derivative financial instruments have been recognized as either an increase or decrease in our current period earnings through derivative income. As part of the restatement process, we have reclassified all previous hedging results reflected in interest expense associated with the affected derivative financial instruments to derivative income. Our independent registered public accounting firm has reviewed the September 30, 2004 financial results and has provided us a review report under Statement on Auditing Standards No. 100, which review report is attached to this amended Quarterly Report on Form 10-Q/A as Exhibit 99.2. The restatement effect on our pre-tax income and net income is summarized below. RESTATEMENTS TO REPORTED INCOME ----------------------------------------------------------------------------------------------------- % CHANGE PRE-TAX TAX EFFECT AFTER-TAX TO REPORTED ------- ---------- --------- ----------- (DOLLARS IN MILLIONS) March 29 through September 30, 2003.................. $(126) $ 46 $(80) (9.5)% Nine months ended September 30, 2004................. 47 (17) 30 2.5 Quarter ended September 30, 2003..................... (708) 258 (450) (95.3) Quarter ended September 30, 2004..................... 5 (2) 3 .9 A detailed summary of the impact of the restatement on our consolidated statement of income and on our consolidated balance sheet is as follows: MARCH 29, 2003 THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED THROUGH SEPTEMBER 30, 2004 SEPTEMBER 30, 2003 SEPTEMBER 30, 2004 SEPTEMBER 30, 2003 --------------------- --------------------- --------------------- --------------------- AS AS AS AS PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED ------------------------------------------------------------------------------------------------------------------------ (IN MILLIONS) Consolidated Statement of Income: Net interest income.... $ 2,035 $ 1,969 $ 2,014* $ 1,916 $ 5,924 $ 5,719 $ 4,017* $ 3,786 Other revenues......... 969 1,040 951* 341 3,064 3,315 1,873* 1,977 Income before income tax expense.......... 473 478 712 4 1,800 1,847 1,275 1,149 Income tax expense..... 151 153 240 (18) 602 619 430 384 Net income............. 322 325 472 22 1,198 1,228 845 765 9 AT SEPTEMBER 30, 2004 AT DECEMBER 31, 2003 --------------------- --------------------- AS AS PREVIOUSLY AS PREVIOUSLY AS REPORTED RESTATED REPORTED RESTATED ------------------------------------------------------------------------------------------------------ (IN MILLIONS) Consolidated Balance Sheet: Derivative financial assets.......................... $ 3,033 $3,001.. $ 3,118 $ 3,016 Long-term debt....................................... 78,516 78,781.. 79,464 79,632 Derivative related liabilities....................... 353 346.... 600 597 Other liabilities.................................... 3,651 3,546.. 3,228 3,131 Common shareholder's equity.......................... 16,912 16,727.. 16,561 16,391 --------------- * Certain reclassifications have been made to prior period amounts to conform to the current year presentation. The resulting accounting does not reflect the economic reality of our hedging activity and has no impact on the timing or amount of operating cash flows or cash flows under any debt or derivative contract. It does not affect our ability to make required payments on our outstanding debt obligations. Furthermore, our economic risk management strategies have not required amendment. 3. SECURITIES -------------------------------------------------------------------------------- Securities consisted of the following available-for-sale investments: GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR SEPTEMBER 30, 2004 COST GAINS LOSSES VALUE --------------------------------------------------------------------------------------------------- (IN MILLIONS) Corporate debt securities............................ $2,393 $26 $ (9) $2,410 Money market funds................................... 749 - - 749 Time deposits........................................ 132 - - 132 U.S. government and federal agency debt securities... 2,355 - (2) 2,353 Non-government mortgage backed securities............ 84 - - 84 Other................................................ 1,155 1 (2) 1,154 ------ --- ---- ------ Subtotal............................................. 6,868 27 (13) 6,882 Accrued investment income............................ 34 - - 34 ------ --- ---- ------ Total securities available for sale.................. $6,902 $27 $(13) $6,916 ====== === ==== ====== GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR DECEMBER 31, 2003 COST GAINS LOSSES VALUE --------------------------------------------------------------------------------------------------- (IN MILLIONS) Corporate debt securities........................... $ 5,641 $11 $ - $ 5,652 Money market funds.................................. 794 - - 794 Time deposits....................................... 952 - - 952 U.S. government and federal agency debt securities........................................ 2,430 - (2) 2,428 Marketable equity securities........................ 14 4 - 18 Non-government mortgage backed securities........... 389 - - 389 Other............................................... 794 2 - 796 ------- --- --- ------- Subtotal............................................ 11,014 17 (2) 11,029 Accrued investment income........................... 44 - - 44 ------- --- --- ------- Total securities available for sale................. $11,058 $17 $(2) $11,073 ======= === === ======= 10 A summary of gross unrealized losses and related fair values as of September 30, 2004, classified as to the length of time the losses have existed follows: LESS THAN ONE YEAR GREATER THAN ONE YEAR --------------------------------------- --------------------------------------- GROSS AGGREGATE GROSS AGGREGATE NUMBER OF UNREALIZED FAIR VALUE OF NUMBER OF UNREALIZED FAIR VALUE OF SEPTEMBER 30, 2004 SECURITIES LOSSES INVESTMENTS SECURITIES LOSSES INVESTMENTS ------------------------------------------------------------------------------------------------------------- (IN MILLIONS) Corporate debt securities.............. 121 $(3) $305 195 $(6) $566 U.S. government and federal agency debt securities.............. - - - 62 (2) 309 Other..................... 24 (1) 147 42 (1) 98 Gross unrealized losses on our securities available for sale have increased during the nine months ended September 30, 2004 due to a general increase in interest rates. Since substantially all of these securities are rated A- or better, no permanent impairment is expected to be realized. The amortized cost of our securities available for sale was adjusted to fair market value at the time of the merger with HSBC. As a result, at December 31, 2003 gross unrealized losses had existed less than one year. 4. RECEIVABLES -------------------------------------------------------------------------------- Receivables consisted of the following: SEPTEMBER 30, DECEMBER 31, 2004 2003 ------------------------------------------------------------------------------------------ (IN MILLIONS) Real estate secured......................................... $ 58,726 $ 51,221 Auto finance................................................ 6,823 4,138 MasterCard(1)/Visa(1)....................................... 11,666 11,182 Private label............................................... 14,000 12,604 Personal non-credit card.................................... 14,888 12,832 Commercial and other........................................ 334 401 -------- -------- Total owned receivables..................................... 106,437 92,378 Purchase accounting fair value adjustments.................. 272 419 Accrued finance charges..................................... 1,489 1,432 Credit loss reserve for owned receivables................... (3,953) (3,793) Unearned credit insurance premiums and claims reserves...... (620) (703) Interest-only strip receivables............................. 559 1,036 Amounts due and deferred from receivable sales.............. 41 258 -------- -------- Total owned receivables, net................................ 104,225 91,027 Receivables serviced with limited recourse.................. 20,175 26,201 -------- -------- Total managed receivables, net.............................. $124,400 $117,228 ======== ======== --------------- (1) MasterCard is a registered trademark of MasterCard International, Incorporated and Visa is a registered trademark of VISA USA, Inc. Purchase accounting fair value adjustments represent adjustments which have been "pushed down" to record our receivables at fair value at the date of acquisition by HSBC. Interest-only strip receivables are reported net of our estimate of probable losses under the recourse provisions for receivables serviced with limited recourse. Our estimate of the recourse obligation totaled 11 $1,246 million at September 30, 2004 and $2,374 million at December 31, 2003. Interest-only strip receivables also included fair value mark-to-market adjustments which increased the balance by $190 million at September 30, 2004 and $257 million at December 31, 2003. Receivables serviced with limited recourse consisted of the following: SEPTEMBER 30, DECEMBER 31, 2004 2003 ------------------------------------------------------------------------------------------ (IN MILLIONS) Real estate secured......................................... $ 165 $ 194 Auto finance................................................ 3,060 4,675 MasterCard/Visa............................................. 8,843 9,967 Private label............................................... 3,921 5,261 Personal non-credit card.................................... 4,186 6,104 ------- ------- Total....................................................... $20,175 $26,201 ======= ======= The combination of receivables owned and receivables serviced with limited recourse, which comprises our managed portfolio, is shown below: SEPTEMBER 30, DECEMBER 31, 2004 2003 ------------------------------------------------------------------------------------------ (IN MILLIONS) Real estate secured......................................... $ 58,891 $ 51,415 Auto finance................................................ 9,883 8,813 MasterCard/Visa............................................. 20,509 21,149 Private label............................................... 17,921 17,865 Personal non-credit card.................................... 19,074 18,936 Commercial and other........................................ 334 401 -------- -------- Total....................................................... $126,612 $118,579 ======== ======== 12 5. CREDIT LOSS RESERVES -------------------------------------------------------------------------------- An analysis of credit loss reserves was as follows: THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------------------------- 2004 2003 2004 2003 -------------------------------------------------------------------------------------------------- (IN MILLIONS) Owned receivables: Credit loss reserves at beginning of period....... $ 3,795 $3,659 $ 3,793 $ 3,333 Provision for credit losses....................... 1,123 1,001 3,048 3,050 Charge-offs....................................... (1,068) (976) (3,176) (2,908) Recoveries........................................ 99 77 271 204 Other, net........................................ 4 18 17 100 ------- ------ ------- ------- Credit loss reserves for owned receivables........ 3,953 3,779 3,953 3,779 ------- ------ ------- ------- Receivables serviced with limited recourse: Credit loss reserves at beginning of period....... 1,904 1,980 2,374 1,759 Provision for credit losses....................... (232) 420 169 1,444 Charge-offs....................................... (418) (459) (1,343) (1,314) Recoveries........................................ 24 24 76 68 Other, net........................................ (32) (11) (30) (3) ------- ------ ------- ------- Credit loss reserves for receivables serviced with limited recourse............................... 1,246 1,954 1,246 1,954 ------- ------ ------- ------- Credit loss reserves for managed receivables........ $ 5,199 $5,733 $ 5,199 $ 5,733 ======= ====== ======= ======= Reductions to the provision for credit losses and overall reserve levels on receivables serviced with limited recourse in 2004 reflect the impact of reduced securitization levels, including our decision to structure new collateralized funding transactions as secured financings. 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 of owned consumer receivables using a roll rate migration analysis that estimates the likelihood that a loan will progress through the various stages of delinquency, or buckets, and ultimately charge off. This analysis considers delinquency status, loss experience and severity and takes into account whether loans are in bankruptcy, have been restructured or rewritten, or are subject to forbearance, an external debt management plan, hardship, modification, extension or deferment. Our credit loss reserves also 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 restructure of accounts, forbearance agreements, extended payment plans, modification arrangements, consumer credit counseling accommodations, loan rewrites and deferments. When customer account management policies, or changes thereto, shift loans from a "higher" delinquency bucket to a "lower" delinquency bucket, this is reflected in our roll rate statistics. To the extent that restructured accounts have a greater propensity to roll to higher delinquency buckets, this is 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 is applied to receivables in all respective delinquency buckets, which increases 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. Risk factors considered in establishing overall loss reserves on consumer receivables include recent growth, product mix, bankruptcy trends, geographic concentrations, economic conditions, portfolio seasoning, account management policies and practices and current levels of charge-offs and delinquencies. 13 While our credit loss reserves are available to absorb losses in the entire portfolio, we specifically consider the credit quality and other risk factors for each of our products. We recognize the different inherent loss characteristics in each of our products as well as customer account management policies and practices and risk management/collection practices. Charge-off policies are also considered when establishing loss reserve requirements to ensure the appropriate reserves exist for products with longer charge-off periods. We also consider key ratios such as reserves to nonperforming loans and reserves as a percent of net charge-offs in developing our loss reserve estimates. Loss reserve estimates are reviewed periodically and adjustments are reported in earnings when they become known. As these estimates are influenced by factors outside of our control, such as consumer payment patterns and economic conditions, there is uncertainty inherent in these estimates, making it reasonably possible that they could change. 6. INTANGIBLE ASSETS -------------------------------------------------------------------------------- Intangible assets consisted of the following: ACCUMULATED CARRYING SEPTEMBER 30, 2004 GROSS AMORTIZATION VALUE ---------------------------------------------------------------------------------------------- (IN MILLIONS) Purchased credit card relationships and related programs.... $1,615 $296 $1,319 Retail services merchant relationships...................... 270 82 188 Other loan related relationships............................ 326 62 264 Trade names................................................. 717 - 717 Technology, customer lists and other contracts.............. 281 85 196 ------ ---- ------ Total....................................................... $3,209 $525 $2,684 ====== ==== ====== AMORTIZATION CARRYING DECEMBER 31, 2003 GROSS ACCUMULATED VALUE ---------------------------------------------------------------------------------------------- (IN MILLIONS) Purchased credit card relationships and related programs.... $1,512 $149 $1,363 Retail services merchant relationships...................... 270 41 229 Other loan related relationships............................ 326 34 292 Trade names................................................. 717 - 717 Technology, customer lists and other contracts.............. 281 26 255 ------ ---- ------ Total....................................................... $3,106 $250 $2,856 ====== ==== ====== Estimated amortization expense associated with our intangible assets for each of the following years is as follows: YEAR ENDING DECEMBER 31, (IN MILLIONS) ------------------------ ------------- 2004........................................................ $360 2005........................................................ 345 2006........................................................ 337 2007........................................................ 320 2008........................................................ 225 During the third quarter of 2004, we completed our annual impairment test of intangible assets and determined that the fair value of each intangible asset exceeded its carrying value. As a result, we have concluded that none of our intangible assets are impaired. 14 7. GOODWILL -------------------------------------------------------------------------------- Goodwill balances associated with our foreign businesses will change from period to period due to movements in foreign exchange. During the quarter ended March 31, 2004, we made final adjustments to the purchase price allocation resulting from our merger with HSBC. Since the one-year anniversary of our merger with HSBC was completed in the first quarter of 2004, no further merger-related adjustments to our goodwill balance will occur, except for changes in estimates of the tax basis in our assets and liabilities or other tax estimates recorded at the date of our merger with HSBC, pursuant to Statement of Financial Accounting Standards Number 109, "Accounting for Income Taxes." During the third quarter of 2004, we reduced our goodwill balance by approximately $15 million as a result of such changes in tax estimates. During the third quarter of 2004, we completed our annual impairment test of goodwill. For purposes of this test, we assigned the goodwill to our reporting units. The fair value of each of the reporting units to which goodwill was assigned exceeded its carrying value. As a result, we have concluded that none of our goodwill is impaired. 8. INCOME TAXES -------------------------------------------------------------------------------- Our effective tax rates were as follows: Three months ended September 30: 2004 (successor)(restated)................................ 32.0% 2003 (successor)(restated)................................ (450.0) Nine months ended September 30, 2004 (successor)(restated)..................................... 33.5 March 29 through September 30, 2003 (successor)(restated)... 33.4 January 1 through March 28, 2003 (predecessor).............. 42.5 The effective tax rate for the three months ended September 30, 2003 was positively impacted by low income housing credits which more than offset the operational income tax expense for the period. The effective tax rate for the period January 1 through March 28, 2003 was adversely impacted by the non- deductibility of certain HSBC acquisition related costs. Excluding HSBC acquisition related costs of $198 million, which resulted in a $27 million tax benefit, our effective tax rate was 33.3 percent for the period January 1 through March 28, 2003. The effective tax rate differs from the statutory federal income tax rate primarily because of the effects of state and local income taxes and tax credits. 9. STOCK-BASED COMPENSATION -------------------------------------------------------------------------------- In 2002, we adopted the fair value method of accounting for our stock option and employee stock purchase plans. We elected to recognize stock compensation cost prospectively for all new awards granted under those plans beginning January 1, 2002 as provided under SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure (an amendment of FASB Statement No. 123)" ("SFAS No. 148"). Prior to 2002, we applied the recognition and measurement provisions of APB No. 25, "Accounting for Stock Issued to Employees" in accounting for those plans. Because options granted prior to November 2002 vested upon completion of the merger with HSBC on March 28, 2003, all of our stock options are now accounted for using the fair value method. Our employees currently participate in one or more stock compensation plans sponsored by HSBC. Compensation expense relating to stock awards is charged to earnings over the vesting period. During the first quarter of 2004, we began to consider forfeitures for all stock awards granted subsequent to March 28, 2003 as part of our estimate of compensation cost rather than adjust compensation cost for forfeitures as they occur. The cumulative impact of this change was not material. 15 The following table illustrates the effect on net income if the fair value method had been applied to all outstanding and unvested awards in the period prior to our acquisition by HSBC: JANUARY 1 THROUGH MARCH 28, 2003 --------------------------------------------------------------------------- (PREDECESSOR) (IN MILLIONS) Net income, as reported..................................... $246 Add stock-based employee compensation expense included in reported net income, net of tax: Stock option and employee stock purchase plans............ 7 Restricted stock rights................................... 11 Deduct stock-based employee compensation expense determined under the fair value method, net of tax: Stock option and employee stock purchase plans............ (53) Restricted stock rights................................... (45) ---- Pro forma net income........................................ $166 ==== 10. RELATED PARTY TRANSACTIONS -------------------------------------------------------------------------------- In the normal course of business, we conduct transactions with HSBC and its subsidiaries. The following tables present related party balances and the income and (expense) generated by related party transactions: SEPTEMBER 30, DECEMBER 31, 2004 2003 ------------------------------------------------------------------------------------------ (IN MILLIONS) ASSETS AND (LIABILITIES): Derivative financial assets, net............................ $ 2,491 $ 1,789 Other assets................................................ 2 1 Due to affiliates, net HSBC and subsidiaries..................................... (11,972) (7,589) HSBC Investments (North America) Inc. .................... 601 - Other liabilities........................................... (109) (26) 16 THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS ENDED ENDED ENDED ENDED SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 2004 2003 2004 2003 --------------------------------------------------------------------------------------------------------- (IN MILLIONS) INCOME/(EXPENSE): Interest expense on borrowings from HSBC and subsidiaries........................ $ (95) $(23) $(213) $(28) HSBC Bank USA, National Association: Real estate secured servicing revenues............................. 4 - 9 - Real estate secured sourcing, underwriting and pricing revenues.... 1 - 3 - Gain on sale of receivables............. 10 - 25 - Other servicing, processing, origination and support revenues................. 3 - 8 - Support services from HSBC affiliates..... (183) - (556) - HSBC Technology and Services (USA) Inc.: Rental revenue.......................... 8 - 24 - Administrative services revenue......... 5 - 13 - Other income from HSBC affiliates......... 4 - 4 - The notional value of derivative contracts outstanding with HSBC subsidiaries totaled $59.2 billion at September 30, 2004 and $39.7 billion at December 31, 2003. Affiliate swap counterparties have provided collateral in the form of securities which are not recorded on our balance sheet and totaled $1.5 billion at September 30, 2004 and $.5 billion at December 31, 2003. During the second quarter of 2004, we made advances to our immediate parent, HSBC Investments (North America) Inc. ("HINO") totaling $266 million which were repaid during the third quarter of 2004. During the third quarter, we granted a $1 billion line of credit to HINO which matures in July 2005. The balance outstanding under the line of credit at September 30, 2004 was $601 million and is included in due to affiliates. Interest income associated with these advances, which totaled $2 million for both periods, is included in other income and is reflected in other income from HSBC affiliates in the above table. During the third quarter of 2004, our Canadian business began to originate and service auto loans for an HSBC affiliate in Canada. Fees received for these services are included in other income and are reflected in other income from HSBC affiliates in the above table. Due to affiliates also includes amounts owed to subsidiaries of HSBC (other than preferred stock). This funding was at interest rates (both the underlying benchmark rate and credit spreads) comparable to third-party rates for debt with similar maturities. In the first quarter of 2004, we sold approximately $.9 billion of real estate secured receivables from our mortgage services business to HSBC Bank USA, National Association ("HSBC Bank USA") and recorded a pre-tax gain of $15 million on the sale. Under a separate servicing agreement, we have agreed to service all real estate secured receivables sold to HSBC Bank USA including all future business they purchase from our correspondents. As of September 30, 2004, we were servicing $4.9 billion of real estate secured receivables for HSBC Bank USA. We also received fees from HSBC Bank USA pursuant to a service level agreement under which we sourced, underwrote and priced $.7 billion of real estate secured receivables purchased by HSBC Bank USA during the quarter and $2.2 billion year-to-date. These revenues have been recorded as other income. Under various service level agreements, we also provide various services to HSBC Bank USA. These services include credit card servicing and processing activities through our credit card services business, loan origination and servicing through our auto finance business and other operational and administrative 17 support. Fees received for these services are reported as other income. On July 1, 2004, Household Bank (SB), N.A. purchased the account relationships associated with $970 million of MasterCard and Visa credit card receivables from HSBC Bank USA for approximately $99 million which are included in intangible assets. The receivables will continue to be owned by HSBC Bank USA. Originations of new accounts and receivables are made by Household Bank (SB), N.A. and new receivables are sold daily to HSBC Bank USA. Gains on the daily sale of credit card receivables to HSBC Bank USA are recorded in other income. As part of ongoing integration efforts, HSBC has instituted certain changes to its North American organization structure. Among these initiatives was the creation of a new technology services company, HSBC Technology and Services (USA) Inc. ("HTSU"). Effective January 1, 2004, our technology services employees, as well as technology services employees from other HSBC entities in North America, were transferred to HTSU. In addition, technology related assets and software purchased subsequent to January 1, 2004 are generally purchased and owned by HTSU. Technology related assets owned by Household prior to January 1, 2004 currently remain in place and were not transferred to HTSU. In addition to information technology services, HTSU also provides certain item processing and statement processing activities to us pursuant to a master service level agreement. As a result of these changes, operating expenses relating to services provided by HTSU, which have previously been reported as salaries and fringe benefits, occupancy and equipment expenses or other servicing and administrative expenses, are now reported as support services from HSBC affiliates. Support services from HSBC affiliates includes services provided by HTSU as well as banking services and other miscellaneous services provided by HSBC Bank USA and other subsidiaries of HSBC. We also receive revenue from HTSU for certain office space which we have rented to them, which has been recorded as a reduction of occupancy and equipment expenses, and for certain administrative costs, which has been recorded as other income. In addition, we utilize a related HSBC entity to lead manage substantially all ongoing debt issuances. Fees paid for such services totaled approximately $7.8 million for the nine months ended September 30, 2004 and approximately $7.7 million for the period March 29 through September 30, 2003. These fees are amortized over the life of the related debt as a component of interest expense. In September 2004, HSBC North America Holdings Inc. ("HNAH") issued a new series of preferred stock totaling $1.1 billion to HSBC in exchange for our outstanding 6.5% cumulative preferred stock issued to HSBC on March 28, 2003. In October 2004, we paid the accrued dividend of $108 million on our preferred stock. Also in October 2004, our immediate parent, HINO, issued a new series of preferred stock to HNAH in exchange for our 6.5% cumulative preferred stock. 11. PENSION AND OTHER POSTRETIREMENT BENEFITS -------------------------------------------------------------------------------- Components of net periodic benefit cost related to our defined benefit pension plans and our postretirement benefits other than pensions were as follows: OTHER POSTRETIREMENT PENSION BENEFITS BENEFITS ------------------------- ------------------------- THREE MONTHS ENDED SEPTEMBER 30 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (IN MILLIONS) Service cost - benefits earned during the period........................................ $ 14 $ 12 $1 $1 Interest cost................................... 13 12 3 3 Expected return on assets....................... (23) (16) - - Amortization of prior service cost.............. - - - - Recognized (gains) losses....................... (1) - - - ---- ---- -- -- Net periodic benefit cost....................... $ 3 $ 8 $4 $4 ==== ==== == == 18 PENSION BENEFITS OTHER POSTRETIREMENT BENEFITS --------------------------------------------- --------------------------------------------- NINE MONTHS MARCH 29 JANUARY 1 NINE MONTHS MARCH 29 JANUARY 1 ENDED THROUGH THROUGH ENDED THROUGH THROUGH SEPTEMBER 30, SEPTEMBER 30, MARCH 28, SEPTEMBER 30, SEPTEMBER 30, MARCH 28, 2004 2003 2003 2004 2003 2003 ------------------------------------------------------------------------------------------------------------------------ (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (IN MILLIONS) Service cost - benefits earned during the period................. $ 41 $ 24 $ 11 $ 3 $2 $1 Interest cost............ 40 24 5 10 7 1 Expected return on assets................. (67) (32) (16) - - 2 Amortization of prior service cost........... - - - - - - Recognized (gains) losses................. (4) - 14 - - - ---- ---- ---- --- -- -- Net periodic benefit cost................... $ 10 $ 16 $ 14 $13 $9 $4 ==== ==== ==== === == == On November 9, 2004, sponsorship of the United States defined benefit pension plan was transferred to HNAH. 12. NEW ACCOUNTING PRONOUNCEMENTS -------------------------------------------------------------------------------- In December 2003, the American Institute of Certified Public Accountants ("AICPA") released Statement of Position 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer" ("SOP 03-3"). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities acquired in a transfer if those differences are attributable to credit quality. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004. Adoption is not expected to have a material impact on our financial position or results of operations. In December 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 132 (revised), "Employers' Disclosures about Pensions and Other Postretirement Benefits" ("SFAS 132 (revised)"). SFAS 132 (revised) revises employers' disclosures about pension plans and other postretirement benefit plans. It does not change the measurement or recognition of those plans. SFAS 132 (revised) revises certain disclosure requirements contained in the original SFAS 132. It also requires additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. We adopted the annual disclosure requirements for SFAS 132 (revised) as of December 31, 2003, which are included in the 2003 financial information in our 2004 Form 10-K, and the interim period disclosure requirements in our Form 10-Q beginning with the quarter ended March 31, 2004. In January 2004, the FASB issued FASB Staff Position 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" ("FSP 106-1"). FSP 106-1 was issued in response to a new Medicare bill that provides prescription drug coverage to Medicare-eligible retirees and was signed into law in December 2003. FSP 106-1 allowed plan sponsors the option of accounting for the effects of this new law in financial statements for periods that cover the date of enactment or making a one-time election to defer the accounting for the effects of the new law. We elected to defer the accounting for the effects of the new law. In May 2004, the FASB issued FASB Staff Position FAS 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" ("FSP 106-2"), which superceded FSP 106-1. FSP 106-2 is effective for the first interim period beginning after June 15, 2004. For companies that elected deferral under FSP 106-1, and for which enactment is deemed to be a "significant event," FSP 106-2 provides two methods of transition - retroactive application or prospective application from the date of adoption. If the effects of the new law are deemed not to be a "significant event", the effect can be incorporated into the next measurement date following the effective date. Based on the information currently available, adoption of FSP 106-2 is not expected to have a material impact on 19 our accumulated postretirement benefit obligation or our net periodic benefit cost and, as such, we do not consider the effects of the new law to be a significant event. Accordingly, we will account for the effects of the new law beginning on December 31, 2004, our next measurement date. In March 2004, the FASB reached a consensus on EITF 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" ("EITF 03-1"). EITF 03-1 provides guidance for determining when an investment is impaired and whether the impairment is other than temporary. EITF 03-1 also incorporates into its consensus the required disclosures about unrealized losses on investments announced by the EITF in late 2003 and adds new disclosure requirements relating to cost-method investments. The new disclosure requirements are effective for annual reporting periods ending after June 15, 2004 and the new impairment accounting guidance was to become effective for reporting periods beginning after June 15, 2004. In September 2004, the FASB delayed the effective date of EITF 03-1 for measurement and recognition of impairment losses until implementation guidance is issued. We do not expect the adoption of the impairment guidance contained in EITF 03-1 to have a material impact on our financial position or results of operations. 20 Household International, Inc. -------------------------------------------------------------------------------- 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 the 2003 financial information included in our Annual Report on Form 10-K for the year ended December 31, 2004 (the "2004 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. Our results may differ materially from those noted in the forward-looking statements. Words such as "believe", "expects", "estimates", "targeted", "anticipates", "goal" and similar expressions are intended to identify forward-looking statements but should not be considered as the only means through which these statements may be made. Statements that are not historical facts, including statements about management's beliefs and expectations, are forward-looking statements which involve inherent risks and uncertainties and are based on current views and assumptions. A number of factors could cause actual results to differ materially from those contained in any forward-looking statements. For a list of important factors that may affect our actual results, see Cautionary Statement on Forward Looking Statements in Part I, Item 1 of our 2004 Form 10-K. RESTATEMENT -------------------------------------------------------------------------------- We have restated our consolidated financial statements for the previously reported period March 29, 2003 through December 31, 2003, the previously reported quarterly periods ended June 30, 2004 and March 31, 2004 and for the three and nine month periods ended September 30, 2004. This amended Quarterly Report on Form 10-Q/A and the exhibits included herewith include all adjustments relating to the restatement for the periods covered by this report. During the fourth quarter of 2004, as part of our preparation for the implementation of International Financial Reporting Standards ("IFRS") by HSBC from January 1, 2005, we undertook a review of our hedging activities to confirm conformity with the accounting requirements of IFRS, which differ in several respects from the hedge accounting requirements under U.S. GAAP as set out in Statement of Financial Accounting Standards No. 133, "Accounting for Derivatives and Hedging Activities ("SFAS 133"). As a result of this review, management determined that there were some deficiencies in the documentation required to support hedge accounting under U.S. GAAP. These documentation deficiencies arose following our acquisition by HSBC. As a consequence of the acquisition, pre-existing hedging relationships, including hedging relationships that had previously qualified under the "shortcut" method of accounting pursuant to SFAS 133, were required to be reestablished. At that time there was some debate in the accounting profession regarding the detailed technical requirements resulting from a business combination. We consulted with our independent accountants, KPMG LLP, in reaching a determination of what was required in order to comply with SFAS 133. Following this, we took the actions we believed were necessary to maintain hedge accounting for all of our historical hedging relationships in our consolidated financial statements for the period ended December 31, 2003 and those consolidated financial statements received an unqualified audit opinion. Management, having determined during the fourth quarter of 2004 that there were certain documentation deficiencies, engaged independent expert consultants to advise on the continuing effectiveness of the identified hedging relationships and again consulted with our independent accountants, KPMG LLP. As a result of this assessment, we concluded that a substantial number of our hedges met the correlation effectiveness requirement of SFAS 133 throughout the period following our acquisition by HSBC. However, we also determined in conjunction with KPMG LLP that, although a substantial number of the impacted hedges satisfied the correlation effectiveness requirement of SFAS 133, there were technical deficiencies in the documentation that could not be corrected retroactively or disregarded notwithstanding 21 Household International, Inc. -------------------------------------------------------------------------------- the proven effectiveness of the hedging relationships in place and, consequently, that the requirements of SFAS 133 were not met and that hedge accounting was not appropriate during the period these documentation deficiencies existed. We have therefore determined that we should restate all the reported periods since our acquisition by HSBC to eliminate hedge accounting on all hedging relationships outstanding at March 29, 2003 and certain fair value swaps entered into after that date. This was accomplished primarily by reclassifying the mark to market of the changes in fair market value of the affected derivative financial instruments previously classified in either debt or other comprehensive income into current period earnings. The period to period changes in the fair value of these derivative financial instruments have been recognized as either an increase or decrease in our current period earnings through derivative income. As part of the restatement process, we have reclassified all previous hedging results reflected in interest expense associated with the affected derivative financial instruments to derivative income. Our independent registered public accounting firm has reviewed our September 30, 2004 financial results and has provided us a review report under Statement on Auditing Standards No. 100, which review report is attached to this amended Quarterly Report on Form 10-Q/A as Exhibit 99.2. The cumulative restatement is as follows for the periods presented below: RESTATEMENTS TO REPORTED INCOME ---------------------------------------------- % CHANGE PRE-TAX TAX EFFECT AFTER TAX TO REPORTED ----------------------------------------------------------------------------------------------------- (DOLLARS IN MILLIONS) March 29, 2003 through September 30, 2003............ $(126) $ 46 $ (80) (9.5)% Nine months ended September 30, 2004................. 47 (17) 30 2.5 Quarter ended September 30, 2003..................... (708) 258 (450) (95.3) Quarter ended September 30, 2004..................... 5 (2) 3 .9 See Note 2, "Restatement," for a detailed summary of the impact of the restatement on our consolidated statement of income and our consolidated balance sheet for the periods presented. The resulting accounting does not reflect the economic reality of our hedging activity and has no impact on the timing or amount of operating cash flows or cash flows under any debt or derivative contract. It does not affect our ability to make required payments on our outstanding debt obligations. Furthermore, the restatement has no impact on our results on a U.K. GAAP basis, which are used in measuring and rewarding performance of employees. Finally, our economic risk management strategies have not required amendment. EXECUTIVE OVERVIEW -------------------------------------------------------------------------------- Household International, Inc. is principally a non-operating holding company and an indirect wholly owned subsidiary of HSBC Holdings plc ("HSBC"). Household may also be referred to in MD&A as "we", "us", or "our". Household's acquisition by HSBC on March 28, 2003 has resulted in a new basis of accounting reflecting the fair market value of our assets and liabilities for the "successor" period beginning March 29, 2003. Information for all "predecessor" periods prior to the merger is presented using our historical basis of accounting, which impacts comparability to our "successor" period beginning March 29, 2003. During the nine months ended September 30, 2003, the "predecessor" period contributed $246 million of net income and the "successor" period contributed $765 million of net income. To assist in the comparability of our financial results and to make it easier to discuss and understand our results of operations, MD&A combines the "predecessor" period (January 1 to March 28, 2003) with the "successor" period (March 29 to September 30, 2003) to present "combined" results for the nine months ended September 30, 2003. 22 Household International, Inc. -------------------------------------------------------------------------------- In addition to owned basis reporting, we also monitor our operations and evaluate trends on a managed basis (a non-GAAP financial measure), which assumes that securitized receivables have not been sold and are still on our balance sheet. See "Basis of Reporting" for further discussion of the reasons we use this non-GAAP financial measure. On September 30, 2004, we commenced the rebranding of the majority of our U.S. and Canadian businesses, including Household International, to the HSBC brand. The rebranding means that businesses previously operating under the Household name will be called HSBC. Our consumer lending business will retain the HFC and Beneficial brands, accompanied by the HSBC Group's endorsement signature, "Member HSBC Group." The single brand will allow HSBC in North America to better align its businesses, providing a stronger platform to service customers and advance growth. The HSBC brand also positions us to expand the products and services offered to our customers. As part of this initiative and subject to regulatory approvals, we expect to merge with our subsidiary, Household Finance Corporation, in December 2004. At the time of the merger, Household International, Inc. will change its name to HSBC Finance Corporation. In measuring our results, management's primary focus is on managed receivable growth and operating net income (a non-GAAP financial measure which excludes $167 million, after-tax, of HSBC acquisition related costs and other merger related items incurred by Household in the first quarter of 2003.) See "Basis of Reporting" for further discussion of operating net income. Net income was $325 million for the quarter ended September 30, 2004, compared to net income of $22 million in the prior year quarter. The increase in net income during the quarter was attributable solely to higher derivative income. Derivative income increased $684 million in the current quarter as compared to the prior year quarter due to the impact of lower long term rates on our portfolio of receive fixed swaps and the impact of higher short term rates on our pay fixed swap portfolio. Excluding the impact of derivative income, net income was lower compared with the prior year quarter. The decrease was primarily due to higher operating expenses and higher provision for credit losses due to receivable growth, partially offset by higher net interest income. Net income for the first nine months of 2004 was $1,228 million, a 4 percent increase from operating net income of $1,178 million for the first nine months of 2003. The increase was primarily due to higher other revenues, including higher derivative income, and higher net interest income partially offset by higher operating expenses. Operating expenses increased due to receivable growth, increases in legal costs and, for the nine month period, higher amortization of intangibles which were established in connection with the HSBC merger. The increase in net interest income during both periods was due to higher average receivable balances offset by lower yields on our receivables, particularly in real estate secured and auto finance receivables. Funding costs were higher during the three month period resulting from a rising interest rate environment. Other revenues increased during the nine month period due to higher derivative and other income, partially offset by reduced initial securitization activity. Amortization of purchase accounting fair value adjustments increased net income by $43 million for the quarter ended September 30, 2004, and by $103 million for the nine months ended September 30, 2004 and compared to $5 million for the quarter ended September 30, 2003 and $41 million for the nine months ended September 30, 2003. 23 Household International, Inc. -------------------------------------------------------------------------------- The financial information set forth below summarizes selected financial highlights of Household as of September 30, 2004 and 2003 and for the three and nine month periods ended September 30, 2004 and 2003. THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ------------------------ 2004 2003 2004 2003 ----------------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (COMBINED) (RESTATED) (RESTATED) (RESTATED) (RESTATED) (DOLLARS ARE IN MILLIONS) NET INCOME:(1)................................. $325 $ 22 $1,228 $1,011 OWNED BASIS RATIOS: Return on average owned assets ("ROA")(1).... 1.04% .08% 1.36% 1.25% Return on average common shareholder's equity ("ROE")(1)................................ 7.1 .1 9.2 9.5 Net interest margin.......................... 7.29 7.98 7.41 7.74 Consumer net charge-off ratio, annualized.... 3.77 3.98 3.98 4.17 Efficiency ratio(1)(2)....................... 45.1 53.5 44.0 44.0 MANAGED BASIS RATIOS:(3) Return on average managed assets ("ROMA")(1)............................... .89% .06% 1.14% 1.02% Net interest margin.......................... 7.88 8.79 8.13 8.62 Risk adjusted revenue........................ 6.66 4.82 6.92 7.06 Consumer net charge-off ratio, annualized.... 4.38 4.68 4.61 4.77 Efficiency ratio(1)(2)....................... 49.0 44.8 43.1 37.4 SEPTEMBER 30, SEPTEMBER 30, 2004 2003 ------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (DOLLARS ARE IN MILLIONS) RECEIVABLES: Owned basis............................................... $106,437 $ 93,028 Managed basis(3).......................................... 126,612 117,137 TWO-MONTH-AND-OVER CONTRACTUAL DELINQUENCY RATIOS: Owned basis............................................... 4.43% 5.36% Managed basis(3).......................................... 4.59 5.36 --------------- (1) The following table includes non-GAAP financial information for the nine months ended September 30, 2003. This information is provided for comparison of our operating trends only and should be read in conjunction with our owned basis GAAP financial information. See "Basis of Reporting" for additional discussion on the use of non-GAAP financial measures and "Reconciliations to GAAP Financial Measures" for quantitative reconciliations to the equivalent GAAP basis financial measure. 24 Household International, Inc. -------------------------------------------------------------------------------- THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------- ----------------------- 2004 2003 2004 2003 --------------------------------------------------------------------------------------------------------------- (RESTATED) (RESTATED) (RESTATED) (RESTATED) (DOLLARS ARE IN MILLIONS) Net income.................................................. $325 $ 22 $1,228 $ 1,011 HSBC acquisition related costs and other merger related items, after-tax.......................................... - - - 167 ---- ---- ------ ---------- Operating net income........................................ $325 $ 22 $1,228 $ 1,178 ==== ==== ====== ========== ROA......................................................... 1.04% .08% 1.36% 1.46% ROE......................................................... 7.1 .1 9.2 11.1 Owned basis efficiency ratio(2)............................. 45.1 53.5 44.0 41.6 ROMA........................................................ .89 .06 1.14 1.19 Managed basis efficiency ratio(2)........................... 49.0 44.8 43.1 35.4 --------------- (2) Ratio of total costs and expenses less policyholders' benefits to net interest income and other revenues less policyholders' benefits. (3) Managed basis reporting is a non-GAAP financial measure. See "Basis of Reporting" for additional discussion on the use of this non-GAAP financial measure and "Reconciliations to GAAP financial Measures" for quantitative reconciliations to the equivalent GAAP basis financial measure. Because HSBC reports results on a U.K. GAAP basis, our management also separately monitors earnings excluding goodwill amortization and net income under U.K. GAAP (non-GAAP financial measures). The following table summarizes U.K. GAAP results: THREE MONTHS ENDED NINE MONTHS MARCH SEPTEMBER 30, ENDED 29 THROUGH ----------------------- SEPTEMBER 30, SEPTEMBER 30, 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------------------ (RESTATED) (RESTATED) (RESTATED) (RESTATED) (DOLLARS ARE IN MILLIONS) Earnings excluding goodwill amortization - U.K. GAAP basis...................................... $621 $576 $2,138 $1,095 Net income - U.K. GAAP basis...................... 491 463 1,745 867 Owned receivables were $106.4 billion at September 30, 2004, $99.4 billion at June 30, 2004, and $93.0 billion at September 30, 2003. We experienced growth in all our receivable products with real estate secured receivables being the primary contributor of the growth. Real estate secured receivable levels reflect sales to HSBC Bank USA, National Association ("HSBC Bank USA") of $.9 billion on March 31, 2004 and $2.8 billion on December 31, 2003 and purchases of correspondent receivables directly by HSBC Bank USA of $.7 billion in the third quarter of 2004 and $2.2 billion year-to-date, a portion of which we otherwise would have purchased. Lower securitization levels also contributed to the increase in owned receivables over June 30, 2004 and September 30, 2003 levels. We previously reported that we intend to transfer our domestic private label credit card portfolio to HSBC Bank USA in 2004. We plan to maintain the related customer account relationships and sell additional volume to HSBC Bank USA on a daily basis following the initial sale. HSBC Bank USA has filed a formal application seeking regulatory approval to acquire our domestic private label portfolio in 2004. We and HSBC Bank USA will consider potential transfers of some of our MasterCard and Visa receivables to HSBC Bank USA in the future based upon continuing evaluations of capital and liquidity at each entity. The private label receivables we expect to sell to HSBC Bank USA by year-end will have a principal balance of approximately $12 billion ($15 billion on a managed basis). Upon receipt of regulatory approval for transfer of the private label portfolio, we will adopt 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") for our entire domestic private label and MasterCard and Visa portfolios. Following the transfer of the private label portfolio, we expect our net 25 Household International, Inc. -------------------------------------------------------------------------------- interest income and fee income will be substantially reduced, but our other income will substantially increase as we record gains from the initial and continuing sales of private label receivables in the future. We cannot predict with any degree of certainty the timing as to when or if regulatory approval will be received and, therefore, when the related asset transfers will be completed. However, if regulatory approval is received, we currently expect that adoption of FFIEC charge-off and account management policies for our domestic private label and MasterCard/Visa credit card portfolios would result in a reduction to net income of approximately $130 million. We also currently expect that we will recognize an after tax gain on sale of approximately $370 million when the domestic private label portfolio is sold to HSBC Bank USA. Updates to the information on the financial impact of the proposed transfer will be reported as the regulatory approval process progresses and the amounts become certain. Our owned basis two-months-and-over-contractual delinquency ratio decreased compared to both the prior quarter and the prior year quarter. The decrease is consistent with the improvements in early delinquency roll rate trends we began to experience in the fourth quarter of 2003 as a result of improvements in the economy and better underwriting, including both improved modeling and improved credit quality of originations. Dollars of delinquency decreased compared to the prior year quarter but increased compared to the prior quarter as securitization levels declined and our interest in the receivables of certain securitization trusts increased. Net charge-offs as a percentage of average consumer receivables for the September 2004 quarter decreased over the June 2004 and prior year quarter as the lower delinquency levels we have been experiencing are having an impact on charge-offs. Also contributing to the decrease in net charge-offs compared to the prior year quarter were improved collections and a decrease in the percentage of the portfolio comprised of personal non-credit card receivables, which have a higher net charge-off rate than other products in our portfolio. During the nine months ended September 30, 2004, we became less reliant on third party debt and initial securitization funding as we used proceeds from the sale of real estate secured receivables to HSBC Bank USA and debt issued to affiliates to assist in the funding of our businesses. Because we are now a subsidiary of HSBC, our credit spreads relative to Treasuries have tightened. We recognized cash funding expense savings, primarily as a result of these tightened credit spreads and lower costs due to shortening the maturity of our liabilities primarily through increased issuance of commercial paper, in excess of $235 million for the first nine months of 2004 and less than $70 million for the prior-year period compared to the funding costs we would have incurred using average spreads from the first half of 2002. Securitization of consumer receivables has been a source of funding and liquidity for us. Under U.K. GAAP as reported by HSBC, our securitizations are treated as secured financings. In order to align our accounting treatment with that of HSBC under U.K. GAAP, we began to structure all new collateralized funding transactions as secured financings in the third quarter of 2004. However, because existing public private label and MasterCard and Visa credit card transactions were structured as sales to revolving trusts that require replenishments of receivables to support previously issued securities, receivables of each of these asset types will continue to be sold to these trusts and the resulting replenishment gains recorded until the revolving periods end, the last of which is expected to occur in 2007. In addition, we will continue to replenish at reduced levels, certain non-public personal non-credit card and MasterCard and Visa securities issued to conduits and record the resulting replenishment gains for a period of time in order to manage liquidity. Since our securitized receivables have varying lives, it will take several years for these receivables to pay-off and the related interest-only strip receivables to be reduced to zero. The termination of sale treatment on new collateralized funding activity reduces our reported net income under U.S. GAAP. There is no impact, however, on cash received from operations or on U.K. GAAP reported results. 26 Household International, Inc. -------------------------------------------------------------------------------- BASIS OF REPORTING -------------------------------------------------------------------------------- Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). Unless noted, the discussion of our financial condition and results of operations included in MD&A is presented on an owned basis of reporting. Household's acquisition by HSBC on March 28, 2003 has resulted in a new basis of accounting reflecting the fair value of our assets and liabilities for the "successor" period beginning March 29, 2003. Information for all "predecessor" periods prior to the merger are presented using our historical basis of accounting, which impacts comparability with the "successor" period beginning March 29, 2003. To assist in the comparability of our financial results and to make it easier to discuss and understand our results of operations, MD&A combines the "predecessor" period (January 1 through March 28, 2003) with the "successor" period (March 29 through September 30, 2003) to present "combined" results for the nine months ended September 30, 2003. 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-GAAP basis: OPERATING RESULTS, PERCENTAGES AND RATIOS Certain percentages and ratios have been presented on an operating basis and have been calculated using "operating net income", a non-GAAP financial measure. "Operating net income" is net income excluding $167 million, after-tax, of HSBC acquisition related costs and other merger related items incurred by Household in the first quarter of 2003. This nonrecurring item is also excluded in calculating our operating basis efficiency ratios. We believe that excluding this nonrecurring item helps readers of our financial statements to better understand the results and trends of our underlying business. MANAGED BASIS REPORTING We monitor our operations and evaluate trends on a managed basis (a non-GAAP financial measure), which assumes that securitized receivables have not been sold and are still on our balance sheet. We manage and evaluate our operations on a managed basis because the receivables that we securitize are subjected to underwriting standards comparable to our owned portfolio, are serviced by operating personnel without regard to ownership and result in a similar credit loss exposure for us. In addition, we fund our operations, review our operating results, and make decisions about allocating resources such as employees and capital on a managed basis. When reporting on a managed basis, net interest income, provision for credit losses and fee income related to receivables securitized are reclassified from securitization revenue in our owned statement of income into the appropriate caption. Additionally, charge-off and delinquency associated with these receivables are included in our managed basis credit quality statistics. Debt analysts, rating agencies and others also evaluate our operations on a managed basis for the reasons discussed above and have historically requested managed basis information from us. We believe that managed basis information enables investors and other interested parties to better understand the performance and quality of our entire managed loan portfolio and is important to understanding the quality of originations and the related credit risk inherent in our owned and securitized portfolios. As the level of our securitized receivables falls over time, managed basis and owned basis results will eventually converge, and we will only report owned basis results. EQUITY RATIOS Tangible shareholder's equity to tangible managed assets ("TETMA"), tangible shareholder's equity plus owned loss reserves to tangible managed assets ("TETMA + Owned Reserves") and tangible common equity to tangible managed assets are non-GAAP financial measures that are used by Household management or certain rating agencies to evaluate capital adequacy. These ratios may differ from similarly named measures presented by other companies. The most directly comparable GAAP financial measure is common and preferred equity to owned assets. 27 Household International, Inc. -------------------------------------------------------------------------------- We also monitor our equity ratios excluding the impact of purchase accounting adjustments. We do so because we believe that the purchase accounting adjustments represent non-cash transactions which do not affect our business operations, cash flows or ability to meet our debt obligations. Preferred securities issued by certain non-consolidated trusts are considered equity in the TETMA and TETMA + Owned Reserves calculations because of their long-term subordinated nature and the ability to defer dividends. Our Adjustable Conversion-Rate Equity Security Units, adjusted for purchase accounting adjustments, are also considered equity in these calculations because they include investor obligations to purchase HSBC ordinary shares in 2006. U.K. GAAP Because HSBC reports results on a U.K. GAAP basis, our management also separately monitors net income and earnings excluding goodwill amortization under U.K. GAAP (non-GAAP financial measures). The following table reconciles our net income on a U.S. GAAP basis to earnings excluding goodwill amortization and net income on a U.K. GAAP basis: THREE MONTHS ENDED NINE MONTHS MARCH 29 SEPTEMBER 30, ENDED THROUGH ----------------------- SEPTEMBER 30, SEPTEMBER 30, 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------------------ (RESTATED) (RESTATED) (RESTATED) (RESTATED) (IN MILLIONS) Net income - U.S. GAAP basis....................... $ 325 $ 22 $1,228 $ 765 Adjustments, net-of-tax: Deferred origination expenses................. 5 (24) (67) (46) Derivative financial instruments.............. (3) 453 (28) 37 Securitizations............................... 177 (168) 426 (348) Intangibles................................... 46 46 163 97 Purchase accounting adjustments............... 76 181 387 560 Other......................................... (5) 66 29 30 ----- ----- ------ ------ Earnings excluding goodwill amortization - U.K. GAAP basis....................................... 621 576 2,138 1,095 Goodwill amortization.............................. (130) (113) (393) (228) ----- ----- ------ ------ Net income - U.K. GAAP basis....................... $ 491 $ 463 $1,745 $ 867 ===== ===== ====== ====== Differences between U.S. and U.K GAAP are as follows: DEFERRED ORIGINATION EXPENSES U.K. GAAP - Fee and commission income is accounted for in the period when receivable, except when it is charged to cover the costs of a continuing service to, or risk borne for, the customer, or is interest in nature. In these cases, it is recognized on an appropriate basis over the relevant period. - Loan origination costs are generally expensed as incurred. As permitted by U.K. GAAP, HSBC applies a restricted definition of the incremental, directly attributable origination expenses that are deferred and subsequently amortized over the life of the loans. U.S. GAAP - Certain loan fee income and direct loan origination costs are amortized to the profit and loss account over the life of the loan as an adjustment to interest income (SFAS 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases".) 28 Household International, Inc. -------------------------------------------------------------------------------- DERIVATIVE FINANCIAL INSTRUMENTS U.K. GAAP - Non-trading derivatives are those which are held for hedging purposes as part of our risk management strategy against cash flows, assets, liabilities, or positions measured on an accruals basis. Non-trading transactions include qualifying hedges and positions that synthetically alter the characteristics of specified financial instruments. - Non-trading derivatives are accounted for on an equivalent basis to the underlying assets, liabilities or net positions. Any profit or loss arising is recognized on the same basis as that arising from the related assets, liabilities or positions. - To qualify as a hedge, a derivative must effectively reduce the price, foreign exchange or interest rate risk of the asset, liability or anticipated transaction to which it is linked and be designated as a hedge at inception of the derivative contract. Accordingly, changes in the market value of the derivative must be highly correlated with changes in the market value of the underlying hedged item at inception of the hedge and over the life of the hedge contract. If these criteria are met, the derivative is accounted for on the same basis as the underlying hedged item. Derivatives used for hedging purposes include swaps, forwards and futures. - Interest rate swaps are also used to alter synthetically the interest rate characteristics of financial instruments. In order to qualify for synthetic alteration, a derivative instrument must be linked to specific individual, or pools of similar, assets or liabilities by the notional principal and interest rate risk of the associated instruments, and must achieve a result that is consistent with defined risk management objectives. If these criteria are met, accrual based accounting is applied, i.e. income or expense is recognized and accrued to the next settlement date in accordance with the contractual terms of the agreement. - Any gain or loss arising on the termination of a qualifying derivative is deferred and amortized to earnings over the original life of the terminated contract. Where the underlying asset, liability or position is sold or terminated, the qualifying derivative is immediately marked-to-market through the profit and loss account. - Derivatives that do not qualify as hedges or synthetic alterations at inception are marked-to-market through the profit and loss account, with gains and losses included within "other income". U.S. GAAP - All derivatives must be recognized as either assets or liabilities in the balance sheet and be measured at fair value (SFAS 133, "Accounting for Derivative Instruments and Hedging Activities"). - The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation as described below: - For a derivative designated as hedging exposure to changes in the fair value of a recognized asset or liability or a firm commitment, the gain or loss is recognized in earnings in the period of change together with the associated loss or gain on the hedged item attributable to the risk being hedged. Any resulting net gain or loss represents the ineffective portion of the hedge. - For a derivative designated as hedging exposure to variable cash flows of a recognized asset or liability, or of a forecast transaction, the derivative's gain or loss associated with the effective portion of the hedge is initially reported as a component of other comprehensive income and subsequently reclassified into earnings when the forecast transaction affects earnings. The ineffective portion is reported in earnings immediately. - For net investment hedges in which derivatives hedge the foreign currency exposure of a net investment in a foreign operation, the change in fair value of the derivative associated with the effective portion of the hedge is included as a component of other comprehensive income, together with the associated loss or gain on the hedged item. The ineffective portion is reported in earnings immediately. 29 Household International, Inc. -------------------------------------------------------------------------------- - In order to apply hedge accounting it is necessary to comply with documentation requirements and to demonstrate the effectiveness of the hedge on an ongoing basis. - For a derivative not designated as a hedging instrument, the gain or loss is recognized in earnings in the period of change in fair value. SECURITIZATIONS U.K. GAAP - FRS 5, "Reporting the Substance of Transactions," requires that the accounting for securitized receivables is governed by whether the originator has access to the benefits of the securitized assets and exposure to the risks inherent in those benefits and whether the originator has a liability to repay the proceeds of the note issue: - The securitized assets should be derecognized in their entirety and a gain or loss on sale recorded where the originator retains no significant benefits and no significant risks relating to those securitized assets. - The securitized assets and the related finance should be consolidated under a linked presentation where the originator retains significant benefits and significant risks relating to those securitized assets but where the downside exposure is limited to a fixed monetary amount and certain other conditions are met. - The securitized assets and the related finance should be consolidated on a gross basis where the originator retains significant benefits and significant risks relating to those securitized assets and does not meet the conditions required for linked presentation. - The run-off of prior period transactions and a lower volume of transactions have resulted in lower income under U.S. GAAP in the quarter and year-to-date periods and, therefore, higher reported net income under U.K. GAAP. U.S. GAAP - SFAS 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," requires that receivables that are sold to a special purpose entity and securitized can only be derecognized and a gain or loss on sale recognized if the originator has surrendered control over those securitized assets. - Control has been surrendered over transferred assets if and only if all of the following conditions are met: - The transferred assets have been put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership. - Each holder of interests in the transferee (i.e., holder of issued notes) has the right to pledge or exchange their beneficial interests, and no condition constrains this right and provides more than a trivial benefit to the transferor. - The transferor does not maintain effective control over the assets through either an agreement that obligates the transferor to repurchase or to redeem them before their maturity or through the ability to unilaterally cause the holder to return specific assets, other than through a clean-up call. - If these conditions are not met the securitized assets should continue to be consolidated. - Where we retain an interest in the securitized assets, such as a servicing right or the right to residual cash flows from the special purpose entity, we recognize this interest at fair value on sale of the assets. - There are no provisions for linked presentation of securitized assets and the related finance. 30 Household International, Inc. -------------------------------------------------------------------------------- INTANGIBLES U.K. GAAP - An intangible asset is recognized separately from goodwill where it is identifiable and controlled. It is identifiable only if it can be disposed of or settled separately without disposing of the whole business. Control requires legal rights or custody over the item. - An intangible asset purchased as part of a business combination is capitalized at fair value based on its replacement cost, which is normally its estimated market value. U.S. GAAP - An intangible asset is recognized separately from goodwill when it arises from contractual or other legal rights or if it is separable, i.e. it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented, or exchanged in combination with a related contract, asset or liability. The effect of this is that certain intangible assets such as trademarks and customer relationships are recognized under U.S. GAAP, although such assets will not be recognized under U.K. GAAP. - Intangible assets are initially recognized at fair value. An intangible asset with a finite useful life is amortized over the period for which it contributes to the future cash flows of the entity. An intangible asset with an indefinite useful life is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. PURCHASE ACCOUNTING ADJUSTMENTS - The reconciling "purchase accounting adjustments" predominantly reflect: - the measurement of equity consideration at the date the terms of acquisition are agreed and announced under U.S. GAAP; under U.K. GAAP equity consideration is measured at the date of acquisition; - recognition of deferred tax on all fair value adjustment under U.S. GAAP, and corresponding amortization post-acquisition; - non-recognition of residual interests in securitization vehicles existing at acquisition under U.K. GAAP. Instead, the assets and liabilities of the securitization vehicles are recognized on the U.K. GAAP balance sheet, and credit provisions are established against the loans and advances. This GAAP adjustment existing at acquisition unwinds over the life of the securitization vehicles; and - certain costs which under U.K. GAAP, relate to either post-acquisition management decisions or certain decisions made prior to the acquisition are required to be expensed to the post-acquisition profit and loss account and cannot be capitalized as goodwill, or included within the fair value of the liabilities of the acquired entity. OTHER - Includes adjustments related to suspension of interest accruals on nonperforming loans, capitalized software costs and other items. - Capitalized software costs - U.K. GAAP - HSBC generally expenses costs of software developed for internal use. If it can be shown that conditions for capitalization are met under FRS 10, "Goodwill and intangible assets," or FRS 15, "Tangible fixed assets", the software is capitalized and amortized over its useful life. Website design and content development costs are capitalized only to the extent that they lead to the creation of an enduring asset delivering benefits at least as great as the amount capitalized. - U.S. GAAP - The American Institute of Certified Public Accountants' ("AICPA") Statement of Position 98-1, "Accounting for the costs of computer software developed or obtained for internal use," requires that all costs incurred in the preliminary project and post implementation stages of internal software development be expensed. Costs incurred in the application development stage must be capitalized and amortized over their estimated useful life. Website design costs are capitalized and website content development costs are expensed as they are incurred. 31 Household International, Inc. -------------------------------------------------------------------------------- GOODWILL AMORTIZATION U.K. GAAP - Goodwill arising on acquisitions of subsidiary undertakings, associates or joint ventures prior to 1998 was charged against reserves in the year of acquisition. - For acquisitions made on or after January 1, 1998, goodwill is included in the balance sheet and amortized over its estimated useful life on a straight-line basis. U.K. GAAP allows goodwill previously eliminated against reserves to be reinstated, but does not require it. - Goodwill included in the balance sheet is tested for impairment when necessary by comparing the recoverable amount of an entity with the carrying value of its net assets, including attributable goodwill. The recoverable amount of an entity is the higher of its value in use, generally the present value of the expected future cash flows from the entity, and its net realizable value. - At the date of disposal of subsidiaries, associates or joint ventures, any unamortized goodwill or goodwill charged directly against reserves is included in our share of the undertakings' total net assets in the calculation of the gain or loss on disposal. - Where quoted securities are issued as part of the purchase consideration in an acquisition, the fair value of those securities for the purpose of determining the cost of acquisition is the market price at the date of completion. U.S. GAAP - Goodwill acquired up to June 30, 2001 was capitalized and amortized over its useful life but not more than 25 years. The amortization of previously acquired goodwill ceased from December 31, 2001. - SFAS 142, "Goodwill and Other Intangible Assets" requires that goodwill should not be amortized but should be tested for impairment annually at the reporting unit level by applying a fair-value-based test. - The goodwill of a reporting unit should be tested for impairment between annual tests in response to events or changes in circumstance which could result in an impairment. - Where quoted securities are issued as part of the purchase consideration in an acquisition, the fair value of those securities for the purpose of determining the cost of acquisition is the average market price of the securities for a reasonable period before and after the date that the terms of the acquisition are agreed and announced. QUANTITATIVE RECONCILIATIONS OF NON-GAAP FINANCIAL MEASURES TO GAAP FINANCIAL MEASURES For a reconciliation of managed basis net interest income, fee income and provision for credit losses to the comparable owned basis amounts, see "Segment Results - Managed Basis" in this MD&A. For a reconciliation of our owned loan portfolio by product to our managed loan portfolio, see Note 4, "Receivables," to the accompanying consolidated financial statements. For additional quantitative reconciliations of non-GAAP financial measures presented herein to the equivalent GAAP basis financial measures, see "Reconciliations to GAAP Financial Measures." 32 Household International, Inc. -------------------------------------------------------------------------------- RECEIVABLES REVIEW -------------------------------------------------------------------------------- The following table summarizes owned receivables at September 30, 2004 and increases (decreases) over prior periods: INCREASES (DECREASES) FROM ----------------------------------- JUNE 30, 2004 SEPTEMBER 30, 2003 SEPTEMBER 30, ------------- ------------------- 2004 $ % $ % ----------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Real estate secured............................. $ 58,726 $2,693 4.8% $ 5,957 11.3% Auto finance.................................... 6,823 1,364 25.0 3,122 84.4 MasterCard(1)/Visa(1)........................... 11,666 850 7.9 1,774 17.9 Private label................................... 14,000 1,241 9.7 1,593 12.8 Personal non-credit card(2)..................... 14,888 869 6.2 1,038 7.5 Commercial and other............................ 334 (12) (3.5) (75) (18.3) -------- ------ ---- ------- ----- Total owned receivables......................... $106,437 $7,005 7.0% $13,409 14.4% ======== ====== ==== ======= ===== --------------- (1) MasterCard is a registered trademark of MasterCard International, Incorporated and Visa is a registered trademark of VISA USA, Inc. (2) Personal non-credit card receivables are comprised of the following: SEPTEMBER 30, JUNE 30, SEPTEMBER 30, 2004 2004 2003 ---------------------------------------------------------------------------------------------------- (IN MILLIONS) Domestic personal non-credit card......................... $ 7,141 $ 6,492 $ 6,459 Union Plus personal non-credit card....................... 510 576 755 Personal homeowner loans.................................. 3,535 3,408 3,735 Foreign personal non-credit card.......................... 3,702 3,543 2,901 ------- ------- ------- Total personal non-credit card............................ $14,888 $14,019 $13,850 ======= ======= ======= RECEIVABLE INCREASES (DECREASES) SINCE SEPTEMBER 30, 2003 Driven by growth in our correspondent and branch businesses, real estate secured receivables increased over the year-ago period. Real estate secured receivable levels reflect sales to HSBC Bank USA of $.9 billion on March 31, 2004 and $2.8 billion on December 31, 2003, as well as HSBC Bank USA's purchase of receivables directly from correspondents totaling $.7 billion in the third quarter of 2004 and $2.2 billion year-to-date, a portion of which we otherwise would have purchased. Growth in real estate secured receivables was supplemented by purchases from a single correspondent relationship which totaled $.6 billion in the third quarter of 2004 and $1.9 billion year-to-date. Real estate secured receivable levels in our branch-based consumer lending business continue to improve, as sales volumes remain higher than the year-ago period and we continue to emphasize real estate secured loans in our branches, including a near-prime mortgage product we introduced in 2003. The increases in the real estate secured receivable levels have been partially offset by run-off of the higher yielding real estate secured receivables, including second lien loans largely due to refinance activity. Auto finance receivables increased over the year-ago period due to newly originated loans acquired from our dealer network, strategic alliances established during 2003, increased growth in the consumer direct loan program and lower securitization levels. MasterCard and Visa receivables reflect organic growth especially in our subprime portfolios and lower securitization levels. Growth in private label receivables reflects year to date portfolio acquisitions of $.5 billion, organic growth through existing merchants and lower securitization levels. Personal non-credit card receivables increased due to lower securitization levels and higher levels of foreign personal non-credit card receivables. 33 Household International, Inc. -------------------------------------------------------------------------------- RECEIVABLE INCREASES (DECREASES) SINCE JUNE 30, 2004 Both our correspondent and branch businesses reported growth in their real estate secured portfolios as discussed above. Growth in our private label portfolio reflects organic growth and lower securitization levels. Growth in our auto finance and personal non-credit card portfolios reflect lower levels of securitizations. Auto finance receivables also increased due to new originations from our dealer network and increased growth in the consumer direct loan program. Personal non-credit card receivables also experienced increased originations. During the third quarter, we began to increase availability of personal non-credit card loans as a result of an improving economy. RESULTS OF OPERATIONS -------------------------------------------------------------------------------- Unless noted otherwise, the following discusses amounts reported in our owned basis statement of income. NET INTEREST INCOME The following table summarizes net interest income: INCREASE (DECREASE) ------------- THREE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT % ----------------------------------------------------------------------------------------------------- (RESTATED) (RESTATED) (DOLLARS ARE IN MILLIONS) Finance and other interest income........................... $2,779 $2,570 $209 8.1% Interest expense............................................ 810 654 156 23.9 ------ ------ ---- ---- Net interest income......................................... $1,969 $1,916 $ 53 2.8% ====== ====== ==== ==== Net interest income as a percent of average interest-earning assets, annualized........................................ 7.29% 7.98% ====== ====== INCREASE (DECREASE) ------------- NINE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT % ----------------------------------------------------------------------------------------------------- (RESTATED) (RESTATED) (DOLLARS ARE IN MILLIONS) Finance and other interest income........................... $7,944 $7,617 $327 4.3% Interest expense............................................ 2,225 2,259 (34) (1.5) ------ ------ ---- ---- Net interest income......................................... $5,719 $5,358 $361 6.7% ====== ====== ==== ==== Net interest income as a percent of average interest-earning assets, annualized........................................ 7.41% 7.74% ====== ====== The increase in dollars of net interest income during the quarter was due to higher average receivables, partially offset by lower yields on our receivables, particularly real estate secured and auto finance receivables, and higher funding costs as a result of a rising interest rate environment. The year-to-date increase was due to higher average receivables and lower funding costs including a higher impact from purchase accounting fair value adjustments, partially offset by lower yields. The lower yields reflect reduced pricing, including higher levels of near prime receivables, as well as the run-off of higher yielding real estate secured receivables, including second lien loans largely due to refinance activity. We experienced a higher benefit from the amortization of purchase accounting fair value adjustments in both periods. Our purchase accounting fair value adjustments include both amortization of fair value adjustments to our external debt obligations and to our receivables. Amortization of purchase accounting fair value adjustments increased net interest income during the quarter by $174 million in 2004 and $182 million in 2003. For the nine month period, amortization of purchase accounting fair value adjustments increased net interest income by $549 million in 2004 and $403 million in 2003. 34 Household International, Inc. -------------------------------------------------------------------------------- Net interest income as a percentage of average interest earning assets declined during both the quarter and year-to-date period. As discussed above, lower yields on our receivables drove the decreases in both periods. For the three-month period, higher funding costs due to a rising interest rate environment also contributed to the decrease. For the nine-month period, lower yields were partially offset by lower funding costs. Our net interest margin on an owned basis was impacted by the loss of hedge accounting on the hedging relationships at the time of the merger. The loss of hedge accounting on the impacted hedging relationships reduced net interest income during the quarter by $66 million in 2004 and $98 million in 2003. For the nine month period, the loss of hedge accounting on the impacted hedging relationships reduced net interest income by $205 million in 2004 and $231 million in 2003. The following table compares our reported net interest margin to what it otherwise would have been had hedge accounting not been lost: THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED (SEPTEMBER 30, 2004 (SEPTEMBER 30, 2003 SEPTEMBER 30, 2004 (SEPTEMBER 30, 2003 ---------------------- ---------------------- ---------------------- --------------------- - WITHOUT WITHOUT WITHOUT WITHOUT LOSS OF LOSS OF LOSS OF LOSS OF AS HEDGE AS HEDGE AS HEDGE AS HEDGE REPORTED ACCOUNTING* REPORTED ACCOUNTING* REPORTED ACCOUNTING* REPORTED ACCOUNTING* ------------------------------------------------------------------------------------------------------------------------ - Net interest margin... 7.29% 7.54% 7.98% 8.39% 7.41% 7.67% 7.74% 8.07% --------------- * Represents a non-GAAP financial measure which is being provided for comparison of our trends and should be read in conjunction with our reported results. Our net interest income on a managed basis includes finance income earned on our owned receivables as well as on our securitized receivables. This finance income is offset by interest expense on the debt recorded on our balance sheet as well as the contractual rate of return on the instruments issued to investors when the receivables were securitized. Managed basis net interest income was $2,550 million in the three months ended September 30, 2004, down 3 percent from $2,631 million in the three months ended September 30, 2003. For the nine months ended September 30, 2004, managed basis net interest income was $7,706 million, up 2 percent from $7,519 million in the nine months ended September 30, 2003. Net interest income as a percent of average managed interest-earning assets, annualized, was 7.88 percent in the current quarter and 8.13 percent year-to-date, compared to 8.79 and 8.62 percent in the year-ago periods. As discussed above, the decreases were due to lower yields on our receivables, particularly in real estate secured and auto finance receivables and, in the three month period, higher funding costs resulting from a rising interest rate environment. For the nine month period, the lower yields were partially offset by lower funding costs including a higher benefit from amortization of purchase accounting fair value adjustments. Net interest income as a percent of receivables on a managed basis is greater than on an owned basis because the managed basis portfolio includes relatively more unsecured loans, which have higher yields. Our net interest margin on a managed basis was impacted by the loss of hedge accounting as discussed above. The following table compares our reported net interest margin to what it otherwise would have been had hedge accounting not been lost: THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED (SEPTEMBER 30, 2004 (SEPTEMBER 30, 2003 SEPTEMBER 30, 2004 (SEPTEMBER 30, 2003 ---------------------- ---------------------- ---------------------- --------------------- - WITHOUT WITHOUT WITHOUT WITHOUT LOSS OF LOSS OF LOSS OF LOSS OF AS HEDGE AS HEDGE AS HEDGE AS HEDGE REPORTED ACCOUNTING* REPORTED ACCOUNTING* REPORTED ACCOUNTING* REPORTED ACCOUNTING* ------------------------------------------------------------------------------------------------------------------------ - Net interest margin... 7.88% 8.08% 8.79% 9.12% 8.13% 8.34% 8.62% 8.89% --------------- * Represents a non-GAAP financial measure which is being provided for comparison of our trends and should be read in conjunction with our reported results. 35 Household International, Inc. -------------------------------------------------------------------------------- PROVISION FOR CREDIT LOSSES The following table summarizes provision for credit losses: INCREASE (DECREASE) ------------- 2004 2003 AMOUNT % --------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Three months ended September 30............................. $1,123 $1,001 $122 12.2% Nine months ended September 30.............................. 3,048 3,050 (2) - Our provision for credit losses increased during the quarter due to receivable growth, including lower securitization levels, which was partially offset by improved credit quality. Provision for credit losses was flat for the nine months ended September 30, 2004 compared to the year ago period as increased requirements due to receivable growth were offset by improving credit quality. The provision as a percent of average owned receivables, annualized, was 4.36 percent in the current quarter and 4.16 percent year-to-date, compared to 4.42 and 4.69 percent in the year-ago periods. We recorded provision for owned credit losses $154 million greater than net charge-offs in the third quarter of 2004 and $143 million year-to-date. During the third quarter of 2004, the provision for owned credit losses was greater than net charge-offs due to receivable growth, partially offset by continued improvement in asset quality. Net charge-off dollars for the nine-month period ended September 30, 2004 increased compared to the prior year period as higher delinquencies in the prior year due to adverse economic conditions migrated to charge-off. In 2003, we recorded provision for owned credit losses greater than net charge-offs of $102 million during the third quarter and $346 million year-to-date. The provision for credit losses may vary from quarter to quarter, depending on the product mix and credit quality of loans in our portfolio. See Note 5, "Credit Loss Reserves" to the accompanying consolidated financial statements for further discussion of factors affecting the provision for credit losses. OTHER REVENUES The following table summarizes other revenues: INCREASE (DECREASE) -------------------- THREE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT % ---------------------------------------------------------------------------------------------------------- (RESTATED) (RESTATED) (DOLLARS ARE IN MILLIONS) Securitization revenue.................................... $ 267 $ 387 $(120) (31.0)% Insurance revenue......................................... 203 193 10 5.2 Investment income......................................... 36 37 (1) (2.7) Derivative income (expense)............................... 72 (612) 684 100+ Fee income................................................ 302 266 36 13.5 Taxpayer financial services (expense) income.............. (3) 2 (5) (100+) Other income.............................................. 163 68 95 100+ ------ ----- ----- ------ Total other revenues...................................... $1,040 $ 341 $ 699 100.0% ====== ===== ===== ====== 36 Household International, Inc. -------------------------------------------------------------------------------- INCREASE (DECREASE) ------------------- NINE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT % ---------------------------------------------------------------------------------------------------------- (RESTATED) (RESTATED) (DOLLARS ARE IN MILLIONS) Securitization revenue..................................... $ 881 $1,114 $(233) (20.9)% Insurance revenue.......................................... 618 553 65 11.8 Investment income.......................................... 107 151 (44) (29.1) Derivative income.......................................... 248 179 69 38.5 Fee income................................................. 809 783 26 3.3 Taxpayer financial services income......................... 209 186 23 12.4 Other income............................................... 443 223 220 98.7 ------ ------ ----- ----- Total other revenues....................................... $3,315 $3,189 $ 126 4.0% ====== ====== ===== ===== SECURITIZATION REVENUE is the result of the securitization of our receivables and includes the following: INCREASE (DECREASE) -------------------- THREE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT % ------------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) Net initial gains(1)........................................ $ - $ 25 $ (25) (100.0)% Net replenishment gains(1).................................. 112 138 (26) (18.8) Servicing revenue and excess spread......................... 155 224 (69) (30.8) ---- ---- ----- ------ Total....................................................... $267 $387 $(120) (31.0)% ==== ==== ===== ====== INCREASE (DECREASE) ------------------- NINE MONTHS ENDED SEPTEMBER 30 2004 2003 AMOUNT % ------------------------------------------------------------------------------------------------- (DOLLARS ARE IN MILLIONS) Net initial gains(1)........................................ $ 25 $ 92 $ (67) (72.8)% Net replenishment gains(1).................................. 344 410 (66) (16.1) Servicing revenue and excess spread......................... 512 612 (100) (16.3) ---- ------ ----- ----- Total....................................................... $881 $1,114 $(233) (20.9)% ==== ====== ===== ===== --------------- (1) Net of our estimate of probable credit losses under the recourse provisions The decreases in securitization revenue were due to decreases in the level and product mix of receivables securitized during 2004, including the impact of higher run-off due to shorter expected lives as a result of our decision to structure all new collateralized funding transactions as secured financings beginning in the third quarter of 2004. However, because existing public private label and MasterCard and Visa credit card transactions were structured as sales to revolving trusts that require replenishments of receivables to support previously issued securities, receivables of each of these asset types will continue to be sold to these trusts and the resulting replenishment gains recorded until the revolving periods end, the last of which is expected to occur in 2007. In addition, we will continue to replenish at reduced levels, certain non-public personal non-credit card and MasterCard and Visa securities issued to conduits and record the resulting replenishment gains for a period of time in order to manage liquidity. Since our securitized receivables have varying lives, it will take several years for these receivables to pay-off and the related interest-only strip receivables to be reduced to zero. The termination of sale treatment on new collateralized funding activity and the reduction of sales under replenishment agreements reduces our reported net income under U.S. GAAP. There is no impact, however, on cash received from operations or on U.K. GAAP reported results. 37 This information is provided by RNS The company news service from the London Stock Exchange

Companies

HSBC Holdings (HSBA)

Monday, 20th May 2024

COMPANIES COVERED:

KWS BLND KNOS

Keywords Studios surges as another London-listed tech firm looks set to be bought out by private equity, Kainos posts 14th consecutive year of growth and British Land sells down its remaining stake in Sheffield’s Meadowhall mall.

Full Archive

UK 100

Latest directors dealings

3 hours ago Aquila Energy Efficiency Trust (EUR)
4 hours ago Boohoo Group
4 hours ago Tritax Big Box Reit
5 hours ago Standard Chartered
5 hours ago Coca-Cola HBC AG (CDI)

All directors dealings today