HSBC NA Q4 2004 10-K-Part 5

HSBC Holdings PLC 28 February 2005 Part 5 DERIVATIVE FINANCIAL INSTRUMENTS The following table summarizes derivative financial instrument activity: EXCHANGE TRADED NON-EXCHANGE TRADED ------------------------------- ------------------------------------------ INTEREST RATE FOREIGN EXCHANGE FUTURES CONTRACTS INTEREST RATE CONTRACTS ------------------- OPTIONS RATE CURRENCY -------------------- PURCHASED SOLD PURCHASED SWAPS SWAPS PURCHASED SOLD ------------------------------------------------------------------------------------------------------ (IN MILLIONS) 2004 Notional amount, 2003... $ - $ - $ 1,900 $ 41,312 $16,538 $ 1,223 $ (594) New contracts........... - - - - - 1,628 (1,432) New contracts purchased from subsidiaries of HSBC.................. - - 3,491 29,607 11,457 17,988 (8,778) Matured or expired contracts............. - - (3,700) (7,568) (1,407) (14,343) 4,840 Terminated contracts.... - - - (7,211) (5,333) - - In-substance maturities(1)......... - - - - - (5,350) 5,350 Assignment of contracts to subsidiaries of HSBC.................. - - - (10,887) (3,105) - - -------- ------- ------- -------- ------- -------- -------- Notional amount, 2004... $ - $ - $ 1,691 $ 45,253 $18,150 $ 1,146 $ (614) ======== ======= ======= ======== ======= ======== ======== Fair value, 2004(3): Fair value hedges..... $ - $ - $ - $ (46) $ $ - $ (2) Cash flow hedges...... - - - 12 403 24 - Net investment in foreign operations.......... - - - - - - - Non-hedging derivatives......... - - - (81) 3,670 - - -------- ------- ------- -------- ------- -------- -------- Total................. $ - $ - $ - $ (115) $ 4,073 $ 24 $ (2) ======== ======= ======= ======== ======= ======== ======== 2003 Notional amount, 2002... $ - $ - $ 3,400 $ 44,506 $11,661 $ 376 $ (2,525) New contracts........... 600 (600) - 7,601 1,219 20,102 (17,548) New contracts purchased from subsidiaries of HSBC.................. - - 3,385 25,369 10,399 3,144 (642) Matured or expired contracts............. - - (4,404) (15,137) (1,401) (3,190) 912 Terminated contracts.... - - (481) (11,984) (146) - - In-substance maturities(1)......... (600) 600 - - - (19,209) 19,209 Assignment of contracts to subsidiaries of HSBC.................. - - - (9,043) (5,194) - - Loss of shortcut accounting(2): Terminated contracts........... - - - (26,530) - - - New contracts......... - - - 26,530 - - - -------- ------- ------- -------- ------- -------- -------- Notional amount, 2003... $ - $ - $ 1,900 $ 41,312 $16,538 $ 1,223 $ (594) ======== ======= ======= ======== ======= ======== ======== Fair value, 2003 (Restated)(3): Fair value hedges..... $ - $ - $ - $ 138 $ 101 $ - $ (23) Cash flow hedges...... - - - (147) 419 41 - Net investment in foreign operations.......... - - - - - - - Non-hedging derivatives......... - - - (162) 2,500 - - -------- ------- ------- -------- ------- -------- -------- Total................. $ - $ - $ - $ (171) $ 3,020 $ 41 $ (23) ======== ======= ======= ======== ======= ======== ======== NON-EXCHANGE TRADED ------------------------------ INTEREST RATE FORWARD CONTRACTS CAPS -------------------- AND PURCHASED SOLD FLOORS TOTAL ------------------------ ----------------------------------------- (IN MILLIONS) 2004 Notional amount, 2003... $ 174 $ - $ 6,627 $ 68,368 New contracts........... - - - 3,060 New contracts purchased from subsidiaries of HSBC.................. 1,643 - 444 73,408 Matured or expired contracts............. (1,443) - (2,691) (35,992) Terminated contracts.... - - - (12,544) In-substance maturities(1)......... - - - (10,700) Assignment of contracts to subsidiaries of HSBC.................. - - - (13,992) ------- ---- ------- -------- Notional amount, 2004... $ 374 $ - $ 4,380 $ 71,608 ======= ==== ======= ======== Fair value, 2004(3): Fair value hedges..... $ - $ - $ - $ (48) Cash flow hedges...... - - - 439 Net investment in foreign operations.......... - - - - Non-hedging derivatives......... - - - 3,589 ------- ---- ------- -------- Total................. $ - $ - $ - $ 3,980 ======= ==== ======= ======== 2003 Notional amount, 2002... $ 159 $ - $ 7,221 $ 69,848 New contracts........... 906 - - 48,576 New contracts purchased from subsidiaries of HSBC.................. 174 - 4,333 47,446 Matured or expired contracts............. (506) - (4,927) (30,477) Terminated contracts.... (559) - - (13,170) In-substance maturities(1)......... - - - (39,618) Assignment of contracts to subsidiaries of HSBC.................. - - - (14,237) Loss of shortcut accounting(2): Terminated contracts........... - - - (26,530) New contracts......... - - - 26,530 ------- ---- ------- -------- Notional amount, 2003... $ 174 $ - $ 6,627 $ 68,368 ======= ==== ======= ======== Fair value, 2003 (Restated)(3): Fair value hedges..... $ - $ - $ - $ 216 Cash flow hedges...... - - - 313 Net investment in foreign operations.......... - - - - Non-hedging derivatives......... - - - 2,338 ------- ---- ------- -------- Total................. $ - $ - $ - $ 2,867 ======= ==== ======= ======== 146 EXCHANGE TRADED NON-EXCHANGE TRADED ------------------------------- ------------------------------------------ INTEREST RATE FOREIGN EXCHANGE FUTURES CONTRACTS INTEREST RATE CONTRACTS ------------------- OPTIONS RATE CURRENCY -------------------- PURCHASED SOLD PURCHASED SWAPS SWAPS PURCHASED SOLD ------------------------------------------------------------------------------------------------------ (IN MILLIONS) 2002 Notional amount, 2001... $ 1,419 $(9,000) $ 2,000 $ 30,483 $ 8,694 $ 109 $ (1,202) New contracts........... 23,113 (8,218) 8,800 30,375 4,416 23,572 (24,350) Matured or expired contracts............. (7,932) 618 (3,400) (10,385) (917) (1,609) 1,363 Terminated contracts.... - - (4,000) (5,967) (532) (30) - In-substance maturities(1)......... (16,600) 16,600 - - - (21,665) 21,665 -------- ------- ------- -------- ------- -------- -------- Notional amount, 2002... $ - $ - $ 3,400 $ 44,506 $11,661 $ 377 $ (2,524) ======== ======= ======= ======== ======= ======== ======== Fair value, 2002(3): Fair value hedges..... $ - $ - $ - $ 1,819 $ 22 $ - $ - Cash flow hedges...... - - - (514) 369 - - Net investment in foreign operations.......... - - - - - 1 (31) Non-hedging derivatives......... - - - 5 - - - -------- ------- ------- -------- ------- -------- -------- Total................. $ - $ - $ - $ 1,310 $ 391 $ 1 $ (31) ======== ======= ======= ======== ======= ======== ======== NON-EXCHANGE TRADED ------------------------------ INTEREST RATE FORWARD CONTRACTS CAPS -------------------- AND PURCHASED SOLD FLOORS TOTAL ------------------------ ----------------------------------------- (IN MILLIONS) 2002 Notional amount, 2001... $ 500 $ - $ 3,013 $ 56,420 New contracts........... 968 (39) 6,161 130,012 Matured or expired contracts............. (1,160) 39 (1,945) (29,368) Terminated contracts.... (149) - (8) (10,686) In-substance maturities(1)......... - - - (76,530) ------- ---- ------- -------- Notional amount, 2002... $ 159 $ - $ 7,221 $ 69,848 ======= ==== ======= ======== Fair value, 2002(3): Fair value hedges..... $ - $ - $ - $ 1,841 Cash flow hedges...... - - - (145) Net investment in foreign operations.......... - - - (30) Non-hedging derivatives......... - - $ 6 11 ------- ---- ------- -------- Total................. $ - $ - $ 6 $ 1,677 ======= ==== ======= ======== --------------- (1) Represent contracts terminated as the market execution technique of closing the transaction either (a) just prior to maturity to avoid delivery of the underlying instrument or (b) at the maturity of the underlying items being hedged. (2) Under the Financial Accounting Standards Board's interpretations of SFAS 133, the shortcut method of accounting was no longer allowed for interest rate swaps which were outstanding at the time of the merger. During 2003, we restructured our interest rate swap portfolio to regain use of the shortcut method for a substantial number of our fair value hedges and to reduce the potential volatility of future earnings. (3) (Bracketed) unbracketed amounts represent amounts to be (paid) received by us had these positions been closed out at the respective balance sheet date. Bracketed amounts do not necessarily represent risk of loss as the fair value of the derivative financial instrument and the items being hedged must be evaluated together. See Note 25, "Fair Value of Financial Instruments," for further discussion of the relationship between the fair value of our assets and liabilities. 147 We operate in three functional currencies, the U.S. dollar, the British pound and the Canadian dollar. The U.S. dollar is the functional currency for exchange-traded interest rate futures contracts and options. Non-exchange traded instruments are restated in U.S. dollars by country as follows: FOREIGN EXCHANGE INTEREST RATE INTEREST RATE CONTRACTS FORWARD OTHER RISK RATE CURRENCY ------------------- CONTRACTS MANAGEMENT SWAPS SWAPS PURCHASED SOLD PURCHASED INSTRUMENTS ------------------------------------------------------------------------------------------------------- (IN MILLIONS) 2004 United States................. $42,365 $17,543 $1,146 $ (599) $ - $4,345 Canada........................ 582 - - (15) 374 - United Kingdom................ 2,306 607 - - - 35 ------- ------- ------ ------- ---- ------ $45,253 $18,150 $1,146 $ (614) $374 $4,380 ======= ======= ====== ======= ==== ====== 2003 United States................. $39,653 $14,995 $1,223 $ (593) $ - $6,595 Canada........................ 405 - - (1) 174 - United Kingdom................ 1,254 1,543 - - - 32 ------- ------- ------ ------- ---- ------ $41,312 $16,538 $1,223 $ (594) $174 $6,627 ======= ======= ====== ======= ==== ====== 2002 United States................. $42,682 $10,211 $ 351 $(2,524) $ - $7,194 Canada........................ 270 - - - 159 - United Kingdom................ 1,554 1,450 26 - - 27 ------- ------- ------ ------- ---- ------ $44,506 $11,661 $ 377 $(2,524) $159 $7,221 ======= ======= ====== ======= ==== ====== The table below reflects the items hedged using derivative financial instruments which qualify for hedge accounting at December 31, 2004. The critical terms of the derivative financial instruments have been designed to match those of the related asset or liability. INTEREST FOREIGN RATE CURRENCY EXCHANGE RATE SWAPS SWAPS CONTRACTS ------------------------------------------------------------------------------------------------- (IN MILLIONS) Investment securities....................................... $ - $ - $ - Commercial paper, bank and other borrowings................. 2,306 - 1,200 Long term debt.............................................. 37,625 8,415 - Advances to foreign subsidiaries............................ - - 560 ------- ------- ------ Total items hedged using derivative financial instruments... $39,931 $ 8,415 $1,760 ======= ======= ====== 148 The following table summarizes the maturities and related weighted-average receive/pay rates of interest rate swaps outstanding at December 31, 2004: 2005 2006 2007 2008 2009 2010 THEREAFTER TOTAL ------------------------------------------------------------------------------------------------------------ (DOLLARS ARE IN MILLIONS) PAY A FIXED RATE/RECEIVE A FLOATING RATE: Notional value................ $8,159 $7,662 $1,042 $ 306 $ 569 $ - $ 589 $18,327 Weighted-average receive rate........................ 2.75% 1.65% 2.09% 2.46% 4.19% - 5.21% 2.37% Weighted-average pay rate..... 2.78 2.10 2.36 3.93 3.84 - 4.82 2.59 ------ ------ ------ ------ ------ ------ ------- ------- PAY A FLOATING RATE/RECEIVE A FIXED RATE: Notional value................ $ - $ - $1,847 $5,552 $4,833 $1,568 $13,156 $26,926 Weighted-average receive rate........................ - - 2.94% 3.49% 4.05% 4.05% 4.87% 4.26% Weighted-average pay rate..... - - 2.14 2.25 2.49 1.90 2.39 2.32 ------ ------ ------ ------ ------ ------ ------- ------- Total notional value............ $8,159 $7,662 $2,889 $5,828 $5,402 $1,568 $13,745 $45,253 ====== ====== ====== ====== ====== ====== ======= ======= TOTAL WEIGHTED-AVERAGE RATES ON SWAPS: Receive rate.................. 2.75% 1.65% 2.63% 3.44% 4.06% 4.05% 4.88% 3.49% Pay rate...................... 2.78 2.10 2.22 2.34 2.63 1.90 2.49 2.43 The floating rates that we pay or receive are based on spot rates from independent market sources for the index contained in each interest rate swap contract, which generally are based on either 1, 3 or 6-month LIBOR. These current floating rates are different than the floating rates in effect when the contracts were initiated. Changes in spot rates impact the variable rate information disclosed above. However, these changes in spot rates also impact the interest rate on the underlying assets or liabilities. We use derivative financial instruments as either qualifying hedging instruments under SFAS 133 or economic hedges to hedge the volatility of earnings resulting from changes in interest rates on the underlying hedged items. Use of interest rate swaps which qualify as effective hedges under SFAS 133 increased our net interest income by 77 basis points in 2004, 64 basis points in 2003 and 31 basis points in 2002. 17. INCOME TAXES -------------------------------------------------------------------------------- Total income taxes were: MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, 2004 2003 2003 2002 ------------------------------------------------------------------------------------------------------ (RESTATED) (IN MILLIONS) Provision for income taxes related to operations.................................. $1,000 $690 $182 $695 Income taxes related to adjustments included in common shareholder's(s') equity: Unrealized gains (losses) on investments and interest-only strip receivables, net..... (71) 105 (13) 53 Unrealized gains (losses) on cash flow hedging instruments...................... 61 (9) 57 (23) Minimum pension liability................... (2) - - (16) Foreign currency translation adjustments.... 12 - (7) (49) Exercise of stock based compensation........ (18) (15) (2) (12) ------ ---- ---- ---- Total......................................... $ 982 $771 $217 $648 ====== ==== ==== ==== 149 Provisions for income taxes related to operations were: MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, 2004 2003 2003 2002 ------------------------------------------------------------------------------------------------------ (RESTATED) (IN MILLIONS) CURRENT United States................................. $ 593 $ 688 $ 74 $731 Foreign....................................... 59 85 19 83 ------ ----- ---- ---- Total current................................. 652 773 93 814 ------ ----- ---- ---- DEFERRED United States................................. 348 (87) 91 (125) Foreign....................................... - 4 (2) 6 ------ ----- ---- ---- Total deferred................................ 348 (83) 89 (119) ------ ----- ---- ---- Total income taxes............................ $1,000 $ 690 $182 $695 ====== ===== ==== ==== The significant components of deferred income tax provisions attributable to income from operations were: MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, 2004 2003 2003 2002 ------------------------------------------------------------------------------------------------------ (RESTATED) (IN MILLIONS) Deferred income tax provision (excluding the effects of other components)................ $348 $ (83) $89 $(136) Adjustment of valuation allowance............. - - - 13 Change in operating loss carryforwards........ - - - 4 ---- ----- --- ----- Deferred income tax provision................. $348 $ (83) $89 $(119) ==== ===== === ===== Income before income taxes were: MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, 2004 2003 2003 2002 ------------------------------------------------------------------------------------------------------ (RESTATED) (IN MILLIONS) United States................................. $2,786 $1,801 $379 $1,932 Foreign....................................... 154 246 49 321 ------ ------ ---- ------ Total income before income taxes.............. $2,940 $2,047 $428 $2,253 ====== ====== ==== ====== 150 Effective tax rates are analyzed as follows: MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, 2004 2003 2003 2002 ------------------------------------------------------------------------------------------------------ (RESTATED) (IN MILLIONS) Statutory federal income tax rate............. 35.0% 35.0% 35.0% 35.0% Increase (decrease) in rate resulting from: State and local taxes, net of federal benefit.................................. 1.4 1.4 1.9 1.4 Tax credits................................. (2.9) (3.0) (5.1) (3.8) Noncurrent tax requirements................. - (1.5) (3.0) (2.2) Nondeductible acquisition costs............. - - 11.0 - Other....................................... .5 1.8 2.7 .5 ---- ---- ---- ---- Effective tax rate............................ 34.0% 33.7% 42.5% 30.9% ==== ==== ==== ==== Provision for U.S. income taxes had not been made on net undistributed earnings of foreign subsidiaries of $643 million at December 31, 2004 and $604 million at December 31, 2003. Determination of the amount of unrecognized deferred tax liability related to investments in foreign subsidiaries is not practicable. On October 22, 2004, the American Jobs Creation Act (the "AJCA") was signed into law. The AJCA includes a deduction of 85% of certain foreign earnings that are repatriated, as defined in the AJCA. We may elect to apply this provision to qualifying earnings repatriations in 2005. We have started an evaluation of the effects of the repatriation provision; however, we do not expect to be able to complete this evaluation until after Congress or the Treasury Department provide additional clarifying language on key elements of the provision. We expect to complete our evaluation of the effects of the repatriation provision within a reasonable period of time following the publication of the additional clarifying language. The range of possible amounts that we are considering for repatriation under this provision is between $0 and $500 million. The related potential range of income tax is between $0 and $30 million. In addition, provision for U.S. income taxes had not been made at December 31, 2004 on $80 million of undistributed, untaxed earnings of our life insurance subsidiary's accumulated in its Policyholders' Surplus Account under tax laws in effect prior to 1984. This amount would generally be subject to taxation in the event our life insurance subsidiary made distributions in excess of its Shareholders' Surplus Account (generally undistributed accumulated after-tax earnings) and certain other events. If our life insurance subsidiary were subject to tax on the full amount of its Policyholders' Surplus Account, the additional income tax payable would be approximately $28 million. Unlike prior law provisions which treated distributions by a life insurance company as first coming out of its Shareholders' Surplus Account and then out of its Policyholders' Surplus Account, the AJCA contains provisions that would reverse such order and treat distributions as first coming out of Policyholders' Surplus Account and then Shareholders' Surplus Account. These new provisions also eliminate the imposition of the income tax on any such distributions from a Policyholders' Surplus Account. Such provisions apply only to distributions made by a life insurance company after December 31, 2004 and before January 1, 2007. At this time, management is evaluating the provisions of this law and is expecting to use these provisions to eliminate some, if not all, of the Policyholders' Surplus Account of our life insurance subsidiary. Household Bank, f.s.b., our U.S. savings and loan subsidiary which was disposed of in the fourth quarter of 2002, previously had credit loss reserves for tax purposes that arose in years beginning before December 31, 1987 in the amount of $55 million. A deferred tax liability was not established previously since we did not expect the amount to become taxable in the future. However, the sale of substantially all of its assets and deposits in 2002 caused this amount to become taxable resulting in a $20 million tax liability. 151 At December 31, 2004, we had net operating loss carryforwards of $865 million for state tax purposes which expire as follows: $320 million in 2005-2009; $145 million in 2010-2014; $305 million in 2015-2019 and $95 million in 2020-2024. Temporary differences which gave rise to a significant portion of deferred tax assets and liabilities were as follows: AT DECEMBER 31, ------------------- 2004 2003 --------------------------------------------------------------------------------- (RESTATED) (IN MILLIONS) DEFERRED TAX LIABILITIES Intangibles................................................. $ 934 $1,058 Receivables sold............................................ 413 793 Fee income.................................................. 375 475 Receivables................................................. 231 337 Deferred loan origination costs............................. 189 91 Leveraged lease transactions, net........................... 129 202 Other....................................................... 191 152 ------ ------ Total deferred tax liabilities.............................. 2,462 3,108 ------ ------ DEFERRED TAX ASSETS Credit loss reserves........................................ 1,497 2,035 Market value adjustment..................................... 214 175 Debt........................................................ 162 486 Other....................................................... 470 539 ------ ------ Total deferred tax assets................................... 2,343 3,235 Valuation allowance......................................... (28) - ------ ------ Total deferred tax assets net of valuation allowance........ 2,315 3,235 ------ ------ Net deferred tax liability (asset).......................... $ 147 $ (127) ====== ====== During 2004, a review of the deferred tax balances was completed and, as a result, the 2003 deferred tax assets and liabilities were realigned with their underlying tax and financial accounting basis differences. Additionally, an increase to total 2003 deferred tax assets of $6 million was recorded with a reduction to goodwill. 18. PREFERRED STOCK -------------------------------------------------------------------------------- In conjunction with the HSBC merger, our 7.625%, 7.60%, 7.50% and 8.25% preferred stock was converted into the right to receive cash which totaled approximately $1.1 billion. In consideration of HSBC transferring sufficient funds to make these payments, we issued the Series A cumulative preferred stock to HSBC on March 28, 2003. Also on March 28, 2003, we called for redemption our $4.30, $4.50 and 5.00% preferred stock. As of December 31, 2004, there were 1,100 shares of the Series A cumulative preferred stock outstanding. Through a series of transactions which concluded in October 2004, the Series A preferred shares were transferred from HSBC HINO. See Note 20, "Related Party Transactions," for further discussion. Dividends are cumulative and payable annually at a rate of 6.5 percent. The Series A preferred stock may be redeemed at our option after March 31, 2008. The redemption and liquidation value is $1 million per share plus accrued and unpaid dividends. The holder of the Series A preferred stock is entitled to payment before any capital distribution is made to the common shareholder and is entitled to vote with the holder of our common stock on matters including the dissolution, liquidation or sale of our assets or business. 152 19. ACCUMULATED OTHER COMPREHENSIVE INCOME -------------------------------------------------------------------------------- As a result of push-down accounting resulting from our merger with HSBC, the balances associated with the components of accumulated other comprehensive income (loss) on a "predecessor" basis were eliminated effective March 28, 2003 when the "successor" period began. Accumulated other comprehensive income (loss) includes the following: DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, DECEMBER 31, 2004 2003 2003 2002 2001 ----------------------------------------------------------------------------------------------------------- (SUCCESSOR) (SUCCESSOR) (PREDECESSOR) (PREDECESSOR) (RESTATED) (PREDECESSOR) (IN MILLIONS) Unrealized gains (losses) on cash flow hedging instruments................. $119 $(11) $(636) $(737) $(699) Unrealized gains on investments and interest-only strip receivables: Gross unrealized gains...... 88 273 462 500 352 Income tax expense.......... 34 105 168 181 128 ---- ---- ----- ----- ----- Net unrealized gains.......... 54 168 294 319 224 Minimum pension liability..... (4) - (30) (30) - Foreign currency translation adjustments................. 474 286 (271) (247) (257) ---- ---- ----- ----- ----- Total accumulated other comprehensive income (loss)...................... $643 $443 $(643) $(695) $(732) ==== ==== ===== ===== ===== The table below shows the changes in each component of accumulated other comprehensive income. TAX (EXPENSE) BEFORE-TAX BENEFIT NET-OF-TAX ------------------------------------------------------------------------------------------------- (IN MILLIONS) YEAR ENDED DECEMBER 31, 2002 (PREDECESSOR) Unrealized gains (losses) on cash flow hedging instruments: Net losses arising during the period...................... $(712) $ 261 $(451) Less: Reclassification adjustment for losses realized in net income............................................. 652 (238) 414 ----- ----- ----- Net losses on cash flow hedging instruments............... (60) 23 (37) Unrealized gains (losses) on investments and interest-only strip receivables: Net unrealized holding gains arising during the period.... 156 (55) 101 Less: Reclassification adjustment for gains realized in net income............................................. (7) 2 (5) ----- ----- ----- Net unrealized gains on investments and interest-only strip receivables...................................... 149 (53) 96 Minimum pension liability................................... (47) 16 (31) Foreign currency translation adjustments.................... (40) 49 9 ----- ----- ----- Other comprehensive income.................................. $ 2 $ 35 $ 37 ===== ===== ===== 153 TAX (EXPENSE) BEFORE-TAX BENEFIT NET-OF-TAX ------------------------------------------------------------------------------------------------- (IN MILLIONS) JANUARY 1 THROUGH MARCH 28, 2003 (PREDECESSOR) Unrealized gains (losses) on cash flow hedging instruments: Net gains arising during the period....................... $ 29 $ (10) $ 19 Less: Reclassification adjustment for losses realized in net income............................................. 129 (47) 82 ----- ----- ----- Net gains on cash flow hedging instruments................ 158 (57) 101 Reclassification adjustment for gains realized in net income on investments and interest-only strip receivables........ (38) 13 (25) Foreign currency translation adjustments.................... (31) 7 (24) ----- ----- ----- Other comprehensive income.................................. $ 89 $ (37) $ 52 ===== ===== ===== MARCH 29 THROUGH DECEMBER 31, 2003 (SUCCESSOR) (RESTATED) Unrealized gains (losses) on cash flow hedging instruments: Net gains arising during the period....................... $ (41) $ 19 $ (22) Less: Reclassification adjustment for losses realized in net income............................................. 21 (10) 11 ----- ----- ----- Net gains on cash flow hedging instruments................ (20) 9 (11) Unrealized gains (losses) on investments and interest-only strip receivables: Net unrealized holding gains arising during the period.... 290 (111) 179 Less: Reclassification adjustment for gains realized in net income............................................. (17) 6 (11) ----- ----- ----- Net unrealized gains on investments and interest-only strip receivables...................................... 273 (105) 168 Foreign currency translation adjustments.................... 286 - 286 ----- ----- ----- Other comprehensive income.................................. $ 539 $ (96) $ 443 ===== ===== ===== YEAR ENDED DECEMBER 31, 2004 (SUCCESSOR) Unrealized gains (losses) on cash flow hedging instruments: Net gains arising during the period....................... $ 106 $ (34) $ 72 Less: Reclassification adjustment for losses realized in net income............................................. 85 (27) 58 ----- ----- ----- Net gains on cash flow hedging instruments................ 191 (61) 130 Unrealized gains (losses) on investments and interest-only strip receivables: Net unrealized holding losses arising during the period... (173) 67 (106) Less: Reclassification adjustment for gains realized in net income............................................. (12) 4 (8) ----- ----- ----- Net unrealized losses on investments and interest-only strip receivables...................................... (185) 71 (114) Minimum pension liability................................... (6) 2 (4) Foreign currency translation adjustments.................... 200 (12) 188 ----- ----- ----- Other comprehensive income.................................. $ 200 $ -- $ 200 ===== ===== ===== 20. RELATED PARTY TRANSACTIONS -------------------------------------------------------------------------------- In the normal course of business, we conduct transactions with HSBC and its subsidiaries. These transactions include funding arrangements, purchases and sales of receivables, servicing arrangements, information technology services, item and statement processing services, banking and other miscellaneous services. The 154 following tables present related party balances and the income and (expense) generated by related party transactions: AT DECEMBER 31, ------------------ 2004 2003 -------------------------------------------------------------------------------- (IN MILLIONS) ASSETS, (LIABILITIES) AND EQUITY: Derivative financial assets, net............................ $ 3,297 $ 1,789 Other assets................................................ 604 1 Due to affiliates........................................... (13,789) (7,589) Other liabilities........................................... (168) (26) Preferred stock............................................. 1,100 1,100 INCOME/(EXPENSE): Interest expense on borrowings from HSBC and subsidiaries... $ (343) $ (73) Interest income on HSBC USA, Inc. advances.................. 5 - HSBC Bank USA, National Association: Real estate secured servicing revenues.................... 13 - Real estate secured sourcing, underwriting and pricing revenues............................................... 4 - Gain on bulk sale of domestic private label receivable portfolio.............................................. 663 - Gain on daily sale of domestic private label receivable originations........................................... 3 - Gain on sale of real estate secured and MasterCard/Visa receivables............................................ 36 16 Other servicing, processing, origination and support revenues............................................... 19 - Support services from HSBC affiliates....................... (750) - HTSU: Rental revenue............................................ 33 - Administrative services revenue........................... 18 - Other income from HSBC affiliates........................... 3 - The notional value of derivative contracts outstanding with HSBC subsidiaries totaled $62.6 billion at December 31, 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 $2.2 billion at December 31, 2004 and $.5 billion at December 31, 2003. During the second quarter of 2004, we made advances to our immediate parent, HINO, totaling $266 million which were repaid during the third quarter of 2004. During the third quarter of 2004 we extended a line of credit of $1 billion to HSBC USA, Inc. During the fourth quarter of 2004, we increased the available balance on the line of credit to $2 billion. The balance outstanding under the line of credit at December 31, 2004 was $604 million and is included in other assets. Interest income associated with this line of credit is recorded in interest income and reflected as interest income on HSBC USA, Inc. advances in the table above. Due to affiliates 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. At December 31, 2004, we had revolving credit facilities of $2.5 billion from HSBC domestically and $7.5 billion from HSBC in the U.K., which was increased to $8.0 billion in January 2005. A $4.0 billion domestic revolving credit facility with HSBC Private Bank (Suisse) SA, which was new in 2004, expired on December 30, 2004. As of December 31, 2004, $7.4 billion was outstanding under the U.K. lines and no balances were outstanding on the domestic lines. As of December 31, 2003, $3.4 billion was outstanding on the U.K. lines and no balances were outstanding on the domestic lines. Annual commitment fee requirements to 155 support availability of these lines totaled $2 million in 2004 and $2 million in 2003 and are included as a component of interest expense. 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 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 December 31, 2004, we were servicing $5 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 $2.8 billion of real estate secured receivables purchased by HSBC Bank USA during 2004. These revenues have been recorded as other income and are reflected as real estate secured servicing revenues and real estate secured sourcing, underwriting and pricing revenues from HSBC Bank USA in the above table. In December 2004 we sold our domestic private label receivable portfolio, including the retained interests associated with our securitized domestic private label receivables to HSBC Bank USA for $12.4 billion. We recorded an after-tax gain on the sale of $423 million. See Note 5, "Sale of Domestic Private Label Receivable Portfolio and Adoption of FFIEC Policies." We will continue to service the sold private label receivables and will receive servicing fee income from HSBC Bank USA for these services. Servicing fee income from HSBC Bank USA received in December 2004 for servicing the domestic private label credit card receivables subsequent to the initial bulk sale totaled $2.9 million and is included in the table above as a component of other servicing, processing, origination and support revenues from HSBC Bank USA. We continue to maintain the related customer account relationships and, therefore, will sell new domestic private label receivable originations to HSBC Bank USA on a daily basis. Gains on the daily sale of new domestic private label receivable originations of $3 million were recorded in December 2004 subsequent to the initial bulk sale. 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 support. Fees received for these services are reported as other income and are included in the table above as a component of other servicing, processing, origination and support revenues from HSBC Bank USA. During 2003, Household Capital Trust VIII issued $275 million in mandatorily redeemable preferred securities to HSBC. The terms of this issuance were as follows: (DOLLARS ARE IN MILLIONS) Junior Subordinated Notes: Principal balance...................................... $284 Redeemable by issuer................................... September 26, 2008 Stated maturity........................................ November 15, 2033 Preferred Securities: Rate................................................... 6.375% Face value............................................. $275 Issue date............................................. September 2003 During 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. In preparation for the 2005 federal tax return preparation season, effective October 1, 2004 HSBC Bank USA became the originating lender for loans initiated by our taxpayer financial services business for clients of various third party tax preparers. 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 156 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 HSBC Finance Corporation 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 a majority of our ongoing debt issuances. Fees paid for such services totaled approximately $18 million in 2004 and approximately $17 million for the period March 29 through December 31, 2003. These fees are amortized over the life of the related debt as a component of interest expense. In consideration of HSBC transferring sufficient funds to make the payments described in Note 4 with respect to certain HSBC Finance Corporation preferred stock, we issued the Series A preferred stock in the amount of $1.1 billion to HSBC on March 28, 2003. In September 2004, HNAH issued a new series of preferred stock totaling $1.1 billion to HSBC in exchange for our outstanding Series A preferred stock. In October 2004, we paid the accrued dividend of $108 million on our Series A preferred stock. Also in October 2004, our immediate parent, HINO, issued a new series of preferred stock to HNAH in exchange for our Series A preferred stock. 21. STOCK OPTION PLANS -------------------------------------------------------------------------------- STOCK OPTION PLANS The HSBC Holdings Group Share Option Plan (the "Group Share Option Plan"), which replaced the former Household stock option plans, is a long-term incentive compensation plan available to certain employees. Grants are usually made annually. Options granted to employees in 2004 vest 100% upon the attainment of certain performance conditions in either year 3, 4 or 5 and expire 10 years from the date of grant. Options granted to employees in 2003 will vest 75 percent in year three with the remaining 25 percent vesting in year four and expire ten years from the date of grant. Options are granted at market value. Compensation expense related to the Group Share Option Plan, which is recognized over the vesting period, totaled $8 million in 2004 and $1 million for the period March 29 through December 31, 2003. Beginning in 2005, no further options will be granted to employees although existing stock option grants will remain in effect subject to the same conditions as before. Instead employees will receive grants of shares of HSBC stock subject to certain vesting conditions. 157 Information with respect to the Group Share Option Plan is as follows: 2004 2003 --------------------- --------------------- WEIGHTED- WEIGHTED- HSBC AVERAGE HSBC AVERAGE ORDINARY PRICE PER ORDINARY PRICE PER SHARES SHARE SHARES SHARE ------------------------------------------------------------------------------------------------- Outstanding at beginning of year.................. 4,069,800 $15.31 - $ - Granted........................................... 2,638,000 14.37 4,069,800 15.31 Exercised......................................... - - - - Transferred....................................... (462,000) 14.69 - - Expired or canceled............................... - - - - --------- ------ --------- ------ Outstanding at end of year........................ 6,245,800 14.96 4,069,800 15.31 ========= ====== ========= ====== Exercisable at end of year........................ - $ - - $ - ========= ====== ========= ====== Weighted-average fair value of options granted.... $ 2.68 $ 4.74 ====== ====== The transfers shown above relate to our technology services employees who were transferred to HTSU effective January 1, 2004. The following table summarizes information about stock options outstanding under the Group Share Option Plan at December 31, 2004. OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------- ----------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE EXERCISE PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE ------------------------------------------------------------------------------------------------------- $12.51 - $15.00......................... 2,336,000 9.34 $14.37 - $ - $15.01 - $17.50......................... 3,909,800 8.85 15.31 - - The fair value of each option granted under the Group Share Option Plan in 2004, measured at the grant date, was calculated using a binomial lattice methodology model that is based on the underlying assumptions of the Black-Scholes option pricing model. When modeling options with vesting are dependent on attainment of certain performance conditions over a period of time, these performance targets are incorporated into the model using Monte-Carlo simulation. The expected life of options depends on the behavior of option holders, which is incorporated into the option model consistent with historic observable data. The fair values are inherently subjective and uncertain due to the assumptions made and the limitations of the model used. Prior to 2004, options were valued using a simpler methodology also based on the Black-Scholes option pricing model. The significant weighted average assumptions used to estimate the fair value of the options granted in 2004 and 2003 are as follows: 2004 2003 --------------------------------------------------------------------------------- Risk-free interest rate..................................... 4.9% 5.27% Expected life(1)............................................ 6.9 YEARS 5 years Expected volatility......................................... 25.00% 30.00% Prior to the merger with HSBC, certain employees were eligible to participate in the former Household stock option plan. Employee stock options generally vested equally over four years and expired 10 years from the date of grant. Upon completion of the merger with HSBC, all options granted prior to November 2002 vested and became outstanding options to purchase HSBC ordinary shares. Options granted under the former Household plan subsequent to October 2002 were converted into options to purchase ordinary shares of HSBC, but did not vest under the change in control. Compensation expense related to the former Household plan totaled $8 million in 2004, $5 million in the period March 29 through December 31, 2003, $4 million in the period January 1 through March 28, 2003 and $2 million in 2002. 158 Prior to 2003, non-employee directors annually received options to purchase shares of Household's common stock at the stock's fair market value on the day the option was granted. Director options had a term of ten years and one day, fully vested six months from the date granted, and once vested were exercisable at any time during the option term. In November 2002, non-employee directors chose not to receive their annual option to purchase 10,000 shares of Household's common stock in light of the transaction with HSBC. Instead, each director received a cash payment of $120,000 which was the fair market value of the options he or she would have otherwise received. Information with respect to stock options granted under the former Household plan is as follows: 2004 2003 2002 ---------------------- ---------------------- ---------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE PRICE PER PRICE PER PRICE PER SHARES SHARE SHARES SHARE SHARES SHARE --------------------------------------------------------------------------------------------------------- Outstanding at beginning of year......................... 45,194,343 $14.76 19,850,371 $36.80 17,750,284 $37.19 Granted........................ - - - - 2,933,600 29.59 Exercised...................... (5,780,935) 8.43 (439,087) 11.04 (730,977) 15.36 Expired or canceled............ (30,094) 10.66 (231,557) 53.28 (102,536) 49.88 ---------- ------ ---------- ------ ---------- ------ Outstanding at March 28, 2003......................... - - 19,179,727 37.20 - - Conversion to HSBC ordinary shares....................... - - 51,305,796 13.90 - - Exercised...................... - - (4,749,726) 5.00 - - Expired or canceled............ - - (1,361,727) 16.49 - - ---------- ------ ---------- ------ ---------- ------ Outstanding at end of year..... 39,383,314 $15.69 45,194,343 $14.76 19,850,371 $36.80 ========== ====== ========== ====== ========== ====== Exercisable at end of year..... 36,499,789 $16.09 39,743,144 $15.32 13,184,371 $33.80 ========== ====== ========== ====== ========== ====== Weighted-average fair value of options granted.............. $ - $ - $11.57 ====== ====== ====== The following table summarizes information about stock options outstanding under the former Household plan, all of which are in HSBC ordinary shares, at December 31, 2004: OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------- ----------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE EXERCISE PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE ------------------------------------------------------------------------------------------------------- $4.01 - $5.00........................... 12,793 3.43 $ 1.70 12,793 $ 1.70 $5.01 - $10.00.......................... 1,607,664 1.82 7.93 1,607,664 7.93 $10.01 - $12.50......................... 8,374,289 7.01 10.77 5,490,764 10.83 $12.51 - $15.00......................... 9,123,601 3.46 14.11 9,123,601 14.11 $15.01 - $17.50......................... 6,234,187 4.64 16.95 6,234,187 16.95 $17.51 - $20.00......................... 6,459,458 5.84 18.41 6,459,458 18.41 $20.01 - $25.00......................... 7,571,322 6.87 21.37 7,571,322 21.37 159 The fair value of options granted under the former Household plans was estimated as of the date of grant using the Black-Scholes option pricing model. The fair value estimates used the following weighted-average assumptions: 2002 --------------------------------------------------------------------- Risk-free interest rate..................................... 3.17% Expected dividend yield..................................... 3.43 Expected life............................................... 5 years Expected volatility......................................... 55.4% The Black-Scholes model uses different assumptions that can significantly effect the fair value of the options. As a result, the derived fair value estimates cannot be substantiated by comparison to independent markets. Restricted Share Plans Subsequent to our acquisition by HSBC, key employees are also provided awards in the form of restricted shares ("RSRs") under HSBC's Restricted Share Plan. Awards to employees in 2004 will vest over five years contingent upon the achievement of certain performance targets. Additionally, in 2004, a small number of awards granted were subject only to vesting conditions of either three or five years. Awards in 2003 generally vested over a three or five year period and did not require the achievement of performance targets. Information with respect to RSRs awarded under HSBC's Restricted Share Plan is as follows: MARCH 29 YEAR ENDED THROUGH DECEMBER 31, DECEMBER 31, 2004 2003 ------------------------------------------------------------------------------------------------------ RSRs awarded.............................................. 2,996,878 5,893,889 Weighted-average fair market value per share.............. $ 15.09 $ 12.43 RSRs outstanding at December 31........................... 7,030,688 5,893,889 Compensation cost: (in millions) Pre-tax................................................. $ 17 $ 9 After-tax............................................... 11 6 Prior to the merger, Household's executive compensation plans also provided for issuance of RSRs which entitled an employee to receive a stated number of shares of Household common stock if the employee satisfied the conditions set by the Compensation Committee for the award. Upon completion of the merger with HSBC, all RSRs granted under the former Household plan prior to November 2002 vested and became outstanding shares of HSBC. RSRs granted under the former Household plan subsequent to October 2002 were converted into rights to receive HSBC ordinary shares. Upon vesting, the employee can elect to receive either HSBC ordinary shares or American depository shares. Information with respect to RSRs awarded under the pre-merger Household plan is as follows: 2004 2003 2002 ----------------------------------------------------------------------------------------------- RSRs awarded............................................. - 134,552 1,711,661 Weighted-average fair market value per share............. $ - $ 27.11 $ 34.19 RSRs outstanding at December 31.......................... 2,238,628 2,512,242 4,740,827 Compensation cost: (in millions) Pre-tax................................................ $ 8 $ 23 $ 57 After-tax.............................................. 5 15 36 The pre-tax compensation cost with respect to the RSR's awarded under the pre-merger Household plan reflected above includes $5 million for the period March 29 to December 31, 2003. EMPLOYEE STOCK PURCHASE PLANS The HSBC Sharesave Contribution Plan (the "HSBC Sharesave Plan"), which replaced the former Household employee stock purchase plan, allows eligible employees to enter into 160 savings contracts to save up to approximately $400 per month, with the option to use the savings to acquire shares. There are currently two types of plans offered which allow the participant to select saving contracts of either a 3 or 5 year length. The options are exercisable within six months following the third or fifth year, respectively, of the commencement of the related savings contract, at a 20 percent discount for options granted in 2004 and 2003. HSBC ordinary shares granted and the related fair value of the options for 2004 and 2003 are presented below: 2004 2003 -------------------------------- -------------------------------- HSBC FAIR VALUE PER HSBC FAIR VALUE PER ORDINARY SHARE OF ORDINARY SHARE OF SHARES GRANTED SHARES GRANTED SHARES GRANTED SHARES GRANTED ------------------------------------------------------------------------------------------------------------- 3 year vesting period................... 1,124,776 $3.44 2,810,598 $3.19 5 year vesting period................... 303,981 3.80 903,171 3.28 Compensation expense related to the grants under the HSBC Sharesave Plan totaled $5 million in 2004 and $2 million for the period March 29 through December 31, 2003. The fair value of each option granted under the HSBC Sharesave Plan was estimated as of the date of grant using a third party option pricing model in 2004 and the Black-Scholes option pricing model in 2003. The fair value estimates used the following weighted-average assumptions: 2004 2003 ----------------------------------------------------------------------------------------------- Risk-free interest rate..................................... 4.9% 4.07% Expected life............................................... 3 or 5 years 3 or 5 years Expected volatility......................................... 25.00% 30.00% Prior to the merger, we also maintained an Employee Stock Purchase Plan (the "ESPP"). The ESPP provided a means for employees to purchase shares of our common stock at 85 percent of the lesser of its market price at the beginning or end of a one-year subscription period. The ESPP was terminated on March 7, 2003 and 775,480 shares of our common stock were purchased on that date. Compensation expense related to the ESPP totaled $7 million in the period January 1 to March 28, 2003 and $4 million in 2002. 22. PENSION AND OTHER POSTRETIREMENT BENEFITS -------------------------------------------------------------------------------- DEFINED BENEFIT PENSION PLANS Our employees participate in several defined benefit pension plans covering substantially all of its employees. In November 2004, sponsorship of the U.S. defined benefit pension plan of HSBC Finance Corporation and the U.S. defined benefit pension plan of HSBC Bank USA was transferred to HNAH. Effective January 1, 2005, the two separate plans were merged into a single defined pension plan which facilitates the development of a unified employee benefit policy and unified employee benefit plan administration for HSBC companies operating in the United States. Pension expense (income) for defined benefit plans included the following components: YEAR ENDED MARCH 29 THROUGH JANUARY 1 THROUGH YEAR ENDED DECEMBER 31, 2004 DECEMBER 31, 2003 MARCH 28, 2003 DECEMBER 31, 2002 ----------------------------------------------------------------------------------------------------------- (IN MILLIONS) Service cost - benefits earned during the period................ $ 55 $ 36 $ 11 $ 33 Interest cost on projected benefit obligation............ 53 35 5 24 Expected return on assets................ (91) (49) (16) (67) Amortization of prior service cost.......... 1 1 - - Recognized losses....... (5) - 14 22 ---- ---- ---- ---- Pension expense......... $ 13 $ 23 $ 14 $ 12 ==== ==== ==== ==== 161 The assumptions used in determining pension expense (income) of the domestic defined benefit plans are as follows: 2004 2003 2002 -------------------------------------------------------------------------------- Discount rate(1)............................................ 6.25% 6.50% 7.5% Salary increase assumption.................................. 3.75 4.0 4.0 Expected long-term rate of return on plan assets............ 8.75 8.0 8.0 --------------- (1) The discount rate used for the period January 1 through March 28, 2003 was 6.75%. We retain an unaffiliated third party to provide investment consulting services. Given the plan's current allocation of equity and fixed income securities and using investment return assumptions which are based on long term historical data and supplied by the consultant, the long term expected return for plan assets is reasonable. The funded status of our defined benefit pension plan was as follows: AT DECEMBER 31, ------------- 2004 2003 --------------------------------------------------------------------------- (IN MILLIONS) Funded status............................................... $40 $(53) Unrecognized net actuarial gain............................. 64 148 Unamortized prior service cost.............................. (6) (6) --- ---- Accrued pension liability................................... $98 $ 89 === ==== There were no intangible assets related to these plans in the amounts recognized on our balance sheet at December 31, 2004 and 2003. A reconciliation of beginning and ending balances of the fair value of plan assets associated with our defined benefit pension plans is as follows: YEAR ENDED DECEMBER 31, ------------------- 2004 2003 --------------------------------------------------------------------------------- (IN MILLIONS) Fair value of plan assets at beginning of year.............. $1,072 $ 838 Actual return on plan assets................................ 102 278 Foreign currency exchange rate changes...................... 11 16 Employer contributions...................................... 3 - Benefits paid............................................... (66) (60) ------ ------ Fair value of plan assets at end of year.................... $1,122 $1,072 ====== ====== For our domestic plan, the fair value of plan assets was $1.0 billion at December 31, 2004 and $970 million at December 31, 2003. We do not currently anticipate making employer contributions to our domestic defined benefit plan in 2005. We made contributions totaling $116 million during 2002 to improve the funded status of our defined benefit pension plans given the declines in return on plan assets experienced during the year. 162 The actual allocation of our domestic pension plan assets at December 31, 2004 and 2003 as well as our target allocation for 2005 are as follows: PERCENTAGE OF PLAN ASSETS AT TARGET DECEMBER 31, ALLOCATION -------------- 2005 2004 2003 ------------------------------------------------------------------------------------------ Equity securities........................................... 78% 77% 77% Debt securities............................................. 21 21 21 Other....................................................... 1 2 2 - - - --- --- --- Total....................................................... 100% 100% 100% === === === At December 31, 2003, equity securities included our investment in 177,624 HSBC American depository shares with a fair value of $14 million. There were no investments in HSBC American depository shares at December 31, 2004. The primary objective of our defined benefit pension plans is to provide eligible employees with regular pension benefits. Since our domestic plans are governed by the Employee Retirement Income Security Act of 1974 ("ERISA"), ERISA regulations serve as guidance for the management of plan assets. Consistent with prudent standards of preservation of capital and maintenance of liquidity, the goals of our plans are to earn the highest possible rate of return consistent with our tolerance for risk as determined by our investment committee in its role as a fiduciary. In carrying out these objectives, short-term fluctuations in the value of plan assets are considered secondary to long-term investment results. We use a third party to provide investment consulting services such as recommendations on the type of funds to be invested in and monitoring the performance of fund managers. In order to achieve the return objectives of our plans, our plans are diversified to ensure that adverse results from one security or security class will not have an unduly detrimental effect on the entire investment portfolio. Assets are diversified by type, characteristic and number of investments as well as by investment style of management organization. Equity securities are invested in large, mid and small capitalization domestic stocks as well as international stocks. A reconciliation of beginning and ending balances of the projected benefit obligation of the defined benefit pension plans is as follows: YEAR ENDED DECEMBER 31, --------------- 2004 2003 ----------------------------------------------------------------------------- (IN MILLIONS) Projected benefit obligation at beginning of year........... $1,019 $ 828 Service cost................................................ 55 46 Interest cost............................................... 53 41 Actuarial gains............................................. 91 142 Foreign currency exchange rate changes...................... 10 16 Plan amendments............................................. - 6 Benefits paid............................................... (66) (60) ------ ------ Projected benefit obligation at end of year................. $1,162 $1,019 ====== ====== The accumulated benefit obligation for all defined benefit pension plans was $1.0 billion at December 31, 2004 and $922 million at December 31, 2003. 163 Estimated future benefit payments for our domestic plan are as follows: (IN MILLIONS) 2005........................................................ $ 61 2006........................................................ 56 2007........................................................ 61 2008........................................................ 67 2009........................................................ 70 2010-2014................................................... 411 The assumptions used in determining the projected benefit obligation of the domestic defined benefit plans at December 31 are as follows: 2004 2003 2002 -------------------------------------------------------------------------------- Discount rate............................................... 6.00% 6.25% 6.75% Salary increase assumption.................................. 3.75 3.75 4.00 We also sponsor a non-qualified supplemental retirement plan. This plan, which is currently unfunded, provides eligible employees defined pension benefits outside the qualified retirement plan. Benefits are based on average earnings, years of service and age at retirement. The projected benefit obligation was $82 million at December 31, 2004 and $80 million at December 31, 2003. Pension expense related to the supplemental retirement plan was $19 million in 2004, $9 million in the period March 29 through December 31, 2003, $3 million in the period January 1 through March 28, 2003 and $17 million in 2002. An additional minimum liability of $6 million related to this plan was recognized in 2004. DEFINED CONTRIBUTION PLANS We sponsor various 401(k) savings plans and profit sharing plans for employees meeting certain eligibility requirements. Under these plans, each participant's contribution is matched by the company up to a maximum of 6 percent of the participant's compensation. Prior to the merger with HSBC, company contributions were in the form of Household common stock. Subsequent to the merger, company contributions are in the form of cash. Total expense for these plans was $82 million in 2004, $50 million in the period March 29 through December 31, 2003, $21 million in the period January 1 through March 28, 2003 and $69 million in 2002. POSTRETIREMENT PLANS OTHER THAN PENSIONS Our employees also participate in several plans which provide medical, dental and life insurance benefits to retirees and eligible dependents. These plans cover substantially all employees who meet certain age and vested service requirements. We have instituted dollar limits on our payments under the plans to control the cost of future medical benefits. The net postretirement benefit cost included the following: MARCH 29 JANUARY 1 YEAR ENDED THROUGH THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, MARCH 28, DECEMBER 31, 2004 2003 2003 2002 ------------------------------------------------------------------------------------------------------------ (IN MILLIONS) Service cost - benefits earned during the period................. $ 4 $ 3 $1 $ 4 Interest cost............ 13 10 1 6 Expected return on assets................. - - 2 7 Amortization of prior service cost........... - - - (2) Recognized (gains) losses................. - - - (1) --- --- -- --- Net periodic postretirement benefit cost................... $17 $13 $4 $14 === === == === 164 The assumptions used in determining the net periodic postretirement benefit cost for our domestic postretirement benefit plans are as follows: 2004 2003 2002 -------------------------------------------------------------------------------- Discount rate............................................... 6.25% 6.50% 7.5% Salary increase assumption.................................. 3.75 4.0 4.0 --------------- (1) The discount rate used for the period January 1 through March 28, 2003 was 6.75%. A reconciliation of the beginning and ending balances of the accumulated postretirement benefit obligation is as follows: YEAR ENDED DECEMBER 31, ------------- 2004 2003 --------------------------------------------------------------------------- (IN MILLIONS) Accumulated benefit obligation at beginning of year......... $252 $244 Service cost................................................ 4 4 Interest cost............................................... 13 11 Foreign currency exchange rate changes...................... 1 2 Actuarial losses............................................ (5) 8 Benefits paid............................................... (14) (17) ---- ---- Accumulated benefit obligation at end of year............... $251 $252 ==== ==== Our postretirement benefit plans are funded on a pay-as-you-go basis. We currently estimate that we will pay benefits of approximately $17 million relating to our postretirement benefit plans in 2005. The components of the accrued postretirement benefit obligation are as follows: AT DECEMBER 31, ------------- 2004 2003 --------------------------------------------------------------------------- (IN MILLIONS) Funded status............................................... $254 $252 Unamortized prior service cost.............................. (3) - Unrecognized net actuarial (loss) gain...................... 9 3 Unamortized transition obligation........................... - - ---- ---- Accrued postretirement benefit obligation................... $260 $255 ==== ==== Estimated future benefit payments for our domestic plans are as follows: (IN MILLIONS) 2005........................................................ $ 16 2006........................................................ 18 2007........................................................ 19 2008........................................................ 20 2009........................................................ 20 2010-2014................................................... 107 165 The assumptions used in determining the benefit obligation of our domestic postretirement benefit plans at December 31 are as follows: 2004 2003 2002 -------------------------------------------------------------------------------- Discount rate............................................... 6.00% 6.25% 6.75% Salary increase assumption.................................. 3.75 3.75 4.00 A 11.6 percent annual rate of increase in the gross cost of covered health care benefits was assumed for 2005. This rate of increase is assumed to decline gradually to 5.60 percent in 2013. Assumed health care cost trend rates have an effect on the amounts reported for health care plans. A one-percentage point change in assumed health care cost trend rates would increase (decrease) service and interest costs and the postretirement benefit obligation as follows: ONE PERCENT ONE PERCENT INCREASE DECREASE --------------------------------------------------------------------------------------- (IN MILLIONS) Effect on total of service and interest cost components..... $.6 $(.5) Effect on postretirement benefit obligation................. 8 (8) 23. BUSINESS SEGMENTS -------------------------------------------------------------------------------- We have three reportable segments: Consumer, Credit Card Services, and International. Our segments are managed separately and are characterized by different middle-market consumer lending products, origination processes, and locations. Our Consumer segment consists of our consumer lending, mortgage services, retail services, and auto finance businesses. Our Credit Card Services segment consists of our domestic MasterCard and Visa credit card business. Our International segment consists of our foreign operations in Canada, the United Kingdom and the rest of Europe. The Consumer segment provides real estate secured, automobile secured and personal non-credit card loans. Loans are offered with both revolving and closed-end terms and with fixed or variable interest rates. Loans are originated through branch locations, correspondents, mortgage brokers, direct mail, telemarketing, independent merchants or automobile dealers. The Credit Card Services segment offers MasterCard and Visa credit card loans throughout the United States primarily via strategic affinity and co-branding relationships, direct mail, and our branch network to subprime customers. The International segment offers secured and unsecured lines of credit and secured and unsecured closed-end loans primarily in the United Kingdom, Canada, the Republic of Ireland, the Czech Republic and Hungary. In addition, the United Kingdom operation offers MasterCard and Visa credit cards and credit insurance in connection with all loan products. We also cross sell our credit cards to existing real estate secured, private label and tax services customers. All segments offer products and service customers through the Internet. The All Other caption includes our insurance and Taxpayer Financial Services and commercial businesses, as well as our corporate and treasury activities, each of which falls below the quantitative threshold tests under SFAS No. 131 for determining reportable segments. Effective January 1, 2004, our direct lending business, which has previously been reported in our All Other caption, was consolidated into our consumer lending business and, as a result, is now included in our Consumer segment. Prior periods have not been restated as the impact was not material. There have been no other changes in the basis of our segmentation or any changes in the measurement of segment profit as compared with the prior year presentation. The accounting policies of the reportable segments are described in Note 2, "Summary of Significant Accounting Policies." For segment reporting purposes, intersegment transactions have not been eliminated. We generally account for transactions between segments as if they were with third parties. We evaluate performance and allocate resources based on income from operations after income taxes and returns on equity and managed assets. We allocate resources and provide information to management for decision making on a managed basis. Therefore, an adjustment is required to reconcile the managed financial information to our reported financial 166 information in our consolidated financial statements. This adjustment reclassifies net interest margin, fee income and loss provision into securitization revenue. Income statement information included in the table for 2003 combines January 1 through March 28, 2003 (the "predecessor period") and March 29 to December 31, 2003 (the "successor period") in order to present "combined" financial results for 2003. Fair value adjustments related to purchase accounting and related amortization have been allocated to Corporate, which is included in the "All Other" caption within our segment disclosure. As a result, managed and owned basis consolidated totals for 2003 include combined information from both the "successor" and "predecessor" periods which impacts comparability to the current period. Reconciliation of our managed basis segment results to managed basis and owned basis consolidated totals are as follows: MANAGED CREDIT ADJUSTMENTS/ BASIS OWNED BASIS CARD INTER- ALL RECONCILING CONSOLIDATED SECURITIZATION CONSOLIDATED CONSUMER SERVICES NATIONAL OTHER ITEMS TOTALS ADJUSTMENTS TOTALS ------------------------------------------------------------------------------------------------------------------------ (IN MILLIONS) YEAR ENDED DECEMBER 31, 2004 Net interest income......... $ 7,699 $ 2,070 $ 797 $ (309) $ - $ 10,257 $ (2,455)(6) $ 7,802 Securitization revenue...... (1,433) (338) (88) (145) - (2,004) 3,012(6) 1,008 Fee and other income, excluding gain on sale of domestic private label credit card receivables... 638 1,731 503 1,412 (137)(2) 4,147 (745)(6) 3,402 Gain on bulk sale of domestic private label credit card receivables... 683 - - (20) - 663 - 663 Intersegment revenues....... 101 25 15 (4) (137)(2) - - - Provision for credit losses.................... 2,575 1,625 336 (16) 2(3) 4,522 (188)(6) 4,334 Depreciation and amortization.............. 13 53 34 383 - 483 - 483 Total costs and expenses.... 2,528 1,238 726 1,109 - 5,601 - 5,601 Income tax expense (benefit)................. 915 216 53 (133) (51)(4) 1,000 - 1,000 Net income.................. 1,563 380 95 (10) (88) 1,940 - 1,940 Operating net income(1)..... 1,247 381 95 3 (88) 1,638 - 1,638 Receivables................. 87,839 19,670 13,263 308 - 121,080 (14,225)(8) 106,855 Assets...................... 89,809 20,049 14,236 28,921 (8,600)(5) 144,415 (14,225)(8) 130,190 Expenditures for long-lived assets(7)................. 18 4 20 54 - 96 - 96 ------- ------- ------- ------- ------- -------- -------- -------- 167 MANAGED CREDIT ADJUSTMENTS/ BASIS OWNED BASIS CARD INTER- ALL RECONCILING CONSOLIDATED SECURITIZATION CONSOLIDATED CONSUMER SERVICES NATIONAL OTHER ITEMS TOTALS ADJUSTMENTS TOTALS ------------------------------------------------------------------------------------------------------------------------ (IN MILLIONS) YEAR ENDED DECEMBER 31, 2003 (RESTATED) Net interest income......... $ 7,333 $ 1,954 $ 753 $ 148 $ - $ 10,188 $ (2,874)(6) $ 7,314 Securitization revenue...... 337 (6) 17 (201) - 147 1,314 (6) 1,461 Fee and other income........ 664 1,537 380 1,139 (147)(2) 3,573 (715)(6) 2,858 Intersegment revenues....... 107 30 12 (2) (147)(2) - - - Provision for credit losses.................... 4,275 1,598 359 3 7(3) 6,242 (2,275)(6) 3,967 Depreciation and amortization.............. 14 52 30 295 - 391 - 391 HSBC acquisition related costs incurred by HSBC Finance Corporation....... - - - 198 - 198 - 198 Total costs and expenses.... 2,358 1,099 530 1,204 - 5,191 - 5,191 Income tax expense (benefit)................. 631 287 90 (80) (56)(4) 872 - 872 Net income.................. 1,061 500 170 (30) (98) 1,603 - 1,603 Operating net income(1)..... 1,061 500 170 137 (98) 1,770 - 1,770 Receivables................. 87,104 19,552 11,003 920 - 118,579 (26,201)(8) 92,378 Assets...................... 89,791 22,505 11,923 29,754 (8,720)(5) 145,253 (26,201)(8) 119,052 Expenditures for long-lived assets(7)................. 30 3 18 83 - 134 - 134 ------- ------- ------- ------- ------- -------- -------- -------- YEAR ENDED DECEMBER 31, 2002 Net interest income......... $ 6,976 $ 1,768 $ 641 $ (48) $ - $ 9,337 $ (2,683)(6) $ 6,654 Securitization revenue...... 597 61 47 - - 705 1,429(6) 2,134 Fee and other income, excluding loss on disposition of Thrift. ... 644 1,320 371 911 (187)(2) 3,059 (669)(6) 2,390 Loss on disposition of Thrift. .................. 378 - - - - 378 - 378 Intersegment revenues....... 145 34 10 (2) (187)(2) - - - Provision for credit losses.................... 3,903 1,428 280 64 (20)(3 5,655 (1,923)(6) 3,732 Depreciation and amortization.............. 18 60 24 131 - 233 - 233 Settlement charge and related expenses.......... 525 - - - - 525 - 525 Total costs and expenses.... 2,569 1,054 456 736 - 4,815 - 4,815 Income tax expense (benefit)................. 520 249 90 (103) (61)(4) 695 - 695 Net income.................. 838 414 231 181 (106) 1,558 - 1,558 Operating net income(1)..... 1,411 414 231 181 (106) 2,131 - 2,131 Receivables................. 79,448 18,071 8,769 1,208 - 107,496 (24,934)(8) 82,562 Assets...................... 82,685 21,079 10,011 17,837 (8,818)(5) 122,794 (24,934)(8) 97,860 Expenditures for long-lived assets(7)................. 30 1 29 113 - 173 - 173 ------- ------- ------- ------- ------- -------- -------- -------- (1) This non-GAAP financial measure is provided for comparison of our operating trends only and should be read in conjunction with our owned basis GAAP financial information. Operating net income in 2004 excludes the gain on the bulk sale of our domestic private label credit card receivables of $423 million (after-tax) and the impact of the adoption of FFIEC charge-off policies for the domestic private label and MasterCard/Visa credit card portfolios of $121 million (after-tax). In 2003, operating net income excludes $167 million (after-tax) of HSBC acquisition related costs and other merger related items incurred by HSBC Finance Corporation. In 2002, operating net income excludes the $333 million (after-tax) for the settlement charge and related expenses and the loss of $240 million (after-tax) from the disposition of Thrift assets and deposits. See "Basis of Reporting" for additional discussion on the use of non-GAAP financial measures. (2) Eliminates intersegment revenues. (3) Eliminates bad debt recovery sales between operating segments. (4) Tax benefit associated with items comprising adjustments/reconciling items. 168 (5) Eliminates investments in subsidiaries and intercompany borrowings. (6) Reclassifies net interest income, fee income and provision for credit losses relating to securitized receivables to other revenues. (7) Includes goodwill associated with purchase business combinations other than the HSBC merger as well as capital expenditures. (8) Represents receivables serviced with limited recourse. 24. COMMITMENTS AND CONTINGENT LIABILITIES -------------------------------------------------------------------------------- LEASE OBLIGATIONS: We lease certain offices, buildings and equipment for periods which generally do not exceed 25 years. The leases have various renewal options. The office space leases generally require us to pay certain operating expenses. Net rental expense under operating leases was $117 million in 2004, $112 million in the period March 29 through December 31, 2003, $36 million in the period January 1 through March 28, 2003 and $135 million in 2002. We have a lease obligation on a former office complex which has been subleased through 2010, the end of the lease period. The sublessee has assumed our future rental obligations on this lease. Future net minimum lease commitments under noncancelable operating lease arrangements were: MINIMUM MINIMUM RENTAL SUBLEASE YEAR ENDING DECEMBER 31, PAYMENTS INCOME NET ---------------------------------------------------------------------------------------- (IN MILLIONS) 2005........................................................ $187 $ 77 $110 2006........................................................ 141 42 99 2007........................................................ 125 39 86 2008........................................................ 104 35 69 2009........................................................ 76 23 53 Thereafter.................................................. 182 11 171 ---- ---- ---- Net minimum lease commitments............................... $815 $227 $588 ==== ==== ==== LITIGATION: Both we and certain of our subsidiaries are parties to various legal proceedings resulting from ordinary business activities relating to our current and/or former operations which affect all three of our reportable segments. Certain of these activities are or purport to be class actions seeking damages in significant amounts. These actions include assertions concerning violations of laws and/or unfair treatment of consumers. Due to the uncertainties in litigation and other factors, we cannot be certain that we will ultimately prevail in each instance. Also, as the ultimate resolution of these proceedings is influenced by factors that are outside of our control, it is reasonably possible our estimated liability under these proceedings may change. However, based upon our current knowledge, our defenses to these actions have merit and any adverse decision should not materially affect our consolidated financial condition, results of operations or cash flows. OTHER COMMITMENTS: At December 31, 2004, our mortgage services business had commitments with numerous correspondents to purchase up to $285 million of real estate secured receivables at fair market value, subject to availability based on underwriting guidelines specified by our mortgage services business. These commitments have terms of up to one year and can be renewed upon mutual agreement. 25. FAIR VALUE OF FINANCIAL INSTRUMENTS -------------------------------------------------------------------------------- In accordance with the guidelines for accounting for business combinations, the purchase price paid by HSBC plus related purchase accounting adjustments have been "pushed-down" and recorded in our financial statements for the period subsequent to March 28, 2003. This 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. We have estimated the fair value of our financial instruments in accordance with SFAS No. 107, "Disclosures About Fair Value of Financial Instruments" ("SFAS No. 107"). Fair value estimates, methods and assumptions set forth below for our financial instruments are made solely to comply with the requirements 169 of SFAS No. 107 and should be read in conjunction with the financial statements and notes in this Annual Report. A significant portion of our financial instruments do not have a quoted market price. For these items, fair values were estimated by discounting estimated future cash flows at estimated current market discount rates. Assumptions used to estimate future cash flows are consistent with management's assessments regarding ultimate collectibility of assets and related interest and with estimates of product lives and repricing characteristics used in our asset/liability management process. All assumptions are based on historical experience adjusted for future expectations. Assumptions used to determine fair values for financial instruments for which no active market exists are inherently judgmental and changes in these assumptions could significantly affect fair value calculations. As required under generally accepted accounting principles, a number of other assets recorded on the balance sheets (such as acquired credit card relationships, the value of consumer lending relationships for originated receivables and the franchise values of our business units) are not considered financial instruments and, accordingly, are not valued for purposes of this disclosure. However, on March 29, 2003, as a result of our acquisition by HSBC, these other assets were adjusted to their fair market value based, in part, on third party valuation data, under the "push-down" method of accounting. (See Note 4, "Acquisitions and Divestitures.") We believe there continues to be substantial value associated with these assets based on current market conditions and historical experience. Accordingly, the estimated fair value of financial instruments, as disclosed, does not fully represent our entire value, nor the changes in our entire value. The following is a summary of the carrying value and estimated fair value of our financial instruments: AT DECEMBER 31, ------------------------------------------------------------------------ 2004 2003 ----------------------------------- ---------------------------------- CARRYING ESTIMATED CARRYING ESTIMATED VALUE FAIR VALUE DIFFERENCE VALUE FAIR VALUE DIFFERENCE --------------------------------------------------------------------------------------------------------- (IN MILLIONS) ASSETS: Cash........................... $ 392 $ 392 $ - $ 463 $ 463 $ - Securities purchased under agreements to resell......... 2,651 2,651 - - - - Securities..................... 4,327 4,327 - 11,073 11,073 - Receivables.................... 104,815 105,314 499 91,027 91,597 570 Due from affiliates............ 604 604 - - - - Derivative financial assets.... 4,049 4,049 - 3,016 3,016 - --------- --------- ------- -------- -------- ----- Total assets................... 116,838 117,337 499 105,579 106,149 570 --------- --------- ------- -------- -------- ----- LIABILITIES: Deposits....................... (47) (47) - (232) (233) (1) Commercial paper, bank and other borrowings............. (9,013) (9,013) - (9,122) (9,122) - Due to affiliates.............. (13,789) (13,819) (30) (7,589) (7,603) (14) Long term debt................. (85,378) (86,752) (1,374) (79,632) (80,566) (924) Insurance policy and claim reserves..................... (1,303) (1,370) (67) (1,258) (1,255) 3 Derivative financial liabilities.................. (70) (70) - (149) (149) - --------- --------- ------- -------- -------- ----- Total liabilities.............. (109,600) (111,071) (1,471) (97,982) (98,918) (936) --------- --------- ------- -------- -------- ----- Total.......................... $ 7,238 $ 6,266 $ (972) $ 7,597 $ 7,231 $(366) ========= ========= ======= ======== ======== ===== 170 CASH: Carrying value approximates fair value due to cash's liquid nature. SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL: The fair value of securities purchased under agreements to resell approximates carrying value due to their short-term maturity. SECURITIES: Securities are classified as available-for-sale and are carried at fair value on the balance sheets. Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. RECEIVABLES: The fair value of adjustable rate receivables generally approximates carrying value because interest rates on these receivables adjust with changing market interest rates. The fair value of fixed rate consumer receivables was estimated by discounting future expected cash flows at interest rates which approximate the rates that would achieve a similar return on assets with comparable risk characteristics. Receivables also includes our interest-only strip receivables. The interest-only strip receivables are carried at fair value on our balance sheets. Fair value is based on an estimate of the present value of future cash flows associated with securitizations of certain real estate secured, auto finance, MasterCard and Visa, private label and personal non-credit card receivables. DEPOSITS: The fair value of our savings and demand accounts equaled the carrying amount as stipulated in SFAS No. 107. The fair value of fixed rate time certificates was estimated by discounting future expected cash flows at interest rates that we offer on such products at the respective valuation dates. COMMERCIAL PAPER, BANK AND OTHER BORROWINGS: The fair value of these instruments approximates existing carrying value because interest rates on these instruments adjust with changes in market interest rates due to their short-term maturity or repricing characteristics. DUE TO AFFILIATES: The estimated fair value of our fixed rate debt instruments was determined using either quoted market prices or by discounting future expected cash flows at interest rates offered for similar types of debt instruments. Carrying value is typically used to estimate the fair value of floating rate debt. LONG TERM DEBT: The estimated fair value of our fixed rate debt instruments was determined using either quoted market prices or by discounting future expected cash flows at interest rates offered for similar types of debt instruments. Carrying value is typically used to estimate the fair value of floating rate debt. INSURANCE POLICY AND CLAIM RESERVES: The fair value of insurance reserves for periodic payment annuities was estimated by discounting future expected cash flows at estimated market interest rates at December 31, 2004 and 2003. The fair value of other insurance reserves is not required to be determined in accordance with SFAS No. 107. DERIVATIVE FINANCIAL ASSETS AND LIABILITIES: All derivative financial assets and liabilities, which exclude amounts receivable from or payable to swap counterparties, are carried at fair value on the balance sheet. Where practical, quoted market prices were used to determine fair value of these instruments. For non-exchange traded contracts, fair value was determined using accepted and established valuation methods (including input from independent third parties) which consider the terms of the contracts and market expectations on the valuation date for forward interest rates (for interest rate contracts) or forward foreign currency exchange rates (for foreign exchange contracts). We enter into foreign exchange contracts to hedge our exposure to currency risk on foreign denominated debt. We also enter into interest rate contracts to hedge our exposure to interest rate risk on assets and liabilities, including debt. As a result, decreases/increases in the fair value of derivative financial instruments which have been designated as effective hedges are offset by a corresponding increase/decrease in the fair value of the individual asset or liability being hedged. See Note 16, "Derivative Financial Instruments," for additional discussion of the nature of these items. 26. ATTORNEY GENERAL SETTLEMENT -------------------------------------------------------------------------------- On October 11, 2002, we reached a preliminary agreement with a multi-state working group of state attorneys general and regulatory agencies to effect a nationwide resolution of alleged violations of federal and/or state consumer protection, consumer financing and banking laws and regulations with respect to secured real estate lending from Household Finance Corporation and Beneficial Corporation and their subsidiaries conducting 171 retail branch consumer lending operations. This preliminary agreement, and related subsequent consent decrees and similar documentation entered into with each of the 50 states and the District of Columbia, are referred to collectively as the "Multi-State Settlement Agreement", which became effective on December 16, 2002. Pursuant to the Multi-State Settlement Agreement, we funded a $484 million settlement fund that was divided among the states (and the District of Columbia), with each state receiving a proportionate share of the funds based upon the volume of the retail branch originated real estate secured loans we made in that state during the period of January 1, 1999 to September 30, 2002. No fines, penalties or punitive damages were assessed by the states pursuant to the Multi-State Settlement Agreement. In August 2003, notices of a claims procedure were distributed to holders of approximately 591,000 accounts identified as having potential claims. Approximately 82% of customers accepted funds in settlement and had executed a release of all civil claims against us relating to the specified consumer lending practices. All checks were mailed. Each state agreed that the settlement resolves all current civil investigations and proceedings by the attorneys general and state lending regulators relating to the lending practices at issue. We recorded a pre-tax charge of $525 million ($333 million after-tax) during the third quarter of 2002 related to the Multi-State Settlement Agreement. The charge reflects the costs of this settlement agreement and related matters and has been reflected in the statement of income in total costs and expenses. 27. CONCENTRATION OF CREDIT RISK -------------------------------------------------------------------------------- A concentration of credit risk is defined as a significant credit exposure with an individual or group engaged in similar activities or affected similarly by economic conditions. Because we primarily lend to consumers, we do not have receivables from any industry group that equal or exceed 10 percent of total owned or managed receivables at December 31, 2004 and 2003. We lend nationwide and our receivables are distributed as follows at December 31, 2004: PERCENT OF TOTAL PERCENT OF TOTAL OWNED DOMESTIC MANAGED DOMESTIC STATE/REGION RECEIVABLES RECEIVABLES ------------------------------------------------------------------------------------------------- California.................................................. 12% 12% Midwest (IL, IN, IA, KS, MI, MN, MO, NE, ND, OH, SD, WI).... 23 23 Southeast (AL, FL, GA, KY, MS, NC, SC, TN).................. 21 21 Middle Atlantic (DE, DC, MD, NJ, PA, VA, WV)................ 15 15 Southwest (AZ, AR, LA, NM, OK, TX).......................... 10 11 Northeast (CT, ME, MA, NH, NY, RI, VT)...................... 10 10 West (AK, CO, HI, ID, MT, NV, OR, UT, WA, WY)............... 9 8 28. GEOGRAPHIC DATA -------------------------------------------------------------------------------- The tables below summarize our owned basis assets, revenues and income before income taxes by material country. Purchase accounting adjustments are reported within the appropriate country. AT DECEMBER 31, ---------------------------------------------------------- IDENTIFIABLE ASSETS LONG-LIVED ASSETS(1) ----------------------------- -------------------------- 2004 2003 2002 2004 2003 2002 ----------------------------------------------------------------------------------------------- (RESTATED) (IN MILLIONS) United States...................... $115,938 $107,342 $89,310 $ 8,974 $ 9,132 $1,949 United Kingdom..................... 11,468 9,401 6,845 942 809 88 Canada............................. 2,581 2,183 1,588 129 137 5 Europe............................. 203 126 117 3 2 2 -------- -------- ------- ------- ------- ------ Total.............................. $130,190 $119,052 $97,860 $10,048 $10,080 $2,044 ======== ======== ======= ======= ======= ====== --------------- (1) Includes properties and equipment, goodwill and acquired intangibles. 172 YEAR ENDED DECEMBER 31, ---------------------------------------------------------- REVENUES INCOME BEFORE INCOME TAXES ---------------------------- --------------------------- 2004 2003 2002 2004 2003 2002 --------------------------------------------------------------------------------------------------- (RESTATED) (RESTATED) (IN MILLIONS) United States.......................... $14,346 $13,146 $13,397 $2,858 $2,235 $1,932 United Kingdom......................... 1,316 1,091 1,006 6 147 247 Canada................................. 340 284 236 82 68 55 Europe................................. 16 40 32 (6) 25 19 ------- ------- ------- ------ ------ ------ Total.................................. $16,018 $14,561 $14,671 $2,940 $2,475 $2,253 ======= ======= ======= ====== ====== ====== 173 HSBC Finance Corporation -------------------------------------------------------------------------------- SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) THREE THREE THREE THREE THREE THREE THREE MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS ENDED ENDED ENDED ENDED ENDED ENDED ENDED DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, 2004 2004 2004 2004 2003 2003 2003 ------------------------------------------------------------------------------------------------------------------------ (RESTATED) (RESTATED) (RESTATED) (RESTATED) (RESTATED) (RESTATED) (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (SUCCESSOR) (IN MILLIONS) Finance and other interest income.................. $ 3,001 $ 2,779 $ 2,637 $ 2,528 $ 2,625 $ 2,570 $ 2,503 Interest expense.......... 918 810 707 708 669 654 689 ------- ------- ------- ------- ------- ------- ------- Net interest income....... 2,083 1,969 1,930 1,820 1,956 1,916 1,814 Provision for credit losses on owned receivables............. 1,286 1,123 997 928 917 1,001 1,039 ------- ------- ------- ------- ------- ------- ------- Net interest income after provision for credit losses.................. 797 846 933 892 1,039 915 775 ------- ------- ------- ------- ------- ------- ------- Securitization revenue.... 127 267 266 348 347 387 284 Insurance revenue......... 221 203 204 211 193 193 183 Investment income......... 30 36 30 41 45 37 33 Fee income................ 282 302 242 265 281 266 228 Derivative income......... 263 72 124 52 107 (612) 574 Taxpayer financial services income......... 8 (3) 6 206 (1) 2 3 Other income.............. 164 163 180 100 158 68 86 Gain on bulk sale of private label receivables............. 663 - - - - - - ------- ------- ------- ------- ------- ------- ------- Total other revenues...... 1,758 1,040 1,052 1,223 1,130 341 1,391 ------- ------- ------- ------- ------- ------- ------- Salaries and fringe benefits................ 472 472 457 485 507 493 489 Sales incentives.......... 104 91 90 78 64 77 83 Occupancy and equipment expense................. 86 77 77 83 104 95 100 Other marketing expenses................ 199 174 131 132 142 128 135 Other servicing and administrative expenses................ 209 235 198 226 280 282 264 Support services from HSBC affiliates.............. 194 183 196 177 - - - Amortization of acquired intangibles............. 85 83 79 116 84 82 78 Policyholders' benefits... 113 93 93 113 90 95 98 HSBC acquisition related costs incurred by HSBC Finance Corporation..... - - - - - - - ------- ------- ------- ------- ------- ------- ------- Total costs and expenses................ 1,462 1,408 1,321 1,410 1,271 1,252 1,247 ------- ------- ------- ------- ------- ------- ------- Income before income taxes................... 1,093 478 664 705 898 4 919 Income taxes.............. 381 153 231 235 306 (18) 320 ------- ------- ------- ------- ------- ------- ------- Net income as restated.... $ 712 $ 325 $ 433 $ 470 $ 592 $ 22 $ 599 ======= ======= ======= ======= ======= ======= ======= Net income as previously reported................ $ - $ 322 $ 395 $ 481 $ 574 $ 472 $ 364 ======= ======= ======= ======= ======= ======= ======= Operating net income as restated(1)............. $ 410 $ 325 $ 433 $ 470 $ 592 $ 22 $ 599 ======= ======= ======= ======= ======= ======= ======= Common shareholder's(s') equity - as previously reported................ $ - $16,912 $17,607 $17,049 $16,560 $15,707 $15,232 ======= ======= ======= ======= ======= ======= ======= Common shareholder's(s') equity - as restated.... $15,841 $16,727 $17,379 $16,909 $16,391 $15,581 $15,606 ======= ======= ======= ======= ======= ======= ======= MAR. 29 JAN. 1 THROUGH THROUGH MAR. 31, MAR. 28, 2003 2003 -------------------------- --------------------------- (RESTATED) (SUCCESSOR) (PREDECESSOR) (IN MILLIONS) Finance and other interest income.................. $ 75 $ 2,469 Interest expense.......... 19 897 ------- ------- Net interest income....... 56 1,572 Provision for credit losses on owned receivables............. 34 976 ------- ------- Net interest income after provision for credit losses.................. 22 596 ------- ------- Securitization revenue.... 9 434 Insurance revenue......... 6 171 Investment income......... 1 80 Fee income................ 9 280 Derivative income......... 215 2 Taxpayer financial services income......... - 181 Other income.............. 5 64 Gain on bulk sale of private label receivables............. - - ------- ------- Total other revenues...... 245 1,212 ------- ------- Salaries and fringe benefits................ 18 491 Sales incentives.......... 2 37 Occupancy and equipment expense................. 3 98 Other marketing expenses................ 4 139 Other servicing and administrative expenses................ 9 314 Support services from HSBC affiliates.............. - - Amortization of acquired intangibles............. 2 12 Policyholders' benefits... 3 91 HSBC acquisition related costs incurred by HSBC Finance Corporation..... - 198 ------- ------- Total costs and expenses................ 41 1,380 ------- ------- Income before income taxes................... 226 428 Income taxes.............. 82 182 ------- ------- Net income as restated.... $ 144 $ 246 ======= ======= Net income as previously reported................ $ 9 $ 246 ======= ======= Operating net income as restated(1)............. $ 144 $ 413 ======= ======= Common shareholder's(s') equity - as previously reported................ $14,723 $ 8,935 ======= ======= Common shareholder's(s') equity - as restated.... $14,818 $ 8,935 ======= ======= --------------- (1) Operating net income is a non-GAAP financial measure and is provided for comparison of our operating trends only and should be read in conjunction with our owned basis GAAP financial information. For 2004, operating net income excludes the $121 million decrease in net income relating to the adoption of Federal Financial Institutions Examination Council charge-off policies for our domestic private label and MasterCard/ Visa receivables and the $423 million (after-tax) gain on the bulk sale of domestic private label receivables to an affiliate. For 2003, operating net income excludes HSBC acquisition related costs and other merger related items of $167 million (after-tax). 174 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. -------------------------------------------------------------------------------- None. ITEM 9A. CONTROLS AND PROCEDURES. -------------------------------------------------------------------------------- We conducted an evaluation, with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Our disclosure controls and procedures are designed to ensure that information required to be disclosed by HSBC Finance Corporation in the reports we file or submit under the Securities Exchange Act of 1934, as amended, (the "Exchange Act"), is recorded, processed, summarized and reported on a timely basis. Based upon that evaluation and for the reasons described below, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this report so as to alert them in a timely fashion to material information required to be disclosed in reports we file under the Exchange Act. As a result of this conclusion, we have initiated the remedial actions described below. HSBC Finance Corporation has restated its consolidated financial statements for the previously reported quarterly periods ended March 31, 2004, June 30, 2004 and September 30, 2004; and the period March 29, 2003 through December 31, 2003. This 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," ("SFAS 133"). During the fourth quarter of 2004, as part of our preparation for the implementation of International Financial Reporting Standards ("IFRS") by HSBC Holdings plc ("HSBC") from January 1, 2005, HSBC Finance Corporation undertook a review of its hedging activities to confirm conformity with the requirements of IFRS, which differ in several respects from the hedge accounting requirements under U.S. GAAP as set out in SFAS 133. As a result of this review, we 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 the Derivatives Implementation Group ("DIG") had published Implementation Issue No. E-15 ("E-15") regarding SFAS 133. Also during that time period there was some debate in the accounting profession regarding the detailed technical requirements resulting from a business combination and a proposed change by the FASB that would have changed the conclusion reached in E-15. We consulted with our independent accountants, KPMG LLP, in reaching our determination of what was required in order to comply with SFAS 133, and E-15 in particular. Following this, HSBC Finance Corporation took the actions it believed were necessary to maintain hedge accounting for all of its historical hedge relationships in its consolidated financial statements for the period ended December 31, 2003 and those consolidated financial statements received an unqualified audit opinion. Management has concluded that the control weaknesses noted below constitute a material weakness in our internal controls over financial reporting relating to the process of establishing and maintaining effective hedges under the shortcut method of accounting under SFAS 133. The identified control weaknesses are: - a failure to ensure that individuals with responsibility for implementing and administering our hedge positions received and obtained a thorough understanding of all DIG interpretations that led to a failure to contemporaneously fully document the accounting for hedging relationships under SFAS 133; and - a failure to establish and maintain effective systems and communication between the Treasury and Accounting functions so as to achieve hedge accounting effectively and transparently. 175 In response to these identified weaknesses, we are taking the following remedial actions: - until the hedge operation is adequately staffed with employees with sufficient expertise in hedge accounting requirements under SFAS 133, retain external service providers with an expertise in hedge accounting requirements to provide the support necessary to fully comply with hedge accounting requirements; and - establish detailed polices and procedures that will ensure that personnel remain current on all relevant standards for hedge accounting requirements, including those relating to the shortcut method under SFAS 133. These remedial actions will be undertaken immediately. HSBC Finance Corporation continues the process to complete a thorough review of its internal controls as part of its preparation for compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Section 404 requires our management to report on, and our external auditors to attest to, the effectiveness of our internal control structure and procedures for financial reporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act, our first report under Section 404 will be contained in our Form 10-K for the period ended December 31, 2005. ITEM 9B. OTHER INFORMATION. -------------------------------------------------------------------------------- None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. -------------------------------------------------------------------------------- In accordance with the requirements of Form 10-K, we are filing this report using the reduced disclosure format and therefore are not required to provide information pursuant to this Item 10. However, we are providing the following information to provide disclosure concerning our corporate governance practices and specifically with respect to the audit committee of our Board of Directors. The primary purpose of the audit committee is to assist the Board of Directors in fulfilling its oversight responsibilities relating to HSBC Finance Corporation's accounting, auditing and financial reporting practices. The audit committee is currently comprised of the following independent Directors (as defined by the standards of the New York Stock Exchange): Gary G. Dillon; Robert K. Herdman and Larree M. Renda. In addition, John D. Nichols, Lead Director, and Alan W. Jebson, Chief Operating Officer of HSBC, are ex-officio members of the Committee. The Board has determined that each of these individuals is financially literate. The Board of Directors has determined that Robert K. Herdman qualifies as an audit committee financial expert. CODE OF ETHICS HSBC Finance Corporation's Board of Directors has adopted a Code of Ethics for Senior Financial Officers. That Code of Ethics is included as Exhibit 14 to this Annual Report on Form 10-K. HSBC Finance Corporation also has a general code of ethics applicable to all employees that is referred to as its Statement of Business Principles and Code of Ethics. That document is available on our website at www.household.com or upon written request made to HSBC Finance Corporation, 2700 Sanders Road, Prospect Heights, Illinois 60070, Attention: Corporate Secretary. 176 ITEM 11. EXECUTIVE COMPENSATION. -------------------------------------------------------------------------------- Omitted. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED MATTERS. -------------------------------------------------------------------------------- Omitted. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. -------------------------------------------------------------------------------- Omitted. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. -------------------------------------------------------------------------------- AUDIT FEES. The aggregate amount billed by our principal accountant, KPMG LLP, for audit services performed during the fiscal years ended December 31, 2004 and 2003 was $5,565,000 and $5,687,000, respectively. Audit services include the auditing of financial statements, quarterly reviews, statutory audits and the preparation of comfort letters, consents and review of registration statements. AUDIT RELATED FEES. The aggregate amount billed by KPMG LLP in connection with audit related services performed during the fiscal years ended December 31, 2004 and 2003 was $691,000 and $1,250,000, respectively. Audit related services include employee benefit plan audits, due diligence assistance, internal control review assistance and audit or attestation services not required by statute or regulation. TAX FEES. Total fees billed by KPMG LLP for tax related services for the fiscal years ended December 31, 2004 and 2003 were $2,656,000 and $779,000, respectively. These services include tax related research, general tax services in connection with transactions and legislation and tax services for review of federal and state tax accounts for possible overassessment of interest and/or penalties. ALL OTHER. Other than those fees described above, there were no other fees billed for services performed by KPMG LLP during the fiscal years ended December 31, 2004 and December 31, 2003. All of the fees described above were approved by HSBC Finance Corporation's audit committee. AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES. HSBC Finance Corporation's audit committee pre-approves the audit and non-audit services performed by KPMG LLP, our principal accountants, in order to assure that the provision of such services does not impair KPMG LLP's independence. Unless a type of service to be provided by KPMG LLP has received general pre-approval, it will require specific pre-approval by the audit committee. In addition, any proposed services exceeding pre-approval cost levels will require specific pre-approval by the audit committee. The term of any pre-approval is 12 months from the date of pre-approval, unless the audit committee specifically provides for a different period. The audit committee will periodically revise the list of pre-approved services, based on subsequent determinations, and has delegated pre-approval authority to the Chairman of the audit committee. In the event the Chairman exercises such delegated authority, he will report such pre-approval decisions to the audit committee at its next scheduled meeting. The audit committee does not delegate its responsibilities to pre-approve services performed by the independent auditor to management. 177 PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE. -------------------------------------------------------------------------------- (a)(1) Financial Statements. The consolidated financial statements listed below, together with an opinion of KPMG LLP dated February 28, 2005 with respect thereto, are included in this Form 10-K pursuant to Item 8. Financial Statements and Supplementary Data of this Form 10-K. HSBC FINANCE CORPORATION AND SUBSIDIARIES: Report of Independent Registered Public Accounting Firm Consolidated Statements of Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Changes in Preferred Stock and Common Shareholder's(s') Equity Notes to Consolidated Financial Statements Selected Quarterly Financial Data (Unaudited) (a)(2) Not applicable (a)(3) Exhibits. 3(i) Amended and Restated Certificate of Incorporation of HSBC Finance Corporation dated as of December 15, 2004. 3(ii) Restated Bylaws of HSBC Finance Corporation dated as of December 15, 2004. 4.1 Amended and Restated Standard Multiple-Series Indenture Provisions for Senior Debt Securities of HSBC Finance Corporation dated as of December 15, 2004 (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-3 of HSBC Finance Corporation, Nos. 333-120494, 333-120495 and 333-120496 filed on December 16, 2004). 4.2* Amended and Restated Indenture dated as of December 15, 2004 for Senior Debt Securities between HSBC Finance Corporation and JPMorgan Chase Bank, N.A. (as successor to The Chase Manhattan Bank (National Association)), as Trustee (incorpo- rated by reference to Exhibit 4.2 to the Registration Statement on Form S-3 of HSBC Finance Corporation, Nos. 333-120495 and 333-120496 filed on December 16, 2004). 4.3 The principal amount of debt outstanding under each other instrument defining the rights of Holders of our long-term senior and senior subordinated debt does not exceed 10 percent of our total assets. HSBC Finance Corporation agrees to furnish to the Securities and Exchange Commission, upon request, a copy of each instrument defining the rights of holders of our long-term senior and senior subordinated debt. 12 Statement of Computation of Ratio of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends. 14 Code of Ethics for Senior Financial Officers. 23 Consent of KPMG LLP, Independent Registered Public Accounting Firm. 24 Power of Attorney (included on page 180 of this Form 10-K). 31 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.1 Ratings of HSBC Finance Corporation and its significant subsidiaries. 178 Upon receiving a written request, we will furnish copies of the exhibits referred to above free of charge. Requests should be made to HSBC Finance Corporation, 2700 Sanders Road, Prospect Heights, Illinois 60070, Attention: Corporate Secretary. --------------- * Substantially identical indentures exist with U.S. Bank National Association, BNY Midwest Trust Company and JPMorgan Trust Company, National Association. 179 SIGNATURES -------------------------------------------------------------------------------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, HSBC Finance Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this, the 23rd day of February, 2005. HSBC FINANCE CORPORATION By: /s/ W.F. Aldinger ------------------------------------ W.F. Aldinger Chairman and Chief Executive Officer Each person whose signature appears below constitutes and appoints P.D. Schwartz as his/her true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him/her in his/her name, place and stead, in any and all capacities, to sign and file, with the Securities and Exchange Commission, this Form 10-K and any and all amendments and exhibits thereto, and all documents in connection therewith, granting unto each such attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as he/she might or could do in person, hereby ratifying and confirming all that such attorney-in-fact and agent or their substitutes may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of HSBC Finance Corporation and in the capacities indicated on the 23rd day of February, 2005. SIGNATURE TITLE -------------------------------------------------------------------------------------------------------- /s/ W. F. ALDINGER Chairman and Chief Executive Officer and ------------------------------------------------------ Director (as Principal Executive Officer) (W. F. Aldinger) /s/ W. R. P. DALTON Director ------------------------------------------------------ (W. R. P. Dalton) /s/ R. J. DARNALL Director ------------------------------------------------------ (R. J. Darnall) /s/ G. G. DILLON Director ------------------------------------------------------ (G. G. Dillon) /s/ A. DISNEY Director ------------------------------------------------------ (A. Disney) /s/ J. A. EDWARDSON Director ------------------------------------------------------ (J. A. Edwardson) ------------------------------------------------------ Director (J. D. Fishburn) /s/ C. F. FREIDHEIM, JR. Director ------------------------------------------------------ (C. F. Freidheim, Jr.) /s/ R. K. HERDMAN Director ------------------------------------------------------ (R. K. Herdman) 180 SIGNATURE TITLE -------------------------------------------------------------------------------------------------------- /s/ A. W. JEBSON Director ------------------------------------------------------ (A. W. Jebson) /s/ G. A. LORCH Director ------------------------------------------------------ (G. A. Lorch) /s/ J. D. NICHOLS Director ------------------------------------------------------ (J. D. Nichols) /s/ L. M. RENDA Director ------------------------------------------------------ (L. M. Renda) /s/ S. J. STEWART Director ------------------------------------------------------ (S. J. Stewart) /s/ B. A. SIBBLIES Senior Vice President and Chief Accounting ------------------------------------------------------ Officer (as Principal Accounting Officer) (B. A. Sibblies) /s/ S. C. PENNEY Senior Executive Vice President and Chief ------------------------------------------------------ Financial Officer (as Principal Financial (S. C. Penney) Officer) 181 EXHIBIT INDEX -------------------------------------------------------------------------------- 3(i) Amended and Restated Certificate of Incorporation of HSBC Finance Corporation dated as of December 15, 2004. 3(ii) Restated Bylaws of HSBC Finance Corporation dated as of December 15, 2004. 4.1 Amended and Restated Standard Multiple-Series Indenture Provisions for Senior Debt Securities of HSBC Finance Corporation dated as of December 15, 2004 (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-3 of HSBC Finance Corporation, Nos. 333-120494, 333-120495 and 333-120496 filed on December 16, 2004). 4.2* Amended and Restated Indenture dated as of December 15, 2004 for Senior Debt Securities between HSBC Finance Corporation and JPMorgan Chase Bank, N.A. (as successor to The Chase Manhattan Bank (National Association)), as Trustee (incorporated by reference to Exhibit 4.2 to the Registration Statement on Form S-3 of HSBC Finance Corporation, Nos. 333-120495 and 333-120496 filed on December 16, 2004). 4.3 The principal amount of debt outstanding under each other instrument defining the rights of Holders of our long-term senior and senior subordinated debt does not exceed 10 percent of our total assets. HSBC Finance Corporation agrees to furnish to the Securities and Exchange Commission, upon request, a copy of each instrument defining the rights of holders of our long-term senior and senior subordinated debt. 12 Statement of Computation of Ratio of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends. 14 Code of Ethics for Senior Financial Officers. 23 Consent of KPMG LLP, Independent Registered Public Accounting Firm. 24 Power of Attorney (included on page 180 of this Form 10-K). 31 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.1 Ratings of HSBC Finance Corporation and its significant subsidiaries. --------------- * Substantially identical indentures exist with U.S. Bank National Association, BNY Midwest Trust Company and JPMorgan Trust Company, National Association. EXHIBIT 3(i) AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF HSBC FINANCE CORPORATION DECEMBER 15, 2004 ARTICLE I The name of the corporation is HSBC Finance Corporation (hereinafter referred to as the "Corporation"). ARTICLE II The registered office of the Corporation is to be located at 1209 Orange Street, in the City of Wilmington, in the County of New Castle, in the State of Delaware. The name of its registered agent at that address is The Corporation Trust Company. ARTICLE III The purpose of the Corporation is to engage in any lawful act or activity for which a corporation may be organized under the General Corporation Law of Delaware. ARTICLE IV (1) The total number of shares of all classes of stock which the Corporation shall have the authority to issue is 1200 shares, of which 100 shares, par value $0.01, shall be of a class designated "common stock", and 1100 shares, par value $0.01 per share, shall be of a class designated "preferred stock". (2) The common stock of the Corporation shall be subject to the express terms of the preferred stock and any series thereof. Each share of common stock shall have the right to cast on vote for each share for the election of directors and on all other matters upon which stockholders are entitled to vote. (3) The Board of Directors is authorized, subject to limitations prescribed by law and the provisions of this Article IV, to provide for the issuance from time to time in one or more series of any number of shares of preferred stock, and, by filing a certificate pursuant to the Delaware General Corporation Law (the "Preferred Stock Designation"), to establish the number of shares to be included in each series, and to fix the designations, relative rights, preferences, qualifications and limitations of the shares of each such series. The authority of the Board of Directors with respect to each series shall include, but not be limited to, determination of the following: (i) the designation of the series, which may be by distinguishing number, letter or title; (ii) the number of shares of the series, which number the Board of Directors may thereafter (except where otherwise provided in the Preferred Stock Designation) increase or decrease (but not below the number of shares thereof them outstanding); (iii) the voting rights, if any, of the holders of shares of the series; (iv) shall be cumulative or noncumulative and the dividend rate of the series, and the preferences, if any, over any other series (or of any other series over such series) with respect to dividends; (v) dates at which dividends, if any, shall be payable; (vi) the redemption rights and price or prices, if any, for shares of the series; (vii) the amounts payable on, and the preferences, if any, of shares of the series in the event of any voluntary or involuntary liquidation, dissolution, distribution of assets or winding up of the affairs of the Corporation; (viii) the terms and amount of any purchase, retirement or sinking fund provided for the purchase or redemption of shares of the series; (ix) whether the shares of the series shall be convertible into or exchangeable for shares of any other class or series, or any other security, of the Corporation or any other corporation, and, if so, the specification of such other class or series of such other security, the conversion or exchange price or prices or rate or rates, any adjustments thereof, the date or dates at which such shares shall be convertible or exchangeable and all other terms and conditions upon which such conversion or exchange may be made; (x) whether the issuance of additional shares of preferred stock shall be subject to restrictions as to issuance, or as to the powers, preferences or other rights of any other series; (xi) the right of the shares of such series to the benefit of conditions and restrictions upon the creation of indebtedness of the Corporation or any subsidiary of the Corporation, upon the issue of any additional stock (including additional shares of such series or any other series) and upon the payment of dividends or the making of other distributions on, and the purchase, redemption or other acquisition by the Corporation or any subsidiary of any outstanding stock of the Corporation; and (xii) such other powers, preferences and relative, participating, optional and other special rights, and the qualifications, limitations and restrictions thereof as the Board of Directors shall determine. The holders of preferred stock shall not have any preemptive rights except to the extent such rights shall be specifically provided for in the resolution or resolutions providing for the issuance thereof adopted by the Board of Directors. ARTICLE V The name and address of the incorporator is as follows: Brandon W. Gardner Cleary, Gottlieb, Steen & Hamilton One Liberty Plaza New York, New York 10006 ARTICLE VI Names of the persons constituting the initial Board of Directors of the Corporation are as follows: Youseef A. Nasr 452 Fifth Ave., 10th Floor New York, NY 10018 Paul L. Lee 452 Fifth Ave., 7th Floor New York, NY 10018 ARTICLE VII The following provisions are inserted for the management of the business and for the conduct of the affairs of the Corporation, and for further definition, limitation and regulation of the powers of the Corporation and of its directors and stockholders: (1) The number of directors of the Corporation shall be such as from time to time shall be fixed by, or in the manner provided in, the by-laws. Election of directors need not be by ballot unless the by-laws so provide. 2 (2) The Board of Directors shall have powers without the assent or vote of the stockholders to make, alter, amend, change, add to or repeal the by-laws of the Corporation; to fix and vary the amount to be served for any proper purpose; to authorize and cause to be executed mortgages and liens upon all or any part of the property of the Corporation; to determine the use and disposition of any surplus or net profits; and to fix the times for the declaration and payment of dividends. (3) The directors in their discretion may submit any contract or act for approval or ratification at any annual meeting of the stockholders or at any meeting of the stockholders called for the purpose of considering any such act or contract, and any contract or act that shall be approved or be ratified by the vote of the holders of a majority of the stock of the Corporation which is represented in person or by proxy at such meeting and entitled to vote thereat (provided that a lawful quorum of stockholders be there represented in person or by proxy) shall be as valid and as binding upon the Corporation and upon all the stockholders as though it had been approved or ratified by every stockholder of the Corporation, whether or not the contract or act would otherwise be open to legal attack because of directors' interest, or of any other reason. (4) In addition to the powers and authorities hereinbefore or by statute expressly conferred upon them, the directors are hereby empowered to exercise all such powers and do all such acts and things as may be exercised or done by the Corporation; subject, nevertheless, to the provisions of the statutes of Delaware, of this certificate, and to any by-laws from time to time made by the stockholders; provided, however, that no by-laws so made shall invalidate any prior act of the directors which would have been valid if such by-law had not been made. ARTICLE VIII (1) Each person who was or is made a party or is threatened to be made a party to or is involved in any action, suit or proceeding, whether civil, criminal, administrative, or investigative (hereinafter a "proceeding"), by reason of the fact that he or she, or a person of whom he or she is the legal representative, is or was a director, officer, or employee of the Corporation or is or was serving at the request of the Corporation as a director, officer, employee, or agent of another corporation or of a partnership, joint venture, trust, or other enterprise, including service with respect to employee benefit plans, shall be indemnified and held harmless by the Corporation to the fullest extent authorized by the Delaware General Corporation Law, as the same exists or may hereafter be amended (but, in the case of any such amendment, only to the extent that such amendment permits the Corporation to provide broader indemnification rights than said law permitted the Corporation to provide prior to such amendment), against all expense, liability, and loss (including attorneys' fees, judgments, fines, ERISA excise taxes, or penalties and amounts paid or to be paid in settlement) reasonably incurred or suffered by such person in connection therewith, and such indemnification shall continue as to a person who has ceased to be a director, officer, employee, or agent and shall inure to the benefit of his or her heirs, executors and administrators; provided, however, that except as provided in paragraph (2) hereof, the Corporation shall indemnify any such person seeking indemnification in connection with a proceeding (or part thereof) initiated by such person only if such proceeding (or part thereof) was authorized by the Board of Directors of the Corporation. The right to indemnification conferred in this Section shall be a contract right and shall include the right to be paid by the Corporation the expenses incurred in defending any such proceeding in advance of its final disposition upon delivery to the Corporation of any undertaking to repay all amounts so advanced if it shall ultimately be determined that such person is not entitled to be indemnified under this Section or otherwise. The Corporation may, by action of its Board of Directors, provide indemnification to agents of the Corporation with the same scope and effect as the foregoing indemnification of directors, officers, and employees. (2) If a claim under paragraph (1) of this Section is not paid in full by the Corporation, the claimant may at any time thereafter bring suit against the Corporation to recover the unpaid amount of the claim and, if successful in whole or in part, the claimant shall be entitled to be paid also the expense of prosecuting such claim. It shall be a defense to any such action (other than an action brought to enforce a claim for expenses incurred in defending any proceeding in advance of its final disposition where the required undertaking has been tendered to the Corporation) that the claimant has not met the standards of conduct which make it 3 permissible under the Delaware General Corporation Law and paragraph (1) of this Section for the Corporation to indemnify the claimant for the amount claimed, but the burden of proving such defense shall be on the Corporation. Neither the failure of the Corporation (including its Board of Directors, independent legal counsel, or its stockholders) to have made a determination prior to the commencement of such action that indemnification of the claimant is proper in the circumstances because he or she has met the applicable standard of conduct set forth in the Delaware General Corporation Law, nor an actual determination by the Corporation (including its Board of Directors, independent legal counsel, or its stockholders) that the claimant has not met such applicable standard of conduct, shall be a defense to the action or create a presumption that the claimant has not met the applicable standard of conduct. (3) The right to indemnification and the payment of expenses incurred in defending a proceeding in advance of its final disposition conferred in this Section shall not be exclusive of any other right which any person may have or hereafter acquire under any statute, provision of this Certificate of Incorporation, bylaw, agreement, contract, vote of stockholders or disinterested directors, or otherwise. (4) The Corporation may purchase and maintain insurance on behalf of any person who is or was a director, serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the Corporation would have the power to indemnify him against such liability under the provisions of this Section, the Delaware General Corporation Law, or otherwise. ARTICLE IX Whenever a compromise or arrangement is proposed between the Corporation and its creditors or any class of them and/or between the Corporation and its stockholders or any class of them, any court of equitable jurisdiction within the State of Delaware, may, on the application in a summary way of the Corporation or of any creditor or stockholder thereof or on the application of any receiver or receivers appointed for the Corporation under the provisions of section 291 of Title 8 of the Delaware Code or on the application of trustees in dissolution or of any receiver or receivers appointed for the Corporation under the provisions of section 271 of Title 8 of the Delaware Code order a meeting of the creditors or class of creditors, and/or of the stockholders or class of stockholders of the Corporation, as the case may be, to be summoned in such manner as the said court directs. If a majority in number representing three-fourths in value of the creditors or class of creditors, and/or of the stockholders or class of stockholders of the Corporation, as the case may be, agree to any compromise or arrangement and to any reorganization of the Corporation as consequence of such compromise or arrangement, the said compromise or arrangement and the said reorganization shall, if sanctioned by the court to which the said application has been made, be binding on all the creditors or class of creditors, and/or on all the stockholders or class of stockholders, of the Corporation, as the case may be, and also on the Corporation. ARTICLE X The Corporation reserves the right to amend, alter, change or repeal any provisions contained in this certificate of incorporation in the manner now or hereafter prescribed by law, and all rights and powers conferred herein on stockholders, directors and officers are subject to this reserved power. ARTICLE XI The personal liability of the directors of the Corporation is hereby eliminated to the fullest extent permitted by paragraph (7) of subsection (b) of Section 102 of the General Corporation Law of the State of Delaware, as the same may be amended or supplemented. 4 EXHIBIT 3(ii) HSBC FINANCE CORPORATION BYLAWS (AS IN EFFECT DECEMBER 15, 2004) BYLAWS OF HSBC FINANCE CORPORATION ARTICLE I. DEFINITIONS, PLACES OF MEETINGS. SECTION 1. Definitions. When used herein, "Board" shall mean the Board of Directors of this Corporation, and "Chairman" shall mean Chairman of the Board of Directors. SECTION 2. Places of Meetings of Stockholders and Directors. Unless the Board shall fix another place for the holding of the meeting, meetings of stockholders and of the Board shall be held at the Corporation's headquarters, Prospect Heights, Cook County, Illinois, or at such other place specified by the person or persons calling the meeting. ARTICLE II. STOCKHOLDERS MEETINGS. SECTION 1. Annual Meeting of Stockholders. The annual meeting of stockholders shall be held on such date and at such time as is fixed by the Board. Any previously scheduled annual meeting of stockholders may be postponed by resolution of the Board of Directors upon public announcement given prior to the date previously scheduled for such annual meeting of stockholders. SECTION 2. Special Meetings. Call. Special meetings of the stockholders may be called at any time by the Chief Executive Officer or a majority of the Board of Directors. Any previously scheduled special meeting of stockholders may be postponed by resolution of the Board of Directors upon notice to the stockholders given prior to the date previously scheduled for such special meeting of stockholders. Requisites of Call. A call for a special meeting of stockholders shall be in writing, filed with the Secretary, and shall specify the time and place of holding such meeting and the purpose or purposes for which it is called. SECTION 3. Notice of Meetings. Written notice of a meeting of stockholders setting forth the place, date, and hour of the meeting and the purpose or purposes for which the meeting is called shall be mailed not less than ten nor more than sixty days before the date of the meeting to each stockholder entitled to vote at the meeting. SECTION 4. Quorum and Adjournments. At any meeting of stockholders, the holders of a majority of all the outstanding shares entitled to vote, present in person or by proxy, shall constitute a quorum for the transaction of business, and a majority of such quorum shall prevail except as otherwise required by law, the Certificate of Incorporation, or the bylaws. If the stockholders necessary for a quorum shall fail to be present at the time and place fixed for any meeting, the holders of a majority of the shares entitled to vote who are present in person or by proxy may adjourn the meeting from time to time, until a quorum is present, provided, however, that any stockholders' meeting, annual or special, whether or not a quorum is present, may be adjourned from time to time by the Chairman of the meeting. At any adjourned meeting, any business may be transacted which might have been transacted at the original meeting. SECTION 5. Polls. The date and time of the opening and the closing of the polls for each matter upon which the stockholders will vote at a meeting shall be announced at the meeting. No ballot, proxies or votes, nor any revocations thereof or changes thereto, shall be accepted by the inspectors after the closing of the polls unless the Court of Chancery of the State of Delaware upon application by a stockholder shall determine otherwise. 2 ARTICLE III. BOARD OF DIRECTORS. SECTION 1. General Powers. The business and affairs of this Corporation shall be managed under the direction of the Board. Number. The number of directors shall be fixed from time to time by resolution of the Board. Tenure. The directors shall be elected at the annual meeting of stockholders, except as provided in Section 5 of this Article III, and each director shall hold office until his successor is elected and qualified or until his earlier resignation or removal. SECTION 2. Regular Meetings of the Board. Regular meetings of the Board shall be held at such times and places as the Board may fix. No notice shall be required. SECTION 3. Special Meetings of the Board. Special meetings of the Board shall be held whenever called by the Chairman of the Board or Chief Executive Officer or any four or more directors. At least twenty-four hours written notice or oral notice of each special meeting shall be given to each director. If mailed, notice must be deposited in the United States mail at least seventy-two hours before the meeting. SECTION 4. Quorum. A majority of the members of the Board if the total number is odd or one-half thereof if the total number is even shall constitute a quorum for the transaction of business, but if at any meeting of the Board there is less than a quorum the majority of those present may adjourn the meeting from time to time until a quorum is present. At any such adjourned meeting, a quorum being present, any business may be transacted which might have been transacted at the original meeting. Except as otherwise provided by law, the Certificate of Incorporation, or the bylaws, all actions of the Board shall be decided by vote of a majority of those present. SECTION 5. Vacancies. When any vacancy occurs among the Board, the remaining members of the Board may elect a director to fill each such vacancy at any regular meeting of the Board, or at a special meeting called for that purpose. A director elected to fill a vacancy shall serve for the unexpired portion of the term of his predecessor in office. SECTION 6. Removal of Directors. Any director may be removed either with or without cause, at any time, by a vote of the holders of a majority of the shares of the Corporation at any meeting of stockholders called for that purpose. SECTION 7. Committees. The Board may, by resolution passed by a majority of the entire Board, designate one or more committees of directors which to the extent provided in the resolution shall have and may exercise powers and authority of the Board in the management of the business and affairs of the Corporation. SECTION 8. Action of the Board. Except as otherwise provided by law, corporate action to be taken by the Board shall mean such action at a meeting of the Board. Any action required or permitted to be taken by the Board may be taken without a meeting if all members of the Board consent in writing to a resolution authorizing the action. The resolution and the written consents thereto shall be filed with the minutes of the proceedings of the Board. Any one or more members of the Board may participate in a meeting of the Board by means of a conference telephone or similar communications equipment allowing all persons participating in the meeting to hear each other at the same time. Participation by such means shall constitute presence in person at a meeting. This information is provided by RNS The company news service from the London Stock Exchange

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