HSBC Holdings Regulatory News (HSBA)

5 Mar 2007 12:19

HSBC Holdings PLC05 March 2007 The following table summarizes information about stock options outstanding underthe Group Share Option Plan at December 31, 2006. OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------- ----------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGERANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISEEXERCISE PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE------------------------------------------------------------------------------------------------------- $12.51-15.00............................ 2,181,000 7.34 14.37 - $ -$15.01-17.50............................ 3,879,800 6.85 15.31 2,909,850 $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 methodologythat is based on the underlying assumptions of the Black-Scholes option pricingmodel. When modeling options with vesting that are dependent on attainment ofcertain performance conditions over a period of time, these performance targetsare incorporated into the model using Monte-Carlo simulation. The expected lifeof options depends on the behavior of option holders, which is incorporated intothe option model consistent with historic observable data. The fair values areinherently subjective and uncertain due to the assumptions made and thelimitations of the model used. The significant weighted average assumptions usedto estimate the fair value of the options granted by year are as follows: 2006 2005 2004---------------------------------------------------------------------------------------- Risk-free interest rate..................................... - - 4.9%Expected life............................................... - - 6.9 yearsExpected volatility......................................... - - 25.0% Prior to our acquisition by HSBC, certain employees were eligible to participatein the former Household stock option plan. Employee stock options generallyvested equally over four years and expired 10 years from the date of grant. Uponcompletion of our acquisition by HSBC, all options granted prior to November2002 vested and became outstanding options to purchase HSBC ordinary shares.Options granted under the former Household plan subsequent to October 2002 wereconverted into options to purchase ordinary shares of HSBC, but did not vestunder the change in control. Compensation expense related to the formerHousehold 157 plan totaled $3 million in 2006, $6 million in 2005 and $8 million in 2004. Allshares under the former Household plan fully vested in 2006. Information with respect to stock options granted under the former Householdplan is as follows: 2006 2005 2004 ---------------------- ---------------------- ---------------------- WEIGHTED- WEIGHTED- WEIGHTED- HSBC AVERAGE HSBC AVERAGE HSBC AVERAGE ORDINARY PRICE PER ORDINARY PRICE PER ORDINARY PRICE PER SHARES SHARE SHARES SHARE SHARES SHARE---------------------------------------------------------------------------------------------------- Outstanding at beginning of year................. 36,032,006 $16.09 38,865,993 $15.71 45,194,343 $14.76Granted................... - - - - - -Exercised................. (9,825,954) 12.73 (2,609,665) 10.92 (5,780,935) 8.43Transferred in/(out)...... 47,580 8.62 (142,292) 12.15 (517,321) 14.58Expired or canceled....... (258,043) 16.78 (82,030) 7.97 (30,094) 10.66 ---------- ------ ---------- ------ ---------- ------Outstanding at end of year.................... 25,995,589 $17.34 36,032,006 $16.09 38,865,993 $15.71 ========== ====== ========== ====== ========== ======Exercisable at end of year.................... 25,995,589 $17.34 34,479,337 $16.21 35,373,778 $16.21 ========== ====== ========== ====== ========== ====== The transfers shown above primarily relate to employees who have transferredbetween HTSU and us during each year and to certain of our U.K. employees whowere transferred to HBEU as part of the sale of our U.K. credit card business inDecember 2005. The following table summarizes information about the number of HSBC ordinaryshares subject to outstanding stock options under the former Household plan, atDecember 31, 2006: OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------- ----------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGERANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISEEXERCISE PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE------------------------------------------------------------------------------------------------------- $1.00 - $5.00........................... 8,576 1.64 1.88 8,576 1.88$5.01 - $10.00.......................... 465,504 .86 9.38 465,504 9.38$10.01 - $12.50......................... 3,106,302 5.67 10.68 3,106,302 10.68$12.51 - $15.00......................... 2,920,776 1.79 13.90 2,920,776 13.90$15.01 - $17.50......................... 5,799,498 2.64 16.97 5,799,498 16.97$17.51 - $20.00......................... 6,287,589 3.84 18.41 6,287,589 18.41$20.01 - $25.00......................... 7,407,344 4.87 21.37 7,407,344 21.37 RESTRICTED SHARE PLANS Subsequent to our acquisition by HSBC, key employees arealso provided awards in the form of restricted shares ("RSRs") under HSBC'sRestricted Share Plan prior to 2005 and under the Group Share Plan beginning in2005. Annual awards to employees in 2005 and 2006 are fully vested after threeyears. We also issue a small number of off-cycle grants each year forrecruitment, retention and reward. These RSR awards vest over a varying periodof time depending on the nature of the award, the longest of which vests over afive year period. Annual awards to employees in 2004 vest over five yearscontingent upon the achievement of certain company performance targets. 158 Information with respect to RSRs awarded under HSBC's Restricted SharePlan/Group Share Plan, all of which are in HSBC ordinary shares, is as follows: YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 2006 2005 2004-------------------------------------------------------------------------------------------------- RSRs awarded.......................................... 4,959,838 6,669,152 2,996,878Weighted-average fair market value per share.......... $ 16.96 $ 15.86 $ 15.09RSRs outstanding at December 31....................... 14,326,693 11,787,706 7,030,688Compensation cost: (in millions) Pre-tax............................................. $ 82 $ 42 $ 17 After-tax........................................... 52 27 11 Prior to the merger, Household's executive compensation plans also provided forissuance of RSRs which entitled an employee to receive a stated number of sharesof Household common stock if the employee satisfied the conditions set by theCompensation Committee for the award. Upon completion of the merger with HSBC,all RSRs granted under the former Household plan prior to November 2002 vestedand became outstanding shares of HSBC. RSRs granted under the former Householdplan subsequent to October 2002 were converted into rights to receive HSBCordinary shares. Upon vesting, the employee can elect to receive either HSBCordinary shares or American depository shares. Information with respect to RSRs awarded under the pre-merger Household plan,all of which are in HSBC ordinary shares, is as follows: 2006 2005 2004---------------------------------------------------------------------------------------------- RSRs awarded.............................................. - - -Weighted-average fair market value per share.............. $ - $ - $ -RSRs outstanding at December 31........................... 653,900 1,309,073 2,238,628Compensation cost: (in millions) Pre-tax................................................. $ 4 $ 6 $ 8 After-tax............................................... 2 4 5 EMPLOYEE STOCK PURCHASE PLANS The HSBC Holdings Savings-Related Share OptionPlan (the "HSBC Sharesave Plan"), which replaced the former Household employeestock purchase plan, allows eligible employees to enter into savings contractsto save up to approximately $450 per month, with the option to use the savingsto acquire ordinary shares of HSBC at the end of the contract period. There arecurrently three types of plans offered which allow the participant to selectsaving contracts of a 1, 3 or 5 year length. The 1 year contract period wasoffered for the first time in 2006. The options for the 1 year plan areautomatically exercised if the current share price is at or above the strikeprice, which is at a 15 percent discount to the fair market value of the shareson grant date. If the current share price is below the strike price, theparticipants have the ability to exercise the option during the six monthsfollowing the maturity date if the share price rises. The options under the 3and 5 year plans are exercisable within six months following the third or fifthyear, respectively, of the commencement of the related savings contract, at a 20percent discount for options granted in 2006, 2005 and 2004. HSBC ordinaryshares granted and the related fair value of the options for 2006, 2005 and 2004are presented below: 2006 2005 2004 ------------------------ ------------------------ ------------------------ HSBC FAIR VALUE HSBC HSBC HSBC FAIR VALUE ORDINARY PER SHARE OF ORDINARY ORDINARY ORDINARY PER SHARE OF SHARES SHARES SHARES SHARES SHARES SHARES GRANTED GRANTED GRANTED GRANTED GRANTED GRANTED-------------------------------------------------------------------------------------------------------- 1 year vesting period... 296,410 2.60 - - - -3 year vesting period... 598,814 3.42 1,064,168 3.73 1,124,776 $3.445 year vesting period... 124,563 3.49 236,782 3.78 303,981 $3.80 159 Compensation expense related to the grants under the HSBC Sharesave Plan totaled$5 million in 2006, $6 million in 2005 and $5 million in 2004. The fair value of each option granted under the HSBC Sharesave Plan wasestimated as of the date of grant using a third party option pricing model: 2006 2005 2004---------------------------------------------------------------------------------------------------- Risk-free interest rate........................ 5.0% 4.3% 4.9%Expected life.................................. 1, 3 OR 5 YEARS 3 or 5 years 3 or 5 yearsExpected volatility............................ 17.0% 20.0% 25.0% 20. PENSION AND OTHER POSTRETIREMENT BENEFITS-------------------------------------------------------------------------------- DEFINED BENEFIT PENSION PLANS We adopted FASB Statement No. 158, "Employer'sAccounting for Defined Benefit Pension and Other Postretirement Plans," ("SFASNo. 158") on December 31, 2006. SFAS No. 158 requires balance sheet recognitionof the funded status of pension and other postretirement benefits with theoffset to accumulated other comprehensive income. The adoption of SFAS No. 158at December 31, 2006 had no impact on our pension liability. Deferred taxliabilities increased by $1 million and shareholder's equity was decreased by $1million through accumulated other comprehensive income. In November 2004, sponsorship of the domestic defined benefit pension plan ofHSBC Finance Corporation and the domestic defined benefit pension plan of HSBCBank USA were transferred to HSBC North America. Effective January 1, 2005, thetwo separate plans were combined into a single HSBC North America definedbenefit pension plan which facilitates the development of a unified employeebenefit policy and unified employee benefit plan administration for HSBCcompanies operating in the United States. As a result, the pension liabilityrelating to our domestic defined benefit plan of $49 million, net of tax, wastransferred to HSBC North America as a capital transaction in the first quarterof 2005. The components of pension expense for the domestic defined benefit planreflected in our consolidated statement of income are shown in the table below.The pension expense for the years ended December 31, 2006 and 2005 reflects theportion of the pension expense of the combined HSBC North America pension planwhich has been allocated to HSBC Finance Corporation. YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 2006 2005 2004---------------------------------------------------------------------------------------------------- (IN MILLIONS) Service cost - benefits earned during the period........ $48 $46 $52Interest cost on projected benefit obligation........... 60 54 46Expected return on assets............................... (77) (78) (82)Amortization of prior service cost...................... - - -Recognized losses (gains)............................... 15 4 (5) --- --- ---Pension expense......................................... $46 $26 $11 === === === The information and activity presented below as of and for the years endedDecember 31, 2006 and 2005 relates to the post-merger HSBC North America definedbenefit pension plan, unless noted otherwise. The information and activitypresented as of December 31, 2004 reflect the pre-merger HSBC FinanceCorporation domestic defined benefit pension plan balances and activity. 160 The assumptions used in determining pension expense of the domestic definedbenefit plan are as follows: 2006 2005 2004----------------------------------------------------------------------------------------------------- (POST-MERGER) (POST-MERGER) (PRE-MERGER) Discount rate.......................................... 5.70% 6.00% 6.25%Salary increase assumption............................. 3.75 3.75 3.75Expected long-term rate of return on plan assets....... 8.00 8.33 8.75 HSBC North America retains both an unrelated third party as well as an affiliateto provide investment consulting services. Given the plan's current allocationof equity and fixed income securities and using investment return assumptionswhich are based on long term historical data, the long term expected return forplan assets is reasonable. The funded status of the post-merger HSBC NorthAmerica pension plan and not the interests of HSBC Finance Corporation atDecember 31, 2006 was a liability of $130 million. A reconciliation of beginning and ending balances of the fair value of planassets associated with the domestic defined benefit pension plan is shown below.The activity shown below reflects the activity of the merged HSBC North Americaplan. YEAR ENDED DECEMBER 31, --------------- 2006 2005----------------------------------------------------------------------------- (IN MILLIONS) Fair value of plan assets at beginning of year.............. $2,383 $1,000Transfer in of assets from the former HSBC Bank USA pension plan...................................................... - 1,304Actual return on plan assets................................ 246 168Employer contributions...................................... - -Benefits paid............................................... (62) (89) ------ ------Fair value of plan assets at end of year.................... $2,567 $2,383 ====== ====== It is currently not anticipated that employer contributions to the domesticdefined benefit plan will be made in 2007. The allocation of the domestic pension plan assets at December 31, 2006 and 2005is as follows: PERCENTAGE OF PLAN ASSETS AT DECEMBER 31, -------------- 2006 2005---------------------------------------------------------------------------- Equity securities........................................... 69% 69%Debt securities............................................. 30 31Other....................................................... 1 - --- ---Total....................................................... 100% 100% === === There were no investments in HSBC ordinary shares or American depository sharesat December 31, 2006 or 2005. The primary objective of the defined benefit pension plan is to provide eligibleemployees with regular pension benefits. Since the domestic plans are governedby the Employee Retirement Income Security Act of 1974 ("ERISA"), ERISAregulations serve as guidance for the management of plan assets. Consistent withprudent standards of preservation of capital and maintenance of liquidity, thegoals of the plans are to earn the highest possible rate of return consistentwith the tolerance for risk as determined by the investment committee in itsrole as a fiduciary. In carrying out these objectives, short-term fluctuationsin the value of plan assets are considered secondary to long-term investmentresults. Both a third party and an affiliate are used to provide investmentconsulting services such as recommendations on the type of funds to be investedin 161 and monitoring the performance of fund managers. In order to achieve the returnobjectives of the plans, the plans are diversified to ensure that adverseresults from one security or security class will not have an unduly detrimentaleffect on the entire investment portfolio. Assets are diversified by type,characteristic and number of investments as well as by investment style ofmanagement organization. Equity securities are invested in large, mid and smallcapitalization domestic stocks as well as international stocks. A reconciliation of beginning and ending balances of the projected benefitobligation of the domestic defined benefit pension plan is shown below andreflects the projected benefit obligation of the merged HSBC North America plan. YEAR ENDED DECEMBER 31, ---------------- 2006 2005------------------------------------------------------------------------------ (IN MILLIONS) Projected benefit obligation at beginning of year........... $2,530 $1,019Transfer in from the HSBC Bank USA defined benefit plan..... - 1,174Service cost................................................ 102 94Interest cost............................................... 145 130Actuarial (gains) losses.................................... (17) 202Benefits paid............................................... (62) (89) ------ ------Projected benefit obligation at end of year................. $2,698 $2,530 ====== ====== Our share of the projected benefit obligation at December 31, 2006 isapproximately $1.1 billion. The accumulated benefit obligation for thepost-merger domestic HSBC North America defined benefit pension plan was $2.4billion at December 31, 2006 and $2.2 billion at December 31, 2005. Our share ofthe accumulated benefit obligation was approximately $1.0 billion at December31, 2006 and $1.1 billion at December 31, 2005. Estimated future benefit payments for the HSBC North America domestic definedbenefit plan and HSBC Finance Corporation's share of those payments are asfollows: HSBC HSBC FINANCE NORTH CORPORATION'S AMERICA SHARE------------------------------------------------------------------------------------- (IN MILLIONS) 2007........................................................ $122 $ 612008........................................................ 130 652009........................................................ 137 682010........................................................ 144 712011........................................................ 156 762012-2016................................................... 927 433 The assumptions used in determining the projected benefit obligation of thedomestic defined benefit plans at December 31 are as follows: 2006 2005 2004----------------------------------------------------------------------------------------------------- (POST-MERGER) (POST-MERGER) (PRE-MERGER) Discount rate.......................................... 5.90% 5.70% 6.00%Salary increase assumption............................. 3.75 3.75 3.75 FOREIGN DEFINED BENEFIT PENSION PLANS We sponsor additional defined benefitpension plans for our foreign based employees. Pension expense for our foreigndefined benefit pension plans was $2 million in 2006, $2 million in 2005 and $2million in 2004. For our foreign defined benefit pension plans, the fair valueof plan assets was $160 million at December 31, 2006 and $135 million atDecember 31, 2005. The projected benefit 162 obligation for our foreign defined benefit pension plans was $191 million atDecember 31, 2006 and $164 million at December 31, 2005. SUPPLEMENTAL RETIREMENT PLAN A non-qualified supplemental retirement plan isalso provided. This plan, which is currently unfunded, provides eligibleemployees 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 $92 million at December 31, 2006 and $73million at December 31, 2005. Pension expense related to the supplementalretirement plan was $11 million in 2006 and 2005 and $19 million in 2004. Anadditional minimum liability of $6 million related to this plan was recognizedin 2004 and reversed in 2005. DEFINED CONTRIBUTION PLANS Various 401(k) savings plans and profit sharing plansexist for employees meeting certain eligibility requirements. Under these plans,each participant's contribution is matched by the company up to a maximum of 6percent of the participant's compensation. Company contributions are in the formof cash. Total expense for these plans for HSBC Finance Corporation was $98million in 2006, $91 million in 2005 and $82 million in 2004. Effective January 1, 2005, HSBC Finance Corporation's 401(k) savings plansmerged with the HSBC Bank USA's 401(k) savings plan under HSBC North America. POSTRETIREMENT PLANS OTHER THAN PENSIONS Our employees also participate in planswhich provide medical, dental and life insurance benefits to retirees andeligible dependents. These plans cover substantially all employees who meetcertain age and vested service requirements. We have instituted dollar limits onour payments under the plans to control the cost of future medical benefits. The net postretirement benefit cost included the following: YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 2006 2005 2004---------------------------------------------------------------------------------------------------- (IN MILLIONS) Service cost - benefits earned during the period........ $ 6 $ 5 $ 4Interest cost........................................... 14 15 13Expected return on assets............................... - - -Amortization of prior service cost...................... - - -Recognized (gains) losses............................... - - - --- --- ---Net periodic postretirement benefit cost................ $20 $20 $17 === === === The assumptions used in determining the net periodic postretirement benefit costfor our domestic postretirement benefit plans are as follows: 2006 2005 2004---------------------------------------------------------------------------------------------------- (POST-MERGER) (POST-MERGER) (PRE-MERGER) Discount rate......................................... 5.70% 6.00% 6.25%Salary increase assumption............................ 3.75 3.75 3.75 163 A reconciliation of the beginning and ending balances of the accumulatedpostretirement benefit obligation is as follows: YEAR ENDED DECEMBER 31, ------------- 2006 2005--------------------------------------------------------------------------- (IN MILLIONS) Accumulated benefit obligation at beginning of year......... $242 $254Service cost................................................ 6 5Interest cost............................................... 14 15Foreign currency exchange rate changes...................... - 1Actuarial gains............................................. (8) (15)Benefits paid............................................... (22) (18) ---- ----Accumulated benefit obligation at end of year............... $232 $242 ==== ==== Our postretirement benefit plans are funded on a pay-as-you-go basis. Wecurrently estimate that we will pay benefits of approximately $16 millionrelating to our postretirement benefit plans in 2007. The funded status of ourpostretirement benefit plans was a liability of $232 million at December 31,2006. Estimated future benefit payments for our domestic plans are as follows: (IN MILLIONS)---------------------------------------------------------------------------- 2007........................................................ $162008........................................................ 172009........................................................ 182010........................................................ 182011........................................................ 182012-2016................................................... 92 The assumptions used in determining the benefit obligation of our domesticpostretirement benefit plans at December 31 are as follows: 2006 2005 2002-------------------------------------------------------------------------------- Discount rate............................................... 5.90% 5.70% 6.00%Salary increase assumption.................................. 3.75 3.75 3.75 A 10.4 percent annual rate of increase in the gross cost of covered health carebenefits was assumed for 2007. This rate of increase is assumed to declinegradually to 5.0 percent in 2014. Assumed health care cost trend rates have an effect on the amounts reported forhealth care plans. A one-percentage point change in assumed health care costtrend rates would increase (decrease) service and interest costs and thepostretirement benefit obligation as follows: ONE PERCENT ONE PERCENT INCREASE DECREASE--------------------------------------------------------------------------------------- (IN MILLIONS) Effect on total of service and interest cost components..... $.5 $(.4)Effect on postretirement benefit obligation................. 6 (6) 21. BUSINESS SEGMENTS-------------------------------------------------------------------------------- We have three reportable segments: Consumer, Credit Card Services, andInternational. Our segments are managed separately and are characterized bydifferent middle-market consumer lending products, origination processes, andlocations. Our Consumer segment consists of our Consumer Lending, MortgageServices, Retail Services, and Auto Finance businesses. Our Credit Card Servicessegment consists of our domestic 164 MasterCard and Visa and other credit card business. Our International segmentconsists of our foreign operations in Canada, the United Kingdom, the Republicof Ireland and prior to November 9, 2006, our operations in Slovakia, the CzechRepublic and Hungary. The Consumer segment provides real estate secured,automobile secured, personal non-credit card and private label loans. Loans areoffered with both revolving and closed-end terms and with fixed or variableinterest rates. Loans are originated through branch locations, correspondents,mortgage brokers, direct mail, telemarketing, independent merchants orautomobile dealers. The Credit Card Services segment offers MasterCard and Visaand other credit card loans throughout the United States primarily via strategicaffinity and co-branding relationships, direct mail, and our branch network tonon-prime customers. We also cross sell our credit cards to existing real estatesecured, private label and tax services customers. The International segmentoffers secured and unsecured lines of credit and secured and unsecuredclosed-end loans primarily in the United Kingdom, Canada and the Republic ofIreland. In addition, the United Kingdom operation offers credit insurance inconnection with all loan products. All segments offer products and servicecustomers through the Internet. The All Other caption includes our insurance andtaxpayer financial services and commercial businesses, each of which falls belowthe quantitative threshold tests under Statement of Financial AccountingStandard No. 131, "Disclosures about Segments of an Enterprise and RelatedInformation" ("SFAS No. 131"), for determining reportable segments, as well asour corporate and treasury activities. Fair value adjustments related topurchase accounting resulting from our acquisition by HSBC and relatedamortization have been allocated to Corporate, which is included in the "AllOther" caption within our segment disclosure. The composition of our business segments is consistent with that reported in our2005 Form 10-K. However, corporate goals and individual goals of executives arecurrently calculated in accordance with IFRSs under which HSBC prepares itsconsolidated financial statements. In 2006 we initiated a project to refine themonthly internal management reporting process to place a greater emphasis onIFRS management basis reporting (a non-U.S. GAAP financial measure) ("IFRSManagement Basis"). As a result, operating results are now being monitored andreviewed, trends are being evaluated and decisions about allocating resources,such as employees, are being made almost exclusively on an IFRS ManagementBasis. IFRS Management Basis results are IFRSs results which assume that theprivate label and real estate secured receivables transferred to HSBC Bank USAhave not been sold and remain on our balance sheet. Operations are monitored andtrends are evaluated on an IFRS Management Basis because the customer loan salesto HSBC Bank USA were conducted primarily to appropriately fund prime customerloans within HSBC and such customer loans continue to be managed and serviced byus without regard to ownership. Therefore, we have changed the measurement ofsegment profit to IFRS Management Basis in order to align with our revisedinternal reporting structure. However, we continue to monitor capital adequacy,establish dividend policy and report to regulatory agencies on an U.S. GAAPbasis. A summary of the significant differences between U.S. GAAP and IFRSs asthey impact our results are summarized below: Securitizations - On an IFRSs basis, securitized receivables are treated as owned. Any gains recorded under U.S. GAAP on these transactions are reversed. An owned loss reserve is established. The impact from securitizations resulting in higher net income under IFRSs is due to the recognition of income on securitized receivables under U.S. GAAP in prior periods. Derivatives and hedge accounting (including fair value adjustments) - The IFRSs derivative accounting model is similar to U.S. GAAP requirements, but IFRSs does not permit use of the short-cut method of hedge effectiveness testing. Unlike U.S. GAAP, IFRSs permits hedge accounting for hedges of forecasted cash flows. The differences between U.S. GAAP and IFRSs relate primarily to the fact that a different population of derivatives qualified for hedge accounting under IFRSs than U.S. GAAP throughout the period and that HSBC Finance Corporation elected the fair value option under IFRSs on a significant portion of its fixed rate debt which was being hedged by receive fixed swaps. U.S. GAAP does not currently permit the use of the fair value option. Intangible assets - Intangible assets under IFRSs are significantly lower than that under U.S. GAAP as the newly created intangibles associated with our acquisition by HSBC are reflected in goodwill for IFRSs therefore, amortization of intangible assets is lower under IFRSs. 165 Purchase accounting adjustments - There are differences in the valuation of assets and liabilities under U.K. GAAP (which were carried forward into IFRSs) and U.S. GAAP which result in a different amortization for the HSBC acquisition. Additionally there are differences in the valuation of assets and liabilities under IFRSs and U.S. GAAP resulting from the Metris acquisition in December 2005. Deferred loan origination costs and premiums - Under IFRSs loan origination cost deferrals are more stringent and result in lower costs being deferred than permitted under U.S. GAAP. In addition, all deferred loan origination fees, costs and loan premiums must be recognized based on the expected life of the receivables under IFRSs as part of the effective interest calculation while under U.S. GAAP they may be amortized on either a contractual or expected life basis. Credit loss impairment provisioning - IFRSs requires a discounted cash flow methodology for estimating impairment on pools of homogeneous customer loans which requires the incorporation of the time value of money relating to recovery estimates. Also under IFRSs, future recoveries on charged-off loans are accrued for on a discounted basis and interest is recorded based on collectibility. Loans held for resale - IFRSs requires loans held for resale to be treated as trading assets and recorded at their fair market value. Under U.S. GAAP, loans held for resale are designated as loans on the balance sheet and recorded at the lower of amortized cost or market. Under U.S. GAAP, the income and expenses related to loans held for sale are reported similarly to loans held for investment. Under IFRSs, the income and expenses related to loans held for sale are reported in other operating income. Interest recognition - The calculation of effective interest rates under IFRS 39 requires an estimate of "all fees and points paid or recovered between parties to the contract" that are an integral part of the effective interest rate be included. In 2006, we implemented a methodology for calculating the effective interest rate for introductory rate credit card receivables under IFRS over the expected life of the product. Also in 2006, we implemented a methodology to include prepayment penalties as part of the effective interest rate and recognize such penalties over the expected life of the receivables. U.S. GAAP generally prohibits recognition of interest income to the extent the net interest in the loan would increase to an amount greater than the amount at which the borrower could settle the obligation. Also under U.S. GAAP, prepayment penalties are generally recognized as received. Other - There are other less significant differences between IFRS and U.S. GAAP relating to pension expense, changes in tax estimates and other less significant items. See "Basis of Reporting" in Item 7. Management's Discussion and Analysis ofFinancial Condition and results of Operations in this 2006 Form 10-K for a morecomplete discussion of differences between U.S. GAAP and IFRSs. For comparability purposes, we have restated segment results for the year endedDecember 31, 2005 to the IFRS Management Basis. When HSBC began reporting IFRSresults in 2005, it elected to take advantage of certain options availableduring the year of transition from U.K. GAAP to IFRSs which provided, amongother things, an exemption from applying certain IFRSs retrospectively.Therefore, the segment results reported for the year ended December 31, 2004 arepresented on an IFRS Management Basis excluding the retrospective application ofIAS 32, "Financial Instruments: Presentation" and IAS 39, "FinancialInstruments: Recognition and Measurement which took effect on January 1, 2005and, as a result, the accounting for credit loss impairment provisioning,deferred loan origination costs and premiums and derivative income for the yearended December 31, 2004 remain in accordance with U.K. GAAP, HSBC's previousbasis of reporting. Credit loss provisioning under U.K. GAAP differs from IFRSsin that IFRSs require a discounted cash flow methodology for estimatingimpairment as well as accruing for future recoveries of charged-off loans on adiscounted basis. Under U.K. GAAP only sales incentives were treated as deferredloan origination costs which results in lower deferrals than those reportedunder IFRSs. Additionally, deferred costs and fees could be amortized over thecontractual life of the underlying receivable rather than the expected life asrequired under IFRSs. Derivative and hedge accounting under U.K. GAAP differsfrom U.S. GAAP in many respects, including the determination of when a hedgeexists as well as the reporting of gains and losses. For a more detaileddiscussion of the differences between IFRSs and U.K. GAAP, see Exhibit 99.2 tothis Form 10-K. 166 For segment reporting purposes, intersegment transactions have not beeneliminated. We generally account for transactions between segments as if theywere with third parties. Reconciliation of our IFRS Management Basis segment results to the U.S. GAAPconsolidated totals are as follows: IFRS MANAGEMENT CREDIT ADJUSTMENTS/ BASIS MANAGEMENT CARD INTER- ALL RECONCILING CONSOLIDATED BASIS IFRS CONSUMER SERVICES NATIONAL OTHER ITEMS TOTALS ADJUSTMENTS(7) ADJUSTMENTS(6)------------------------------------------------------------------------------------------------------------------------------ (IN MILLIONS) YEAR ENDED DECEMBER 31, 2006Net interest income.............. $ 8,588 $ 3,151 $ 826 $ (768)(10) $ - $ 11,797 $ (1,254) $ (228)Other operating income (Total other revenues)........... 909 2,360 283 705 (291)(2) 3,966 299 180Loan impairment charges (Provision for credit losses)............. 4,983 1,500 535 (2) 6(3) 7,022 (646) 225Operating expenses (Total costs and expenses)........... 2,998 1,841 495 588 - 5,922 (22) (28)Income tax expense (benefit)........... 528 784 37 (326) (110)(4) 913 (89) 20Net income........... 988 1,386 42 (323) (187) 1,906 (198) (265)Operating net income(1)........... 988 1,386 42 (401) (187) 1,828 (198) (265)Customer loans (Receivables)....... 144,573 28,221 9,520 199 - 182,513 (21,372) 895Assets............... 146,395 28,780 10,764 29,944 (8,197)(5) 207,686 (21,931) (5,871)Intersegment revenues............ 242 20 33 (4) (291)(2) - - -Depreciation and amortization........ 34 67 17 120 - 238 - 179Goodwill............. 46 530 11 9,510 - 10,097 - (3,087)Expenditures for long-lived assets(8)........... 76 1 13 58 - 148 - - -------- ------- ------- ------- ------- -------- -------- --------YEAR ENDED DECEMBER 31, 2005Net interest income.............. $ 8,401 $ 2,150 $ 971 $ (834) $ - $ 10,688 $ (1,438) $ (734)Other operating income (Total other revenues)........... 814 1,892 770 602 (140)(2) 3,938 500 (443)Loan impairment charges (Provision for credit losses)............. 3,362 1,453 620 (41) 9(3) 5,403 (629) (291)Operating expenses (Total costs and expenses)........... 2,757 1,315 635 574 - 5,281 (23) 107Income tax expense (benefit)........... 1,115 461 5 (364) (54)(4) 1,163 (94) (178)Net income........... 1,981 813 481 (401) (95) 2,779 (192) (815)Operating net income(1)........... 1,981 813 481 (401) (95) 2,779 (192) (815)Customer loans (Receivables)....... 128,095 25,979 9,328 211 - 163,613 (20,306) (3,394)Assets............... 130,375 28,453 10,905 26,634 (8,220)(5) 188,147 (20,247) (10,725)Intersegment revenues............ 108 21 17 (6) (140)(2) - - -Depreciation and amortization........ 44 26 30 143 - 243 - 275Goodwill............. - 521 11 9,464 - 9,996 - (2,993)Expenditures for long-lived assets(8)........... 24 525 32 28 - 609 - 2 -------- ------- ------- ------- ------- -------- -------- -------- IFRS U.S. GAAP RECLASS- CONSOLIDATED IFICATIONS(9) TOTALS--------------------- ------------------------------- (IN MILLIONS) YEAR ENDED DECEMBER 3Net interest income.............. $ (127) $ 10,188Other operating income (Total other revenues)........... 978 5,423Loan impairment charges (Provision for credit losses)............. (37) 6,564Operating expenses (Total costs and expenses)........... 888 6,760Income tax expense (benefit)........... - 844Net income........... - 1,443Operating net income(1)........... - 1,365Customer loans (Receivables)....... - 162,036Assets............... (425) 179,459Intersegment revenues............ - -Depreciation and amortization........ (32) 385Goodwill............. - 7,010Expenditures for long-lived assets(8)........... - 148 -------- --------YEAR ENDED DECEMBER 3Net interest income.............. $ (132) $ 8,384Other operating income (Total other revenues)........... 968 4,963Loan impairment charges (Provision for credit losses)............. 60 4,543Operating expenses (Total costs and expenses)........... 776 6,141Income tax expense (benefit)........... - 891Net income........... - 1,772Operating net income(1)........... - 1,772Customer loans (Receivables)....... - 139,913Assets............... (506) 156,669Intersegment revenues............ - -Depreciation and amortization........ (61) 457Goodwill............. - 7,003Expenditures for long-lived assets(8)........... - 611 -------- -------- 167 IFRS MANAGEMENT CREDIT ADJUSTMENTS/ BASIS MANAGEMENT CARD INTER- ALL RECONCILING CONSOLIDATED BASIS IFRS CONSUMER SERVICES NATIONAL OTHER ITEMS TOTALS ADJUSTMENTS(7) ADJUSTMENTS(6)------------------------------------------------------------------------------------------------------------------------------ (IN MILLIONS) YEAR ENDED DECEMBER 31, 2004Net interest income.............. $ 8,180 $ 2,226 $ 899 $ (49) $ - $ 11,256 $ (192) $ (3,132)Other operating income (Total other revenues)........... 502 1,581 313 528 (137)(2) 2,787 571 521Loan impairment charges (Provision for credit losses)............. 3,151 1,786 408 (2) 2(3) 5,345 (139) (1,185)Operating expenses (Total costs and expenses)........... 2,777 1,205 615 490 - 5,087 - (237)Income tax expense (benefit)........... 1,017 295 67 (125) (50)(4) 1,204 185 (389)Net income........... 1,737 521 122 116 (89) 2,407 333 (800)Operating net income(1)........... 1,324 522 122 132 (89) 2,011 333 (706)Customer loans (Receivables)....... 107,769 19,615 13,102 308 - 140,794 (17,225) (16,714)Assets............... 109,238 19,702 14,263 31,103 (8,212)(5) 166,094 (17,270) (18,005)Intersegment revenues............ 101 25 15 (4) (137)(2) - - -Depreciation and amortization........ 33 54 40 102 - 229 - 289Goodwill............. 876 249 1 8,615 - 9,741 - (2,885)Expenditures for long-lived assets(8)........... 18 4 20 54 - 96 - - -------- ------- ------- ------- ------- -------- -------- -------- IFRS U.S. GAAP RECLASS- CONSOLIDATED IFICATIONS(9) TOTALS--------------------- ------------------------------- (IN MILLIONS) YEAR ENDED DECEMBER 3Net interest income.............. $ (130) $ 7,802Other operating income (Total other revenues)........... 1,284 5,163Loan impairment charges (Provision for credit losses)............. 313 4,334Operating expenses (Total costs and expenses)........... 841 5,691Income tax expense (benefit)........... - 1,000Net income........... - 1,940Operating net income(1)........... - 1,638Customer loans (Receivables)....... - 106,855Assets............... (629) 130,190Intersegment revenues............ - -Depreciation and amortization........ (35) 483Goodwill............. - 6,856Expenditures for long-lived assets(8)........... - 96 -------- -------- --------------- (1) This non-U.S. GAAP financial measure is provided for comparison of our operating trends only and should be read in conjunction with our owned basis U.S. GAAP financial information. Operating net income in 2004 excludes the gain on the bulk sale of 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 (excluding retail sales contracts at our consumer lending business) and credit card portfolios of $121 million (after-tax). See "Basis of Reporting" for additional discussion on the use of non-U.S. 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. (5) Eliminates investments in subsidiaries and intercompany borrowings. (6) IFRS Adjustments, which have been described more fully above, consist of the following: PROVISION TOTAL INCOME NET FOR COSTS TAX OPERATING INTEREST OTHER CREDIT AND EXPENSE NET NET INCOME REVENUES LOSSES EXPENSES (BENEFIT) INCOME INCOME -------------------------------------------------------------------------------------------------------------------- (IN MILLIONS) YEAR ENDED DECEMBER 31, 2006 Securitizations........................ $ (244) $ 89 $ 25 $ - $ (62) $(118) $(118) Derivatives and hedge accounting....... (31) 277 - - 91 155 155 Intangible assets...................... - - - 179 (66) (113) (113) Purchase accounting.................... 202 64 195 (4) 25 50 50 Deferred loan origination costs and premiums.............................. (156) 2 - (199) 16 29 29 Credit loss impairment provisioning.... (39) (3) 12 - (20) (34) (34) Loans held for resale.................. 125 (202) - (32) (17) (28) (28) Interest recognition................... (38) (16) - - (20) (34) (34) Other.................................. (47) (31) (7) 28 73 (172) (172) ------- ------- ------- ----- ----- ----- ----- Total.................................. $ (228) $ 180 $ 225 $ (28) $ 20 $(265) $(265) ======= ======= ======= ===== ===== ===== ===== TOTAL RECEIVABLES ASSETS --------------------------------------- ---------------------- (IN MILLIONS) YEAR ENDED DECEMBER 31, 2006 Securitizations........................ $ (948) $ (1,232) Derivatives and hedge accounting....... - (2,966) Intangible assets...................... - (1,494) Purchase accounting.................... 118 (38) Deferred loan origination costs and premiums.............................. 457 457 Credit loss impairment provisioning.... (295) (298) Loans held for resale.................. 1,584 38 Interest recognition................... (53) (53) Other.................................. 32 (285) -------- -------- Total.................................. $ 895 $ (5,871) ======== ======== 168 PROVISION TOTAL INCOME NET FOR COSTS TAX OPERATING INTEREST OTHER CREDIT AND EXPENSE NET NET INCOME REVENUES LOSSES EXPENSES (BENEFIT) INCOME INCOME -------------------------------------------------------------------------------------------------------------------- (IN MILLIONS) YEAR ENDED DECEMBER 31, 2005 Securitizations........................ $ (900) $ (137) $ (315) $ - $(265) $(457) $(457) Derivatives and hedge accounting....... (41) (60) - - (43) (58) (58) Intangible assets...................... - - - 272 (100) (172) (172) Purchase accounting.................... 314 240 51 (15) 138 380 380 Deferred loan origination costs and premiums.............................. (197) 2 - (187) (2) (6) (6) Credit loss impairment provisioning.... (55) 34 (42) - 10 11 11 Loans held for resale.................. 126 (79) - 44 1 2 2 Interest recognition................... - - - - - - - Other.................................. 19 (443) 15 (7) 83 (515) (515) ------- ------- ------- ----- ----- ----- ----- Total.................................. $ (734) $ (443) $ (291) $ 107 $(178) $(815) $(815) ======= ======= ======= ===== ===== ===== ===== YEAR ENDED DECEMBER 31, 2004 Securitizations........................ $(2,462) $ 220 $(1,164) $ - $(390) $(688) $(688) Derivatives and hedge accounting....... (365) 511 - - 54 92 92 Intangible assets...................... - - - - - - - Purchase accounting.................... 226 (169) - 289 (71) (161) (177) Deferred loan origination costs and premiums.............................. (472) (3) - (511) 13 23 23 Credit loss impairment provisioning.... - - - - - - - Loans held for resale.................. - - - - - - - Prepayment penalty..................... - - - - - - - Interest recognition................... (17) - (7) - (4) (6) (6) Other.................................. (42) (38) (14) (15) 9 (60) 50 ------- ------- ------- ----- ----- ----- ----- Total.................................. $(3,132) $ 521 $(1,185) $(237) $(389) $(800) $ 706 ======= ======= ======= ===== ===== ===== ===== TOTAL RECEIVABLES ASSETS --------------------------------------- ---------------------- (IN MILLIONS) YEAR ENDED DECEMBER 31, 2005 Securitizations........................ $ (5,415) $ (7,251) Derivatives and hedge accounting....... - (2,719) Intangible assets...................... - (1,222) Purchase accounting.................... 162 (114) Deferred loan origination costs and premiums.............................. 430 430 Credit loss impairment provisioning.... (280) (232) Loans held for resale.................. 1,723 - Interest recognition................... - - Other.................................. (14) 383 -------- -------- Total.................................. $ (3,394) $(10,725) ======== ======== YEAR ENDED DECEMBER 31, 2004 Securitizations........................ $(17,552) $(16,417) Derivatives and hedge accounting....... - 159 Intangible assets...................... - (775) Purchase accounting.................... - (265) Deferred loan origination costs and premiums.............................. 597 568 Credit loss impairment provisioning.... - Loans held for resale.................. - - Prepayment penalty..................... - - Interest recognition................... - 92 Other.................................. 241 (1,367) -------- -------- Total.................................. $(16,714) $(18,005) ======== ======== (7) Management Basis Adjustments, which represent the private label and real estate secured receivables transferred to HBUS, consist of the following: PROVISION TOTAL INCOME NET FOR COSTS TAX OPERATING INTEREST OTHER CREDIT AND EXPENSE NET NET INCOME REVENUES LOSSES EXPENSES (BENEFIT) INCOME INCOME ----------------------------------------------------------------------------------------------------------------------------- (IN MILLIONS) YEAR ENDED DECEMBER 31, 2006 Private label receivables....................... $(1,175) $287 $(623) $(17) $(75) $(173) $(173) Real estate secured receivables................. (99) 12 (23) (5) (21) (38) (38) Other........................................... 20 - - - 7 13 13 ------- ---- ----- ---- ---- ----- ----- Total........................................... $(1,254) $299 $(646) $(22) $(89) $(198) $(198) ======= ==== ===== ==== ==== ===== ===== YEAR ENDED DECEMBER 31, 2005 Private label receivables....................... $(1,310) $483 $(594) $(22) $(66) $(145) $(145) Real estate secured receivables................. (159) 17 (35) (1) (39) (67) (67) Other........................................... 31 - - - 11 20 20 ------- ---- ----- ---- ---- ----- ----- Total........................................... $(1,438) $500 $(629) $(23) $(94) $(192) $(192) ======= ==== ===== ==== ==== ===== ===== YEAR ENDED DECEMBER 31, 2004 Private label receivables....................... $ (9) $559 $(125) $ - $244 $ 431 $ 431 Real estate secured receivables................. (180) 32 (14) - (51) (83) (83) Other........................................... (3) (20) - - (8) (15) (15) ------- ---- ----- ---- ---- ----- ----- Total........................................... $ (192) $571 $(139) $ - $185 $ 333 $ 333 ======= ==== ===== ==== ==== ===== ===== TOTAL RECEIVABLES ASSETS ------------------------------------------------ ---------------------- (IN MILLIONS) YEAR ENDED DECEMBER 31, 2006 Private label receivables....................... $(18,125) $(18,653) Real estate secured receivables................. (3,247) (3,278) Other........................................... - - -------- -------- Total........................................... $(21,372) $(21,931) ======== ======== YEAR ENDED DECEMBER 31, 2005 Private label receivables....................... $(15,762) $(15,673) Real estate secured receivables................. (4,544) (4,571) Other........................................... - (3) -------- -------- Total........................................... $(20,306) $(20,247) ======== ======== YEAR ENDED DECEMBER 31, 2004 Private label receivables....................... $ 12,217 $(12,225) Real estate secured receivables................. (5,008) (5,031) Other........................................... - (14) -------- -------- Total........................................... $(17,225) $(17,270) ======== ======== (8) Includes goodwill associated with purchase business combinations other than the HSBC merger as well as capital expenditures. (9) Represents differences in balance sheet and income statement presentation between IFRS and U.S. GAAP. (10)In 2006, the "All Other" caption includes a cumulative adjustment to net interest income of approximately $207 million, largely to correct the amortization of purchase accounting adjustments related to certain debt that was not included in the fair value option adjustments under IFRSs in 2005. A portion of the amount recognized would otherwise have been recorded for the year ended December 31, 2005. 169 22. COMMITMENTS AND CONTINGENT LIABILITIES-------------------------------------------------------------------------------- LEASE OBLIGATIONS: We lease certain offices, buildings and equipment for periodswhich 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 $134 million in 2006, $132 millionin 2005 and $117 million in 2004. We have lease obligations on certain office space which has been subleasedthrough the end of the lease period. Under these agreements, the sublessee hasassumed future rental obligations on the lease. Future net minimum lease commitments under noncancelable operating leasearrangements were: MINIMUM MINIMUM RENTAL SUBLEASEYEAR ENDING DECEMBER 31, PAYMENTS INCOME NET---------------------------------------------------------------------------------------- (IN MILLIONS) 2007........................................................ $182 $ 58 $1242008........................................................ 144 36 1082009........................................................ 121 34 872010........................................................ 80 15 652011........................................................ 42 - 42Thereafter.................................................. 127 - 127 ---- ---- ----Net minimum lease commitments............................... $696 $143 $553 ==== ==== ==== In January 2006 we entered into a lease for a building in the Village ofMettawa, Illinois. The new facility will consolidate our Prospect Heights, MountProspect and Deerfield offices. Construction of the building began in the springof 2006 and the relocation is planned for the first and second quarters of 2008.The future lease payments for this building are currently estimated as follows: (IN MILLIONS)---------------------------------------------------------------------------- 2008........................................................ $ 52009........................................................ 112010........................................................ 112011........................................................ 11Thereafter.................................................. 115 ---- $153 ==== LITIGATION: Both we and certain of our subsidiaries are parties to various legalproceedings resulting from ordinary business activities relating to our currentand/or former operations which affect all three of our reportable segments.Certain of these activities are or purport to be class actions seeking damagesin significant amounts. These actions include assertions concerning violationsof laws and/or unfair treatment of consumers. Due to the uncertainties in litigation and other factors, we cannot be certainthat we will ultimately prevail in each instance. Also, as the ultimateresolution of these proceedings is influenced by factors that are outside of ourcontrol, it is reasonably possible our estimated liability under theseproceedings may change. However, based upon our current knowledge, our defensesto these actions have merit and any adverse decision should not materiallyaffect our consolidated financial condition, results of operations or cashflows. OTHER COMMITMENTS: At December 31, 2006, our Mortgage Services business hadcommitments with numerous correspondents to purchase up to $104 million of realestate secured receivables at fair market value, subject to availability basedon underwriting guidelines specified by our mortgage services business. Thesecommitments have terms of up to one year and can be renewed upon mutualagreement. Also at 170 December 31, 2006 our Mortgage Services business had outstanding forward salescommitments relating to real estate secured loans totaling $607 million. At December 31, 2006, we have a commitment to lend up to $3.0 billion to H&RBlock to fund the purchase of a participation interest in refund anticipationloans. 23. FAIR VALUE OF FINANCIAL INSTRUMENTS-------------------------------------------------------------------------------- We have estimated the fair value of our financial instruments in accordance withSFAS No. 107, "Disclosures About Fair Value of Financial Instruments" ("SFAS No.107"). Fair value estimates, methods and assumptions set forth below for ourfinancial instruments are made solely to comply with the requirements of SFASNo. 107 and should be read in conjunction with the financial statements andnotes in this Annual Report. A significant portion of our financial instruments do not have a quoted marketprice. For these items, fair values were estimated by discounting estimatedfuture cash flows at estimated current market discount rates. Assumptions usedto estimate future cash flows are consistent with management's assessmentsregarding ultimate collectibility of assets and related interest and withestimates of product lives and repricing characteristics used in ourasset/liability management process. All assumptions are based on historicalexperience adjusted for future expectations. Assumptions used to determine fairvalues for financial instruments for which no active market exists areinherently judgmental and changes in these assumptions could significantlyaffect fair value calculations. As required under generally accepted accounting principles, a number of otherassets recorded on the balance sheets (such as acquired credit cardrelationships, the value of consumer lending relationships for originatedreceivables and the franchise values of our business units) are not consideredfinancial instruments and, accordingly, are not valued for purposes of thisdisclosure. 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, onthird party valuation data, under the "push-down" method of accounting. Webelieve there continues to be substantial value associated with these assetsbased on current market conditions and historical experience. Accordingly, theestimated fair value of financial instruments, as disclosed, does not fullyrepresent our entire value, nor the changes in our entire value. 171 The following is a summary of the carrying value and estimated fair value of ourfinancial instruments: AT DECEMBER 31, ------------------------------------------------------------------------- 2006 2005 ----------------------------------- ----------------------------------- CARRYING ESTIMATED CARRYING ESTIMATED VALUE FAIR VALUE DIFFERENCE VALUE FAIR VALUE DIFFERENCE----------------------------------------------------------------------------------------------------- (IN MILLIONS) ASSETS:Cash...................... $ 871 $ 871 $ - $ 903 $ 903 $ -Interest bearing deposits with banks.............. 424 424 - 384 384 -Securities purchased under agreements to resell.... 171 171 - 78 78 -Securities................ 4,695 4,695 - 4,051 4,051 -Receivables............... 157,262 154,858 (2,404) 136,989 137,710 721Due from affiliates....... 528 528 - 518 518 -Derivative financial assets.................. 1,461 1,461 - 234 234 - LIABILITIES:Commercial paper, bank and other borrowings........ (11,055) (11,055) - (11,454) (11,454) -Due to affiliates......... (15,172) (15,308) (136) (15,534) (15,568) (34)Long term debt............ (127,590) (129,008) (1,418) (105,163) (106,314) (1,151)Insurance policy and claim reserves................ (1,319) (1,362) (43) (1,291) (1,336) (45)Derivative financial liabilities............. (58) (58) - (292) (292) - CASH: Carrying value approximates fair value due to cash's liquid nature. INTEREST BEARING DEPOSITS WITH BANKS: Carrying value approximates fair value dueto the asset's liquid nature. SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL: The fair value of securitiespurchased under agreements to resell approximates carrying value due to theirshort-term maturity. SECURITIES: Securities are classified as available-for-sale and are carried atfair value on the balance sheets. Fair values are based on quoted market pricesor dealer quotes. If a quoted market price is not available, fair value isestimated using quoted market prices for similar securities. RECEIVABLES: The fair value of adjustable rate receivables generallyapproximates carrying value because interest rates on these receivables adjustwith changing market interest rates. The fair value of fixed rate consumerreceivables was estimated by discounting future expected cash flows at interestrates which approximate the current interest rates that would achieve a similarreturn on assets with comparable risk characteristics. Receivables also includesour interest-only strip receivables. The interest-only strip receivables arecarried at fair value on our balance sheets. Fair value is based on an estimateof the present value of future cash flows associated with securitizations ofcertain real estate secured, auto finance, credit card, private label andpersonal non-credit card receivables. DUE FROM AFFILIATES: Carrying value approximates fair value because the interestrates on these receivables adjust with changing market interest rates. COMMERCIAL PAPER, BANK AND OTHER BORROWINGS: The fair value of these instrumentsapproximates existing carrying value because interest rates on these instrumentsadjust with changes in market interest rates due to their short-term maturity orrepricing characteristics. At December 31, 2006 deposits have been classified asbank and other borrowings due to their short-term nature. Prior period amountshave been reclassed to conform to the current presentation. 172 DUE TO AFFILIATES: The estimated fair value of our debt instruments due toaffiliates was determined by discounting future expected cash flows at currentinterest rates offered for similar types of debt instruments. Carrying value istypically used to estimate the fair value of floating rate debt. LONG TERM DEBT: The estimated fair value of our fixed rate debt instruments wasdetermined using either quoted market prices or by discounting future expectedcash flows at current interest rates offered for similar types of debtinstruments. Carrying value is typically used to estimate the fair value offloating rate debt. INSURANCE POLICY AND CLAIM RESERVES: The fair value of insurance reserves forperiodic payment annuities was estimated by discounting future expected cashflows at estimated market interest rates at December 31, 2006 and 2005. The fairvalue of other insurance reserves is not required to be determined in accordancewith SFAS No. 107. DERIVATIVE FINANCIAL ASSETS AND LIABILITIES: All derivative financial assets andliabilities, which exclude amounts receivable from or payable to swapcounterparties, are carried at fair value on the balance sheet. Where practical,quoted market prices were used to determine fair value of these instruments. Fornon-exchange traded contracts, fair value was determined using discounted cashflow modeling techniques in lieu of market value quotes. We enter into foreignexchange contracts to hedge our exposure to currency risk on foreign denominateddebt. We also enter into interest rate contracts to hedge our exposure tointerest rate risk on assets and liabilities, including debt. As a result,decreases/increases in the fair value of derivative financial instruments whichhave been designated as effective hedges are offset by a correspondingincrease/decrease in the fair value of the individual asset or liability beinghedged. See Note 14, "Derivative Financial Instruments," for additionaldiscussion of the nature of these items. 24. CONCENTRATION OF CREDIT RISK-------------------------------------------------------------------------------- A concentration of credit risk is defined as a significant credit exposure withan individual or group engaged in similar activities or having similar economiccharacteristics that would cause their ability to meet contractual obligationsto be similarly affected by changes in economic or other conditions. We generally serve non-conforming and non-prime consumers. Such customers areindividuals who have limited credit histories, modest incomes, highdebt-to-income ratios or have experienced credit problems caused by occasionaldelinquencies, prior charge-offs, bankruptcy or other credit related actions. Asa result, the majority of our secured receivables have a high loan-to-valueratio. Due to customer demand we offer interest-only loans and expect tocontinue to do so. These interest-only loans allow customers to pay only theaccruing interest for a period of time which results in lower payments duringthe initial loan period. Depending on a customer's financial situation, thesubsequent increase in the required payment to begin making payment towards theloan principal could affect our customer's ability to repay the loan at somefuture date when the interest rate resets and/or principal payments arerequired. As with all our other non-conforming and nonprime loan products, weunderwrite and price interest-only loans in a manner that is appropriate tocompensate for their higher risk. At December 31, 2006, the outstanding balanceof our interest-only loans was $6.2 billion, or 4 percent of receivables. AtDecember 31, 2005, the outstanding balance of our interest-only loans was $4.9billion, or 3 percent of receivables. Also due to customer demand, we offer adjustable rate mortgage loans whichallows us to adjust pricing on the receivable in line with market movements. AtDecember 31, 2006, we had approximately $29.8 billion in adjustable ratemortgage loans at our Consumer Lending and Mortgage Services businesses. In 2007and 2008, approximately $10.8 billion and $5.1 billion, respectively, of ouradjustable rate mortgage loans will experience their first interest rate resetbased on receivable levels outstanding at December 31, 2006. In addition, ouranalysis indicates that a significant portion of the second lien mortgages inour Mortgage Services portfolio at December 31, 2006 are subordinated to firstlien adjustable rate mortgages that will face a rate reset in the next threeyears. As interest rates have risen over the last three years, many adjustablerate loans are expected to require a significantly higher monthly paymentfollowing their first adjustment. A customer's financial situation at the timeof the interest rate reset could affect our customer's ability to repay the loanafter the adjustment. 173 Additionally during 2006 and 2005 we increased our portfolio of stated income(low documentation) loans. Stated income loans have a lower income documentationrequirement during the underwriting process and, accordingly, carry a higherrisk of default if the customer has not accurately reflected their income. Weprice stated income loans in a manner that is appropriate to compensate fortheir higher risk. The outstanding balance of our stated income loan portfoliowas $11.8 billon at December 31, 2006 and $7.3 billion at December 31, 2005. Because we primarily lend to consumers, we do not have receivables from anyindustry group that equal or exceed 10 percent of total receivables at December31, 2006 and 2005. We lend nationwide and our receivables are distributed asfollows at December 31, 2006: PERCENT OF TOTAL DOMESTICSTATE/REGION RECEIVABLES------------------------------------------------------------------------------- California.................................................. 13%Midwest (IL, IN, IA, KS, MI, MN, MO, NE, ND, OH, SD, WI).... 23Southeast (AL, FL, GA, KY, MS, NC, SC, TN).................. 20Middle Atlantic (DE, DC, MD, NJ, PA, VA, WV)................ 15Southwest (AZ, AR, LA, NM, OK, TX).......................... 10Northeast (CT, ME, MA, NH, NY, RI, VT)...................... 11West (AK, CO, HI, ID, MT, NV, OR, UT, WA, WY)............... 8 25. GEOGRAPHIC DATA-------------------------------------------------------------------------------- The tables below summarize our owned basis assets, revenues and income beforeincome taxes by material country. Purchase accounting adjustments are reportedwithin the appropriate country. AT DECEMBER 31, ---------------------------------------------------------- IDENTIFIABLE ASSETS LONG-LIVED ASSETS(1) ------------------------------ ------------------------- 2006 2005 2004 2006 2005 2004----------------------------------------------------------------------------------------------- (IN MILLIONS) United States...................... $168,597 $145,955 $115,938 $9,046 $9,382 $ 8,974United Kingdom..................... 6,592 7,006 11,468 452 403 942Canada............................. 4,181 3,479 2,581 157 153 129Europe............................. 89 229 203 - 3 3 -------- -------- -------- ------ ------ -------Total.............................. $179,459 $156,669 $130,190 $9,655 $9,941 $10,048 ======== ======== ======== ====== ====== ======= --------------- (1) Includes properties and equipment, goodwill and acquired intangibles. YEAR ENDED DECEMBER 31, --------------------------------------------------------- REVENUES INCOME BEFORE INCOME TAXES --------------------------- --------------------------- 2006 2005 2004 2006 2005 2004-------------------------------------------------------------------------------------------------- (IN MILLIONS) United States.......................... $21,130 $15,961 $14,326 $2,330 $2,609 $2,858United Kingdom......................... 1,222 1,737 1,426 (170) (37) 6Canada................................. 601 450 340 129 96 82Europe................................. 32 31 16 (2) (5) (6) ------- ------- ------- ------ ------ ------Total.................................. $22,985 $18,179 $16,108 $2,287 $2,663 $2,940 ======= ======= ======= ====== ====== ====== 174 HSBC Finance Corporation--------------------------------------------------------------------------------SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) THREE THREE THREE THREE THREE THREE THREE THREE MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS ENDED ENDED ENDED ENDED ENDED ENDED ENDED ENDED DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31, 2006 2006 2006 2006 2005 2005 2005 2005--------------------------------------------------------------------------------------------------------------------------------- (IN MILLIONS) Finance and other interest income....... $4,629 $4,535 $4,311 $4,087 $3,725 $3,402 $3,139 $2,950Interest expense: HSBC affiliates....................... 320 283 173 153 206 222 134 151 Non-affiliates........................ 1,736 1,650 1,589 1,470 1,221 1,017 970 911 ------ ------ ------ ------ ------ ------ ------ ------Net interest income..................... 2,573 2,602 2,549 2,464 2,298 2,163 2,035 1,888Provision for credit losses on owned receivables........................... 3,066 1,384 1,248 866 1,310 1,361 1,031 841 ------ ------ ------ ------ ------ ------ ------ ------Net interest income after provision for credit losses......................... (493) 1,218 1,301 1,598 988 802 1,004 1,047 ------ ------ ------ ------ ------ ------ ------ ------Other revenues:.........................Securitization related revenue.......... 21 24 51 71 31 41 54 85Insurance revenue....................... 251 280 226 244 257 251 255 234Investment income....................... 175 31 34 34 35 33 33 33Derivative income (expense)............. 72 68 (7) 57 (34) (53) 76 260Fee income.............................. 558 542 429 382 469 439 354 306Enhancement services revenue............ 133 129 130 123 98 86 79 75Taxpayer financial services income...... - 4 20 234 17 (1) 18 243Gain on receivable sales to HSBC affiliates............................ 139 101 97 85 105 99 109 100Servicing and other fees from HSBC affiliates............................ 151 121 116 118 111 109 109 111Other income............................ (7) 34 79 73 86 135 74 41 ------ ------ ------ ------ ------ ------ ------ ------Total other revenues.................... 1,493 1,334 1,175 1,421 1,175 1,139 1,161 1,488 ------ ------ ------ ------ ------ ------ ------ ------Costs and expenses:Salaries and fringe benefits............ 617 571 564 581 536 513 526 497Sales incentives........................ 86 94 98 80 108 117 90 82Occupancy and equipment expense......... 77 78 79 83 82 83 82 87Other marketing expenses................ 268 197 176 173 170 196 185 180Other servicing and administrative expenses.............................. 353 287 222 253 267 186 180 284Support services from HSBC affiliates............................ 304 261 270 252 237 226 217 209Amortization of acquired intangibles........................... 63 63 63 80 65 90 83 107Policyholders' benefits................. 119 123 107 118 109 109 116 122 ------ ------ ------ ------ ------ ------ ------ ------Total costs and expenses................ 1,887 1,674 1,579 1,620 1,574 1,520 1,479 1,568 ------ ------ ------ ------ ------ ------ ------ ------Income before income taxes.............. (887) 878 897 1,399 589 421 686 967Income taxes............................ (323) 327 329 511 196 140 214 341 ------ ------ ------ ------ ------ ------ ------ ------Net income.............................. $ (564) $ 551 $ 568 $ 888 $ 393 $ 281 $ 472 $ 626 ====== ====== ====== ====== ====== ====== ====== ======Operating net income(1)................. $ (642) $ 551 $ 568 $ 888 $ 393 $ 281 $ 472 $ 626 ====== ====== ====== ====== ====== ====== ====== ====== --------------- (1)Operating net income is a non-U.S. GAAP financial measure and is provided for comparison of our operating trends only and should be read in conjunction with our owned basis U.S. GAAP financial information. For the three months ended December 31, 2006, operating net income excludes the $78 million (after-tax) gain on the sale of our investment in Kanbay. 175 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ANDFINANCIAL DISCLOSURE.-------------------------------------------------------------------------------- There were no disagreements on accounting and financial disclosure mattersbetween HSBC Finance Corporation and its independent accountants during 2006. ITEM 9A. CONTROLS AND PROCEDURES.-------------------------------------------------------------------------------- We maintain a system of internal and disclosure controls and procedures designedto ensure that information required to be disclosed by HSBC Finance Corporationin the reports we file or submit under the Securities Exchange Act of 1934, asamended, (the "Exchange Act"), is recorded, processed, summarized and reportedon a timely basis. Our Board of Directors, operating through its auditcommittee, which is composed entirely of independent outside directors, providesoversight to our financial reporting process. We conducted an evaluation, with the participation of the Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by this report.Based upon that evaluation, the Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures were effective asof the end of the period covered by this report so as to alert them in a timelyfashion to material information required to be disclosed in reports we fileunder the Exchange Act. There have been no significant changes in our internal and disclosure controlsor in other factors which could significantly affect internal and disclosurecontrols subsequent to the date that we carried out our evaluation. HSBC Finance Corporation continues the process to complete a thorough review ofits internal controls as part of its preparation for compliance with therequirements of Section 404 of the Sarbanes-Oxley Act of 2002. Section 404requires our management to report on, and our external auditors to attest to,the effectiveness of our internal control structure and procedures for financialreporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act, ourfirst report under Section 404 will be contained in our Form 10-K for the periodended December 31, 2007. ITEM 9B. OTHER INFORMATION.-------------------------------------------------------------------------------- None. PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.-------------------------------------------------------------------------------- DIRECTORS Set forth below is certain biographical information relating to the members ofHSBC Finance Corporation's Board of Directors. Each director is electedannually. There are no family relationships among the directors. WILLIAM R. P. DALTON, age 63, joined HSBC Finance Corporation's Board in April2003. Mr. Dalton retired in May 2004 as an Executive Director of HSBC Holdingsplc, a position he held from April 1998. He also served HSBC as Global Head ofPersonal Financial Services from August 2000 to May 2004. From April 1998 toJanuary 2004 he was Chief Executive of HSBC Bank plc. Mr. Dalton held positionswith various HSBC entities for 25 years. Mr. Dalton is a member of the Compensation Committee. GARY G. DILLON, age 72, joined HSBC Finance Corporation's Board in 1984. Mr.Dillon retired as Chairman of the Board of Schwitzer Group (a manufacturer ofengine components) in March 1999. He had served as Chairman of Schwitzer from1991 and Chief Executive Officer of Schwitzer from 1989. From 1989 to 1997 healso served as President of Schwitzer. Prior to 1989 he was President and ChiefExecutive Officer of Household Manufacturing, Inc., the former diversifiedmanufacturing subsidiary of HSBC Finance Corporation. 176 Mr. Dillon is currently a member of the Compensation, Executive and AuditCommittees and will retire from the Board in April 2007. J. DUDLEY FISHBURN, age 60, joined HSBC Finance Corporation's Board in 1995. Mr.Fishburn became Chairman of the Board of HFC Bank Ltd. (HSBC FinanceCorporation's primary subsidiary in the United Kingdom) in 1998. He is also onthe Board of HSBC Bank (UK) plc. He previously served as the Conservative Memberof Parliament for Kensington in London from 1988 to 1997. Prior to enteringParliament, Mr. Fishburn was Executive Editor for The Economist Newspaper Ltd.from 1979 until 1988. He is also a Director of Altria Inc., Henderson SmallerCompanies Investment Trust plc and Beazley Group plc. He is a trustee of theFoundation for Liver Research, The Peabody Trust and Reading University. Mr. Fishburn is a member of the Nominating & Governance Committee. DOUGLAS J. FLINT, age 51, joined HSBC Finance Corporation's Board in February2007. Mr. Flint serves as the Group Finance Director with responsibility forstrategy, investor relations, finance and tax at HSBC. He joined HSBC as anexecutive Director in 1995. Mr. Flint chaired the Financial Reporting Council'sreview of the Turnbull Guidance on Internal Control, served on the AccountingStandards Board and the Standards Advisory Council of the InternationalAccounting Standards Board from 2001 to 2004 and is former partner in KPMG. Heis a non-executive Director of BP plc since January 2005. Mr. Flint is an ex-officio non-voting member of the Audit Committee. CYRUS F. FREIDHEIM, JR., age 71, joined HSBC Finance Corporation's Board in1992. He currently serves as the Chief Executive Officer of the Sun-Times MediaGroup Inc., and is a member of the Board since October 2005. Mr. Freidheimserved as Chairman of the Board and Chief Executive Officer of Chiquita BrandsInternational, Inc. from March 2002 until January 2004 and Chairman until May2004. In March 2002, he retired as Vice Chairman of Booz, Allen & Hamilton, Inc.(a management consulting firm), with which he had been affiliated since 1966. Heis also a Director of Allegheny Energy, Inc. and Virgin America Inc. He is aTrustee for The Brookings Institution, Rush University Medical Center, ChicagoCouncil on Global Affairs and the Chicago Symphony Orchestra. Mr. Freidheim is aMember of the Advisory Council of the Mendosa School of Business at theUniversity of Notre Dame, The Economic Club of Chicago and The Commercial Clubof Chicago, Council of Foreign Relations. Mr. Freidheim is the Lead Director and as such is the Chair of the ExecutiveCommittee and an ex-officio member of the Audit, Compensation and Nominating andGovernance Committees. ROBERT K. HERDMAN, age 58, joined HSBC Finance Corporation's Board in 2004. Healso serves as a member of the Board of Directors of HSBC North America HoldingsInc. Mr. Herdman is a partner and Managing Director of Kalorama Partners LLC, aWashington, D.C. consulting firm. Mr. Herdman was the Chief Accountant of theU.S. Securities and Exchange Commission from October 2001 to November 2002. TheChief Accountant serves as the principal advisor to the Commission on accountingand auditing matters, and is responsible for formulating and administering theaccounting program and policies of the Commission. Prior to joining the SEC, Mr.Herdman was Ernst & Young's Vice Chairman of Professional Practice for itsAssurance and Advisory Business Services (AABS) practice in the Americas and theGlobal Director of AABS Professional Practice for Ernst & Young International.Mr. Herdman was the senior E&Y partner responsible for the firms' relationshipswith the SEC, Financial Accounting Standards Board (FASB) and American Instituteof Certified Public Accountants (AICPA). He was on the AICPA's SEC PracticeSection Executive Committee (1995-2001) and a member of the AICPA's Board ofDirectors (2000-2001). Mr. Herdman is Chair of the Audit Committee. GEORGE A. LORCH, age 65, joined HSBC Finance Corporation's Board in 1994. Healso serves as a member of the Board of Directors of HSBC North America HoldingsInc. From May 2000 until August 2000, Mr. Lorch served as Chairman, Presidentand Chief Executive Officer of Armstrong Holdings, Inc. (the parent of ArmstrongWorld Industries, Inc.). Mr. Lorch served as Chairman of the Board, ChiefExecutive Officer and President of Armstrong World Industries, Inc. (amanufacturer of interior finishes) from 1994 and President 177 and Chief Executive Officer from 1993 until May 1994. Mr. Lorch is a Director ofThe Williams Companies, Inc., Autoliv, Inc. and Pfizer Inc. Mr. Lorch is Chair of the Compensation Committee and a member of the Nominating& Governance Committee. LARREE M. RENDA, age 48, joined HSBC Finance Corporation's Board in 2001. Ms.Renda has been employed by Safeway Inc. since 1974. She became Executive VicePresident, Chief Strategist and Administrative Officer of Safeway, Inc. inNovember, 2005. Prior to her current position she served as Executive VicePresident for Retail Operations, Human Resources, Public Affairs, Labor andGovernment Relations since 1999. Prior to this position, she was a Senior VicePresident from 1994 to 1999, and a Vice President from 1991 to 1994. She is alsoa director and Chairwoman of the Board of The Safeway Foundation and serves onthe board of directors for Casa Ley, S.A. de C.V. Ms. Renda is a member of theRetailing Initiative Advisory Board of the Wharton School of Business and servesas a Trustee on the National Joint Labor Management Committee. Additionally sheserves on the board of directors of both the California and U.S. Chamber ofCommerce and serves as a National Vice President of the Muscular DystrophyAssociation. Ms. Renda is Chair of the Nominating & Governance Committee and a member of theAudit Committee. MICHAEL R. P. SMITH, age 50, joined HSBC Finance Corporation's Board in 2006.Mr. Smith joined the HSBC Group in 1978 and since that time has held a widevariety of posts in Hong Kong, the Asia-Pacific region, the UK, Australia, theMiddle East and South America. Mr. Smith is the President and Chief ExecutiveOfficer of The Hongkong and Shanghai Banking Corporation. He became Chairman ofHSBC Bank Malaysia Berhad and a director of HSBC Bank Australia Limited inJanuary 2004 and Chairman of Hang Seng Bank Limited in April 2005 and in June2005, he took on the role of Global Head of Commercial Banking for the HSBCGroup, positions he continues to hold. Mr. Smith is a member of VISAInternational Asia Pacific Regional Board, as well as a Fellow of the Hong KongManagement Association. He is Head of Advisory Council of Asia InvestmentCorporation and a member of Chongqing Mayor's International Economic AdvisoryCouncil. 178 EXECUTIVE OFFICERS Information regarding the executive officers of HSBC Finance Corporation as ofMarch 5, 2007 is presented in the following table. ----------------------------------------------------------------------------------------------- YEARNAME AGE APPOINTED PRESENT POSITION----------------------------------------------------------------------------------------------- Brendan P. McDonagh 48 2007 Chief Executive OfficerAndrew C. Armishaw 44 2004 Group Executive - Chief Information OfficerPatrick A. Cozza 51 2004 Group ExecutiveThomas M. Detelich 50 2002 Group ExecutiveWalter G. Menezes 61 2004 Group ExecutiveDavid D. Gibbons 51 2007 Senior Executive Vice President - Corporate Risk and ComplianceKenneth H. Robin 60 1989 Senior Executive Vice President - General Counsel & Corporate SecretaryChristopher D. Spooner 56 2006 Senior Executive Vice PresidentAnthony J. Murphy 47 2007 Senior Executive Vice President - Portfolio ManagementSteven B. Gonabe 55 2005 Executive Vice President - AdministrationLisa M. Sodeika 43 2004 Executive Vice President - Corporate AffairsMark A. Melas 50 2007 Executive Vice President - Corporate Real EstateJohn J. Haines 43 2004 Managing Director - Auto FinanceJoseph W. Hoff 56 2005 Managing Director - Retail ServicesGary R. Esposito 46 2005 Managing Director - Mortgage ServicesPatrick J. Burke 45 2006 Managing Director - Card ServicesThomas M. Kimble 58 2007 Managing Director - Strategic Cost Initiative and Global ResourcingBeverley A. Sibblies 45 2004 Senior Vice President - Chief Financial OfficerWilliam H. Kesler 55 2006 Senior Vice President - TreasurerJames E. Binyon 43 2006 Vice President and Chief Accounting Officer----------------------------------------------------------------------------------------------- Brendan P. McDonagh, Chief Executive Officer of HSBC Finance Corporation sinceFebruary 2007. Mr. McDonagh served as Chief Operating Officer of HSBC FinanceCorporation prior to his appointment as Chief Executive Officer in February2007. From December 2006 to February 2007, Mr. McDonagh held the title of GroupExecutive of HSBC Finance Corporation. From October 2004 to December 2006 heserved as Chief Operating Officer of HSBC Bank USA. He is also a Group GeneralManager of HSBC Holdings plc having been appointed as such in August 2005. Aninternational manager for the HSBC Group for more than twenty five years, Mr.McDonagh began his career with HSBC in 1979, completing various assignmentsthroughout the world. In September 2002, he transferred to the United States torun the retail and commercial banking operations of HSBC Bank USA. Mr. McDonaghis active in several US and Ireland organizations including the New YorkRegional Board of the American Ireland Fund and USA Board of Co-operationIreland. Mr. McDonagh is Chairman-elect of the Consumer Bankers Association. Andrew C. Armishaw, Group Executive and Chief Information Officer of HSBCFinance Corporation and Senior Executive Vice President and Chief InformationOfficer of HSBC North America Holdings Inc. since January 2004. From January2001 to December 2003 Mr. Armishaw was Head of Global Resourcing for HSBC andfrom 1994 to 1999 was Chief Executive Officer of First Direct (a subsidiary ofHSBC) and Chief Information Officer of First Direct. Patrick A. Cozza, Group Executive of HSBC Finance Corporation since April 2004.Prior to that Mr. Cozza became President - Refund Lending and Insurance Servicesin 2002 and Managing Director and Chief 179 Executive Officer - Refund Lending in 2000. He also serves on the board ofdirectors of Junior Achievement in New Jersey, Cancer Hope Network, SomersetBusiness Partnership and American Council of Life Insurers PAC. Mr. Cozza servesas board member and officer of Household Life Insurance Company, First CentralNational Life Insurance Company and HSBC Insurance Company of Delaware, allsubsidiaries of HSBC Finance Corporation. Thomas M. Detelich, Group Executive, Consumer and Mortgage Lending of HSBCFinance Corporation since August 2006. Mr. Detelich is also a Group GeneralManager for HSBC since October 1, 2006. He became Group Executive, ConsumerLending in July 2002. Mr. Detelich also held the positions of Managing Directorat Beneficial Corporation from March 2000 to July 2002 and Managing Director ofHousehold Finance Corporation from January 1999 to July 2002 and regionalgeneral manager of consumer lending in 1998. Mr. Detelich was formerly withTransamerica for 21 years, becoming Executive Vice President of BranchOperations in 1997. Walter G. Menezes, Group Executive of HSBC Finance Corporation since April 2004and is responsible for HSBC Finance Corporation's credit card and private labelcredit card operations. Mr. Menezes is also a Group General Manager for HSBCsince October 1, 2006. Mr. Menezes held the title of President and ChiefExecutive Officer for Auto Finance from 2002 to August 2004 and ManagingDirector and Chief Credit Officer of Credit Card Services since from 1998 to2002. He joined HSBC Finance Corporation in 1996 as National DirectorCollections - Credit Card Services. David D. Gibbons, Senior Executive Vice President, Corporate Risk and Complianceof HSBC Finance Corporation and of HSBC North America Holdings Inc. sinceFebruary 2007. Prior to that Mr. Gibbons was Senior Executive Vice President,Chief Risk Officer of HSBC Finance Corporation and of HSBC North AmericaHoldings Inc. since March 2004. Mr. Gibbons served as Deputy Comptroller forSpecial Supervision from October 2002 to March 2004, was with the Office of theComptroller of the Currency from September 1977 to March 2004 and served asDeputy Comptroller of the Currency for Credit Risk from 1997 to 2002. Kenneth H. Robin, Senior Executive Vice President, General Counsel and CorporateSecretary of HSBC Finance Corporation since May 2003 and Senior Executive VicePresident, General Counsel and Corporate Secretary of HSBC North AmericaHoldings Inc. since January 2004. Prior to that Mr. Robin was Senior VicePresident, General Counsel and Secretary of HSBC Finance Corporation, since1993. Christopher D. Spooner, Senior Executive Vice President of HSBC FinanceCorporation and Senior Executive Vice President and Chief Financial Officer ofHSBC North America Holdings Inc. since December 2006. Mr. Spooner has heldvarious positions since arriving at HSBC in 1994 including Group Tax Controllerand Head of Group Financial Planning and Tax for HSBC Holdings plc., a positionhe continues to hold. Anthony J. Murphy, Senior Executive Vice President - Portfolio Management forHSBC Finance Corporation since February 2007. Prior to his appointment to thisposition, Mr. Murphy was President and Chief Executive Officer of HSBCSecurities (USA) Inc. and Chief Operating Officer of CIBM Americas. He was alsoCo-Head of Corporate, Investment Banking and Markets (CIBM Americas) sinceNovember 2004. Mr. Murphy has been with the HSBC Group since 1990. Prior to hisappointment as Chief Executive Officer of HSBC Securities (USA) Inc. in April2003, Mr. Murphy served as Chief Strategic Officer of CIBM Americas from 2000.Prior to that assignment, he was Head of Market Risk Management for HSBC Bankplc and HSBC Investment Bank in London from 1996. Steven B. Gonabe, Executive Vice President of Administration of HSBC FinanceCorporation and of HSBC North America Holdings Inc. since July 2005. From June1997 to July 2005 Mr. Gonabe was Vice President of Human Resources for HSBCcredit card services, auto finance and mortgage services businesses. Mr. Gonabehas served on the board of directors for the United Way of Monterey County andis a member of the Junior Achievement of Silicon Valley and Monterey Bay,California. He is currently involved with Students in Free Enterprise (SIFE), anorganization designed to develop an understanding of the principles of financialeducation for young people. Lisa M. Sodeika, Executive Vice President of Corporate Affairs of HSBC FinanceCorporation and of HSBC North America Holdings Inc. since June 2005. Ms. Sodeikadirects HSBC North America's public affairs, 180 employee communications, government relations, consumer advocacy, communitydevelopment and philanthropic services activities. From January 2003 to June2005 Ms. Sodeika was Senior Vice President - Corporate Affairs and VicePresident - Consumer Affairs. Since joining HSBC Finance Corporation, Ms.Sodeika has held management positions in a variety of operational areas withinthe consumer finance and retail services businesses including marketing,collections, quality assurance and compliance, underwriting and human resources.Ms. Sodeika serves as chairperson of the Federal Reserve Board's ConsumerAdvisory Council. Mark A. Melas, Executive Vice President - Corporate Real Estate, North Americasince 2000. Prior to that, Mr. Melas held the position of Senior Vice Presidentfrom April 1995. From 1978 through March 1995 he was employed at New YorkTelephone (NYNEX) as an Area Operations Manager in Corporate Real Estate. John J. Haines, Managing Director of Auto Finance of HSBC Finance Corporationsince joining HSBC Finance Corporation in August 2004. From May 1989 to August2004 Mr. Haines worked for General Electric where most recently he was SeniorVice President - Products and Services for General Electric Fleet Services andSenior Vice President - North American Operations for General Electric FleetServices. Mr. Haines is a member of the Automotive Finance Committee of theConsumer Bankers Association. Mr. Haines is on the Board of Directors of the SanDiego Chamber of Commerce, United Way and NP Strategies, a non-profitorganization. Joseph W. Hoff, Managing Director of Retail Services of HSBC Finance Corporationsince March 2005. Mr. Hoff served as Chief Financial Officer for the RetailServices business from April 1995 to March 2005. He has been with HSBC FinanceCorporation since 1976 in various accounting and corporate finance positions. Gary R. Esposito, Managing Director and Chief Executive Officer of MortgageServices for HSBC North America Holdings Inc. From 2002 to 2005, Mr. Espositoheld the positions of Managing Director - U.S. branch operations for theConsumer Lending business and was the President, Chief Executive Officer andChairman for HSBC Canada from October 2000 to November 2003. He was alsoNational Director, branch and retail operations from 1998 through 2000. He hasbeen with HSBC Finance Corporation since 1982. Patrick J. Burke, Managing Director and Chief Executive Officer of Credit CardServices for HSBC Finance since January 2006. He was appointed President andChief Executive Officer of HSBC Financial Limited Canada in January 2003 untilJuly 2006. Patrick was appointed Chief Financial Officer with HFC Bank Limitedfrom 2000 until 2003. From the start of his career with HSBC in 1989, Patrickhas served the company in many roles including Deputy Director of Mergers andAcquisitions and Vice President of Strategy and Development. Thomas M. Kimble, Managing Director - Strategic Cost Initiative and GlobalResourcing of HSBC Finance Corporation and of HSBC North America Holdings Inc.since February 2007. Prior to his appointment to this position, since July 2006Mr. Kimble served as the Managing Director - Global Projects and Operations forHSBC North America Holdings Inc. and prior to that, Managing Director ofOperations for Household/ HSBC Card Services for eight years. Mr. Kimble hasbeen active in the Salinas Valley Chamber of Commerce and is a past president ofthe Chamber. He is also a Past President of Shelter Outreach Plus, a domesticviolence shelter. Beverley A. Sibblies, Senior Vice President and Chief Financial Officer of HSBCFinance Corporation and Executive Vice President of Finance of HSBC NorthAmerica Holdings Inc. since October 2005. Ms. Sibblies joined HSBC FinanceCorporation in November 2004 as the Senior Vice President and Chief AccountingOfficer. Prior to joining HSBC Finance Corporation, she served as Executive VicePresident and Chief Financial Officer for EMC Mortgage from June 2000 toFebruary 2004. Prior to that, she served as a partner in the financial servicespractice of Deloitte & Touche, LLP from July 1997 to June 2000. William H. Kesler, Senior Vice President - Treasurer since April 1, 2006. Mr.Kesler joined HSBC Finance Corporation in 1992 and since that time has heldvarious treasury management positions. He is a trustee of the Hospice ofNortheastern Illinois Foundation and serves on the Foundation's executivecommittee. 181 James E. Binyon, Vice President and Chief Accounting Officer since February2006, and from September 2004 was Vice President and Controller of CorporateFinance. From November 2001 to August 2004 he served as Finance Director ofFirst Direct, and from February 1995 to October 2001 was Senior Area AccountingManager, and Manager - Balance Sheet Management for HSBC Hong Kong. Mr. Binyonwas Manager-Asset Management & Funding, and Manager - Treasury Audit Departmentbetween 1992 and 1995. Prior to joining HSBC, Mr. Binyon spent five years atKPMG. CORPORATE GOVERNANCE-------------------------------------------------------------------------------- BOARD OF DIRECTORS - COMMITTEES AND CHARTERS The Board of Directors of HSBC Finance Corporation has four standing committees:the Audit Committee, the Compensation Committee, the Nominating and GovernanceCommittee and the Executive Committee. The charters of the above-mentionedcommittees, as well as our Corporate Governance Standards, are available on ourwebsite at www.hsbcusa.com or upon written request made to HSBC FinanceCorporation, 2700 Sanders Road, Prospect Heights, Illinois 60070, Attention:Corporate Secretary. Audit Committee The primary purpose of the audit committee is to assist the Board of Directorsin fulfilling its oversight responsibilities relating to HSBC FinanceCorporation's system of internal controls over financial reporting and itsaccounting, auditing and financial reporting practices. The audit committee iscurrently comprised of the following independent Directors (as defined by HSBCFinance Corporation's Corporate Governance Standards which are based upon therules of the New York Stock Exchange): Gary G. Dillon, Robert K. Herdman andLarree M. Renda. In addition, Cyrus F. Freidheim, Jr., Lead Director, andDouglas J. Flint, Group Finance Director of HSBC, are non-voting members of theaudit committee. The Board has determined that each of these individuals isfinancially literate. The Board of Directors has determined that Robert K.Herdman qualifies as an audit committee financial expert. Compensation Committee The primary purpose of the Compensation Committee is to assist the Board ofDirectors in discharging its responsibilities related to the compensation of theChief Executive Officer of HSBC Finance Corporation and the officers that aredirect reports to the Chief Executive Officer and such other officers as may bedesignated by the Board of Directors. The Compensation Committee is currentlycomprised of the following directors: George A. Lorch (Chair), William R. P.Dalton, Gary G. Dillon and Cyrus F. Freidheim, Jr. (ex-officio member). With theexception of Mr. Dalton, all members of the Compensation Committee areindependent directors under HSBC Finance Corporation's Corporate GovernanceStandards. The Charter of the Compensation Committee lists the primary responsibilities,powers and authorities of the Compensation Committee. The listed items include(i) review and approve corporate goals and performance objectives relevant tothe compensation of the Chief Executive Officer and executive officers, evaluatethe performance of the Chief Executive Officer and executive officers in lightof those goals and objectives, and review its findings with the Board ofDirectors in executive session, (ii) submit recommendations concerning basesalary, performance-based cash and long term equity-based incentive awards forthe Chief Executive Officer and executive officers to the Remuneration Committeeof HSBC ("REMCO") for approval, (iii) recommend to REMCO equity incentives underHSBC plans to all employees, except those awards that the Chief ExecutiveOfficer may determine based upon a delegation of authority by REMCO, (iv) reviewand approve benefits and perquisites of the Chief Executive Officer andexecutive officers to the extent such benefits are not available to allemployees, (v) recommend to the Board of Directors and REMCO the creation oramendment of any welfare, or tax qualified employee benefit plan or program ofHSBC Finance Corporation, or any long-term executive compensation plan orprogram of HSBC Finance Corporation whose participants include the ChiefExecutive Officer or executive officers, (vi) review and recommend to REMCO anyemployment and severance contracts for the Chief Executive Officer and executiveofficers, as well as any severance payouts to such officers, (vii) review andconsider "best practices" of peer companies 182 with respect to compensation philosophies, policies and practices, (viii) reviewmanagement's Compensation Discussion and Analysis ("CD&A") to be included inHSBC Finance Corporation's Annual Report on Form 10-K, discuss the CD&A'scontent with management, and prepare the Compensation Committee Reportconcerning the CD&A and recommend to the Board of Directors that the CD&A beincluded in the annual report on Form 10-K and (ix) engage in an annual selfassessment with the goal for continuing improvement, and to review and assessthe adequacy of this charter at least annually and recommend any proposedchanges to the Board of Directors for approval. The Compensation Committee may in its discretion retain and dischargeconsultants to assist the Compensation Committee in evaluating director, ChiefExecutive Officer or executive officer compensation and to determine theappropriate terms of engagement and the fees to be paid to such consultants. TheChief Executive Officer is given full authority, which may be delegated, toestablish the compensation and salary ranges for all other employees of HSBCFinance Corporation and its subsidiaries whose salaries are not subject toreview by the Compensation Committee and approval by REMCO. For more informationabout the compensation policy of HSBC Finance Corporation please see Item 11.Executive Compensation - Compensation Discussion and Analysis. Nominating and Governance Committee The primary purpose of the Nominating and Governance Committee is to assist theBoard of Directors of HSBC Finance Corporation in discharging itsresponsibilities related to identifying and nominating members of the Board ofDirectors to the Board, recommending the composition of each committee of theBoard of Directors and the Chair of each committee, establishing and reviewingHSBC Finance Corporation's corporate governance and making recommendations tothe Board of Directors regarding compensation for service of the non-executiveBoard members. The Nominating and Governance Committee ensures that HSBC FinanceCorporation maintains "best practices" with respect to corporate governance inorder to ensure effective representation of its stakeholders. The Nominating and Governance Committee is currently comprised of the followingdirectors: J. Dudley Fishburn, Cyrus F. Freidheim, Jr. (ex-officio member),George A. Lorch and Larree M. Renda (Chair). With the exception of Mr. Fishburn,all members of the Nominating and Governance Committee are independent directorsunder HSBC Finance Corporation's Corporate Governance Standards. Executive Committee The Executive Committee may exercise the powers and authority of the Board ofDirectors in the management of the business and affairs of the corporationduring the intervals between meetings of the Board of Directors. Messrs. Gary G.Dillon and Cyrus F. Freidheim, Jr. are members of the Executive Committee. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Exchange Act, as amended, requires certain of ourDirectors, executive officers and any persons who own more than ten percent of aregistered class of our equity securities to report their initial ownership andany subsequent change to the SEC and the New York Stock Exchange ("NYSE"). Withrespect to the 6.36% Series B Preferred Stock of HSBC Finance Corporation, wereviewed copies of all reports furnished to us and obtained writtenrepresentations from our Directors and executive officers that no other reportswere required. Based solely on a review of copies of such forms furnished to usand written representations from the applicable Directors and executiveofficers, all required reports of changes in beneficial ownership were filed ona timely basis for the 2006 fiscal year. CODE OF ETHICS HSBC Finance Corporation's Board of Directors has adopted a Code of Ethics forSenior Financial Officers. That Code of Ethics is incorporated by reference inExhibit 14 to this Annual Report on Form 10-K. HSBC Finance Corporation also hasa general code of ethics applicable to all employees that is referred to as itsStatement of Business Principles and Code of Ethics. That document is availableon our website at 183 www.hsbcusa.com or upon written request made to HSBC Finance Corporation, 2700Sanders Road, Prospect Heights, Illinois 60070, Attention: Corporate Secretary. ITEM 11. EXECUTIVE COMPENSATION.-------------------------------------------------------------------------------- COMPENSATION DISCUSSION AND ANALYSIS ("2006 CD&A") The following discussion summarizes the principles, objectives and factorsconsidered by HSBC Finance Corporation in evaluating and determining thecompensation of executive officers in 2006. Specific compensation informationrelating to Siddharth N. Mehta, Chairman and Chief Executive Officer of HSBCFinance Corporation until February 15, 2007; Thomas M. Detelich and Walter G.Menezes, Group Executives; Kenneth H. Robin, Senior Executive Vice President,General Counsel and Corporate Secretary; and Beverley A. Sibblies, Senior VicePresident and Chief Financial Officer, is contained in this portion of the Form10-K. OVERSIGHT OF COMPENSATION DECISIONS HSBC Finance Corporation is a wholly owned subsidiary of HSBC Holdings plc("HSBC"). The Board of Directors of HSBC has the authority to delegate any ofits powers, authorities and judgments to any committee consisting of one or moredirectors and has established a Remuneration Committee ("REMCO") for the purposeof setting the remuneration policy for HSBC and its subsidiaries and thecompensation of senior executives. REMCO's responsibilities include reviewingand approving performance-based remuneration by reference to corporate goals andobjectives established by the Board of Directors of HSBC from time to time andapproving overall market positioning of the compensation package, individualbase salaries and increases, and annual and long-term incentive/bonusarrangements for certain executives, including Messrs. Mehta, Detelich, Menezesand Robin. In November 2006, REMCO delegated its authority for approval ofsalaries and annual cash incentive awards relating to certain classes ofexecutives to Michael F. Geoghegan, the HSBC Group Chief Executive (the "HSBCCEO"). However, REMCO retained exclusive authority over compensation of the moresenior executives within HSBC and its subsidiaries. As a result, REMCO hadauthority over the compensation of Messrs. Mehta, Detelich and Menezes in 2006while the HSBC CEO had authority over Mr. Robin. REMCO has exclusive authoritywith respect to all long-term incentive plan awards involving interests in HSBCordinary shares. The members of REMCO in 2006 were Sir Mark Moody-Stuart (Chairman), W.K.L. Fung,S. Hintze, Sir John Kemp-Welch (until retirement on May 26, 2006) and J.D.Coombe (effective as of June 1, 2006), all of whom were or are non-executivedirectors of HSBC. REMCO has retained the services of Towers Perrin, a humanresource consulting firm, to provide independent advice on executivecompensation issues. The Compensation Committee of the Board of Directors of HSBC Finance Corporation(the "Compensation Committee") seeks to ensure that our compensation policiesand practices support the objectives of HSBC Finance Corporation's compensationprogram, which is based upon compensation objectives established by REMCO. TheCompensation Committee makes advisory recommendations for all compensation to bepaid to our Chief Executive Officer and each of his direct reports. Throughout the year, management of our Human Resources Department consults withHSBC Human Resources executives concerning compensation policies and specificawards for certain executives. Our Human Resources executives work with theCompensation Committee to prepare a comprehensive annual compensation packagefor Mr. Mehta and each executive officer that reports to him. This package isprepared and late in each calendar year is forwarded to HSBC Human Resourcesmanagement for submission to REMCO and the HSBC CEO, as appropriate, andincludes advisory recommendations for salary for the ensuing calendar year, apreliminary performance-based cash award and an equity-based long-term incentiveaward. As the performance-based cash award is dependent upon satisfaction ofobjectives that cannot be evaluated until the end of the performance measurementyear, the final determination of that component of 184 compensation is not made until the Compensation Committee receives reports frommanagement concerning satisfaction of corporate, business unit and individualobjectives in January. REMCO or the HSBC CEO, as appropriate, will approve orrevise the advisory recommendations provided by the Compensation Committee. Theterms of compensation for Ms. Sibblies are proposed by the Chief FinancialOfficer of HSBC North America Holdings Inc., in consultation with our HumanResources executives, and is approved by the HSBC Finance Corporation ChiefExecutive Officer. The Compensation Committee is comprised of the following individuals: George A.Lorch (Chair), William R. P. Dalton, Gary G. Dillon and Cyrus F. Freidheim, Jr.(ex-officio member). During 2006, with the exception of Mr. Dalton, theCompensation Committee was composed of independent directors, as defined underHSBC Finance Corporation's Corporate Governance Standards. Additionalinformation with regard to the Compensation Committee, including a descriptionof its responsibilities under the its charter, is contained in the section ofthis Form 10-K entitled Item 10. Directors, Executive Officers and CorporateGovernance -- Corporate Governance. OBJECTIVES OF HSBC FINANCE CORPORATION'S COMPENSATION PROGRAM Our compensation program is designed to support the successful recruitment,development, and retention of high performing executive talent and to incentthose executives to achieve HSBC Finance Corporation's short-term businessobjectives and to optimize its long-term financial returns. We design ourcompensation programs to be competitive with a comparator group of benchmarkfinancial institutions. HSBC Finance Corporation's comparator group is comprisedof U.S.-based organizations that compete with us for business, customers, andexecutive talent. Our comparator group includes American Express Company, Bankof America Corporation, Capital One Financial Corporation, Countrywide FinancialCorporation, Citigroup, Inc., FifthThird Bancorp, JP Morgan Chase, MBNACorporation, National City Corporation, US Bancorp, Wachovia Corporation andWells Fargo & Company (collectively, the "Comparator Group"). While most ofthese organizations are publicly held companies, our operations are ofcomparable scale and complexity and our compensation program is designed toprovide the flexibility to offer compensation that is competitive with theComparator Group so that we may attract and retain the highest performingexecutives. The philosophy underlying our executive compensation program which is designedto promote the compensation objectives of our parent, HSBC, is as follows: Link to Company Performance We seek to offer competitive base salaries with a significant portion ofvariable compensation components determined by measuring performance of theexecutives, their business unit(s), HSBC Finance Corporation and HSBC. Theperformance-based cash compensation plans that are more fully described underElements of Compensation - Annual Performance-Based Awards, emphasize revenueand expense growth, net income, receivable growth, profits, and other keyperformance measures. Other considerations taken into account in settingcompensation policies and making compensation decisions include demonstratedleadership, future potential, adherence to HSBC's ethical standards and theability to leverage capabilities across businesses. Corporate, business unitand/or individual goals are established at the beginning of each year. Compensation plans motivate our executives to improve the overall performanceand profitability of HSBC as well as the specific region, unit, or function towhich they are assigned. Each executive's individual performance andcontribution is considered in making salary adjustments and determining theamount of annual performance bonus paid and the value of HSBC equity sharesgranted each year. We have historically used grants of stock options and restricted shares toreward and provide longer term incentives for our executives. However, in 2005,HSBC adopted a new philosophy to provide only restricted shares, called"Achievement Shares", which vest on a specified date if the executive remainsemployed through that date and "Performance Shares" that require continuedemployment and satisfaction of corporate performance conditions designed toreinforce a long-term focus on HSBC's Managing for Growth strategy anddelivering value to its shareholders. Performance shares are granted to the mostsenior executives whose 185 business units have the ability to have a direct impact on HSBC's consolidatedresults. Achievement share awards are granted to other high performingexecutives. Competitive Compensation Levels and Marketplace Research We endeavor to maintain compensation programs that are competitive with ourComparator Group. We operate in a highly competitive business environment, inwhich our Comparator Group and other financial services companies continuouslylook to gain market share and competitive advantage by hiring top executivetalent. On an annual basis and as needed when recruiting, we compare thecompensation for our executive officers to that of executives with similarresponsibilities and scope of business. In 2006 the Compensation Committeeconsidered comparative data from a general industry survey of 340 non-financialservices companies, a financial services survey of 150 companies and a survey ofour Comparator Group to help establish compensation levels for our executives. We research the types of compensation programs provided by other companies,compensation levels for executives, details of certain compensation programs,historical marketplace compensation trends, marketplace practices regarding paymix, stock vesting terms, equity ownership levels, the amount of pay that isderived from equity incentives and the benefits provided to executives. We alsoresearch different aspects of performance, including the relationship betweenperformance and pay, a comparison of HSBC Finance Corporation's historicalperformance to our Comparator Group, and types of performance measures that areused by other companies for their annual and long-term incentive programs.Research data is gathered from several different sources, including generalsurveys of the marketplace and through retained compensation consultants. Our compensation programs generally provide executives with the opportunity toearn a base salary that is near the 50th percentile average of our ComparatorGroup. We believe this represents a competitive base salary for meeting generalbusiness objectives. However, total compensation, which includes incentiveawards, is targeted to be in the 75th percentile if we, HSBC and the executivemeet established performance goals. This provides greater incentive to achievehigher performance standards and the specific goals established by theCompensation Committee each year. The level of compensation paid to an executivefrom year to year will differ based upon performance. This year-to-yeardifference stems mainly from HSBC Finance Corporation's and/or an individualbusiness unit's performance results and, for individuals eligible forperformance-based stock awards, awards may vary based upon HSBC's performanceresults. Compensation levels will also increase or decrease based on theexecutive's individual performance and level of responsibility. We also track the amount of an executive's compensation that is subject tomulti-year vesting restrictions and the Compensation Committee considers awealth accumulation analysis and total annual compensation summary for eachexecutive. This information helps the Compensation Committee to gauge ourability to retain highly talented executives and provide advice on competitivecompensation packages to REMCO or to the HSBC CEO, as appropriate. Repricing of Stock Options and Timing of Option Grants The exercise price of stock options under historical Household International,Inc. option plans was based upon the stock price on the date the option grantwas approved. For HSBC discretionary option plans, the exercise price of awardsmade in 2003 and 2004 was the higher of the average market value for ordinaryshares on the five business days preceding the grant date or the market value onthe date of the grant. HSBC also offers all employees a plan in which options to acquire ordinaryshares are awarded when an employee commits to contribute up to L250 (or theequivalent) each month for one, three or five years. At the end of the term, theaccumulated amount, plus interest, may be used to purchase shares under theoption, if the employee chooses to do so. The exercise price for such options isthe average market value for ordinary shares on the five business days precedingthe date of the invitation to participate, less a 15-20% discount (dependingupon the term). 186 We do not, and our parent, HSBC does not, reprice stock option grants. Inaddition, we and HSBC have never engaged in the practice known as "back-dating"of stock option grants. Dilution from Equity-Based Compensation While dilution is not a primary factor in determining award amounts, there arelimits to the number of shares that can be issued under HSBC equity programswhich were established by vote of HSBC shareholders in 2005. Perquisites It is our philosophy to provide few perquisites to executives. The perquisiteswe provide are intended to help executives be more productive and efficient orto protect HSBC Finance Corporation and its executives from certain businessrisks and potential threats. Our review of competitive market data indicatesthat the perquisites provided to executives are reasonable and within marketpractice. See the Summary Compensation Table below for further information onperquisites awarded to our executives. Retirement Benefits We offer a pension retirement plan that executives may participate in thatprovides a benefit equal to that provided to all employees of HSBC FinanceCorporation. However, both qualified and non-qualified defined benefit plans aremaintained so that this level of pension benefit can be continued without regardto certain Internal Revenue Service limits. Executives and other highlycompensated employees can elect to participate in a nonqualified deferredcompensation plan, where such employees can elect to defer the receipt of earnedcompensation to a future date. We also maintain a qualified 401(k) plan withcompany matching contributions. Another nonqualified deferred compensation planprovides executives and other highly compensated employees with a companymatching contribution (based on the level of the employee's election to deferearned compensation to the qualified 401(k) plan) to the extent that suchcompany contributions cannot be allocated to the 401(k) plan because of certainInternal Revenue Service limits. We do not pay any above-market or preferentialinterest in connection with deferred amounts. Employment Contracts and Severance Protection Certain executive officers, including Mr. Mehta, have employment agreements withHSBC Finance Corporation. The main purpose of the employment agreements is toprotect us from certain business risks (threats from competitors, loss ofconfidentiality or trade secrets, disparagement, solicitation of customers andemployees) and to define our right to terminate the employment relationship. Theemployment agreements also protect executives from certain risks, such as achange in control of HSBC Finance Corporation and death or disability. Certainother executives, including Mr. Menezes, have entered into agreements that onlyprovide additional severance benefits upon a change of control of HSBC FinanceCorporation. The terms of Messrs. Mehta's and Menezes' employment agreements arecontained in the descriptions of their compensation under the headingCompensation of Officers Reported in the Summary Compensation Table. Role of Executive Officers and External Consultants in Compensation Decisions HSBC Finance Corporation has engaged Strategic Consulting Group, an executivecompensation consulting firm, to provide comparator data and to assist in thedevelopment of competitive compensation packages for our executives. Inaddition, in late 2006 the Compensation Committee independently retainedFrederic W. Cook & Co., Inc., to provide compensation consulting services.Recommendations and comparative data provided by these consultants are reviewedby the Chief Executive Officer and the Executive Vice President, Administrationof HSBC Finance Corporation, to assist them in making initial recommendationsfor compensation of executives to the Compensation Committee. The ChiefExecutive Officer is not present when the Compensation Committee receivescomparative data or establishes recommendations for the Chief ExecutiveOfficer's compensation. As discussed above, the Compensation Committee preparesan annual compensation package for our Chief Executive Officer and his directreports. The compensation proposals are forwarded to HSBC's Group GeneralManager of Human Resources who provides this information to the 187 HSBC CEO for review. As permitted under the terms of REMCO's delegation ofauthority, the HSBC CEO may approve cash components of compensation for certainofficers, including Mr. Robin. Cash components for Mr. Mehta (until February 15,2007) and Messrs. Detelich and Menezes, as well as equity-based advisoryrecommendations for all executives are forwarded to REMCO for approval. The HSBCGroup General Manager of Human Resources subsequently informs HSBC Finance HumanResources executives of approved compensation awards. REMCO is provided withcomparator information from Towers Perrin which obtains compensation data forexecutive positions with companies of similar size and complexity that aresubsidiaries of peer financial services companies. In addition, market data hasbeen obtained from American Express Company, Bank of America Corporation, BankOne Corporation, BB&T Corporation, Capital One Financial, Citigroup, Inc.Countrywide Financial Corporation, FifthThird Bancorp, KeyCorp, LaSalle BankCorporation, Merrill Lynch & Co., Inc., National City Corporation, The PNCFinancial Services Group Inc., Royal Bank of Canada, State Street Corporation,Sun Trust Banks, Inc., US Bancorp, Wachovia Corporation, Washington Mutual Inc.and Wells Fargo & Company. Comparator and market data is used by REMCO toevaluate the competitiveness of proposed executive compensation. Accounting Considerations We adopted the fair value method of accounting under Statement of FinancialAccounting Standards No. 123 (revised 2004), "Share Based Payment" ("SFAS123(R)") effective January 1, 2006. SFAS 123(R) applies to all equityinstruments granted to employees beginning January 1, 2006 and does not apply toawards granted in prior periods before the effective date, except to the extentthat prior periods' awards are modified, repurchased or cancelled after therequired effective date. Prior to 2006, we adopted the fair value method ofaccounting prospectively in 2002 for all new equity instruments granted toemployees as provided under Statement of Financial Accounting Standards No. 148,"Accounting for Stock-Based Compensation - Transition and Disclosure (anamendment of FASB Statement No. 123)." The Board of Directors believes that thistreatment reflects greater accuracy and transparency of the cost of theseincentives and promotes better corporate governance. Tax Considerations Limitations on the deductibility of compensation paid to executive officersunder Section 162(m) of the Internal Revenue Code is not applicable to HSBCFinance Corporation, as it is not a public corporation as defined by Section162(m). As such, all compensation to our executive officers is deductible forfederal income tax purposes, unless there are excess golden parachute paymentsunder Section 4999 of the Internal Revenue Code following a change in control. ELEMENTS OF COMPENSATION We strive for a pay mix that reflects our pay-for-performance philosophy andresults-oriented culture. We attract and retain executives that are highlymotivated to achieve results, and our compensation programs support thatenvironment. Our philosophy is to place a significant amount of compensation at risk toensure that company performance objectives are met. In line with ourpay-for-performance philosophy, on average, approximately 20% of executivecompensation is base salary and 80% of compensation for top executives relatesto short-term and long-term incentives where the amount paid is based upondefined performance goals. In the case of the HSBC Finance Corporation ChiefExecutive Officer, approximately 90% of compensation is targeted to beperformance-based. Of the 80% incentive compensation, on average, approximately45% of such compensation relates to long-term incentives, while approximately35% relates to short-term incentives. Our allocation between short-term andlong-term incentives is based on our need to recognize past performance(short-term incentives) in conjunction with our need to motivate and retain ourtalent (long-term incentives). We believe these allocations are competitivewithin the market and reinforce our pay-for-performance philosophy which 188 requires that a greater part of compensation is at risk and aligns executives'interests with those of HSBC's shareholders. The primary elements of executive compensation are base salary, annualnon-equity performance-based awards, and long-term equity-based incentives. Inlimited circumstances, discretionary bonuses may also be awarded. In addition,executives are eligible to receive company funded retirement benefits that areoffered to all employees. Perquisites are not a significant component ofcompensation. In establishing executive compensation packages, the CompensationCommittee provides advisory recommendations and ultimately REMCO and/or the HSBCCEO approve remuneration under each element based on what they believe is anappropriate balance between performance-based compensation and other forms ofcompensation, the level of responsibility and individual contribution of theexecutive and competitive practice in the marketplace for executives fromcompanies of similar industry, size, and complexity as HSBC Finance Corporation. Base Salary Base salary is reviewed annually and increases, if any, are based on corporateand individual performance. When establishing base salaries for executives,consideration is given to compensation paid for similar positions at companiesincluded in compensation surveys of our Comparator Group, targeting the 50thpercentile, which the Compensation Committee believes, when combined withsignificant performance-based compensation opportunities, enables HSBC FinanceCorporation to attract and retain high performing executives. In addition, otherfactors such as individual and corporate performance, potential for futureadvancement, specific job responsibilities, length of time in current position,individual pay history, and comparison to comparable internal positions(internal equity) influences the final base salary recommendations forindividual executives. Annual Performance-Based Awards Annual non-equity performance-based awards are paid in cash upon satisfaction ofindividual, business unit, corporate financial and operational goals. Superiorperformance is encouraged by placing a significant part of the executive's totalcompensation at risk. In the event certain quantitative or qualitativeperformance goals are not met, annual performance awards may be less than themaximum permitted. Performance goals are set based on prior year's performance, expectations forthe upcoming year, our annual business plan, the HSBC Managing for Growthbusiness strategy, and objectives related to building value for HSBCshareholders. The general concept is if both HSBC Finance Corporation and theexecutive perform well for the year, the performance award earned should be at ahigh level. If either HSBC Finance Corporation or the executive does not performwell, the award earned should be at a low level. In support of our pay-for-performance philosophy, we have two annual non-equityperformance-based award programs: the Executive Bonus Pool and the ManagementIncentive Program. EXECUTIVE BONUS POOL The Executive Bonus Pool is an annual cash incentive planthat is comprised primarily of corporate and business quantitative goals, aswell as one or more qualitative objective goals. The quantitative business andcorporate factors are specific measures of performance that relate to near andlong-term business unit and corporate profitability. The qualitative objectivegoals include cross-business initiatives that create revenue, leverage talentacross businesses and share and support execution of "best practices" and/oradopt another business' "best practice." Eligibility in the Executive Bonus Pool is determined annually based onresponsibility. Participants are limited to the Chief Executive Officer and hisor her direct reports. In 2006, there were ten participants in the ExecutiveBonus Pool, including Messrs. Mehta, Detelich, Menezes and Robin. At thebeginning of each year the Compensation Committee establishes allocations forthe participants in the Executive Bonus Pool based upon data for our ComparatorGroup, the relative responsibilities of our executives and the opportunity ofeach executive to impact the operating results. The assigned allocations withrespect to the Executive Bonus Pool for Messrs. Mehta, Detelich, Menezes andRobin in 2006 were 20%, 12%, 12% and 6% respectively. 189 The maximum potential aggregate award to all participants in the Executive BonusPool each year is equal to 5% of HSBC Finance Corporation's net income thatexceeds the net income required to achieve a 12% return on average commonstockholder's equity (the "Available Bonus Pool"). The Compensation Committeerecommends actual bonus awards under the Executive Bonus Pool by comparing ourresults to the Comparator Group and by evaluating the performance of eachparticipating executive against the quantitative financial objectives and thequalitative objectives established at the beginning of each year. TheCompensation Committee is not required to recommend that any, or all, of theAvailable Bonus Pool be actually paid out in any year regardless of ourfinancial performance. Historically, actual aggregate payout awarded toexecutives has been less than half of the Available Bonus Pool. An executive'slevel of participation in the Executive Bonus Pool does not impact his or herbase salary or long-term incentive compensation. Payouts from the ExecutiveBonus Pool are made in February following the measurement year. In any year, if the return on equity achieved by HSBC Finance Corporation isless than the designated threshold set by the Compensation Committee, no bonuswill be paid under the Executive Bonus Pool. In 2006, IFRS Management Basis netincome of $2,562 million was required to achieve a 12% return on average commonstockholder's equity. In January 2007, the Compensation Committee providedadvisory recommendations for awards under the Executive Bonus Pool based uponpreliminary 2006 results. In early February it was determined that the return onaverage stockholder's equity threshold was not met and the bonus pool was notfunded. However, the Compensation Committee recommended and the HSBC CEOsubsequently agreed that certain executives should receive a discretionary bonusaward equal to the amount that would have been paid if the Executive Bonus Poolhad been funded. REMCO ratified these payments at a meeting held on March 1,2007. This decision was based upon several factors, including the need to ensurethe continuity of management following the resignation of Mr. Mehta, performancewithin the areas of responsibility of the individuals, recognition that theexecutives to receive payments were not responsible for the events that led tothe failure to meet the return on average stockholder's equity threshold andthat the executive management team of HSBC Finance Corporation was to receivereduced long-term equity based awards as a result of the disappointingconsolidated performance of HSBC Finance Corporation. As a result, Messrs.Detelich, Menezes and Robin received discretionary bonus awards in February2007. Under the Executive Bonus Plan, Messrs. Mehta, Detelich, Menezes and Robinshared several common quantitative financial and operating performanceobjectives for the consolidated results of HSBC Finance Corporation. Thoseobjectives are set out below, but because the average stockholder's equitythreshold was not met and no award could be made under the Executive Bonus Plan,these objectives were not specifically considered in making the discretionarybonus awards to Messrs. Detelich, Menezes and Robin. Those corporate objectives for 2006 were: Objective - Profit Before Tax - Net Income - Return on Equity - Receivables Growth - Revenue Growth - Expense Growth - Efficiency Ratio - The greater of: Reserves to Charge-offs and Reserves to Non-performing Loans - Net Charge-off Messrs. Mehta, Detelich and Menezes had additional common quantitative goals,Mr. Mehta's relating to the consolidated results of HSBC Finance Corporationshown above, while Mr. Detelich's were measured on the performance of theConsumer Lending business and Mr. Menezes' were based upon the performance ofboth the Credit Card Services and Retail Services businesses. The quantitativegoals for each were: - Business Net Income - Business Revenue - Business Expense Growth 190 - Business Net Charge-off - Business Two-Month-and-Over Delinquency - Business Return on Managed Assets Messrs. Mehta, Detelich, Menezes and Robin shared a common qualitative objectiveto leverage capabilities across businesses by initiating or supporting crossbusiness initiatives that created revenue, leveraging talent across businessesand sharing and supporting the execution of best practices among HSBC NorthAmerica businesses and/or adopting a best practice. MANAGEMENT INCENTIVE PROGRAM The Management Incentive Program is an annual cashincentive plan that uses quantitative and qualitative goals to motivateemployees who have a significant role in the corporation that do not participatein the Executive Bonus Plan. The quantitative objectives may include meetingrevenue and/or receivable targeted growth, a targeted loss reserve ratio, atargeted equity to managed assets ratio, a targeted earnings per share,reduction in expenses and charge-offs by specified percentages, specified netincome and operating efficiency ratios for HSBC Finance Corporation and/or theexecutive's respective business unit, and an increase in the number of ourproducts used by each customer. The quantitative objectives often coincide withthose of executives participating in the Executive Bonus Pool. Qualitativeobjectives may include key strategic business initiatives or projects for theexecutive's respective business unit. Award opportunity and payouts aredetermined as a percentage of base salary and are based on comparison to otherinternal comparable positions (internal equity) and external market practices.Cash incentive awards under the Management Incentive Program are paid inFebruary of the year following the measurement year. Ms. Sibblies participated in the Management Incentive Program in 2006. Adiscussion of the quantitative and qualitative objectives for Ms. Sibblies, andthe performance against those goals can be found below under the headingCompensation of Officers Reported in the Summary Compensation Table - ChiefFinancial Officer Compensation. Long-term Incentives Long-term incentive compensation is awarded through grants of HSBC equityinstruments. The purpose of equity-based incentives is to help HSBC FinanceCorporation attract and retain outstanding employees and to promote the growthand success of our business over a period of time by aligning the financialinterests of these employees with HSBC's shareholders. Historically, equityincentives were awarded through stock options and restricted share grants. All stock options granted prior to November 2002 vested in full upon the mergerof HSBC Finance Corporation and HSBC, and options granted in November 2002 havesubsequently vested in full. From the time of the merger in March 2003 to 2005,options on HSBC ordinary shares were granted to certain executives andrestricted shares to others. The awarded options have an exercise price equal tothe greater of the average market value of HSBC ordinary shares on the fivebusiness days prior to the grant of the option and the market value of HSBCordinary shares on the grant date. Option without a performance conditiontypically vest in 3, 4 or 5 equal installments based on continued employment andexpire ten years from the grant date. However, certain options awarded to keyexecutives had a "total shareholder return" performance vesting condition andonly vest if and when the condition is satisfied. No stock options were grantedto executive officers in 2005 or 2006 in conjunction with HSBC's philosophicalshift on the form of equity based compensation. Awards of restricted shares is another form of long-term incentive compensationutilized to compensate and incent our employees. When restricted shares aregranted to an executive officer, the underlying shares are held in a trust forthe benefit of the employee and are released only after the defined vestingconditions are met at the end of the holding period. While in such trust,dividend equivalents are paid on all underlying shares of restricted stock atthe same rate paid to ordinary shareholders. The dividend equivalents are paidin the form of additional shares for awards made after 2004 and in cash paid tothe executive for all prior awards. There are three types of restricted shares used by HSBC: those with a timevesting condition awarded to recognize significant contribution to HSBC FinanceCorporation ("Achievement Shares"), those with time 191 and performance-based vesting conditions ("Performance Shares"), and those witha time vesting condition for retention purposes ("Retention Awards").Achievement Shares are awarded to key executives as part of the annual payreview process in recognition of past performance and to further motivate andretain executives. The amount granted is based on general guidelines establishedby REMCO which include a percentage of base pay, position within HSBC FinanceCorporation and potential for growth. Performance Shares are awarded to keyexecutives whose performance can have a direct impact on HSBC's consolidatedresults and in 2006, within HSBC Finance Corporation, only the Chief ExecutiveOfficer and certain of his direct reports received such awards. Retention Awardshave typically not been granted on an annual basis but rather have been grantedon an as needed basis. No Retention Awards were granted to executive officers in2006. As described above, Performance Shares are awarded to an executive and vestingof those shares is based on achievement of defined levels of future performanceof HSBC. Performance Shares are divided into two equal parts subject to distinctperformance conditions measured over a three year period. A total shareholderreturn award, which accounts for 50% of each Performance Share award, will vestin whole or in part (based on a sliding scale of 0% to 100%) depending upon howthe growth in HSBC's share value, plus declared dividends, compares to theaverage shareholder return of a defined competitor group which for 2006 grantswas comprised of 28 major banking institutions including: ABN AMRO Holding N.V.,Banco Bilbao Vizcaya Argentaria, S.A., Banco Santander Central Hispano S.A.,Bank of America Corporation, The Bank of New York Company, Inc., Barclays PLC,BNP Paribas S.A., Citigroup, Inc., Credit Agricole SA, Credit Suisse Group,Deutsche Bank AG, HBOS plc, JP Morgan Chase, Lloyds TSB Group plc, MitsubishiTokyo Financial Group Inc., Mizuho Financial Group Inc., Morgan Stanley,National Australia Bank Limited, Royal Bank of Canada, The Royal Bank ofScotland Group plc, Societe Generale, Standard Chartered PLC, UBS AG, UnicreditoItaliano, US Bancorp, Wachovia Corporation, Wells Fargo & Company and WestpacBanking Corporation. The earnings per share award accounts for 50% of each Performance Share awardand is measured using a defined formula based on HSBC's earnings per sharegrowth over the three-year period as compared to the base-year earnings pershare, which is earnings per share for the year prior to the year thePerformance Shares are granted. None of the earnings per share PerformanceShares will vest unless a minimum earnings per share is reached at the end ofthree years. REMCO maintains discretion to determine that a Performance Share award will notvest unless REMCO is satisfied that HSBC's financial performance has shownsustained improvement since the date of the award. REMCO may also waive, amendor relax performance conditions if it believes the performance conditions havebecome unfair or impractical and believes it appropriate to do so. Due to theprobability of one or both of the performance conditions not being met in partor in full, grants of Performance Shares are for a greater number of shares thanAchievement Share grants. The expected value of Performance Shares is equal to44% of the face value. Additional information concerning the conditions tovesting of Performance Share awards is contained in Footnote 2 to the Grants ofPlan Based Awards table on page 200. COMPENSATION OF OFFICERS REPORTED IN THE SUMMARY COMPENSATION TABLE Below is a summary of the factors that affected the compensation earned by theexecutive officers listed in the Summary Compensation Table in 2006. Indetermining the compensation of each of our executives, management and theCompensation Committee evaluated competitive levels of compensation for officersmanaging operations or functions of similar size and complexity and theimportance of retaining executives with the strategic, leadership and financialskills to ensure our continued growth and success and their potential forassumption of additional responsibilities. Chief Executive Officer Compensation On February 15, 2007, Mr. Mehta resigned as the Chief Executive Officer of HSBCFinance Corporation. Until that time, he participated in the same programs andgenerally received compensation based on the same factors as the other executiveofficers. However, Mr. Mehta's overall compensation level reflected his greater 192 degree of policy- and decision-making authority, his higher level ofresponsibility with respect to the strategic direction of HSBC FinanceCorporation and his ultimate responsibility for our financial and operationalresults. In January 2006, the Compensation Committee made an advisory recommendation toREMCO that Mr. Mehta's base salary be increased by $100,000 to its 2006annualized level of $1,000,000. In reviewing Mr. Mehta's base salary, theCompensation Committee considered competitive compensation levels and found Mr.Mehta's then current base salary was below the 50th percentile amongsimilarly-placed executives in each of the surveys considered, including asurvey of our Comparator Group. The raise placed his base salary at the 50thpercentile of the Comparator Group. REMCO approved the increase in Mr. Mehta'sbase salary in February 2006. Also in January 2006, the Compensation Committee made an advisory recommendationthat Mr. Mehta receive a grant of Performance Shares valued at $4,000,000. Therecommendation reflected the Compensation Committee's view of the value of hislong-term contribution to, and leadership of HSBC Finance Corporation, HSBCNorth America Holdings Inc. and HSBC as it seeks to expand the consumer financebusiness to appropriate markets worldwide. The recommendation further reflectedthe Compensation Committee's desire to retain Mr. Mehta and to incent continuedexceptional performance. On January 23, 2006, REMCO met and considered theproposed equity based awards for all HSBC executives and awarded Mr. MehtaPerformance Shares with a grant date value of $4,000,010. In making the award,REMCO also considered internal equity of compensation paid to management peerswithin HSBC and its subsidiaries and external benchmarking as described above. As discussed above, Mr. Mehta's maximum cash performance-based incentiveopportunity for 2006 was 20% of the Executive Bonus Pool, or $7,240,000. Underhis employment agreement (discussed below), Mr. Mehta was entitled to a bonusguaranteed to be not less than $1,875,000. At a January 2007 meeting, theCompensation Committee established Mr. Mehta's Annual Cash Incentive Based Awardat $1,875,000. In establishing that recommendation, the Compensation Committeeconsidered the overall results of HSBC Finance Corporation for 2006 and theimpact of the performance of the Mortgage Services business. However, due to thedisappointing results of the Mortgage Services business, Mr. Mehta voluntarilywaived his right to a guaranteed bonus under his employment agreement. Other compensation paid to Mr. Mehta in 2006, including perquisites such as acar allowance and life insurance premiums, was consistent with perquisites paidto similarly-placed executive officers within and outside of HSBC. Mr. Mehta had an employment agreement which was scheduled to expire on March 28,2008. Pursuant to his agreement, Mr. Mehta was to serve as Chairman and ChiefExecutive Officer of HSBC Finance Corporation and also Chief Executive Officerof HSBC North America Holdings Inc. The terms of that agreement are summarizedbelow. As stated above, Mr. Mehta resigned as of February 15, 2007. The terms of theseverance arrangements agreed with Mr. Mehta will be described in HSBC FinanceCorporation's 2007 Form 10-K. During the term of the employment agreement, Mr. Mehta was entitled to receivean annual base salary (which as of January 1, 2006 was increased to $1 million),and an annual bonus of at least $1,875,000 (75 percent of the annual average ofhis bonus earned in 2003, 2004 and 2005). During the term of the agreement, Mr.Mehta was eligible to participate in any equity-based incentive compensationplan or program of HSBC as in effect from time to time for similarly situatedsenior executives of HSBC Finance Corporation, as approved by REMCO. Inaddition, during the term of the agreement, Mr. Mehta was eligible toparticipate in the various retirement, medical, disability and life insuranceplans, programs and arrangements in accordance with the terms of HSBC FinanceCorporation's benefit plans. Under the terms of the employment agreement, if Mr. Mehta's employment wasterminated by HSBC Finance Corporation other than for "cause" or disability, orhe resigned for "good reason," subject to his execution of a general release infavor of HSBC Finance Corporation and its affiliates, Mr. Mehta was to 193 continue to receive his base salary and annual bonus described above as if hehad remained employed until March 28, 2008. In addition, to the extent permittedunder the terms of the applicable plans, Mr. Mehta's welfare benefits, umbrellaliability insurance and automobile and financial counseling allowances were tocontinue until March 28, 2008, unless he became eligible to participate insimilar plans of another employer prior to that date. In 2003 and 2005, Mr. Mehta was awarded Retention Awards of HSBC restrictedshares with values of $5 and $8 million, respectively, in each case based on theclosing price of HSBC ordinary shares as of the date of the grant. The 2003award was to vest in five equal installments on March 28 of each year through2008. The 2005 award was to vest in five equal installments on March 26 of eachyear through 2010. Each award was to vest in full upon termination of Mr.Mehta's employment by HSBC Finance Corporation other than for cause or , withrespect to the 2003 award, by Mr. Mehta due to a material breach by HSBC FinanceCorporation of Mr. Mehta's employment agreement, or with respect to the 2005award, by Mr. Mehta for good reason. Chief Financial Officer Compensation The Chief Financial Officer of HSBC Finance Corporation, Ms. Beverley A.Sibblies, participates in general benefits available to officers of thecorporation and the Management Incentive Program. Her cash compensation isdetermined by Mr. Mehta upon recommendation of the Chief Financial Officer ofHSBC North America Holdings Inc. in consultation with Human Resourcesexecutives. As with all executives, REMCO has authority over Ms. Sibblies'Achievement Share awards. Ms. Sibblies' base salary in 2006 was $375,000. Ms. Sibblies was promoted toChief Financial Officer in September 2005 and received a salary increasereflective of her increased responsibilities at that time. Based upon thatincrease and review of comparator data, she did not receive a salary increase in2006. Ms. Sibblies' cash incentive compensation under the Management Incentive Programis determined based upon satisfaction of quantitative and qualitative objectivesthat provide for a target cash award equal to 75% of her base salary, up to amaximum of 150% of base salary. Ms. Sibblies' cash incentive compensationrequired satisfaction of objectives that included: the corporation achieving atargeted net income goal, leveraging talent and promoting collaboration amongHSBC North America management, support of diversity initiatives, effectiveimplementation of SOX 404 internal controls testing and documentation,development of mentoring, talent management and succession planning programswithin the Corporate Finance function, design and implementation of enhancementsto accounting processes, oversight of improved clarity of financial disclosures,and development of accounting staff through participation in HSBC financetraining programs. Management assessed Ms. Sibblies' and HSBC FinanceCorporation's performance against the objectives and found that there wascomplete or substantial satisfaction of each. Ms. Sibblies was awarded cashincentive compensation equal to 145% of her base salary, or $543,750, which waspaid to her in February 2007. In March 2006, Ms. Sibblies was granted Achievement Shares with a grant datevalue of $500,000, which vest in three years and have no performance conditions.This reflected management's recognition of the value of her contribution to andleadership of HSBC Finance Corporation, HSBC's desire to retain Ms. Sibblies andto incent outstanding performance. Other compensation paid to Ms. Sibblies, including perquisites such as lifeinsurance premiums, is consistent with perquisites paid to similarly-placedexecutive officers within and outside of HSBC. Mr. Thomas M. Detelich's Compensation In 2006, Mr. Detelich's base salary remained the same as 2005, at $650,000. For2006, the Compensation Committee reviewed competitive compensation levels andfound Mr. Detelich's then current cash compensation level was above the 50thpercentile among similarly-placed executives in our Comparator Group. In keepingwith the goal of maintaining executive base salaries in the 50th percentile, itdid not recommend an increase to his salary. On January 23, 2006, REMCO approved the Compensation Committee's advisoryrecommendation that Mr. Detelich receive Performance Shares with a grant datevalue of $1,775,687. The award is subject to three- 194 year performance vesting conditions. The vesting criteria of the PerformanceShares is set out in Footnote 2 to the Grants and Plan-based Awards Table onpage 200. The grant reflects REMCO's view of the value of Mr. Detelich'sexpected long-term contribution to and leadership of HSBC North America, andHSBC's desire to retain Mr. Detelich and incent exceptional performance. As discussed above, Mr. Detelich's maximum cash incentive under the 2006Executive Bonus Pool was 12% of the available Bonus Pool, or $4,344,000. Basedupon preliminary results of HSBC Finance Corporation, the Compensation Committeemade an advisory recommendation that Mr. Detelich receive a bonus of $2 million.The Compensation Committee made the award recommendation in recognition ofexcellent results within the Consumer Lending business in 2006. In consideringMr. Detelich's award, the Compensation Committee considered Mr. Detelich'sindividual performance, demonstrated leadership, future potential, adherence toHSBC's ethical standards and the ability to leverage capabilities acrossbusinesses. REMCO agreed with the Compensation Committee's assessment andapproved the award. However, in early February 2007 it was determined that thereturn on average stockholder's equity threshold was not met and the ExecutiveBonus Pool was not funded. As a result, Mr. Detelich was not entitled to anaward under the plan. Subsequently, the Compensation Committee recommended andthe HSBC CEO agreed that Mr. Detelich should receive a discretionary bonus awardin the amount of $2 million. REMCO ratified these payments at a meeting held onMarch 1, 2007. This award was made in recognition of the need to ensure thecontinuity of management following the resignation of Mr. Mehta, superiorperformance of the Consumer Lending operations under Mr. Detelich's managementand recognition that Mr. Detelich had no responsibility for the events that ledto the failure to meet the return on average stockholder's equity threshold andthe fact that Mr. Detelich's equity award was reduced as a result of thedisappointing consolidated performance of HSBC Finance Corporation. Other compensation paid to Mr. Detelich, including perquisites such as lifeinsurance premiums, is consistent with perquisites paid to similarly-placedexecutive officers within and outside of HSBC. Mr. Walter G. Menezes' Compensation In February 2006, in recognition of his assumption of responsibility of the CardServices and Retail Services businesses, Mr. Menezes' base salary increased by$50,000 to its current level of $650,000. To determine Mr. Menezes' base salary,the Compensation Committee reviewed competitive compensation levels and foundMr. Menezes' then current cash compensation level fell below the 50th percentileamong similarly-placed executives in our Comparator Group. The CompensationCommittee also considered that Mr. Menezes' base salary was below Mr. Detelich'swho the Compensation Committee deemed to have comparable responsibilities. REMCOconcurred with the Compensation Committee's assessment and, as a result, hisbase salary was increased. On January 23, 2006, REMCO approved the Compensation Committee's advisoryrecommendation that Mr. Menezes receive Performance Shares with a grant datevalue of $1,775,687. The award is subject to three-year performance vestingconditions. The vesting criteria of the Performance Shares is set out inFootnote 2 of the Grants and Plan-based Awards Table on page 200. The grantreflects REMCO's view of the value of Mr. Menezes' expected long-termcontribution to and leadership of HSBC North America, and HSBC's desire toretain Mr. Menezes and incent exceptional performance. As discussed above, Mr. Menezes' maximum cash incentive under the 2006 ExecutiveBonus Pool was 12% of the available Bonus Pool, or $4,344,000. Based uponpreliminary results of HSBC Finance Corporation, the Compensation Committee madean advisory recommendation that Mr. Menezes receive a bonus of $2 million. TheCompensation Committee made the award recommendation in recognition of excellentresults within the Credit Card and Retail Services businesses in 2006. Inconsidering Mr. Menezes' award, the Compensation Committee considered Mr.Menezes' individual performance, demonstrated leadership, future potential,adherence to HSBC's ethical standards and the ability to leverage capabilitiesacross businesses. REMCO agreed with the Compensation Committee's assessment andapproved the award. However, in early February 2007 it was determined that thereturn on average stockholder's equity threshold was not met and the ExecutiveBonus Pool was not funded. As a result, Mr. Menezes was not entitled to an awardunder the plan. Subsequently, the Compensation Committee recommended and theHSBC CEO agreed that 195 Mr. Menezes should receive a discretionary bonus award in the amount of $2million. REMCO ratified these payments at a meeting held on March 1, 2007. Thisaward was made in recognition of the need to ensure the continuity of managementfollowing the resignation of Mr. Mehta, superior performance of the Credit Cardand Retail Services operations under Mr. Menezes' management and recognitionthat Mr. Menezes had no responsibility for the events that led to the failure tomeet the return on average stockholder's equity threshold and the fact that Mr.Menezes' equity award was reduced as a result of the disappointing consolidatedperformance of HSBC Finance Corporation. Other compensation paid to Mr. Menezes, including perquisites such as lifeinsurance premiums, is consistent with perquisites paid to similarly-placedexecutive officers within and outside of HSBC. Mr. Menezes, has an employment protection agreement pursuant to which if, duringthe 18 month period following a change in control of HSBC Finance Corporation,Mr. Menezes' employment is terminated due to a "qualifying termination" (whichincludes a termination other than for "cause" or disability, or resignation byMr. Menezes for "good reason"), he will be entitled to receive a cash paymentconsisting of: - A pro rata annual bonus through the date of termination, based on the highest of the annual bonuses payable during the three years preceding the year in which the termination occurs; - A payment equal to 1.5 times the sum of the applicable base salary and highest annual bonus; and - A payment equal to the value of 18 months of additional employer contributions under HSBC North America's tax-qualified and supplemental defined contribution plans. In addition, upon a qualifying termination following a change in control, Mr.Menezes will be entitled to continued welfare benefit coverage for 18 monthsafter the date of termination, 18 months of additional age and service creditunder HSBC North America's tax-qualified and supplemental defined benefitretirement plans, and outplacement services. If any amounts or benefits receivedunder the employment protection agreement or otherwise are subject to the excisetax imposed under section 4999 of the Internal Revenue Code, an additionalpayment will be made to restore Mr. Menezes to the after-tax position in whichhe would have been if the excise tax had not been imposed. However, if a smallreduction in the amount payable would render the excise tax inapplicable, thenthis reduction will be made instead. MORE TO FOLLOW This information is provided by RNS The company news service from the London Stock Exchange