10-K 1 c62397e10vk.htm FORM 10-K e10vk
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UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
 
     
(Mark One)
 
x
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2010
OR
     
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from           to           
 
Commission file number 1-8198
HSBC FINANCE CORPORATION
(Exact name of registrant as specified in its charter)
 
     
Delaware
(State of incorporation)
26525 North Riverwoods Boulevard, Mettawa, Illinois
(Address of principal executive offices)
  86-1052062
(I.R.S. Employer Identification No.)
60045
(Zip Code)
(224) 544-2000
Registrant’s telephone number, including area code
 
Securities registered pursuant to Section 12(b) of the Act:
     
Title of Each Class
 
Name of Each Exchange on Which Registered
 
63/4% Notes due May 15, 2011
  New York Stock Exchange
5.7% Notes due June 1, 2011
  New York Stock Exchange
Floating Rate Notes due April 24, 2012
  New York Stock Exchange
5.9% Notes due June 19, 2012
  New York Stock Exchange
Floating Rate Notes due July 19, 2012
  New York Stock Exchange
Floating Rate Notes due September 14, 2012
  New York Stock Exchange
Floating Rate Notes due January 15, 2014
  New York Stock Exchange
5.25% Notes due January 15, 2014
  New York Stock Exchange
5.0% Notes due June 30, 2015
  New York Stock Exchange
5.5% Notes due January 19, 2016
  New York Stock Exchange
Floating Rate Notes due June 1, 2016
  New York Stock Exchange
6.875% Notes due January 30, 2033
  New York Stock Exchange
6% Notes due November 30, 2033
  New York Stock Exchange
Depositary Shares (each representing one-fortieth share of
6.36% Non-Cumulative Preferred Stock, Series B, $.01 par,
$1,000 liquidation preference)
  New York Stock Exchange
Guarantee of Preferred Securities of HSBC Finance Capital Trust IX
  New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
             
Large accelerated filer o
  Accelerated filer o   Non-accelerated filer x
(Do not check if a smaller reporting company)
  Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
 
As of February 25, 2011, there were 66 shares of the registrant’s common stock outstanding, all of which are owned by HSBC Investments (North America) Inc.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
None.
 


Table of Contents

 
TABLE OF CONTENTS
 
             
Part/Item No
      Page
 
Part I
Item 1.
 
Business:
       
   
  Organization History and Acquisition by HSBC
    4  
   
  HSBC North America Operations
    4  
   
  HSBC Finance Corporation – General
    5  
   
  Funding
    6  
   
  Employees and Customers
    6  
   
  Operations
    7  
   
  Regulation and Competition
    9  
   
  Corporate Governance and Controls
    13  
   
  Cautionary Statement on Forward-Looking Statements
    14  
Item 1A.
 
Risk Factors
    14  
Item 1B.
 
Unresolved Staff Comments
    22  
Item 2.
 
Properties
    22  
Item 3.
 
Legal Proceedings
    22  
Item 4.
 
Submission of Matters to a Vote of Security Holders
    22  
 
Part II
Item 5.
 
Market for Registrant’s Common Equity and Related Stockholder Matters
    22  
Item 6.
 
Selected Financial Data
    23  
Item 7.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations:
    25  
   
  Executive Overview
    25  
   
  Basis of Reporting
    38  
   
  Critical Accounting Policies and Estimates
    42  
   
  Receivables Review
    48  
   
  Real Estate Owned
    51  
   
  Results of Operations
    52  
   
  Segment Results – IFRS Management Basis
    63  
   
  Credit Quality
    71  
   
  Liquidity and Capital Resources
    96  
   
  Off Balance Sheet Arrangements and Secured Financings
    102  
   
  Fair Value
    103  
   
  Risk Management
    106  
   
  New Accounting Pronouncements to be Adopted in Future Periods
    115  
   
  Glossary of Terms
    116  
   
  Credit Quality Statistics
    119  
   
  Analysis of Credit Loss Reserves Activity
    121  
   
  Net Interest Margin
    123  
   
  Reconciliations to U.S. GAAP Financial Measures
    125  
Item 7A.
 
Quantitative and Qualitative Disclosures About Market Risk
    127  
Item 8.
 
Financial Statements and Supplementary Data
    127  
   
Selected Quarterly Financial Data (Unaudited)
    223  
Item 9.
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    224  
Item 9A.
 
Controls and Procedures
    224  
Item 9B.
 
Other Information
    224  


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Part/Item No
      Page
 
Part III
Item 10.
 
Directors, Executive Officers and Corporate Governance
    224  
Item 11.
 
Executive Compensation
    236  
Item 12.
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    268  
Item 13.
 
Certain Relationships and Related Transactions, and Director Independence
    269  
Item 14.
 
Principal Accountant Fees and Services
    270  
 
Part IV
Item 15.
 
Exhibits and Financial Statement Schedules
    271  
Index
    274  
Signatures     277  
 EX-12
 EX-21
 EX-23
 EX-31
 EX-32


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HSBC Finance Corporation
 
PART I
 
Item 1. Business.
 
Organization History and Acquisition by HSBC
 
HSBC Finance Corporation traces its origin to 1878 and operated as a consumer finance company under the name Household Finance Corporation (“HFC”) for most of its history. In 1981, HFC shareholders approved a restructuring that resulted in the formation of Household International, Inc. (“Household”) as a publicly held holding company and HFC became a wholly-owned subsidiary of Household. For a period, Household diversified its operations outside the financial services industry, but returned solely to consumer finance operations through a series of divestitures in the 1980’s and 1990’s.
 
On March 28, 2003, Household was acquired by HSBC Holdings plc (“HSBC” or “HSBC Group”) by way of merger with H2 Acquisition Corporation (“H2”), an indirect wholly owned subsidiary of HSBC, in a purchase business combination. Following the acquisition, H2 was renamed “Household International, Inc.” Subsequently, HSBC transferred its ownership interest in Household to a wholly owned subsidiary, HSBC North America Holdings Inc. (“HSBC North America”), which subsequently contributed Household to its wholly-owned subsidiary, HSBC Investments (North America) Inc. (“HINO”).
 
On December 15, 2004, Household merged with its wholly owned subsidiary, HFC. By operation of law, following the merger, all obligations of HFC became direct obligations of Household. Following the merger, Household changed its name to HSBC Finance Corporation.
 
HSBC North America Operations
 
HSBC North America is the holding company for HSBC’s operations in the United States. The principal subsidiaries of HSBC North America at December 31, 2010 were HSBC Finance Corporation, HSBC USA Inc. (“HUSI”), a U.S. bank holding company, HSBC Markets (USA) Inc., a holding company for certain global banking and markets subsidiaries and HSBC Technology & Services (USA) Inc. (“HTSU”), a provider of information technology and centralized operational and support services including human resources, tax, finance, compliance, legal, corporate affairs and other services shared among the subsidiaries of HSBC North America. In late January 2010, HSBC North America sold HSBC Bank Canada, a Federal bank chartered under the laws of Canada (“HBCA”), to an affiliate as part of an internal HSBC reorganization. As a result, HBCA is no longer a subsidiary of HSBC North America. HUSI’s principal U.S. banking subsidiary is HSBC Bank USA, National Association (together with its subsidiaries, “HSBC Bank USA”). Under the oversight of HSBC North America, HSBC Finance Corporation works with its affiliates to maximize opportunities and efficiencies in HSBC’s operations in the United States. These affiliates do so by providing each other with, among other things, alternative sources of liquidity to fund operations and expertise in specialized corporate functions and services. This has been demonstrated by purchases and sales of receivables between HSBC Bank USA and HSBC Finance Corporation and a pooling of resources within HTSU to provide shared, allocated support functions to all HSBC North America subsidiaries. In addition, clients of HSBC Bank USA and other affiliates are investors in HSBC Finance Corporation’s debt and preferred securities, providing significant sources of liquidity and capital to HSBC Finance Corporation. HSBC Securities (USA) Inc., a Delaware corporation, registered broker dealer and a subsidiary of HSBC Markets (USA) Inc., has led or participated as underwriter of domestic issuances of HSBC Finance Corporation’s term debt, as well as historically, led or participated as underwriter for issuances of asset-backed securities. While HSBC Finance Corporation has not received advantaged pricing, underwriting fees and commissions payable to HSBC Securities (USA) Inc. benefit HSBC as a whole.


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HSBC Finance Corporation – General
 
HSBC Finance Corporation’s subsidiaries provide lending products to middle-market consumers in the United States. HSBC Finance Corporation is the principal fund raising vehicle for the operations of its subsidiaries. In this Form 10-K, HSBC Finance Corporation and its subsidiaries are referred to as “we,” “us” or “our.”
 
Our lending products currently include MasterCard(1), Visa(1), American Express(1) and Discover(1) credit card receivables as well as private label receivables. A portion of new credit card and all new private label receivable originations are sold on a daily basis to HSBC Bank USA. We also offer specialty insurance products in the United States and Canada. Historically, we also provided several other types of loan products in the United States including real estate secured , personal non-credit card and auto finance loans as well as tax refund anticipation loans and related products, all of which we no longer originate.
 
In March 2010, we sold our auto finance servicing operations, including all related assets, as well as certain auto finance receivables with a carrying value of $927 million to Santander Consumer USA Inc. (“SC USA”). Under the terms of the sale agreement, we also agreed to assign our auto servicing facilities in San Diego, California and Lewisville, Texas to SC USA. In August 2010, we sold our remaining auto loan portfolio to SC USA with an outstanding principal balance of $2.6 billion at the time of sale. As a result, our Auto Finance business, which was previously considered a non-core business, is now reported in discontinued operations.
 
During the third quarter of 2010, the Internal Revenue Service (“IRS”) announced it would stop providing information regarding certain unpaid obligations of a taxpayer (the “Debt Indicator”), which has historically served as a significant part of our underwriting process in our Taxpayer Financial Services (“TFS”) business. We determined that, without use of the Debt Indicator, we could no longer offer the product that has historically accounted for the substantial majority of our TFS loan production and that we might not be able to offer the remaining products available under the program in a safe and sound manner. As a result, in December 2010, it was determined that we would not offer any tax refund anticipation loans or related products for the 2011 tax season and we exited the TFS business. As a result of this decision, our TFS business, which was previously considered a non-core business, is now reported in discontinued operations.
 
For a full discussion of our discontinued Auto Finance and TFS businesses, see the “2010 Events” section of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”) and Note 3 “Discontinued Operations,” in the accompanying consolidated financial statements.
 
Until May 2008, when we sold our United Kingdom business to an affiliate, we also offered consumer loans and insurance products in the United Kingdom and the Republic of Ireland. The insurance operations in the United Kingdom were sold November 1, 2007 to Aviva plc and its subsidiaries (“Aviva”) and from that time until May 2008, we distributed our insurance products in the United Kingdom through our branch network but they were underwritten by Aviva. Prior to the sale of our Canadian operations to an affiliate in November 2008, we also provided consumers several types of loan products in Canada. For a full discussion of the discontinued operations of the United Kingdom and Canadian businesses, see Note 3, “Discontinued Operations” in the accompanying consolidated financial statements.
 
 
 (1) MasterCard is a registered trademark of MasterCard International Incorporated (d/b/a MasterCard Worldwide); Visa is a registered trademark of Visa, Inc.; American Express is a registered trademark of American Express Company and Discover is a registered trademark of Discover Financial Services.


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HSBC Finance Corporation
 
Income (Loss) Before Income Tax Expense – Significant Trends Loss from continuing operations before income tax expense, and various trends and activity affecting operations, are summarized in the following table.
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Loss from continuing operations before income tax from prior year
  $ (10,098 )   $ (3,695 )   $ (5,376 )
Increase (decrease) in income from continuing operations before income tax expense attributable to:
                       
Net interest income
    (873 )     (2,878 )     (921 )
Provision for credit losses
    3,470       2,760       (2,480 )
Mark-to-market on derivatives which do not qualify as effective hedges
    (675 )     792       (310 )
Gain (loss) on debt designated at fair value and related derivatives
    2,866       (5,285 )     1,890  
Credit card fee income and enhancement services revenue
    (542 )     (1,253 )     (527 )
Gain on bulk and on-going receivable sales to HSBC affiliates
    21       259       (159 )
Servicing and other fees from HSBC affiliates
    (82 )     203       12  
Lower of cost or market adjustment on receivables held for sale
    376       140       (459 )
Salaries and employee benefits
    522       475       515  
Other marketing
    (130 )     166       367  
REO expenses
    (75 )     143       (9 )
Goodwill and other intangible asset impairment charges
    2,308       (1,979 )     3,872  
All other activity(1)
    6       54       (110 )
                         
      7,192       (6,403 )     1,681  
                         
Loss from continuing operations before income tax for current year
  $ (2,906 )   $ (10,098 )   $ (3,695 )
                         
 
 
(1)  Reflects other activity for other revenues and operating expenses.
 
For additional discussion regarding changes in the components of income and expense, see the caption “Results of Operations” in the MD&A section of this Form 10-K.
 
Funding
 
Our primary sources of funding in 2010 were cash generated from operations, the sale of our remaining auto portfolio, the issuance of retail notes, subordinated debt and Series C preferred stock, and capital contributions from our parent. During 2010, issuances of commercial paper continued to be lower than our historical levels. The majority of outstanding commercial paper is expected to be directly placed, domestic commercial paper. Euro commercial paper will continue to be marketed predominately to HSBC clients.
 
A detailed description of our sources of funding of our operations are set forth in the “Liquidity and Capital Resources” and “Off Balance Sheet Arrangements and Secured Financings” sections of the MD&A.
 
We use the cash generated by these funding sources to fund our operations, service our debt obligations, originate new credit card and private label receivables and pay dividends to our preferred stockholders.
 
Employees and Customers
 
At December 31, 2010, we had approximately 6,650 employees. The decrease in number of employees from last year of 10,489 was largely due to our sale of the Auto Finance business to SC USA, the continuing activity related to the runoff of the Consumer Mortgage business, the centralization of legal, compliance, tax and finance employees to HTSU and the transfer of certain employees in our real estate receivable servicing department to HSBC Bank USA in July 2010.


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At December 31, 2010, we had over 34 million customers. Some of these customers are customers of more than one of our businesses. Consumers residing in the State of California accounted for 10 percent of our consumer receivables. We also have significant concentrations of domestic consumer receivables in Florida (6 percent), New York (7 percent), Pennsylvania (6 percent) and Ohio (5 percent).
 
Operations
 
We have two reportable segments: Card and Retail Services and Consumer. Our segments are managed separately and are characterized by different middle-market consumer lending products. Our segment results are reported on a continuing operations basis. For additional financial information relating to our business and our operating segments, see the section “Segment Results – IFRS Management Basis” in the MD&A and Note 24, “Business Segments” in the accompanying consolidated financial statements.
 
Our Card and Retail Services segment includes our MasterCard, Visa, American Express and Discover credit card as well as our private label credit card operations. The Card and Retail Services segment offers these products throughout the United States primarily via strategic affinity and co-branding relationships, merchant relationships and direct mail. We also offer products and provide customer service through the Internet.
 
Our Consumer segment consists of our run-off Consumer Lending and Mortgage Services businesses. The Consumer segment provided real estate secured and personal non-credit card loans. Loans in our Consumer Lending business were offered with both revolving and closed-end terms and with fixed or variable interest rates and were originated through branch locations and direct mail. Products were also offered and customers serviced through the Internet. Prior to the first quarter of 2007, through our Mortgage Services business we acquired loans from correspondent lenders and prior to September 2007 we also originated loans sourced through mortgage brokers. While these businesses are operating in run-off mode, they have not been reported as discontinued operations because we continue to generate cash flow from the ongoing collections of the receivables, including interest and fees.
 
Information about businesses or functions that fall below the segment reporting quantitative threshold tests such as our Insurance Services and Commercial operations, as well as our Treasury and Corporate activities, which include certain fair value adjustments related to purchase accounting and related amortization, are included under the “All Other” caption within our segment disclosure in the MD&A.
 
As discussed more fully in Note 3, “Discontinued Operations,” in the accompanying consolidated financial statements, our Auto Finance business, which was previously reported in our Consumer segment, and our Taxpayer Financial Services business, which was previously included in the “All Other” caption, are now reported as discontinued operations and are no longer included in our segment presentation in the case of our Auto Finance business and under the “All Other” caption in the case of our Taxpayer Financial Services business.
 
Corporate goals and individual goals of executives are currently calculated in accordance with International Financial Reporting Standards (“IFRSs”) under which HSBC prepares its consolidated financial statements. As a result, operating results are monitored and reviewed, trends are evaluated and decisions about allocating resources, such as employees, are made almost exclusively on an IFRS Management basis (a non-U.S. GAAP financial measure). Accordingly, in conformity with applicable accounting standards, our segment reporting is on an IFRS Management basis. However, we continue to monitor capital adequacy, establish dividend policy and report to regulatory agencies on a U.S. GAAP basis. For additional financial information relating to our business and operating segments as well as a summary of the significant differences between U.S. GAAP and IFRSs as they impact our results, see Note 24, “Business Segments” in the accompanying consolidated financial statements.
 
We are currently in the process of re-evaluating the financial information used to manage our business, including the scope and content of the financial data being reported to our Management and our Board. To the extent we make changes to this reporting in 2011, we will evaluate any impact such changes may have to our segment reporting.
 
Card and Retail Services Our Card and Retail Services business includes our MasterCard, Visa, American Express and Discover receivables (“Cards”) in the United States originated under various brands, including The GM Card®,


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HSBC Finance Corporation
 
the Union Plus® (“UP”) credit card, Household Bank, Orchard Bank and HSBC branded credit cards. Our Card and Retail Services business also originates private label receivables. The private label receivables, along with the GM and UP receivables are sold daily to HSBC Bank USA, which we continue to service for a fee.
 
The Cards business has approximately $9.9 billion in receivables at December 31, 2010 and approximately 15 million active customer accounts. According to The Nilson Report, we are the seventh largest issuer of MasterCard and Visa credit cards in the United States (based on managed receivable balances).
 
GM, a co-branded credit card issued as part of our program with General Motors Company, enables customers to earn discounts on the purchase or lease of a new, eligible GM vehicle. The UP card program provides benefits and services to members of various national and international labor unions. The Household Bank and Orchard Bank credit cards offer specialized credit card products to consumers underserved by traditional providers. The credit card portfolio of our Card and Retail Services business is generated primarily through direct mail, telemarketing, Internet applications, application displays, promotional activity associated with our affinity and co-branding relationships, mass-media advertisement (The GM Card) and merchant relationships. In January 2009, we sold our GM and UP MasterCard and Visa portfolios with an outstanding principal balance of $12.4 billion at the time of sale to HSBC Bank USA. We sell all new originations under these programs to HSBC Bank USA on a daily basis. The Card and Retail Services business continues to service the receivables on behalf of HSBC Bank USA for a fee. In July 2004, we purchased the account relationships associated with certain credit card receivables from HSBC Bank USA and sell all new receivable originations to HSBC Bank USA on a daily basis. We continue to service this portfolio as well as other smaller credit card receivable portfolios for HSBC Bank USA, which have a balance at December 31, 2010 of $2.0 billion, for a fee.
 
The private label credit card (“PLCC”) business has approximately 14 million active customer accounts and 23 active merchant relationships. The Nilson Report lists our private label servicing portfolio as the third largest portfolio in the United States. At December 31, 2010, our PLCC receivables were sourced from the following business lines: approximately 49 percent in consumer electronics, 20 percent in power sport vehicles (snowmobiles, personal watercraft, all terrain vehicles and motorcycles), 17 percent in department stores, and 5 percent of receivables in furniture stores. The private label financing products are generated through merchant retail locations, merchant catalog and telephone sales, and direct mail and Internet applications. On December 29, 2004, our PLCC portfolio was sold to HSBC Bank USA, and agreements were entered into to sell substantially all future receivables to HSBC Bank USA on a daily basis and to service the portfolio for HSBC Bank USA for a fee. As a result, we sell all new private label receivables upon origination, but service the entire portfolio on behalf of HSBC Bank USA.
 
Consumer In late February 2009, we decided to discontinue all originations by our Consumer Lending business. Under the HFC and Beneficial brands and the HSBC Credit Centers, our Consumer Lending business offered secured and unsecured loan products, such as first and second lien position closed-end mortgage loans, open-end home equity loans and personal non-credit card loans. The bulk of the mortgage lending products originated in the branch network were for refinancing and debt consolidation rather than home purchases. We continue to service the remaining portfolio as it runs off while helping qualifying customers in need of assistance with appropriate loan modifications and other account management programs. At December 31, 2010, our Consumer Lending business had $33.3 billion in real estate secured receivables, of which approximately 95 percent are fixed rate loans and 90 percent are in a first lien position. Additionally, our Consumer Lending business had $7.1 billion in personal non-credit card receivables at December 31, 2010. In total, our Consumer Lending business had approximately 1.2 million active customer accounts at December 31, 2010.
 
Prior to the first quarter of 2007 when we ceased new purchase activity, our Mortgage Services business purchased non-conforming first and second lien real estate secured loans from a network of unaffiliated third party lenders (i.e. correspondents) based on our underwriting standards. Our Mortgage Services business included the operations of Decision One Mortgage Company (“Decision One”) which historically originated mortgage loans sourced by independent mortgage brokers and sold such loans to secondary market purchasers, including Mortgage Services. As a result of the deterioration in the subprime mortgage lending industry, in September 2007 we announced that Decision One originations would cease. In 2009, we entered into agreements with several of the largest purchasers of Decision One loans, which limits the potential for repurchase demands from these loan purchasers. In addition,


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the Decision One contracts had certain contractual breach, discovery and notification requirements between Decision One and the counterparties. These requirements strengthen our position to defend claims. As a result, we believe repurchase exposures in that portfolio are not significant. We continue to service the remaining Mortgage Services portfolio as it runs off. At December 31, 2010, our Mortgage Services business has $16.0 billion in receivables remaining. Approximately 63 percent of the Mortgage Services portfolio is fixed rate loans and 86 percent is in a first lien position. In total, our Mortgage Services business had approximately 165,000 active customer accounts at December 31, 2010.
 
All Other Our Insurance business designs and distributes term life, credit life, unemployment, accidental death and disability, whole life, annuities, disability, long term care and a variety of other specialty protection products to our customers and the customers of affiliated financial institutions, such as HSBC Bank USA and HSBC Bank Canada. Such products currently are offered throughout the United States and Canada to customers based upon their particular needs. The Insurance business has approximately 7.5 million customers, which includes customers of our other businesses and of our affiliated financial institutions. Insurance distributed to our customers is directly written by or reinsured with one or more of our subsidiaries. Insurance sold to customers of HSBC Bank USA and certain other affiliates is written primarily by unaffiliated insurance companies.
 
Regulation and Competition
 
Regulation
 
Financial Regulatory Reform On July 21, 2010, the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (“Dodd-Frank”) was signed into law. This legislation is a sweeping overhaul of the financial regulatory system. The new law is comprehensive and includes many provisions specifically relevant to our businesses and the businesses of our affiliates.
 
For instance, over a transition period from 2013 to 2015, the Federal Reserve Board will apply more stringent capital and risk management requirements on bank holding companies such as HSBC North America, which will require a minimum leverage ratio of five percent and a minimum total risk-based capital ratio of ten percent.
 
In order to preserve financial stability in the industry, the legislation has created the Financial Stability Oversight Council which may take certain actions, including precluding mergers, restricting financial products offered, restricting or terminating activities or imposing conditions on activities or requiring the sale or transfer of assets, against any bank holding company with assets greater than $50.0 billion that is found to pose a grave threat to financial stability. Large bank holding companies, such as HSBC North America, will also be required to file resolution plans and identify how insured bank subsidiaries are adequately protected from risk of other affiliates. The Federal Reserve Board will also adopt a series of increased supervisory standards to be followed by large bank holding companies. Additionally, activities of bank holding companies, such as the ability to acquire U.S. banks or to engage in non-banking activities, will be more directly tied to examination ratings of “well-managed” and “well capitalized.” There are also provisions in Dodd-Frank that relate to governance of executive compensation, including disclosures evidencing the relationship between compensation and performance and a requirement that some executive incentive compensation is forfeitable in the event of an accounting restatement.
 
In relation to requirements for bank transactions with affiliates, the legislation which will be in effect beginning in July 2012 extends current quantitative limits on credit transactions to now include credit exposure related to repurchase agreements, derivatives and securities lending transactions. This provision may limit the use of intercompany transactions between us and our affiliates which may impact our current funding and hedging strategies.
 
The legislation has numerous provisions addressing derivatives. There is the imposition of comprehensive regulation of over-the-counter (“OTC”) derivatives markets, including credit default and interest rate swaps, as well as limits on FDIC-insured banks’ overall OTC derivatives activities. Most of the significant provisions are to be implemented within two to three years of the enactment of the legislation. There is also the requirement for the use of mandatory derivative clearing houses and exchanges, which will significantly change the derivatives industry.


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The legislation has created the Bureau of Consumer Financial Protection (the “CFPB”). The CFPB will be a new independent bureau within the Federal Reserve Board and will act as a single primary Federal consumer protection supervisor to regulate credit, savings, payment and other consumer financial products and services and providers of those products and services. Establishment of the CFPB is underway and the agency expects to be operational as of July 21, 2011. The CFPB will have the authority to issue regulations to prevent unfair, deceptive or abusive practices in connection with consumer financial products or services and to ensure features of any consumer financial products or services are fully, accurately and effectively disclosed to consumers. The CFPB will also have authority to examine large banks, including our affiliate HSBC Bank USA, and their affiliates, for compliance with those regulations.
 
With respect to certain laws governing the provision of consumer financial products by national banks such as our affiliate HSBC Bank USA and our credit card banking subsidiary, HSBC Bank Nevada, N.A. (“HSBC Bank Nevada”), the legislation codifies the current judicial standard of federal preemption with respect to national banks but adds procedural steps which must be followed by the Office of the Comptroller of the Currency (“OCC”) when considering preemption determinations after July 21, 2011. Furthermore, the legislation removes the ability of subsidiaries or agents of a national bank to claim federal preemption of consumer financial laws after July 21, 2011, although the legislation does not purport to affect existing contracts. These limitations on federal preemption may elevate our costs of compliance, while increasing litigation expenses as a result of potential Attorneys General or plaintiff challenges and the risk of courts not giving deference to the OCC, as well as increasing complexity due to the lack of uniformity in state law. At this time, we are unable to determine the extent to which the limitations on federal preemption will impact our businesses and those of our competitors.
 
The legislation contains many other customer-related provisions including provisions addressing mortgage reform. In the area of mortgage origination, there is a requirement to apply a net tangible benefit test for all refinancing transactions. We used a net tangible benefits test in evaluating loan refinancings since March 2003. There are also numerous revised servicing requirements for mortgage loans.
 
The legislation will have a significant impact on the operations of many financial institutions in the U.S., including our affiliates. As the legislation calls for extensive regulations to be promulgated to interpret and implement the legislation, we are unable to determine precisely the impact that Dodd-Frank and related regulations will have on our financial results at this time.
 
Consumer Regulation Our businesses operate in a highly regulated environment. In addition to the establishment of the CFPB and the other consumer related provisions of Dodd-Frank described above, our businesses are subject to laws relating to consumer protection including, without limitation, fair lending, fair debt collection practices, use of credit reports, privacy matters, and disclosure of credit terms and correction of billing errors. Local, state and national regulatory and enforcement agencies continue efforts to address perceived problems with the mortgage lending and credit card industries through broad or targeted legislative or regulatory initiatives aimed at lenders’ operations in consumer lending markets. There continues to be a significant amount of legislative activity, nationally, locally and at the state level, designed to limit certain lending practices while mandating servicing activities. We are also subject to certain regulations and legislation that limit operations in certain jurisdictions. For example, limitations may be placed on the amount of interest or fees that a loan may bear, the amount that may be borrowed, the types of actions that may be taken to collect or foreclose upon delinquent loans or the information about a customer that may be shared. For consumer loans still being serviced by HSBC Finance Corporation, certain consumer finance subsidiaries and affiliated entities assisting with this servicing are generally licensed by state regulatory bodies in the jurisdictions in which they operate. Such licenses have limited terms but are renewable, and are revocable for cause. Failure to comply with these laws and regulations may limit the ability of our licensed entities to collect or enforce loan agreements made with consumers and may cause these subsidiaries to be liable for damages and penalties.
 
On May 22, 2009, the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the “CARD Act”) was signed into law and we have implemented all of its applicable provisions. The CARD Act has required us to make changes to our business practices, and will require us and our competitors to manage risk differently than has historically been the case. Pricing, underwriting and product changes have either been implemented or are under continuing analysis to partially mitigate the impact of the new legislation and implementing regulations. Although


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implementation of the new rules has had a significant financial impact on us, the full impact of the CARD Act remains uncertain at this time as it will ultimately depend upon successful implementation of our strategies, consumer behavior, and the actions of our competitors as well as the clarifying rules by the regulators. See ’Segment Results – IFRSs Management Basis” with the Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) within this Form 10-K for further discussion of the impact of the CARD Act on our business.
 
Due to the turmoil in the mortgage lending markets, there has also been a significant amount of federal and state legislative and regulatory focus on this industry. Increased regulatory oversight over residential mortgage lenders has occurred, including through state and federal examinations and periodic inquiries from state attorneys general for information. Several regulators, legislators and other governmental bodies have promoted particular views of appropriate or “model” loan modification programs, suitable loan products and foreclosure and loss mitigation practices. We have developed a modification program that employs procedures which we believe are most responsive to our customers needs and continue to enhance and refine these practices as other programs are announced, and we evaluate the results of our customer assistance efforts. We continue to be active in various home preservation initiatives through participation at local events sponsored by public officials, community leaders and consumer advocates.
 
State and federal officials are investigating the procedures followed by mortgage servicing companies and banks, including HSBC Finance Corporation and certain of our affiliates, relating to foreclosures. We and our affiliates have responded to all related inquiries and cooperated with all applicable investigations, including a joint examination by staffs of the Federal Reserve Board (the “Federal Reserve”) and the Office of the Comptroller of the Currency (the “OCC”) as part of their broad horizontal review of industry foreclosure practices. Following the examination, the Federal Reserve issued a supervisory letter to HSBC Finance Corporation and HSBC North America noting certain deficiencies in the processing, preparation and signing of affidavits and other documents supporting foreclosures and in governance of and resources devoted to our foreclosure processes, including the evaluation and monitoring of third party law firms retained to effect our foreclosures. Certain other processes were deemed adequate. The OCC issued a similar supervisory letter to HSBC Bank USA. We have suspended foreclosures until such time as we have substantially addressed the noted deficiencies in our processes. We are also reviewing foreclosures where judgment has not yet been entered and will correct deficient documentation and re-file affidavits where necessary. See “Executive Overview” in MD&A for further discussion.
 
We and our affiliates are engaged in discussions with the Federal Reserve and the OCC regarding the terms of consent cease and desist orders, which will prescribe actions to address the deficiencies noted in the joint examination. We expect the consent orders will be finalized shortly after the date this Form 10-K is filed. While the impact of the Federal Reserve consent order on HSBC Finance Corporation depends on the final terms, we believe it has the potential to increase our operational, reputational and legal risk profiles and expect implementation of its provisions will require significant financial and managerial resources. In addition, the consent orders will not preclude further actions against HSBC Finance Corporation or our affiliates by bank regulatory or other agencies, including the imposition of fines and civil money penalties. We are unable at this time, however, to determine the likelihood of any further action or the amount of penalties or fines, if any, that may be imposed by the regulators or agencies.
 
As a result of publicized foreclosure practices of certain servicers, certain courts have issued new rules relating to foreclosures and we anticipate that scrutiny of foreclosure documentation and practices, including practices of foreclosure law firms, will increase. In some areas, court officials are requiring additional verification of information filed prior to the foreclosure proceeding. If these trends continue after we have reinstituted foreclosures, there could be additional delays in the processing of foreclosures.
 
Banking Institutions In December 2007, U.S. regulators published a final rule regarding Risk-Based Capital Standards: Advanced Capital Adequacy Framework – Basel II. This final rule represents the U.S. adoption of the Basel II International Capital Accord (“Basel II”). The final rule became effective April 1, 2008, and requires large bank holding companies, including HSBC North America to adopt its provisions subject to regulatory approval no later than April 1, 2011 in accordance with current regulatory timelines. HSBC North America has established a


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comprehensive Basel II infrastructure project. While we will not report separately under the new rules, the composition of our balance sheet will impact the overall HSBC North America capital requirements. As a result, we took a series of actions in 2010 to achieve targeted total capital levels under these new regulations, including the exchange of certain existing senior notes for newly issued subordinated debt, the reopening of the subordinated debt to additional investors and the sale of our auto finance receivable portfolio which reduced asset levels. Further increases in regulatory capital may be required prior to HSBC North America’s Basel II adoption date. The exact amount of additional capital required, however, will depend upon both our prevailing risk profile and that of our North America affiliates under various stress scenarios.
 
HSBC North America and HSBC Finance Corporation also continue to support the HSBC implementation of the Basel II framework, as adopted by the U.K. Financial Services Authority (“FSA”). We supply data regarding credit risk, operational risk and market risk to support HSBC’s regulatory capital and risk weighted asset calculations. Revised FSA capital adequacy rules for HSBC became effective January 1, 2008.
 
In December 2010, the Basel Committee on Banking Supervision (the “Basel Committee”) issued final rules on “A global regulatory framework for more resilient banks and banking systems,” commonly referred to as Basel III, which presents details of a bank capital and liquidity reform program to address both firm-specific and broader, systemic risks to the banking sector. HSBC North America is in the process of evaluating the Basel III framework for liquidity risk management. Although the Basel Committee has issued guidance, we are still awaiting formal instructions as to how the ratios will be calculated by the U.S. regulators. The proposals include both a Liquidity Coverage Ratio (“LCR”) designed to ensure banks have sufficient high-quality liquid assets to survive a significant stress scenario lasting 30 days and a Net Stable Funding Ratio (“NSFR”) with a time horizon of one year to ensure a sustainable maturity structure of assets and liabilities. For both ratios, HSBC North America will be expected to achieve a ratio of 100 percent or better. The observation period for the ratios begins in 2012 with LCR introduced by 2015 and NSFR by 2018. Based on the results of the observation periods, the Basel Committee and the regulators may make further changes by 2013 and 2016 for LCR and NSFR, respectively. We anticipate meeting these requirements well in advance of their formal introduction. HSBC Finance Corporation may need to increase its liquidity profile to support HSBC North America’s compliance with the new rules. We are unable at this time, however, to determine the extent of changes HSBC Finance Corporation will need to make to its liquidity position, if any.
 
Our credit card banking subsidiary, HSBC Bank Nevada, is a federally chartered ‘credit card bank’ and a member of the Federal Reserve System. HSBC Bank Nevada is subject to regulation, supervision and examination by the OCC. Any deposits held by HSBC Bank Nevada are insured by the Federal Deposit Insurance Corporation (“FDIC”) which renders it subject to relevant FDIC regulation.
 
HSBC Bank Nevada, like other FDIC-insured banks, currently is required to pay assessments to the FDIC for deposit insurance under the FDIC’s Bank Insurance Fund. Under the FDIC’s risk-based system for setting deposit insurance assessments, an institution’s assessments vary according to its deposit levels and other factors. Beginning in the second quarter of 2011, FDIC assessments will be based on average consolidated total assets and risk profile. However, the fees to HSBC Bank Nevada are anticipated to be immaterial.
 
In addition, U.S. bank regulatory agencies have maintained the ‘leverage’ regulatory capital requirements that generally require United States banks and bank holding companies to maintain a minimum amount of capital in relation to their balance sheet assets (measured on a non-risk-weighted basis). HSBC Bank Nevada is subject to these capital requirements, which require HSBC Bank Nevada to maintain approximately $100 million in capital to maintain a 6% leverage ratio. At December 31, 2010, capital at HSBC Bank Nevada exceeded this requirement.
 
As a result of our acquisition by HSBC, HSBC Finance Corporation and its subsidiaries became subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). HSBC is a bank holding company under the U.S. Bank Holding Company Act of 1956, as amended (the “BHCA”) as a result of its ownership of HSBC Bank USA. On January 1, 2004, HSBC created a North American organization structure to hold all of its North America operations, including HSBC Finance Corporation and its subsidiaries. This company, HSBC North America is also a bank holding company under the BHCA, by virtue of its ownership of HSBC Bank USA. HSBC and HSBC North America are registered as financial


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holding companies under the Gramm-Leach-Bliley Act amendments to the BHCA, enabling them to offer a broad range of financial products and services. HSBC North America, as a financial holding company, is supervised and examined by the Federal Reserve Bank of Chicago. We are also regularly examined and reviewed by the Federal Reserve Bank of Chicago. The Federal Deposit Insurance Corporation Improvement Act of 1991 provides for extensive regulation of insured depository institutions such as HSBC Bank Nevada, including requiring Federal banking regulators to take prompt corrective action with respect to FDIC-insured banks that do not meet minimum capital requirements. At December 31, 2010, HSBC Bank Nevada was well-capitalized under applicable OCC and FDIC regulations.
 
Competition The credit card industry in which we operate is highly fragmented and intensely competitive with a broad range of institutions offering both bank cards and private label cards. Terms such as annual percentage rates, fees, and credit lines as well as other card benefits and/or features are normally what lead customers to apply for one particular card over another. With ample competition in the credit card industry and low costs for a customer to switch to another card issuer, consumer loyalty in this industry tends to be minimal. Competitive pressure, particularly in the prime credit card market, may increase as credit card issuers increase origination activities while the demand for credit and levels of customer spending are expected to remain below historical levels for the foreseeable future.
 
As more fully discussed in the MD&A, in the current market conditions, lending is curtailed and is likely to continue to be curtailed for some time. The ultimate impact on competitive conditions of the upheaval in the marketplace, negative economic conditions and the resulting increased regulation over our industry generally at the Federal and state level and specifically over the credit card industry is unclear at this time. The ultimate impact on competition as the economy recovers is also unclear.
 
Corporate Governance and Controls
 
HSBC Finance Corporation maintains a website at www.us.hsbc.com on which we make available, as soon as reasonably practicable after filing with or furnishing to the SEC, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports. Our website also contains our Corporate Governance Standards and committee charters for the Audit and Risk, Compliance and Executive Committees of our Board of Directors. We have a Statement of Business Principles and Code of Ethics that expresses the principles upon which we operate our businesses. Integrity is the foundation of all our business endeavors and is the result of continued dedication and commitment to the highest ethical standards in our relationships with each other, with other organizations and individuals who are our customers. Our Statement of Business Principles and Code of Ethics can be found on our corporate website. We also have a Code of Ethics for Senior Financial Officers that applies to our finance and accounting professionals that supplements the Statement of Business Principles. That Code of Ethics is incorporated by reference in Exhibit 14 to this Annual Report on Form 10-K. Printed copies of this information can be requested at no charge. Requests should be made to HSBC Finance Corporation, 26525 North Riverwoods Boulevard, Mettawa, Illinois 60045, Attention: Corporate Secretary.
 
Certifications In addition to certifications from our Chief Executive Officer and Chief Financial Officer pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 (attached to this report on Form 10-K as Exhibits 31 and 32), we also file a written affirmation of an authorized officer with the New York Stock Exchange (the “NYSE”) certifying that such officer is not aware of any violation by HSBC Finance Corporation of the applicable NYSE corporate governance listing standards in effect as of February 28, 2011.


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Cautionary Statement on Forward-Looking Statements
 
Certain matters discussed throughout this Form 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make or approve certain statements in future filings with the SEC, in press releases, or oral or written presentations by representatives of HSBC Finance Corporation that are not statements of historical fact and may also constitute forward-looking statements. Words such as “may”, “will”, “should”, “would”, “could”, “appears”, “believe”, “intends”, “expects”, “estimates”, “targeted”, “plans”, “anticipates”, “goal” and similar expressions are intended to identify forward-looking statements but should not be considered as the only means through which these statements may be made. These matters or statements will relate to our future financial condition, economic forecast, results of operations, plans, objectives, performance or business developments and will involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from that which was expressed or implied by such forward-looking statements. Forward-looking statements are based on our current views and assumptions and speak only as of the date they are made. We undertake no obligation to update any forward-looking statement to reflect subsequent circumstances or events.
 
Item 1A. Risk Factors
 
The following discussion provides a description of some of the important risk factors that could affect our actual results and could cause our results to vary materially from those expressed in public statements or documents. However, other factors besides those discussed below or elsewhere in other of our reports filed or furnished with the SEC could affect our business or results. The reader should not consider any description of such factors to be a complete set of all potential risks that we may face.
 
The current uncertain market and economic conditions may continue to affect our business, results of operations and financial condition. Our business and earnings are affected by general business, economic and market conditions in the United States and abroad. Given our concentration of business activities in the United States and due to the nature of our historical business as a consumer lender to generally non-conforming and non-prime customers, we are particularly exposed to any additional turmoil in the economy, housing downturns, high unemployment, tight credit conditions and reduced economic growth that have occurred over the past three years and appear likely to continue in 2011. General business, economic and market conditions that could continue to affect us include:
 
  •  low consumer confidence and reduced consumer spending;
 
  •  a “double dip” recession;
 
  •  unemployment levels:
 
  •  wage income levels and declines in wealth;
 
  •  market value of real estate throughout the United States;
 
  •  inflation;
 
  •  monetary supply;
 
  •  fluctuations in both debt and equity capital markets in which we fund our operations;
 
  •  unexpected geopolitical events;
 
  •  fluctuations in the value of the U.S. dollar;
 
  •  short-term and long-term interest rates;
 
  •  availability of liquidity;
 
  •  tight consumer credit conditions;


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  •  higher bankruptcy filings; and
 
  •  new laws, regulations or regulatory initiatives.
 
In a challenging economic environment such as currently being experienced in the United States, more of our customers are likely to, and have in fact become, delinquent on their loans or other obligations as compared to historical periods as many of our customers are experiencing reductions in cash flow available to service their debt. These delinquencies, in turn, have resulted in higher levels of provision for credit losses and charge-offs, which have adversely affected our earnings and resulted in significant losses from the third quarter of 2007 to date. The problems in the housing markets in the United States in the last four years have been exacerbated by continued high unemployment rates. If businesses remain cautious to hire, additional losses are likely to be significant in all types of our consumer loans, including credit cards, due to decreased consumer income.
 
Although during the first half of 2010, housing prices began to stabilize and even recover in certain markets, housing prices started to decline again in the latter half of 2010. If housing prices continue to decline, there may be increased delinquency and losses in our real estate portfolio.
 
Mortgage lenders have substantially tightened lending standards. These actions have impacted borrowers’ abilities to refinance existing mortgage loans. The ability to refinance and extract equity from their homes is no longer an option for many of our customers. This, in turn, impacted both credit performance and run-off rates and has resulted in significantly elevated delinquency rates for real estate secured loans in our portfolio. Additionally, the high levels of inventory of homes for sale combined with depressed property values in many markets has resulted in higher loss severities on homes that are foreclosed and remarketed. Despite our cessation in processing foreclosures in December, our inventory of foreclosed properties (real estate owned or “REO”) continued to increase during 2010 and is at its highest levels since the third quarter of 2008. Although average REO loss severities were relatively stable in 2010 compared to 2009, the level of severities has been increasing in the latter half of 2010. If severities continue to increase, it could have a significant impact on future losses.
 
In the event economic conditions continue to be depressed or become further depressed and lead to a “double dip” recession, there would be a significant negative impact on delinquencies, charge-offs and losses in all loan portfolios with a corresponding impact on our results of operations.
 
We may incur additional costs and expenses in ensuring that we satisfy requirements relating to our mortgage foreclosure processes and the industry-wide delay in processing foreclosures may have a significant impact upon loss severity. State and federal officials are investigating the procedures followed by mortgage servicing companies and banks, including HSBC Finance Corporation and certain of our affiliates, relating to foreclosures. We and our affiliates have responded to all related inquiries and cooperated with all applicable investigations, including a joint examination by staffs of the Federal Reserve and the OCC as part of their broad horizontal review of industry foreclosure practices. Following the examination, the Federal Reserve issued a supervisory letter to HSBC Finance Corporation and HSBC North America noting certain deficiencies in the processing, preparation and signing of affidavits and other documents supporting foreclosures and in governance of and resources devoted to our foreclosure processes, including the evaluation and monitoring of third party law firms retained to effect our foreclosures. Certain other processes were deemed adequate. The OCC issued a similar supervisory letter to HSBC Bank USA. We have suspended foreclosures until such time as we have substantially addressed the noted deficiencies in our processes. We are also reviewing foreclosures where judgment has not yet been entered and will correct deficient documentation and re-file affidavits where necessary.
 
We and our affiliates are engaged in discussions with the Federal Reserve and the OCC regarding the terms of consent cease and desist orders, which will prescribe actions to address the deficiencies noted in the joint examination. We expect the consent orders will be finalized shortly after the date this Form 10-K is filed. While the impact of the Federal Reserve consent order on HSBC Finance Corporation depends on the final terms, we believe it has the potential to increase our operational, reputational and legal risk profiles and expect implementation of its provisions will require significant financial and managerial resources. In addition, the consent orders will not preclude further actions against HSBC Finance Corporation or our affiliates by bank regulatory or other


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agencies, including the imposition of fines and civil money penalties. We are unable at this time, however, to determine the likelihood of any further action or the amount of penalties or fines, if any, that may be imposed by the regulators or agencies.
 
We expect to incur additional costs and expenses in connection with the correction or affirmation of previously filed foreclosure paperwork and the resulting delays in foreclosures, including costs associated with the maintenance of properties while foreclosures are delayed, legal expenses associated with re-filing documents or, as necessary, re-filing foreclosure cases, and costs associated with fluctuations in home prices while foreclosures are delayed. These costs could increase depending on the length of the delay. In addition, we may incur additional costs and expenses as a result of legislative, administrative or regulatory investigations or actions relating to our foreclosure processes or with respect to the mortgage servicing industry in general. We may also see an increase in private litigation concerning our practices. However, it is not possible at this time to predict the ultimate outcome of these matters or the impact that they will have on our financial results.
 
Due to the significant slow-down in foreclosures, and in some instances, cessation of all foreclosure processing by numerous loan servicers, including us, for some period of time in 2011 there may be some reduction in the number of properties being marketed following foreclosure. The impact of that decrease may increase demand for properties currently on the market resulting in a stabilization of home prices but could also result in a larger number of vacant properties in communities creating downward pressure on general property values. As a result, the short term impact of the foreclosure processing delay is highly uncertain. However, the longer term impact is even more uncertain as eventually servicers will again begin to foreclose and market properties in large numbers which is likely to create a significant over-supply of housing inventory. This could lead to a significant increase in loss severity on REO properties.
 
Recently implemented Federal and state laws and regulations may significantly impact our operations. We operate in a highly regulated environment. Changes in federal, state and local laws and regulations, including changes in tax rates, affecting banking, consumer credit, bankruptcy, privacy, consumer protection or other matters could materially impact our performance. Ensuring compliance with increasing regulatory requirements and initiatives could affect operations costs and negatively impact our overall results. Specifically, attempts by local, state and national regulatory agencies to address perceived problems with the credit card industry and, more recently, to additionally address perceived problems in the financial services industry generally through broad or targeted legislative or regulatory initiatives aimed at lenders’ operations in consumer lending markets, could affect us in substantial and unpredictable ways, including limiting the types of products we can offer, how these products may be originated, the fees and charges that may be applied to accounts, and how accounts may be collected or security interests enforced which ultimately could negatively impact our results. There is also significant focus on loss mitigation and foreclosure activity for real estate loans. We cannot fully anticipate the response by national regulatory agencies, state attorneys general, or certain legislators, or if significant changes to our operations and practices will be required as a result.
 
On July 21, 2010, the “Dodd-Frank Wall Street Reform and Consumer Protection Act,” which is a sweeping overhaul of the financial services industry, was signed into law. For a description of the law, see the “Regulation – Financial Regulatory Reform” section under the “Regulation and Competition” section of Item 1. Business. The law will have significant impact on the operations of financial institutions in the U.S., including us and our affiliates. We are unable at this time, however, to determine the full impact of the law due to the significant number of new rules and regulations which will be promulgated in order to implement the law. Also, specifically and of utmost relevance to our Card and Retail Services and Consumer businesses, we do not know what will be the far-reaching effect on our business of the newly created Consumer Financial Protection Bureau (“CFPB”), since the CFPB has been given broad based authority over consumer products and services such as provided by our Card and Retail Services and Consumer businesses.
 
On May 22, 2009, the Credit Card Accountability Responsibility and Disclosure Act of 2009 was signed into law and we have implemented all of its applicable provisions. The CARD Act required changes to our business practices, and will require us and our competitors to manage risk differently than has historically been the case. Pricing, underwriting and product changes have either been implemented or are under continuing analysis to


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partially mitigate the impact of the new legislation and implementing regulations. Although implementation of the new rules has had a significant financial impact on us, the full impact of the CARD Act remains uncertain at this time as it will ultimately depend upon successful implementation of our strategies, consumer behavior and the actions of our competitors, as well as the clarifying rules issued by the regulators.
 
The transition to Basel II in 2011 may continue to put significant pressure on regulatory capital. Subject to regulatory approval, HSBC North America will be required to adopt Basel II provisions no later than April 1, 2011, in accordance with current regulatory timelines. While Basel II does not apply directly to us, as a subsidiary of HSBC North America, we may be required to execute certain actions or strategies to ensure HSBC North America meets its capital requirements. For instance, in the fourth quarter of 2010, we executed two balance sheet management strategies to increase total capital as measured under the Basel guidelines. First, we exchanged $1.8 billion in outstanding senior unsecured debt for $1.9 billion of subordinated debt. Second, we reopened the subordinated debt issuance described above and increased the outstanding balance of this debt issue by $1.0 billion. In both instances, interest expense increased and net interest income declined as we replaced senior debt positions with the higher yielding subordinated debt. The amount of capital required prior to the Basel II adoption date will depend on our prevailing risk profile and that of our North America affiliates under various stress scenarios. Adoption of the Basel II provisions must be preceded by a parallel run period of at least four quarters, and requires the approval of U.S. regulators. This parallel run, which was initiated by HSBC North America in January 2010, encompasses enhancements to a number of risk policies, processes and systems to align with the Basel II final rule requirements. HSBC North America will seek regulatory approval for adoption when the program enhancements have been completed which may extend beyond April 1, 2011.
 
Key employees may be difficult to retain due to contraction of the business and limits on promotional opportunities. Our employees are our most important resource and, in many areas of the financial services industry, competition for qualified personnel is intense. If we are unable to continue to attract and retain qualified key employees to support the various functions of our businesses, our performance, including our competitive position, could be materially adversely affected. The significant losses we have recognized, reductions in variable compensation and other benefits, reductions of the size and scope of operations and the winding down of significant portions of the businesses could raise concerns about key employees’ future compensation and promotional opportunities. As economic conditions improve, there will be increased risk to retain top performers and critical skill employees. If key personnel were to leave us and equally knowledgeable or skilled personnel are unavailable within HSBC or could not be sourced in the market to fill these roles, our ability to efficiently manage through the difficult economy and transformational changes may be hindered or impaired.
 
Performance of modified loans in the current economic conditions may prove less predictable and result in higher losses. In an effort to provide assistance to our customers who are experiencing financial difficulties in the current weak economy, in the last four years we have agreed to modify the terms of a significant number of our loans. While we have a long-standing history of working with customers experiencing financial difficulties, the number of customers that have needed and qualified for loan modifications is significantly higher than our historical experience. Under the current economic conditions, the credit performance of these modified loans may not conform to either historical experience or our expectations. In addition, further deterioration in housing prices and unemployment could negatively impact the performance of the modified portfolio. While our credit loss reserve process considers whether loans have been reaged, re-written or are subject to modification, loss reserve estimates are influenced by factors outside our control, such as consumer payment patterns and economic conditions, making it reasonably possible that they could change in either direction.
 
A significant rise in interest rates may significantly impact our net interest income which may adversely impact our financial results. Both our consumer lending and mortgage services’ real estate secured receivables will continue to remain on our balance sheet for extended durations. Reduced mortgage prepayment rates and higher levels of loan modifications have had the effect of extending the projected average life of these loan portfolios. As a result, both net interest income at risk and asset portfolio valuations have increasingly become exposed to rising interest rates as the average life of our liability portfolios has declined while the average life of our asset portfolios has extended. In the event we are not successful in fully mitigating these risks and interest rates rise


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significantly, net interest income, and consequently, net income or loss, would be negatively affected. Also, with increased risks remaining on the balance sheet, we may be called upon by HSBC North America to raise capital or to execute certain actions or strategies to ensure HSBC North America meets its capital requirements.
 
Operational risks, such as systems disruptions or failures, breaches of security, human error, changes in operational practices or inadequate controls may adversely impact our business and reputation. Operational risk is inherent in virtually all of our activities. While we have established and maintain an overall risk framework that is designed to balance strong corporate oversight with well-defined independent risk management, we continue to be subject to some degree of operational risk. Our businesses are dependent on our ability to process a large number of complex transactions. If any of our financial, accounting, or other data processing and other recordkeeping systems and management controls fail or have other significant shortcomings, we could be materially adversely affected. HSBC North America will continue the implementation of several high priority systems improvements and enhancements in 2011, each of which may present increased or additional operational risk that may not be known until their implementation is complete. Also, in order to react quickly to newly implemented regulatory requirements, implementation of changes to systems and enhancements may be required to be completed within very tight time frames, which would increase operational risk.
 
We may also be subject to disruptions of our operating systems infrastructure arising from events that are wholly or partially beyond our control, which may include:
 
  •  computer viruses or electrical or telecommunications outages;
 
  •  natural disasters such as hurricanes and earthquakes;
 
  •  events arising from local, regional or international politics, including terrorist acts;
 
  •  unforeseen problems encountered while implementing major new computer systems; or
 
  •  global pandemics, which could have a significant effect on our business operations as well as on HSBC affiliates world-wide.
 
Such disruptions may give rise to losses in service to customers, an inability to collect our receivables in affected areas and other loss or liability to us.
 
We are similarly dependent on our employees. We could be materially adversely affected if an employee causes a significant operational break-down or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our operations or systems. Third parties with which we do business could also be sources of operational risk to us, including risks relating to break-downs or failures of such parties’ own systems or employees. Any of these occurrences could result in diminished ability by us to operate one or more of our businesses, potential liability to clients, reputational damage and regulatory intervention, all of which could materially adversely affect us. In a company as large and complex as ours, lapses or deficiencies in internal control over financial reporting are likely to occur from time to time.
 
In recent years, instances of identity theft and fraudulent attempts to obtain personal financial information from individuals and from companies that maintain such information pertaining to their customers have become more prevalent. Use of the internet for these purposes has also increased. Such acts can have the following possible impacts:
 
  •  threaten the assets of our customers;
 
  •  negatively impact customer credit ratings;
 
  •  impact customers’ ability to repay loan balances;
 
  •  increase costs for us to respond to such threats and to enhance our processes and systems to ensure maximum security of data; or
 
  •  damage our reputation from public knowledge of intrusion into our systems and databases.


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In addition, there is the risk that our controls and procedures as well as business continuity and data security systems could prove to be inadequate. Any such failure could affect our operations and could have a material adverse effect on our results of operations by requiring us to expend significant resources to correct the defect, as well as by exposing us to litigation or losses not covered by insurance.
 
Changes to operational practices from time to time could materially positively or negatively impact our performance and results. Such changes may include:
 
  •  raising the minimum payment or fees to be charged on credit card accounts;
 
  •  determinating to acquire or sell credit card, real estate secured or other receivables;
 
  •  changes to our charge-off policies or customer account management and risk management/collection policies and practices;
 
  •  increasing investment in technology, business infrastructure and specialized personnel; or
 
  •  outsourcing of various operations.
 
Lawsuits and regulatory investigations and proceedings may continue and increase in the current economic and anticipated regulatory environment. HSBC Finance Corporation and our subsidiaries are named as defendants in various legal actions, including class actions and other litigation or disputes with third parties, as well as investigations or proceedings brought by regulatory agencies. We saw continued litigation in 2010 resulting from the deterioration of customers’ financial condition, the mortgage market’s continued downturn and general economic conditions. There is no certainty that the litigation will decrease in the near future, especially in the event of continued high unemployment rates, a resurgent recession or additional regulatory investigations by the federal and state governments or agencies. With the increased regulatory environment, particularly in the financial services industry, there may be additional regulatory investigations and reviews conducted by banking regulators, state attorneys general or state regulators which may cause financial or reputational harm. With the increased regulatory environment, particularly in the financial services industry, there may be additional regulatory investigations and reviews conducted by regulators and other enforcement agencies that, if determined adversely, may result in judgments, settlements, fines, penalties or other results, including additional compliance requirements, which could materially adversely affect our business, financial condition or results of operation, or cause us serious reputational harm.
 
Our inability to meet funding requirements due to our balance sheet attrition or ratings could impact operations. Adequate liquidity is critical to our ability to operate our businesses. The pace of our balance sheet attrition has a significant impact on our liquidity and risk management processes. Properly managing these processes is critical to mitigating liquidity risk. Lower cash flow resulting from declining non-core receivable balances as well as lower cash generated from balance sheet attrition due to increased charge-offs may not provide sufficient cash to fully cover maturing debt over the next four to five years. If market pricing for receivables improves, a portion of the required funding could be generated through sales of receivable portfolios. Additionally, HSBC Finance Corporation continues to enjoy access to funding through issuance in the primary debt markets. A portion of any funding gap could be covered through the selected issuance of debt. In the event a portion of this gap was met through issuances of term debt to either retail or institutional investors, we anticipate these issuances would be structured to better match the projected cash flows of the remaining run-off portfolio and reduce reliance on direct HSBC support.
 
Our credit ratings are an important part of maintaining our liquidity. As indicated by the major credit rating agencies, our credit ratings are directly dependent on the continued support of HSBC. Any downgrade in credit ratings would increase borrowing costs, impact the ability to issue commercial paper and, depending on the severity of the downgrade, substantially limit access to capital markets, require cash payments or collateral posting, and permit termination of certain significant contracts.
 
Our reputation has a direct impact on our financial results and ongoing operations. Our ability to attract customers and conduct business transactions with our counterparties could be adversely affected to the extent our


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reputation, or the reputation of affiliates operating under the HSBC brand, is damaged. Our failure to address, or to appear to fail to address, various issues that could give rise to reputational risk could cause harm to us and our business prospects. Reputational issues include, but are not limited to:
 
  •  appropriately addressing potential conflicts of interest;
 
  •  legal and regulatory requirements;
 
  •  ethical issues, including alleged deceptive or unfair lending or servicing practices;
 
  •  anti-money laundering and economic sanctions programs;
 
  •  privacy issues;
 
  •  fraud issues;
 
  •  data security issues related to our customers or employees;
 
  •  record-keeping;
 
  •  sales and trading practices;
 
  •  the proper identification of the legal, reputational, credit, liquidity and market risks inherent our businesses; and
 
  •  general company performance.
 
The failure to address these issues appropriately could make our customers unwilling to do business with us or give rise to increased regulatory action, which could adversely affect our results of operations.
 
Unanticipated risks may impact our results. We seek to monitor and manage our risk exposure through a variety of separate but complementary financial, credit market, operational, compliance and legal reporting systems, including models and programs that predict loan delinquency and loss. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques and prepare contingency plans in anticipation of developments, those techniques and plans and the judgments that accompany their application are complex and cannot anticipate every economic and financial outcome or the specifics and timing of such outcomes. Accordingly, our ability to successfully identify and manage all significant risks we face is an important factor that can significantly impact our results.
 
Competition in the credit card industry may have a material adverse impact on our future results. We operate in a highly competitive environment. Competitive conditions are expected to continue to intensify as continued merger activity in the financial services industry produces larger, better-capitalized and more geographically diverse companies. New products, customers and channels of distribution are constantly emerging. Such competition may impact the terms, rates, costs and/or profits historically included in the financial products we offer and purchase. There is no assurance that the significant and increasing competition within the financial services industry will not materially adversely affect our future results.
 
Management projections, estimates and judgments based on historical performance may not be indicative of our future performance. Our management is required to use certain estimates in preparing our financial statements, including accounting estimates to determine loan loss reserves, reserves related to litigation, deferred tax assets and the fair market value of certain assets and liabilities, including goodwill and intangibles, among other items. Certain asset and liability valuations and, in particular, loan loss reserve estimates are judgmental and are influenced by factors outside our control. Judgment remains a more significant factor in the estimation of inherent probable losses in the portfolios. To the extent historical averages of the progression of loans into stages of delinquency and the amount of loss realized upon charge-off are not predictive of future losses and management is unable to accurately evaluate the portfolio risk factors not fully reflected in historical models, unexpected additional losses could result. Alternatively, the recent historical performance trends of high unemployment rates and home price depreciation occurring in the last several years, may now not be reflective of the performance of loans modified since January 2007 as a result of recent improvements in the economic environment, so judgment is again a more significant factor in the estimation of losses related to modified loans.


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Another example in which management judgment is significant is in the evaluation of the recognition of deferred tax assets and in the determination of whether there is a need for a related valuation allowance. We are required to establish a valuation allowance for deferred tax assets and record a charge to income or shareholders’ equity if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, we estimate future taxable income based on management approved business plans, future capital requirements and ongoing tax planning strategies, including capital support from HSBC as a necessary part of such plans and strategies. This process involves significant management judgment about assumptions that are subject to change from period to period. The recognition of deferred tax assets requires management to make significant judgments about future earnings, the periods in which items will impact taxable income, and the application of inherently complex tax laws. However, since market conditions have created losses in HSBC North America in recent periods and volatility on our pre-tax book income, the analysis of the realizability of the deferred tax asset significantly discounts any future taxable income expected from continuing operations and relies to a greater extent on continued capital support from our parent, HSBC, including tax planning strategies implemented in relation to such support. Included in our forecasts are assumptions regarding our estimate of future expected credit losses which include assumptions about further home price depreciation and future unemployment levels and their related impact on credit losses. The use of different assumptions can result in changes in the amounts of deferred tax items recognized, which can result in equity and earnings volatility because such changes are reported in current period earnings. See Note 18, “Income Taxes,” in the accompanying consolidated financial statements for additional discussion of our deferred tax assets and the related valuation allowance.
 
Changes in accounting standards are beyond our control and may have a material impact on how we report our financial results and condition. Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, the Financial Accounting Standards Board (“FASB”), the International Accounting Standards Board (“IASB”), the SEC and our bank regulators, including the Office of Comptroller of the Currency and the Federal Reserve Board, change the financial accounting and reporting standards, or the interpretation thereof, and guidance that govern the preparation and disclosure of external financial statements. These changes are beyond our control, can be hard to predict and could materially impact how we report and disclose our financial results and condition, including our segment results. We could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements in material amounts. We may, in certain instances, change a business practice in order to comply with new or revised standards.
 
Significant reductions in pension assets may require additional financial contributions from us. Effective January 1, 2005, our previously separate qualified defined benefit pension plan was combined with that of HSBC Bank USA’s into a single HSBC North America qualified defined benefit plan. We are responsible for providing approximately 33 percent of the financial support required by the plan. In 2010 and 2009, the plan had allocated assets between three primary strategies: domestic equities, international equities and fixed income securities. At December 31, 2010, plan assets were lower than projected plan liabilities resulting in an under-funded status. During 2010, domestic and international equity indices increased between 11 percent and 17 percent while interest rates decreased. After expenses, the combination of positive equity returns and fixed income returns along with a $187 million contribution to the plan by HSBC North America in 2010 resulted in an overall increase in plan assets of 20 percent in 2010. This increase, when combined with an increase in the projected benefit obligation continued to result in an under-funded status. At December 31, 2010, the defined benefit plan was frozen, significantly reducing future benefit accruals. The projected benefit obligation exceeded the fair value of the plan assets by approximately $820 million. As these obligations relate to the HSBC North America pension plan, only a portion of this deficit should be considered our responsibility. We and other HSBC North American affiliates with employees participating in this plan will be required to make up this shortfall over a number of years as specified under the Pension Protection Act. This can be accomplished through direct contributions, appreciation in plan assets and/or increases in interest rates resulting in lower liability valuations. See Note 22, “Pension and Other Postretirement Benefits,” in the accompanying consolidated financial statements for further information concerning the HSBC North America defined benefit plan.


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Item 1B.  Unresolved Staff Comments.
 
We have no unresolved written comments from the Securities and Exchange Commission Staff that have been outstanding for more than 180 days at December 31, 2010.
 
Item 2.  Properties
 
Our operations are located throughout the United States, with principal facilities located in Washington, D.C., District of Columbia; Brandon, Florida; Chesapeake, Virginia; Hanover, Maryland; Las Vegas, Nevada; Tigard, Oregon; Mettawa, Illinois; Schaumburg, Illinois; Vernon Hills, Illinois; Elmhurst, Illinois; Salinas, California; London, Kentucky; and Sioux Falls, South Dakota. Our principal executive offices are located in Mettawa, Illinois. A facility in Volo, Illinois, owned by our affiliate HTSU, provides data processing support for our operations.
 
Substantially all corporate offices, regional processing and regional servicing center spaces are operated under lease with the exception of a credit card processing facility in Las Vegas, Nevada; a data processing center in Vernon Hills, Illinois; and servicing facilities in London, Kentucky and Chesapeake, Virginia. We believe that such properties are in good condition and meet our current and reasonably anticipated needs.
 
Item 3.  Legal Proceedings
 
See “Litigation and Regulatory Matters” in Note 27, “Commitments and Contingent Liabilities,” in the accompanying consolidated financial statements beginning on page 218 for our legal proceedings, disclosure which is incorporated herein by reference.
 
Item 4. Submission of Matters to a Vote of Security Holders.
 
Not applicable
 
PART II
 
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.
 
Not applicable


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Item 6. Selected Financial Data
 
In December 2010, we determined we could no longer offer Taxpayer Financial Services (“TFS”) loans in a safe and sound manner and, therefore, it was determined that we would no longer offer these loans and related products going forward. In March 2010 we sold our auto finance receivables servicing operations and certain auto finance receivables to a third party and in August 2010, we sold the remainder of our auto finance receivable portfolio to a third party. In May 2008, we sold all of the common stock of Household International Europe Limited, the holding company for our United Kingdom business (“U.K. Operations”) to HSBC Overseas Holdings (UK) Limited (“HOHU”), an HSBC affiliate. In November 2008, we sold all of the common stock of HSBC Financial Corporation Limited, the holding company of our Canadian business (“Canadian Operations”) to HSBC Bank Canada, an HSBC affiliate. As a result, our former U.K. and Canadian Operations and our TFS and Auto Finance businesses are now reported as discontinued operations for all periods presented. The following selected financial data presented below excludes the results of our discontinued operations for all periods presented unless otherwise noted.
 
                                         
Year Ended December 31,   2010     2009     2008     2007     2006  
   
    (in millions)  
 
Statement of Income (Loss)
                                       
Net interest income
  $ 4,185     $ 5,058 (1)   $ 7,936     $ 8,857     $ 8,563  
Provision for credit losses
    6,180       9,650 (1)     12,410       9,930       5,572  
Other revenues excluding the change in value of fair value optioned debt and related derivatives
    1,826       2,837       2,791       4,330       4,376  
Change in value of fair value optioned debt and related derivatives
    741       (2,125 )     3,160       1,270       -  
Operating expenses, excluding goodwill and other intangible asset impairment charges
    3,478       3,910       4,843       5,702       5,499  
Goodwill and other intangible asset impairment charges
    -       2,308       329       4,201       -  
                                         
Income (loss) from continuing operations before income tax benefit (expense)
    (2,906 )     (10,098 )     (3,695 )     (5,376 )     1,868  
Income tax benefit (expense)
    1,007       2,632       1,087       1,060       (674 )
                                         
Income (loss) from continuing operations
    (1,899 )     (7,466 )     (2,608 )     (4,316 )     1,194  
Income (loss) from discontinued operations, net of tax
    (17 )     16       (175 )     (590 )     249  
                                         
Net income (loss)
  $ (1,916 )   $ (7,450 )   $ (2,783 )   $ (4,906 )   $ 1,443  
                                         
 
                                         
As of December 31,   2010     2009     2008     2007     2006  
   
    (in millions)  
 
Balance Sheet Data
                                       
Total assets
  $ 76,336     $ 89,645     $ 120,118     $ 141,770     $ 155,279  
Receivables:
                                       
Real estate secured(2)
  $ 49,336     $ 59,535     $ 71,666     $ 84,381     $ 92,592  
Credit card(3)
    9,897       11,626       13,231       30,091       27,499  
Private label
    -       -       65       147       289  
Personal non-credit card(2)
    7,117       10,486       15,568       18,045       18,244  
Commercial and other
    33       50       93       144       181  
                                         
Total receivables
  $ 66,383     $ 81,697     $ 100,623     $ 132,808     $ 138,805  
                                         
Credit loss reserves(1)
  $ 6,491     $ 9,091     $ 12,030     $ 10,127     $ 5,980  
Receivables held for sale:
                                       
Real estate secured
  $ 4     $ 3     $ 323     $ 80     $ 1,741  
Credit card
    -       -       13,571       -       -  
                                         
Total receivables held for sale(4)
  $ 4     $ 3     $ 13,894     $ 80     $ 1,741  
                                         
Real estate owned
  $ 962     $ 592     $ 885     $ 1,008     $ 661  
Commercial paper and short-term borrowings
    3,156       4,291       9,639       7,725       10,797  
Due to affiliates(5)
    8,255       9,043       13,543       11,359       10,887  
Long-term debt
    54,616       68,880       88,048       115,700       120,159  
Preferred stock
    1,575       575       575       575       575  
Common shareholder’s equity(6)
    6,145       7,804       12,862       13,584       19,515  
                                         
 


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Year Ended December 31,   2010   2009   2008   2007   2006
 
 
Selected Financial Ratios
                                       
Return on average assets
    (2.23 )%     (7.45 )%     (1.98 )%     (2.74 )%     .82 %
Return on average common shareholder’s equity
    (27.70 )     (68.41 )     (19.76 )     (26.19 )     6.50  
Net interest margin
    5.23       5.08       6.24       6.32       6.41  
Efficiency ratio
    50.39       108.04       36.33       67.99       41.36  
Consumer net charge-off ratio
    11.98 (7)     13.59 (7)     7.90       4.23       2.72  
Consumer two-month-and-over contractual delinquency
    14.41       14.74 (8)     13.19       8.08       4.67  
Reserves as a percent of net charge-offs
    73.9 (7)     72.2 (7)(8)     136.4       175.8       168.0  
Reserves as a percent of receivables
    9.78       11.13 (8)     11.96       7.63       4.31  
Reserves as a percent of nonperforming loans
    88.5       102.4 (8)     110.0       125.3       121.6  
Reserves as a percent of two-months-and-over contractual delinquency
    67.9       75.5 (8)     79.7       94.5       91.2  
Common and preferred equity to total assets
    10.09       8.86       10.27       8.56       11.21  
Tangible common equity to tangible assets(9)
    7.37       7.60       6.68       6.09       6.11  
 
 
(1)  In December 2009, we implemented changes to our charge-off policies for real estate secured and personal non-credit card receivables. As a result of these changes, real estate secured receivables are written down to net realizable value less cost to sell generally no later than the end of the month in which the account becomes 180 days contractually delinquent and personal non-credit card receivables are charged-off generally no later than the end of the month in which the account becomes 180 days contractually delinquent. These changes resulted in a reduction to net interest income of $351 million and an increase to our provision for credit losses of $1 million which collectively increased our loss before tax by $352 million and our net loss by $227 million in 2009. These changes also resulted in a significant reduction in our credit loss reserve levels. See “Executive Overview” and “Credit Quality” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” (“MD&A”) as well as Note 8, “Changes in Charge-off Policies During 2009,” in the accompanying consolidated financial statements for additional discussion.
 
(2)  The overall trend in real estate secured and personal non-credit card receivables reflects our decision to reduce the size of our balance sheet and lower our risk profile beginning in 2007, including the decision in 2007 to discontinue correspondent channel acquisitions by our Mortgage Services business as well as the decision in late February 2009 to discontinue new customer account originations of all products in our Consumer Lending business. For further discussion of the trends in our real estate secured and personal non-credit card receivable portfolios, see “Receivables Review” in MD&A.
 
(3)  The trend in credit card receivables in 2010 and 2009 reflects the continued impact of numerous actions taken to manage risk, reduced consumer spending and, in 2010, an increased focus and ability on the part of consumers to reduce outstanding credit card debt. The trend in credit card receivables in 2008 reflects the transfer of receivables with an outstanding principal balance of $14.7 billion at the time of transfer to receivables held for sale. For further discussion of the trends in our credit card receivable portfolio, see “Receivables Review” in MD&A.
 
(4)  The decrease in receivables held for sale largely reflects the sale in January 2009 of credit card receivables with an outstanding principal balance of $12.4 billion at the time of sale.
 
(5)  As of December 31, 2010, 2009, 2008, 2007 and 2006, we have received a cumulative total of $46.5 billion, $55.0 billion, $45.1 billion, $41.0 billion and $40.3 billion, respectively, in HSBC related funding. See “Liquidity and Capital Resources” in MD&A for further discussion.
 
(6)  In 2010, 2009, 2008 and 2007, we received capital contributions of $200 million, $2.7 billion, $3.5 billion and $950 million, respectively, from HSBC Investments (North America) Inc. to support ongoing operations and to maintain capital at levels we believe are prudent in the current market conditions.
 
(7)  The net charge-off ratio for 2010 and 2009 and the ratio of reserves as a percentage of net charge-offs for 2009 are not comparable to the historical periods as comparability has been impacted by the aforementioned charge-off policy changes implemented in December 2009 for real estate secured and personal non-credit card receivables. Charge-off for these receivables under the revised policy is recognized sooner for these products beginning in 2009 than during the historical periods. See “Credit Quality” in MD&A for discussion of these ratios and related trends.
 
(8)  The aforementioned charge-off policy changes implemented in December 2009 significantly impacted these ratios and the comparability of such ratios to prior periods. See “Credit Quality” in MD&A for discussion of these ratios and related trends as well as the 2009 ratios excluding the impact of the December 2009 charge-off policy changes discussed above. Reserve ratios for all periods exclude loan portfolios which are considered held for sale as these receivables are carried at the lower of cost or fair value with no corresponding credit loss reserves.
 
(9)  Tangible common equity to tangible assets is a non-U.S. GAAP financial ratio that is used by HSBC Finance Corporation management, certain rating agencies and our credit providing banks as a measure to evaluate capital adequacy and may differ from similarly named measures presented by other companies. See “Basis of Reporting” in MD&A for additional discussion on the use of non-U.S. GAAP financial measures and “Reconciliations to U.S. GAAP Financial Measures” in MD&A for quantitative reconciliations to the equivalent U.S. GAAP basis financial measure.

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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Executive Overview
 
Organization and Basis of Reporting HSBC Finance Corporation and subsidiaries is an indirect wholly owned subsidiary of HSBC North America Holdings Inc. (“HSBC North America”) which is a wholly owned subsidiary of HSBC Holdings plc (“HSBC”). HSBC Finance Corporation may also be referred to in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) as “we”, “us”, or “our”.
 
We currently provide MasterCards(1), Visa(1), American Express and Discover(1) credit cards as well as private label cards to customers in the United States. A portion of new credit card and all new private label receivable originations are sold on a daily basis to HSBC Bank USA, National Association (“HSBC Bank USA”). We also offer specialty insurance products in the United States and Canada. Historically, we also provided several other types of loan products in the United States including real estate secured loans, personal non-credit card loans, auto finance loans and tax refund anticipation loans and related products. Prior to November 2008, we also offered consumer loans in Canada and prior to May 2008 we offered loans and specialty insurance products in the United Kingdom and the Republic of Ireland. Prior to 2007, we also offered consumer loans in Slovakia, the Czech Republic and Hungary (“European Operations”).
 
We generate cash to fund our businesses primarily by collecting receivable balances, selling certain credit card and all private label receivables to HSBC Bank USA on a daily basis, borrowing from HSBC affiliates and customers of HSBC, and issuing commercial paper, retail notes, long-term debt. We also receive capital contributions as necessary from HSBC which serve as an additional source of funding. We use the cash generated to invest in and originate new credit card receivables, to service our debt obligations and to pay dividends to our parent, when possible.
 
The following discussion of our financial condition and results of operations excludes the results of our discontinued operations unless otherwise noted. See Note 3, “Discontinued Operations” in the accompanying consolidated financial statements for further discussion of these transactions.
 
Current Environment During 2010, economic conditions in the United States generally improved, although the pace of improvement continued to be slow. Liquidity returned to the financial markets for most sources of funding except for mortgage securitization. Companies in the financial sector are generally able to issue debt with credit spreads approaching levels historically seen prior to the financial crisis, despite the expiration of some of the U.S. government’s support programs. European sovereign debt fears first triggered by Greece in May and again by Ireland in November continue to pressure borrowing costs in the U.S. During the first half of 2010, housing prices stabilized in many markets and began to recover in others as the first-time homebuyer tax credit and low interest rates attributable to government monetary policy actions served as stabilizing forces improving home sales. However, beginning in the third quarter of 2010 and continuing to the end of the year, we again began to see home price declines in many markets as the homebuyer tax credit ended and housing prices remain under pressure due to elevated foreclosure levels.
 
Despite positive job creation overall in 2010, the economy began to lose jobs again in the third quarter of 2010 as job creation in the private sector, while positive, slowed and was more than offset by reductions in government-related jobs. While job creation again turned positive in the fourth quarter, fear remains as to how pronounced any economic recovery may be. Such fear appeared to lessen, however, toward the end of 2010, as consumer spending increased and retail sales showed signs of improvement. U.S. unemployment rates, which have been a major factor in the deterioration of credit quality in the U.S., improved, but remained high at 9.4 percent in December 2010, decreasing from a rate of 10.0 percent at December 2009. However, a significant number of U.S. residents are no longer looking for work and, therefore, are not reflected in the U.S. unemployment rates. Unemployment rates in
 
 
 (1) MasterCard is a registered trademark of MasterCard International Incorporated (d/b/a MasterCard Worldwide); Visa is a registered trademark of Visa, Inc.; American Express is a registered trademark of American Express Company and Discover is a registered trademark of Discover Financial Services.


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18 states are at or above the U.S. national average. Unemployment rates in five states are at or above 11 percent, including California and Florida, states where we have receivable portfolios in excess of 5 percent of our total outstanding receivables. High unemployment rates have generally been most pronounced in the markets which had previously experienced the highest appreciation in home values. Unemployment has continued to have an impact on the provision for credit losses in our loan portfolio and in loan portfolios across the industry.
 
Although we noted signs of improvement in mortgage lending industry trends during 2010, we continue to be affected by the following:
 
  Overall levels of delinquencies remain elevated;
 
  Mortgage loan originations from 2005 to 2008 continue to perform worse than originations from prior periods;
 
  Real estate markets in a large portion of the United States continue to be affected by stagnation or declines in property values experienced over the last three years;
 
  While home prices began to stabilize in many markets and recover in others during the first half of 2010, we began to see a reversal of this trend during the second half of 2010 as home prices continue to remain under pressure due to elevated foreclosure levels and the expiration of the homebuyer tax credit;
 
  Lower secondary market demand for subprime loans resulting in reduced liquidity for subprime mortgages; and
 
  Tighter lending standards by mortgage lenders which impacts the ability of borrowers to refinance existing mortgage loans.
 
In our core credit card business, while consumer spending increased in 2010, we saw continued declines in our credit card receivable balances due to an increased focus and ability by customers to reduce outstanding credit card debt. We also continued to see the effect of actions previously taken to manage risk which also contributed to the decline in outstanding credit card receivables in 2010. While credit card marketing has increased in 2010, marketing remains low compared to historical levels. Credit quality continued to improve in 2010 as the impact of the current economic environment, including high unemployment rates, has not been as severe as originally expected due in part to improved customer payment behavior which has resulted in continued improvements in delinquency, including early stage delinquency roll rates. While adoption of the new credit card legislation resulted in reductions to revenue, the impact was mitigated by improved credit quality for our Cards business in 2010.
 
Concerns about the future of the U.S. economy, including the pace and magnitude of recovery from the recent economic recession, consumer confidence, volatility in energy prices, credit market volatility and trends in corporate earnings will continue to influence the U.S. economic recovery and the capital markets. In particular, continued improvement in unemployment rates and a sustained recovery of the housing markets remain critical components of a broader U.S. economic recovery. Further weakening in these components as well as in consumer confidence may result in additional deterioration in consumer payment patterns and credit quality. Weak consumer fundamentals including declines in wage income, consumer spending, declines in wealth and a difficult job market continue to depress consumer confidence. Additionally, there is uncertainty as to the future course of monetary policy and uncertainty as to the impact on the economy and consumer confidence when the remaining actions taken by the government to restore faith in the capital markets and stimulate consumer spending end, including the recent extension of unemployment insurance benefits and the prior presidential administration’s tax cuts. These conditions in combination with general economic weakness and the impact of recent regulatory changes will continue to impact our results in 2011, the degree of which is largely dependent upon the nature and extent of the economic recovery.
 
As discussed in prior filings, on May 22, 2009, the Credit Card Accountability Responsibility and Disclosure Act of 2009 (“Card Act”) was signed into law and became fully effective. For a discussion of the Card Act as well as the impact to our operations, see “Segment Results – IFRS Management Basis.”


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State and federal officials are investigating the procedures followed by mortgage servicing companies and banks, including HSBC Finance Corporation and certain of our affiliates, relating to foreclosures. We and our affiliates have responded to all related inquiries and cooperated with all applicable investigations, including a joint examination by staffs of the Federal Reserve Board (the “Federal Reserve”) and the Office of the Comptroller of the Currency (the “OCC”) as part of their broad horizontal review of industry foreclosure practices. Following the examination, the Federal Reserve issued a supervisory letter to HSBC Finance Corporation and HSBC North America noting certain deficiencies in the processing, preparation and signing of affidavits and other documents supporting foreclosures and in governance of and resources devoted to our foreclosure processes, including the evaluation and monitoring of third party law firms retained to effect our foreclosures. Certain other processes were deemed adequate. The OCC issued a similar supervisory letter to HSBC Bank USA. We have suspended foreclosures until such time as we have substantially addressed the noted deficiencies in our processes. We are also reviewing foreclosures where judgment has not yet been entered and will correct deficient documentation and re-file affidavits where necessary.
 
We and our affiliates are engaged in discussions with the Federal Reserve and the OCC regarding the terms of consent cease and desist orders, which will prescribe actions to address the deficiencies noted in the joint examination. We expect the consent orders will be finalized shortly after the date this Form 10-K is filed. While the impact of the Federal Reserve consent order on HSBC Finance Corporation depends on the final terms, we believe it has the potential to increase our operational, reputational and legal risk profiles and expect implementation of its provisions will require significant financial and managerial resources. In addition, the consent orders will not preclude further actions against HSBC Finance Corporation or our affiliates by bank regulatory or other agencies, including the imposition of fines and civil money penalties. We are unable at this time, however, to determine the likelihood of any further action or the amount of penalties or fines, if any, that may be imposed by the regulators or agencies.
 
Due to the significant slow-down in foreclosures, and in some instances, cessation of all foreclosure processing by numerous loan servicers, including us, for some period of time in 2011 there may be some reduction in the number of properties being marketed following foreclosure. The impact of that decrease may increase demand for properties currently on the market resulting in a stabilization of home prices but could also result in a larger number of vacant properties in communities creating downward pressure on general property values. As a result, the short term impact of the foreclosure processing delay is highly uncertain. However, the longer term impact is even more uncertain as eventually servicers will again begin to foreclose and market properties in large numbers which is likely to create a significant over-supply of housing inventory. This could lead to a significant increase in loss severity on REO properties.
 
As a result of industry-wide compliance issues, certain courts have issued new rules relating to foreclosures and we anticipate that scrutiny of foreclosure documentation will increase. Also, in some areas, officials are requiring additional verification of information filed prior to the foreclosure proceeding. If these trends continue, there could be additional delays in the processing of foreclosures, which could have an adverse impact upon housing prices which is likely to result in higher loss severities and expenses for the maintenance of properties while foreclosures are delayed.
 
Financial Regulatory Reform On July 21, 2010, the “Dodd-Frank Wall Street Reform and Consumer Protection Act” was signed into law and is a sweeping overhaul of the financial regulatory system (the “Dodd-Frank Act”). For a full description of the Dodd-Frank Act see “Regulation – Financial Regulatory Reform” section under the “Regulation and Competition” section in Item 1. Business. The Dodd-Frank Act will have a significant impact on the operations of many financial institutions in the U.S., including our affiliates. As the Dodd-Frank Act calls for extensive regulations to be promulgated to interpret and implement the legislation, it is not possible to precisely determine the impact to operations and financial results at this time.
 
Business Focus HSBC Holdings plc acquired Household International, Inc. (“Household”), the predecessor to HSBC Finance Corporation, in March 2003. In connection with the acquisition, HSBC also announced its expectation that funding costs for the Household businesses would be lower as a result of the financial strength and funding diversity of HSBC. As a result, we work with our affiliates under the oversight of HSBC North America to maximize opportunities and efficiencies in HSBC’s operations in the U.S., including funding efficiencies.


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As discussed in this and prior filings, during the past few years we have made numerous strategic decisions regarding our operations, with the intent to lower the risk profile of our operations as well as reduce the capital and liquidity requirements of our operations by reducing the size of the balance sheet. As a result of these strategic decisions, our core lending operations currently consist of our credit card and retail services business. Our lending products currently include primarily MasterCard and Visa credit cards and private label credit cards. A portion of new credit card and all new private label receivable originations are sold on a daily basis to HSBC Bank USA, National Association (“HSBC Bank USA”). Our core credit card receivable portfolio totaled $9.9 billion at December 31, 2010 reflecting a decrease of 15 percent since December 31, 2009. This decrease is a continuation of the decline that began during the fourth quarter of 2007 as the result of numerous actions we have taken to manage risk, including reduced marketing levels as well as during 2010, the impact of an increased focus and ability by consumers to reduce outstanding credit card debt. Although marketing levels have increased in 2010, they remain low compared to historical levels prior to our risk mitigation actions.
 
Our Consumer Lending and Mortgage Services businesses are not considered central to our core operations. As a result, the real estate secured and personal non-credit card receivable portfolios of these non-core businesses, which totaled $56.4 billion at December 31, 2010, are currently running off. The timeframe in which these portfolios will liquidate is dependent upon the rate at which receivables pay off or charge-off prior to their maturity, which fluctuates for a variety of reasons such as interest rates, availability of refinancing, home values and individual borrowers’ credit profile all of which are outside of our control. In light of the current economic conditions and mortgage industry trends described above, our loan prepayment rates have slowed when compared to historical experience even though interest rates remain low. Additionally, our loan modification programs which are primarily designed to improve cash collections and avoid foreclosure as determined to be appropriate, are contributing to these slower loan prepayment rates.
 
While difficult to project both loan prepayment rates and default rates, based on current experience we expect the receivable portfolios of our non-core businesses to decline between 50 percent and 60 percent over the next five years and be comprised primarily of real estate secured receivables at the end of this period. Attrition will not be linear during this period. Over the near term, charge-off related receivable run-off is expected to remain elevated due to the economic environment. Run-off is expected to later slow as charge-offs decline and the remaining real estate secured receivables stay on the balance sheet longer due to the impact of modifications and/or the lack of re-financing alternatives.
 
In December 2010, it was determined that we would not offer any tax refund anticipation loans or other related products for the 2011 tax season and we exited the business. In August 2010, we sold the remainder of our auto finance receivable portfolio. As a result, our non-core Taxpayer Financial Services and Auto Finance businesses are now reported as discontinued operations. See Note 3, “Discontinued Operations,” in the accompanying consolidated financial statements for additional discussion.
 
We continue to evaluate our operations as we seek to optimize our risk profile as well as our liquidity, capital and funding requirements and review opportunities in the credit card industry as the credit markets stabilize. This could result in further strategic actions that may include changes to our legal structure, asset levels and further alterations or refinement of product offerings. Although nothing is currently contemplated, we continue to evaluate additional ways to identify strategic opportunities with HSBC Bank USA, within the regulatory framework.
 
2010 Events
 
  •  Due to the impact of the marketplace conditions described above on the performance of our receivable portfolios, we have incurred significant losses in 2010, 2009 and 2008. If our forecasts hold true, we expect to continue to generate losses at least through 2011. While our 2011 funding strategy includes a mix of balance sheet attrition, cash generated from operations and other actions to meet our current obligations, we will remain dependent on capital infusions from HSBC as necessary to fully meet our funding requirements and maintain capital at levels we believe are prudent until we return to profitability. HSBC has indicated it is fully committed and has the capacity to continue to provide such support. In 2010 and 2009, HSBC Investments (North America) Inc. (“HINO”) made capital contributions to us totaling $200 million and $2.7 billion, respectively.


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  •  In our real estate secured and personal non-credit card receivable portfolios, credit quality continued to improve as dollars of two-months-and-over contractual delinquency decreased $1.9 billion at December 31, 2010 compared to December 31, 2009 as a result of lower receivable levels, seasoning and the impact of improved economic and credit conditions since year-end 2009. As compared to December 31, 2009, the balance of delinquent accounts which have migrated to charge-off have been replaced with lower levels of newly delinquent loans as the portfolios continue to season. Dollars of net charge-offs for real estate secured and personal non-credit card receivables also decreased in 2010 reflecting lower average receivable levels and lower delinquency levels for both products. See “Credit Quality” in this MD&A for additional discussion.
 
The credit performance of our credit card receivable portfolio improved during 2010 as dollars of two-months-and-over contractual delinquency decreased $599 million at December 31, 2010 compared to December 31, 2009 as a result of lower receivable levels due to the actions previously taken to tighten underwriting and reduce the risk profile of the portfolio as well as an increased focus and ability by consumers to reduce outstanding credit card debt. Dollars of net charge-offs also decreased during 2010 reflecting the lower receivable levels, lower delinquency levels, lower levels of personal bankruptcy filings and higher recoveries.
 
We anticipate delinquency and charge-off will remain under pressure during 2011. While the U.S. economic environment improved during 2010, there remains uncertainty as to the nature and extent of the current economic recovery which could impact our results.
 
  •  In March 2010, we sold our auto finance receivable operations and certain auto finance receivables to Santander Consumer USA (“SC USA”). Subsequently, in August 2010, we sold our remaining portfolio of auto finance receivables to SC USA. As a result of these transactions, our Auto Finance business, which was previously considered a non-core business, is now reported in discontinued operations. See Note 3, “Discontinued Operations,” for a full discussion of these transactions.
 
  •  During the third quarter of 2010, the Internal Revenue Service (“IRS”) announced it would stop providing information regarding certain unpaid obligations of a taxpayer (the “Debt Indicator”), which has historically served as a significant part of our underwriting process in our Taxpayer Financial Services (“TFS”) business. We determined that, without use of the Debt Indicator, we could no longer offer the product that has historically accounted for the substantial majority of our TFS loan production and that we might not be able to offer the remaining products available under the program in a safe and sound manner. As a result, in December 2010, it was determined that we would not offer any tax refund anticipation loans or related products for the 2011 tax season and we exited the TFS business. As a result of this decision, our TFS business, which was previously considered a non-core business, is now reported in discontinued operations. See Note 3, “Discontinued Operations,” for additional information.
 
Performance, Developments and Trends Our operating results improved during 2010. Loss from continuing operations was $1.9 billion in 2010 compared to $7.5 billion in 2009 and $2.6 billion in 2008. Loss from continuing operations before income tax was $2.9 billion in 2010 compared to $10.1 billion in 2009 and $3.7 billion in 2008. Our results in these periods were significantly impacted by the change in the fair value of debt and related derivatives for which we have elected fair value option and, during 2009 and 2008, goodwill and other intangible asset impairment charges. Additionally, our results in 2009 were impacted by certain policy changes relating to loans discussed below. In order to better understand the underlying performance trends of our business, the


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following table summarizes the collective impact of these items on our loss from continuing operations before income tax for all periods presented:
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Loss from continuing operations before income tax, as reported
  $ (2,906 )   $ (10,098 )   $ (3,695 )
(Gain) loss in value of fair value option debt and related derivatives
    (741 )     2,125       (3,160 )
Goodwill and other intangible asset impairment charges
    -       2,308       329  
Impact of the December 2009 Charge-off Policy Change
    -       352 (2)     -  
Policy change for unrecorded interest on re-aged receivables
    -       190 (3)     -  
                         
Loss from continuing operations before income tax, excluding above items(1)
  $ (3,647 )   $ (5,123 )   $ (6,526 )
                         
 
 
(1)  Represents a non-U.S. GAAP financial measure.
 
(2)  In December 2009, we implemented changes to our charge-off policies for real estate secured and personal non-credit card receivables due to changes in customer behavior (the “December 2009 Charge-off Policy Changes”). See “Credit Quality” in this MD&A as well as Note 8, “Changes in Charge-off Policies During 2009,” in the accompanying consolidated financial statements for additional discussion.
 
(3)  In December 2009, we implemented changes to our policy for recognizing interest income on re-aged real estate secured and certain personal non-credit card receivables. See the caption “2009 as compared to 2008” in this Executive Overview for additional discussion.
 
Excluding the collective impact of the items in the above table, our results for 2010 improved $1.5 billion compared to 2009 driven by a significantly lower provision for credit losses and lower operating expenses partially offset by lower net interest income and lower other revenues including lower derivative related income. Our 2010 results were impacted by significantly lower derivative related income reflecting the impact of decreasing interest rates on the mark-to-market on derivatives in our non-qualifying economic hedge portfolio which resulted in losses of $188 million during 2010 as compared to a gain of $487 million during 2009. Our portfolio of non-qualifying economic hedges acted as economic hedges by lowering our overall interest rate risk through more closely matching both the structure and duration of our liabilities to the structure and duration of our assets even though they did not qualify as effective hedges under hedge accounting principles.
 
Net interest income decreased during 2010 primarily due to lower average receivables as a result of receivable liquidation, risk mitigation efforts and an increased focus and ability by consumers to reduce outstanding credit card debt, partially offset by higher overall receivable yields and lower interest expense. During 2010, we experienced higher yields for all receivable products as a result of lower levels of nonperforming receivables, including reduced levels of nonperforming modified real estate secured receivables, due to charge-off and declines in new modification volumes. Higher yields in our real estate secured receivable portfolio were partially offset by the impact of an increase in the expected lives of receivables in payment incentive programs since December 2009. Higher yields in our credit card receivable portfolio were partially offset by the implementation of certain provisions of the Card Act including restrictions impacting repricing of delinquent accounts and periodic re-evaluation of rate increases. We anticipate credit card loan yields in future periods may continue to be negatively impacted by various provisions of the Card Act which require certain rate increases to be periodically re-evaluated. As receivable yields vary between receivable products, overall receivable yields were negatively impacted by a shift in receivable mix to higher levels of lower yielding first lien real estate secured receivables as higher yielding second lien real estate secured and personal non-credit card receivables have run-off at a faster pace than first lien real estate secured receivables. The decrease in net interest income during 2010 was partially offset by higher net interest income on our non-insurance investment portfolio reflecting higher levels of investments held and slightly higher yields. These decreases in interest income were partially offset by lower interest expense due to lower average borrowings and lower average rates.
 
Net interest margin was 5.23 percent in 2010 and 5.08 percent in 2009. Net interest margin in 2010 increased due to lower cost of funds as a percentage of average interest-earning assets as well as higher overall yields on our


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receivable portfolio. See “Results of Operations” in this MD&A for additional discussion regarding net interest income and net interest margin.
 
Other revenues during 2010 were impacted by changes in the value of debt designated at fair value and related derivatives. Excluding the gain (loss) on debt designated at fair value and related derivatives, other revenues decreased during 2010 primarily driven by significantly lower derivative-related income as discussed above, lower fee income, lower servicing and other fees from HSBC affiliates and to a lesser extent, lower enhancement services and insurance revenues, partially offset by lower fair value write-downs on receivables held for sale. Lower fee income reflects lower late and overlimit fees due to lower volumes and lower delinquency levels, changes in customer behavior and the impact from the implementation of the Card Act which resulted in lower late and overlimit fees as well as restrictions on fees charged to process on-line and telephone payments. Lower servicing and other fees from HSBC affiliates reflects lower levels of receivables being serviced. Lower enhancement services revenue reflects the impact of lower credit card receivable levels while lower insurance revenue reflects the reduced size of our insurance operations. Lower fair value markdowns reflect a smaller portfolio of held for sale receivables than during 2009. See “Results of Operations” for a more detailed discussion of other revenues.
 
Our provision for credit losses decreased significantly during 2010 as discussed below.
 
  •  Provision for credit losses for our core credit card receivable portfolio decreased $916 million during 2010. The decrease reflects lower receivable levels as a result of actions taken beginning in the fourth quarter of 2007 to manage risk as well as an increased focus and ability by consumers to reduce outstanding credit card debt. The decrease also reflects improvement in the underlying credit quality of the portfolio including continuing improvements in early stage delinquency roll rates and lower delinquency levels as customer payment rates have been strong throughout 2010. The impact on credit card receivable losses from the current economic environment, including high unemployment levels, has not been as severe as originally expected due in part to improved customer payment behavior.
 
  •  The provision for credit losses for the real estate secured receivable portfolios in our Consumer Lending and Mortgage Services business decreased $658 million and $342 million, respectively, during 2010. The decrease reflects lower receivable levels as the portfolios continue to liquidate, lower delinquency levels, improved loss severities and improvements in economic conditions since 2009. The decrease also reflects lower loss estimates on troubled debt restructurings (“TDR Loans”), partially offset by the impact of continued high unemployment levels, lower receivable prepayments, higher loss estimates on recently modified loans and for real estate secured receivables in our Consumer Lending business, portfolio seasoning. Improvements in loss severities reflect an increase in the number of properties for which we accepted a deed to the property in lieu of payment (also referred to as “deed-in-lieu”) and an increase in the number of properties for which we agreed to allow the borrower to sell the property for less than the current outstanding receivable balance (also referred to as a “short sale”), both of which result in lower losses compared to loans which are subject to a formal foreclosure process for which average loss severities in 2010 have remained relatively flat to 2009 levels.
 
  •  The provision for credit losses for our personal non-credit card receivables decreased $1.6 billion reflecting lower receivable levels, lower delinquency levels and improvements in economic conditions since 2009, partially offset by higher reserve requirements on TDR Loans.
 
See “Results of Operations” for a more detailed discussion of our provision for credit losses.
 
In 2010, we decreased our credit loss reserves as the provision for credit losses was $2.6 billion less than net charge-offs. Lower credit loss reserve levels reflect lower receivable levels, improved economic and credit conditions since 2009 including lower delinquency levels and overall improvements in loss severities on real estate secured receivables as discussed above. Reserve levels for real estate secured receivables at our Mortgage Services and


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Consumer Lending businesses as well as for receivables in our credit card business can be further analyzed as follows:
 
                                                 
    Consumer Lending     Mortgage Services     Credit Cards  
Year Ended December 31,   2010     2009     2010     2009     2010     2009  
   
                (in millions)              
 
Credit loss reserves at beginning of period
  $ 3,047     $ 3,392     $ 2,385     $ 3,726     $ 1,824     $ 2,258  
Provision for credit losses
    2,339       2,997       1,575       1,917       840       1,756  
Charge-offs(1)
    (3,038 )     (3,371 )     (2,230 )     (3,296 )     (1,914 )     (2,397 )
Recoveries
    61       29       51       38       234       207  
                                                 
Credit loss reserves at end of period
  $ 2,409     $ 3,047     $ 1,781     $ 2,385     $ 984     $ 1,824  
                                                 
 
 
(1)  Charge-offs for Consumer Lending and Mortgage Services real estate secured receivables in 2009 includes $1.4 billion and $979 million, respectively, related to the December 2009 Charge-off Policy Changes.
 
Beginning in 2008, we significantly increased the use of loan modifications in an effort to assist our customers who are currently experiencing financial difficulties. As a result, a significant portion of our receivable portfolio are considered troubled debt restructures (“TDR Loans”) which are reserved using a discounted cash flow analysis which generally results in a higher reserve requirement for these loans. Additionally, in December 2009, changes made to the charge-off policy for our real estate secured receivable portfolio have resulted in a significant portion of real estate secured receivables in our portfolio being carried at net realizable value less cost to sell. The following table summarizes these receivables, which either carry higher reserves using a discounted cash flow analysis or are carried at net realizable value, in comparison to our entire receivable portfolio:
 
                 
At December 31,   2010     2009  
   
    (in millions)  
 
Total receivable portfolio
  $ 66,383     $ 81,697  
                 
Real estate secured receivables carried at net realizable value less cost to sell
  $ 5,095     $ 3,420  
TDR Loans:
               
Credit card
    427       461  
Real estate secured(1)
    7,875       8,354  
Personal non-credit card
    704       726  
                 
TDR Loans
    9,006       9,541  
                 
Receivables carried at either net realizable value or reserved for using a discounted cash flow methodology
  $ 14,101     $ 12,961  
                 
Real estate secured receivables carried at either net realizable value or reserved for using a discounted cash flow methodology as a percentage of real estate secured receivables
    26.3 %     19.8 %
                 
Receivables carried at either net realizable value or reserved for using a discounted cash flow methodology as a percentage of total receivables
    21.2 %     15.9 %
                 
 
 
(1)  Excludes TDR Loans which are recorded at net realizable value less cost to sell.
 
Total operating expenses during 2009 were significantly impacted by the following items which impact comparability between periods:
 
  •  Restructuring charges totaling $151 million primarily recorded during 2009, related to the decision to discontinue all new customer account originations for our Consumer Lending business and to close the Consumer Lending branch offices. See Note 5, “Strategic Initiatives,” in the accompanying consolidated financial statements for additional information related to this decision;


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  •  Goodwill impairment charges of $2.3 billion during 2009 related to our Card and Retail Services and Insurance Services businesses. Additionally, during 2009 impairment charges of $14 million during the first quarter of 2009 relating to technology, customer lists and loan related relationships resulting from the discontinuation of originations for our Consumer Lending business.
 
Excluding these items in 2009, total operating expenses decreased $281 million, or 7 percent during 2010 primarily due to lower salary expense reflecting reduced headcount reflecting the further reduced scope of our business operations since March 2009 and continued entity-wide initiatives to reduce costs as well as lower occupancy and equipment expenses. These decreases were partially offset by higher real estate owned (“REO”) expenses, higher legal costs, higher marketing expenses for credit card receivables and higher support services from HSBC affiliates. See “Results of Operations” for a more detailed discussion of operating expenses.
 
Our effective income tax rate for continuing operations was (34.7) percent in 2010 and (26.1) percent in 2009. The effective tax rate for continuing operations in 2010 was primarily impacted by state taxes, including states where we file combined unitary state tax returns with other HSBC affiliates and amortization of purchase accounting adjustments on leveraged leases that matured in December 2010.
 
2009 as compared to 2008 Loss from continuing operations in 2009 was significantly impacted by the change in fair value debt and related derivatives for which we have elected fair value option, goodwill and other intangible asset impairment charges and the impact of policy changes in December 2009 related to the timing of charge-off of real estate secured and personal non-credit card receivables and policies for unrecorded interest on re-aged receivables as discussed below. Excluding the collective impact of these items, our results improved to a loss of $5.1 billion in 2009 as compared to a loss of $6.5 billion in 2008 as lower net interest income and slightly lower other revenues were more than offset by lower provision for credit losses and lower operating expenses.
 
In December 2009 as a result of changes in customer behavior and resultant payment patterns, we elected to adopt more bank-like charge-off policies for our real estate secured and personal non-credit card receivables. As a result of these policy changes, beginning in December 2009, we write down real estate secured receivables to net realizable value less the estimated cost to sell generally no later than the end of the month in which the account becomes 180 days contractually delinquent. For personal non-credit card receivables, charge-off occurs generally no later than the end of the month in which the account becomes 180 days contractually delinquent. As a result of these actions, delinquent real estate secured and personal non-credit card receivables charge-off earlier during 2009 than in the historical periods. The impact of this change resulted in an increase to our loss before income tax of $352 million ($227 million after-tax). For additional information regarding this policy change, see “Credit Quality” within this MD&A or see Note 8, “Change in Charge-off Policies During 2009,” in the accompanying consolidated financial statements.
 
As part of our decision to move to policies which more accurately reflect the underlying performance of our real estate secured receivable portfolio, in the fourth quarter of 2009 we also elected to adopt a more bank-like income recognition policy relating to unrecorded interest on real estate secured receivables placed on non-accrual which were subsequently re-aged under our standard criteria (the “December 2009 Unrecorded Interest Policy Changes”). We now recognize unrecorded interest at an estimated collectible amount when the customer has made the equivalent of six qualifying payments under the terms of the loan while maintaining a current payment status at the time of the sixth payment. Separately, as it relates to personal homeowner loans (“PHLs”) which, although technically secured by real estate were historically underwritten, priced, serviced and reported like an unsecured loan, we no longer follow the real estate secured policy for income recognition upon re-age. Rather, we follow our historical policy for other personal non-credit card loans that have been re-aged which generally results in the recognition of interest when collected. The combination of these changes resulted in a decrease to finance and other interest income during the fourth quarter of 2009 of $108 million for real estate secured receivables and $82 million for PHL receivables compared to what would otherwise have been recognized under the prior practice.
 
Net interest income during 2009 includes the impact of the charge-off and unrecorded interest policy changes as discussed above which reduced net interest income by $351 million and $190 million, respectively. Excluding the impact of these items, net interest income remained lower in 2009 due to lower average receivables reflecting lower


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origination volumes due to our risk mitigation efforts, including our decision to stop all new account originations in our Mortgage Services and Consumer Lending businesses, as well as lower consumer spending levels. The decrease in net interest income also reflects lower levels of performing receivables and lower overall yields on our receivable portfolios, partially offset by lower interest expense. Our net interest margin decreased to 5.08 percent in 2009 compared to 6.24 percent in 2008. The decrease was due to the lower overall yields on our receivable portfolio, partially offset by lower funding costs due to lower average interest rates for short-term borrowings which reflect actions taken by the Federal Reserve Bank resulting in lower Federal Funds Rates during 2009 as compared to 2008. For additional discussion of the decrease in both net interest income, including a discussion of the changes in receivable yields by product, and net interest margin, see “Results of Operations” in this MD&A.
 
Other revenues in 2009 was significantly impacted by a loss on debt designated at fair value and related derivatives due to a narrowing of our credit spreads during 2009. The loss on debt designated at fair value and related derivatives decreased other revenues by $2.1 billion during 2009 compared to a gain which increased other revenues by $3.2 billion in 2008. Excluding the gain (loss) on debt designated at fair value and related derivatives, other revenues decreased slightly during 2009 due to lower fee income and enhancement services revenue, primarily due to lower credit card receivable levels and changes in credit card customer behavior, partially offset by higher derivative related income, higher gains on daily and bulk sales of receivables to HSBC Bank USA, higher servicing and other fees from HSBC affiliates due to higher volumes of receivables serviced as a result of the sale of the GM and UP Portfolios as previously discussed and lower fair value adjustments on receivables held for sale. For additional discussion of the changes in other revenues, see “Results of Operations” in this MD&A.
 
Our provision for credit losses declined significantly in 2009 as discussed more fully below. The provision for credit losses in 2009 reflects an incremental provision of $1 million as a result of the December 2009 Charge-off Policy Changes as discussed above.
 
  •  The provision for credit losses in our credit card receivable portfolio decreased significantly in 2009 due to lower receivable levels primarily due to the impact of the transfer of the GM and UP Portfolios to receivables held for sale in June 2008 and November 2008, respectively, as well as $2.0 billion of non-prime credit card receivables to receivables held for sale in June 2008. Excluding the impact of these transferred receivables from the prior year periods as applicable, our provision for credit losses remained significantly lower due to lower non-prime receivable levels as a result of lower consumer spending levels and actions taken beginning in the fourth quarter of 2007 and continuing through 2009 to manage risk, partially offset by lower recovery rates on defaulted receivables.
 
  •  The provision for credit losses for real estate secured receivables decreased in 2009 reflecting the continued liquidation in these portfolios which has resulted in lower charge-off levels. The lower provision also reflects a reduction to provision of $192 million as a result of the December 2009 Charge-off Policy changes, which includes the reserve impact of the policy change related to accrued interest. Accrued interest written off as part of this policy change was reflected as a reduction of finance and other interest income, while the release of loss reserves associated with principal and accrued interest was reflected in provision. The decrease in the provision for credit losses for real estate secured receivables was partially offset by higher provisions for first lien real estate secured receivables in our Consumer Lending business, lower receivable prepayments, higher loss severities relative to 2008 due to deterioration in real estate values in some markets, higher reserve requirements for real estate secured TDR Loans and portfolio seasoning in our Consumer Lending real estate secured receivable portfolio.
 
  •  The provision for credit losses for personal non-credit card receivables increased during 2009, including an increase in provision for credit losses of $193 million related to the December 2009 Charge-off Policy Change which reflects the reserve impact of the policy change to accrued interest as discussed above and the charge-off of the total receivable balance, ignoring future recoveries while the corresponding release of credit loss reserves considered future recoveries, unlike real estate secured receivables which are written down to net realizable value less cost to sell. Excluding the incremental impact of the December 2009 Charge-off Policy Changes, our provision for credit losses in our personal non-credit card portfolio remained


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  higher in 2009 due to higher levels of charge-off resulting from deterioration in the 2006 and 2007 vintages which was more pronounced in certain geographic regions, partially offset by lower receivable levels.
 
The provision for credit losses for all products in 2009 was negatively impacted by rising unemployment rates in an increasing number of markets, continued deterioration in the U.S. economy and housing markets and higher levels of personal bankruptcy filings. For additional discussion regarding the decrease in the provision for credit losses during 2009, see “Results of Operations” in this MD&A.
 
During 2009, the provision for credit losses was $2.9 billion lower than net charge-offs. Lower credit loss reserve levels primarily reflect the impact of the December 2009 Charge-off Policy Changes as a result of the acceleration of charge-off of $3.5 billion, a substantial portion of which would otherwise have charged-off in future periods. Excluding the impact of the December 2009 Charge-off Policy Changes, the provision for credit losses was $533 million greater than net charge-offs in 2009 compared to provision in excess of charge-offs of $3.1 billion in 2008 reflecting a slowing in the rate of deterioration of credit quality, lower receivable levels and the impact of higher unemployment rates on losses not being as severe as previously anticipated. For additional discussion of credit loss reserves, see “Credit Quality” in this MD&A.
 
Total operating expenses increased in 2009 and were negatively impacted by the restructuring charges recorded during 2009 associated with the Consumer Lending closure as discussed above as well as goodwill and intangible asset impairment charges recorded during 2009 and 2008 previously discussed. Excluding the impact of the restructuring charges recorded in 2009 as well as the goodwill and intangible asset impairment charges recorded during 2009 and 2008, total operating expenses decreased $1.1 billion, or 28.8 percent during 2009 due to lower salary expense, lower marketing expenses, lower branch related expenses due to the closure of the Consumer Lending branch offices, lower real estate owned expenses and the impact of entity-wide initiatives to reduce costs, partially offset by higher collection costs. For additional discussion of our operating expenses, see “Results of Operations” in this MD&A.
 
Our effective income tax rate for continuing operations was (26.1) percent in 2009 and (29.4) percent in 2008. The effective tax rate for continuing operations in 2009 was significantly impacted by the non-tax deductible impairment of goodwill, the relative level of pretax book loss, increase in the state and local income tax valuation allowance which is included in the state and local taxes, and a decrease in low income housing credits.
 
Performance Ratios Our efficiency ratio from continuing operations was 50.4 percent in 2010 compared to 108.4 percent in 2009 and 36.3 percent in 2008. Our efficiency ratio from continuing operations during all periods was impacted by the change in the fair value of debt and related derivatives for which we have elected fair value option accounting. Additionally, the efficiency ratio in 2009 and 2008 were also significantly impacted by goodwill and intangible asset impairment charges and in 2009, the Consumer Lending closure costs, as discussed above. Excluding these items from the periods presented, our efficiency ratio deteriorated significantly during 2010 reflecting significantly lower net interest income and other revenues driven by receivable portfolio liquidation, lower derivative-related income and lower fee income which outpaced the decrease in operating expenses. Excluding the items discussed above from the periods presented, in 2009 our efficiency ratio deteriorated 216 basis points as a result of lower net interest income and lower fee and enhancement services revenues as a result of the sale of the GM and UP Portfolios in January 2009, partially offset by increased revenues associated with the bulk gain and daily sales of receivables to HSBC Bank USA.
 
Our return on average common shareholder’s equity (“ROE”) was (27.70) percent in 2010 compared to (68.41) percent in 2009 and (19.76) percent in 2008. Our return on average assets (“ROA”) was (2.23) percent in 2010 compared to (7.45) percent in 2009 and (1.98) percent in 2008. ROE and ROA in all periods were significantly impacted by the change in the fair value of debt for which we have elected fair value option accounting. During 2009, ROA and ROE were impacted by the December 2009 Charge-off Policy Changes and the Consumer Lending closure costs as discussed above. During 2009 and 2008, ROA and ROE were also significantly impacted by goodwill and intangible asset impairment charges. Excluding these items, ROE deteriorated 257 basis points during 2010 and ROA improved 67 basis points during 2010. The deterioration in ROE in 2010 was driven by lower average shareholder’s equity which outpaced the change in our loss from continuing operations. The


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improvement in ROA in 2010 was driven by the change in our loss from continuing operations which outpaced the decrease in average assets. Excluding these same items discussed above, ROE improved 43 basis points during 2009 as compared to 2008 driven by the improvement in our loss from continuing operations which outpaced the decrease in average shareholder’s equity. ROA for 2009 deteriorated 19 basis points as compared to 2008, as the decrease in average assets outpaced the improvement in our loss from continuing operations.
 
Receivables Receivables decreased to $66.4 billion at December 31, 2010, a 19 percent decrease from December 31, 2009. The decrease in our core credit card receivable portfolio reflects the continuing impact of actions previously taken to mitigate risk and an increased focus and ability of consumers to reduce outstanding credit card debt. The decrease in our non-core receivable portfolios reflects the continued liquidation of these portfolios which will continue going forward. As it relates to our real estate secured receivable portfolio, liquidation rates continue to be impacted by declines in loan prepayments as fewer refinancing opportunities for our customers exist and the previously discussed trends impacting the mortgage lending industry. See “Receivables Review” for a more detailed discussion of the decreases in receivable balances.
 
Credit Quality Dollars of two-months-and-over contractual delinquency as a percentage of receivables and receivables held for sale (“delinquency ratio”) decreased to 14.41 percent at December 31, 2010 as compared 14.74 percent at December 31, 2009. Dollars of contractual delinquency decreased for all receivable products reflecting lower receivable levels due to lower origination volumes in our core credit card receivable portfolio, continued liquidation of our non-core receivable portfolios and for credit card and personal non-credit card receivables, improved early stage delinquency roll rates due to improvements in economic conditions since 2009. The decrease in dollars of contractual delinquency for real estate secured receivables was partially offset in our Consumer Lending real estate secured receivable portfolio by portfolio seasoning. The delinquency ratio decreased as compared to December 31, 2009 as dollars of delinquency decreased at a slightly faster pace than receivable levels. See “Credit Quality-Delinquency” for a more detailed discussion of our delinquency ratios.
 
Dollars of net charge-offs during 2010 decreased for all our receivable portfolios primarily due to lower delinquency levels as a result of lower average receivables, improvements in economic conditions since year-end 2009 and as it relates to credit card receivables, higher recoveries. A portion of the decrease in dollars of net charge-offs for our non-core receivable portfolio reflects charge-off activity during 2009 that would have been recorded in prior periods had the changes made to the charge-off policy in December 2009 for real estate secured and personal non-credit card receivables been effective prior to 2009. Dollars of net charge-offs for real estate secured receivables during 2010 also reflect improvements in total loss severities as a result of an increase in the number of properties for which we accepted a deed-in-lieu and an increase in the number of short sales, both of which result in lower losses compared to loans which are subject to a formal foreclosure process for which average loss severities in 2010 have remained relatively flat to 2009 levels. The net charge-off ratio for full year 2010 decreased 161 basis points as compared to full year 2009 as the decline in dollars of net charge-off as discussed above outpaced the decrease in average receivables.
 
Funding and Capital During 2010, HINO made a capital contribution to us totaling $200 million to support ongoing operations and to maintain capital above the minimum levels we believe are prudent. Until we return to profitability, HSBC’s continued support is required to properly manage our business operations and maintain appropriate levels of capital. HSBC has provided significant capital in support of our operations in the last few years and has indicated that it is fully committed and has the capacity and willingness to continue that support.
 
During the fourth quarter of 2010, our Board of Directors approved the issuance of up to 1,000 shares of Series C preferred stock. As a result, in November 2010 we replaced $1.0 billion in loans from HSBC North America, which had been scheduled to mature between 2022 and 2025 with the issuance of the Series C preferred stock. This transaction enhanced our total capital level as well as both our common and preferred equity to total assets and tangible shareholder’s equity to tangible assets ratios. It did not, however, impact our tangible common equity to tangible assets ratio.
 
Additionally, during the fourth quarter of 2010, as part of an initiative to enhance the total regulatory capital levels for HSBC North America, we offered noteholders of certain series of our senior debt the ability to exchange their existing senior notes for newly issued subordinated debt. As a result, we issued $1.9 billion in new 10-year fixed rate


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subordinated debt in exchange for tendered debt totaling $1.8 billion. In December 2010, we issued an additional $1.0 billion of 10-year fixed rate subordinated debt to institutional investors.
 
During 2010, we retired $16.5 billion of term debt as it matured or was redeemed, including $1.8 billion of senior debt exchanged for $1.9 billion in new subordinated debt as discussed above. The maturing and redeemed debt cash requirements were met through planned balance sheet attrition, cash generated from operations, asset sales, capital contributions from HSBC, the issuance of subordinated debt and cost effective retail debt and the issuance of debt secured by credit card receivables. The balance sheet and credit dynamics described above continue to have an impact on our liquidity and risk management processes. Continued success in reducing the size of our non-core receivable portfolio coupled with the stabilization in our core credit card receivable portfolio will be the primary driver of our liquidity management process going forward. Lower cash flow, as a result of declining receivable balances as well as lower cash generated from balance sheet attrition due to increased charge-offs, may not provide sufficient cash to fully cover maturing debt over the next four to five years. The required incremental funding will be generated through the execution of alternative liquidity management strategies, including selected debt issuances. In the event a portion of our incremental funding need is met through issuances of unsecured term debt, we anticipate these issuances would be structured to better match the projected cash flows of the remaining run-off portfolio and reduce reliance on direct HSBC support. HSBC has indicated it remains fully committed and has the capacity to continue to provide such support.
 
In the current market environment, market pricing continues to value the cash flows associated with our receivables at amounts which are significantly lower than what we believe will ultimately be realized and we do not expect a return of pricing that would typically be seen under more normal marketplace conditions for the foreseeable future. Therefore, we have decided to hold our receivable portfolios for investment purposes. However, should market pricing improve in the future or if HSBC North America calls upon us to execute certain strategies in order to address capital considerations, it could result in the reclassification of a portion of our receivable portfolio into receivables held for sale.
 
The tangible common equity to tangible assets ratio was 7.37 percent and 7.60 percent at December 31, 2010 and 2009, respectively. This ratio represents a non-U.S. GAAP financial ratio that is used by HSBC Finance Corporation management, certain rating agencies and our credit providing banks to evaluate capital adequacy and may be different from similarly named measures presented by other companies. See “Basis of Reporting” and “Reconciliations to U.S. GAAP Financial Measures” for additional discussion and quantitative reconciliation to the equivalent U.S. GAAP basis financial measure.
 
Subject to regulatory approval, HSBC North America will be required to implement Basel II no later than April 1, 2011 in accordance with current regulatory timelines. While we will not report separately under the new rules, the composition of our balance sheet will impact the overall HSBC North America regulatory capital requirement. Based on a comprehensive analysis of the HSBC North America balance sheet, we have taken a series of actions in accordance with the overall HSBC North America’s objective to achieve targeted total regulatory capital levels under these new regulations, including the exchange of senior debt for subordinated debt discussed above which occurred during the fourth quarter of 2010. Adoption of the Basel II provisions must be preceded by a parallel run period of at least four quarters, and requires the approval of U.S. regulators. This parallel run, which was initiated by HSBC North America in January 2010, encompasses enhancements to a number of risk policies, processes and systems to align with the Basel II final rule requirements. HSBC North America will seek regulatory approval for adoption when the program enhancements have been completed which may extend beyond April 1, 2011.
 
Future Prospects Our on-going operations are limited to our Card and Retail Services and Insurance Services businesses. The receivables of our Consumer Lending and Mortgage Services businesses will continue to run-off over several years.
 
Funding of our operations will continue to be dependent on balance sheet attrition, capital contributions from our parent and, to a lesser extent, access to the global capital markets. Numerous factors, both internal and external, may impact our access to, and the costs associated with, these markets. These factors may include the success of our efforts to restructure the risk profile of our operations, our debt ratings, overall economic conditions, overall capital


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markets volatility, the counterparty credit limits of investors to the HSBC Group and the effectiveness of our management of credit risks inherent in our customer base.
 
Our results are also impacted by general economic conditions, including unemployment, housing market conditions, property valuations, interest rates and legislative and regulatory changes, all of which are out of our control. Because our Consumer Lending and Mortgage Services businesses and our non-prime credit card operations have historically lent to customers who have limited credit histories, modest incomes and high debt-to-income ratios or who have experienced prior credit problems, overall our customers are more susceptible to economic slowdowns than other consumers. When unemployment increases or changes in the rate of home value appreciation or depreciation occur, a higher percentage of our customers default on their loans and our charge-offs increase. Changes in interest rates generally affect both the rates that we charge to our customers and the rates that we must pay on our borrowings. In 2010, the interest rates that we paid on our short-term debt decreased. During 2010, we experienced higher overall yields on our receivable portfolio primarily due to lower levels of nonperforming receivables, including reduced levels of nonperforming modified real estate secured receivables, due to charge-off and declines in new modification volumes. The higher yields on our receivable portfolio were partially offset by a shift in receivable mix to higher levels of lower yielding first lien real estate secured receivables as higher yielding second lien real estate secured and personal non-credit card receivables have run-off at a faster pace than first lien real estate secured receivables. See “Results of Operations” in this MD&A for additional discussion on receivable yields. The primary risks to our performance in 2011 are largely dependent upon macro-economic conditions which include a weak housing market, high unemployment rates, the nature and extent of the economic recovery, the performance of modified loans, consumer spending and consumer confidence, all of which could impact loan volume, delinquencies, charge-offs, net interest income and ultimately our results of operations.
 
Basis of Reporting
 
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). Unless noted, the discussion of our financial condition and results of operations included in MD&A are presented on a continuing operations basis of reporting. Certain reclassifications have been made to prior year amounts to conform to the current year presentation.
 
In addition to the U.S. GAAP financial results reported in our consolidated financial statements, MD&A includes reference to the following information which is presented on a non-U.S. GAAP basis:
 
Equity Ratios Tangible common equity to tangible assets is a non-U.S. GAAP financial measure that is used by HSBC Finance Corporation management, certain rating agencies and our credit providing banks to evaluate capital adequacy. This ratio excludes from equity the impact of unrealized gains (losses) on cash flow hedging instruments, postretirement benefit plan adjustments, unrealized gains (losses) on investments, intangible assets as well as subsequent changes in fair value recognized in earnings associated with debt for which we elected the fair value option and the related derivatives. This ratio may differ from similarly named measures presented by other companies. The most directly comparable U.S. GAAP financial measure is the common and preferred equity to total assets ratio. For a quantitative reconciliation of these non-U.S. GAAP financial measures to our common and preferred equity to total assets ratio, see “Reconciliations to U.S. GAAP Financial Measures.”
 
International Financial Reporting Standards Because HSBC reports results in accordance with International Financial Reporting Standards (“IFRSs”) and IFRSs results are used in measuring and rewarding performance of employees, our management also separately monitors net income under IFRSs (a non-U.S. GAAP financial measure). All purchase accounting fair value adjustments relating to our acquisition by HSBC have been “pushed


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down” to HSBC Finance Corporation for both U.S. GAAP and IFRSs consistent with our IFRS Management Basis presentation. The following table reconciles our net loss on a U.S. GAAP basis to net loss on an IFRSs basis:
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Net loss – U.S. GAAP basis
  $ (1,916 )   $ (7,450 )   $ (2,783 )
Adjustments, net of tax:
                       
Derivatives and hedge accounting (including fair value adjustments)
    (16 )     2       1  
Intangible assets
    35       43       58  
Loan origination
    17       76       65  
Loan impairment
    (95 )     199       28  
Loans held for sale
    (51 )     (98 )     173  
Interest recognition
    2       (1 )     (1 )
Other-than-temporary impairments on available-for-sale securities
    3       2       (9 )
Securities
    17       (63 )     (64 )
Extinguishment of debt
    22       -       -  
Present value of long term insurance business
    7       54       -  
Loss on sale of auto finance receivables and other related assets
    (47 )     -       -  
Loss on sale of U.K. and Canadian businesses to affiliates
    -       -       (598 )
Pension and other postretirement benefit costs
    55       32       25  
Goodwill and other intangible asset impairment charges
    -       (615 )     (509 )
Other
    22       (67 )     41  
                         
Net loss – IFRSs basis
    (1,945 )     (7,886 )     (3,573 )
Tax benefit – IFRSs basis
    1,085       2,443       977  
                         
Loss before tax – IFRSs basis
  $ (3,030 )   $ (10,329 )   $ (4,550 )
                         
 
A summary of the significant differences between U.S. GAAP and IFRSs as they impact our results are presented below:
 
Derivatives and hedge accounting (including fair value adjustments) – The historical use of the “shortcut” and “long haul” hedge accounting methods for U.S. GAAP resulted in different cumulative adjustments to the hedged item for both fair value and cash flow hedges. These differences are recognized in earnings over the remaining term of the hedged items. All of the hedged relationships which previously qualified under the shortcut method provisions of derivative accounting principles have been redesignated and are now either hedges under the long-haul method of hedge accounting or included in the fair value option election.
 
Intangible assets – Intangible assets under IFRSs are significantly lower than those under U.S. GAAP as the newly created intangibles associated with our acquisition by HSBC were reflected in goodwill for IFRSs. As a result, amortization of intangible assets is lower under IFRSs.
 
Deferred loan origination costs and fees – Under IFRSs, loan origination cost deferrals are more stringent and result in lower costs being deferred than permitted under U.S. GAAP. In addition, all deferred loan origination fees, costs and loan premiums must be recognized based on the expected life of the receivables under IFRSs as part of the effective interest calculation while under U.S. GAAP they may be recognized on either a contractual or expected life basis. As a result, in years with lower levels of receivable originations, net income is lower under U.S. GAAP as the higher costs deferred in prior periods are amortized into income without the benefit of similar levels of cost deferrals for current period originations.
 
Loan impairment provisioning – IFRSs requires a discounted cash flow methodology for estimating impairment on pools of homogeneous customer loans which requires the incorporation of the time value of money relating to recovery estimates. Also under IFRSs, future recoveries on charged-off loans are accrued for on a discounted basis and a recovery asset is recorded. Subsequent recoveries are recorded to earnings under U.S. GAAP, but are adjusted


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against the recovery asset under IFRSs. As a result, the impact of the December 2009 Charge-off Policy Changes was lower on an IFRSs basis as a portion of the impact under IFRSs was offset by the establishment of the recovery asset. Interest is recorded based on collectibility under IFRSs.
 
Loans held for sale – IFRSs requires loans designated as held for sale at the time of origination to be treated as trading assets and recorded at their fair market value. Under U.S. GAAP, loans designated as held for sale are reflected as loans and recorded at the lower of amortized cost or fair value. Under U.S. GAAP, the income and expenses related to receivables held for sale are reported similarly to loans held for investment. Under IFRSs, the income and expenses related to receivables held for sale are reported in other operating income.
 
For receivables transferred to held for sale subsequent to origination, IFRSs requires these receivables to be reported separately on the balance sheet but does not change the recognition and measurement criteria. Accordingly for IFRSs purposes, such loans continue to be accounted for in accordance with IAS 39, “Financial Instruments: Recognition and Measurement” (“IAS 39”), with any gain or loss recorded at the time of sale. U.S. GAAP requires loans that meet the held for sale classification requirements be transferred to a held for sale category at the lower of cost or fair value.
 
Certain receivables that were previously classified as held for sale under U.S. GAAP have now been transferred to held for investment as we now intend to hold for the foreseeable future. Under U.S. GAAP, these receivables were subject to lower of amortized cost or fair value (“LOCOM”) adjustments while classified as held for sale and have been transferred to held for investment at LOCOM. Under IFRSs, these receivables were always reported within loans and the measurement criteria did not change. As a result, loan impairment charges are now being recorded under IFRSs which were essentially included as a component of the lower of cost or fair value adjustments under U.S. GAAP.
 
Interest recognition – The calculation of effective interest rates under IAS 39 requires an estimate of “all fees and points paid or recovered between parties to the contract” that are an integral part of the effective interest rate be included. U.S. GAAP generally prohibits recognition of interest income to the extent the net investment 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-than-temporary impairment on available-for-sale securities – Under U.S. GAAP we are allowed to evaluate perpetual preferred securities for potential other-than-temporary impairment similar to a debt security provided there has been no evidence of deterioration in the credit of the issuer and record the unrealized losses as a component of other comprehensive income. There are no similar provisions under IFRSs as all perpetual preferred securities are evaluated for other-than-temporary impairment as equity securities. Under IFRSs all impairments are reported in other operating income.
 
Effective January 1, 2009 under U.S. GAAP, the credit loss component of an other-than-temporary impairment of a debt security is recognized in earnings while the remaining portion of the impairment loss is recognized in other comprehensive income provided a company concludes it neither intends to sell the security nor concludes that it is more-likely-than-not that it will have to sell the security prior to recovery. Under IFRSs, there is no bifurcation of other-than-temporary impairment and the entire decline in value is recognized in earnings.
 
Securities – Under IFRSs, securities include HSBC shares held for stock plans at fair value. These shares are recorded at fair value through other comprehensive income and subsequently recognized in profit and loss as the shares vest. If it is determined these shares have become impaired, the fair value loss is recognized in profit and loss and any fair value loss recorded in other comprehensive income is reversed. There is no similar requirement under U.S. GAAP.
 
During the second quarter of 2009, under IFRSs we recorded income for the value of additional shares attributed to HSBC shares held for stock plans as a result of HSBC’s rights offering earlier in 2009. During 2010, under IFRSs we recorded additional gains as these shares vest. The additional shares are not recorded under U.S. GAAP.
 
Extinguishment of debt – During the fourth quarter of 2010, we exchanged $1.8 billion in senior debt for $1.9 billion in new fixed rate subordinated debt. Under IFRSs, the population of debt exchanged which qualified for


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extinguishment treatment was larger than under U.S. GAAP which resulted in a gain on extinguishment of debt under IFRSs compared to a small loss under U.S. GAAP.
 
Present value of long-term insurance contracts – Under IFRSs, the present value of an in-force (“PVIF”) long-term insurance contracts is determined by discounting future cash flows expected to emerge from business currently in force using appropriate assumptions plus a margin in assessing factors such as future mortality, lapse rates and levels of expenses, and a discount rate that reflects the risk free rate plus a margin for operational risk. Movements in the PVIF of long-term insurance contracts are included in other operating income. Under U.S. GAAP, revenue is recognized over the life insurance policy term.
 
During the second quarter of 2009, we refined the income recognition methodology in respect to long-term insurance contracts. This resulted in the recognition of a revenue item on an IFRSs basis of $66 million ($43 million after-tax). Approximately $43 million ($28 million after-tax) would have been recorded prior to January 1, 2009 if the refinement in respect of income recognition had been applied at that date.
 
Loss on sale of auto finance receivables and other related assets – The differences in the loss on sale of the auto finance receivables between IFRSs and U.S. GAAP primarily reflect the differences in loan impairment provisioning between IFRSs and U.S. GAAP as discussed above. These differences resulted in a higher loss under IFRSs, as future recoveries are accrued for on a discounted basis.
 
Loss on sale of U.K. and Canadian business to affiliates – IFRSs require that operations be transferred to held for sale and carried at the lower of cost or fair value with adjustments recorded through earnings when the decision has been made to dispose of the operations regardless of whether the sale will be to a third party or related party. Under U.S. GAAP, when the transfer of net assets will be between affiliates under common control, it is generally reflected as a capital transaction in the period in which the transaction occurs and carried at historical cost until that time. However, because the transfer price of our Canadian operations was lower than the book value, including goodwill, a goodwill impairment charge was recorded under U.S. GAAP through earnings. As the Canadian Operations has a higher carrying value under IFRSs, the write down through earnings is higher under IFRSs.
 
Pension and other postretirement benefit costs – Net income under U.S. GAAP is lower than under IFRSs as a result of the amortization of the amount by which actuarial losses exceed gains beyond the 10 percent “corridor.” Furthermore in 2010 changes to future accruals for legacy participants under the HSBC North America Pension Plan were accounted for as a plan curtailment under IFRSs, which resulted in immediate income recognition. Under US GAAP, these changes were considered to be a negative plan amendment which resulted in no immediate income recognition. During the first quarter of 2009, the curtailment gain related to postretirement benefits and also resulted in lower net income under U.S. GAAP than IFRSs.
 
Goodwill and other intangible asset impairment charges – Goodwill levels established as a result of our acquisition by HSBC were higher under IFRSs than U.S. GAAP as the HSBC purchase accounting adjustments reflected higher levels of intangibles under U.S. GAAP. Consequently, the amount of goodwill allocated to our Card and Retail Services and Insurance Services businesses and written off during 2009 was greater under IFRSs. Additionally, the intangible assets allocated to our Consumer Lending business and written off during the first quarter of 2009 were higher under U.S. GAAP. There are also differences in the valuation of assets and liabilities under IFRSs and U.S. GAAP resulting from the Metris acquisition in December 2005.
 
Other – There are other differences between IFRSs and U.S. GAAP including purchase accounting and other miscellaneous items.
 
IFRS Management Basis Reporting As previously discussed, corporate goals and individual goals of executives are currently calculated in accordance with IFRSs under which HSBC prepares its consolidated financial statements. As a result, operating results are being monitored and reviewed, trends are being evaluated and decisions about allocating resources, such as employees, are being made almost exclusively on an IFRS Management Basis. IFRS Management Basis results are IFRSs results which assume that the GM and UP Portfolios and the private label and real estate secured receivables transferred to HSBC Bank USA have not been sold and remain on our balance sheet and the revenues and expenses related to these receivables remain on our


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income statement. Additionally, IFRS Management Basis assumes that all purchase accounting fair value adjustments relating to our acquisition by HSBC have been “pushed down” to HSBC Finance Corporation. Operations are monitored and trends are evaluated on an IFRS Management Basis because the receivable sales to HSBC Bank USA were conducted primarily to appropriately fund prime customer loans more efficiently through bank deposits and such receivables continue to be managed by us. Accordingly, our segment reporting is on an IFRS Management Basis. However, we continue to monitor capital adequacy, establish dividend policy and report to regulatory agencies on an U.S. GAAP legal entity basis. A summary of the significant differences between U.S. GAAP and IFRSs as they impact our results are also summarized in Note 24, “Business Segments,” in the accompanying consolidated financial statements.
 
We are currently in the process of re-evaluating the financial information used to manage our business, including the scope and content of the financial data being reported to our Management and our Board. To the extent we make changes to this reporting in 2011, we will evaluate any impact such changes may have to our segment reporting.
 
Quantitative Reconciliations of Non-U.S. GAAP Financial Measures to U.S. GAAP Financial Measures For quantitative reconciliations of non-U.S. GAAP financial measures presented herein to the equivalent GAAP basis financial measures, see “Reconciliations to U.S. GAAP Financial Measures.”
 
Critical Accounting Policies and Estimates
 
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. We believe our policies are appropriate and fairly present the financial position of HSBC Finance Corporation.
 
The significant accounting policies used in the preparation of our financial statements are more fully described in Note 2, “Summary of Significant Accounting Policies and New Accounting Pronouncements,” to the accompanying consolidated financial statements. Certain critical accounting policies, which affect the reported amounts of assets, liabilities, revenues and expenses, are complex and involve significant judgment by our management, including the use of estimates and assumptions. As a result, changes in estimates, assumptions or operational policies could significantly affect our financial position or our results of operations. We base and establish our accounting estimates on historical experience, observable market data, inputs derived from or corroborated by observable market data by correlation or other means, and on various other assumptions including those based on unobservable inputs that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. In addition, to the extent we use certain modeling techniques to assist us in measuring the fair value of a particular asset or liability, we strive to use such techniques which are consistent with those used by other market participants. Actual results may differ from these estimates due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change. The impact of estimates and assumptions on the financial condition or operating performance may be material.
 
We believe that of the significant accounting policies used in the preparation of our consolidated financial statements, the items discussed below involve critical accounting estimates and a high degree of judgment and complexity. Our management has discussed these critical accounting policies with the Audit and Risk Committee of our Board of Directors, including certain underlying estimates and assumptions, and the Audit and Risk Committee has reviewed our disclosure relating to these accounting policies and practices in this MD&A.
 
Credit Loss Reserves Because we lend money to others, we are exposed to the risk that borrowers may not repay amounts owed to us when they become contractually due. Consequently, we maintain credit loss reserves at a level that we consider adequate, but not excessive, to cover our estimate of probable incurred losses of principal, interest and fees, including late, over-limit and annual fees, in the existing portfolio. Loss reserves are set at each business unit in consultation with the Finance and Risk Departments. Loss reserve estimates are reviewed periodically and adjustments are reflected through the provision for credit losses in the period when they become known. We believe


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the accounting estimate relating to the reserve for credit losses is a “critical accounting estimate” for the following reasons:
 
  •  Changes in the provision can materially affect our financial results;
 
  •  Estimates related to the reserve for credit losses require us to project future delinquency and charge-off trends which are uncertain and require a high degree of judgment; and
 
  •  The reserve for credit losses is influenced by factors outside of our control such as customer payment patterns, economic conditions such as national and local trends in housing markets, interest rates, unemployment rates, bankruptcy trends and changes in laws and regulations.
 
Because our loss reserve estimates involve judgment and are influenced by factors outside of our control, there is uncertainty inherent in these estimates, making it reasonably possible such estimates could change. Our estimate of probable net credit losses is inherently uncertain because it is highly sensitive to changes in economic conditions, which influence growth, portfolio seasoning, bankruptcy trends, trends in housing markets, the ability of customers to refinance their adjustable rate mortgages, the performance of modified loans, unemployment levels, delinquency rates and the flow of loans through the various stages of delinquency, the realizable value of any collateral and actual loss exposure. Changes in such estimates could significantly impact our credit loss reserves and our provision for credit losses. For example, a 10 percent change in our projection of probable net credit losses on receivables would have resulted in a change of approximately $618 million in our credit loss reserves for receivables at December 31, 2010. The reserve for credit losses is a critical accounting estimate for both our Consumer and Card and Retail Services segments.
 
We maintain credit loss reserves to cover probable inherent losses of principal, accrued interest and fees, including late, overlimit and annual fees. Credit loss reserves are based on estimates and are intended to be adequate but not excessive. We estimate probable losses for consumer receivables using a roll rate migration analysis that estimates the likelihood that a loan will progress through the various stages of delinquency, or buckets, and ultimately be charged-off based upon recent historical performance experience of other loans in our portfolio. This analysis considers delinquency status, loss experience and severity and takes into account whether loans are in bankruptcy, have been re-aged, or are subject to forbearance, an external debt management plan, hardship, modification, extension or deferment. Our credit loss reserves also take into consideration the expected loss severity based on the underlying collateral, if any, for the loan in the event of default. Delinquency status may be affected by customer account management policies and practices, such as the re-age of accounts, forbearance agreements, extended payment plans, modification arrangements and deferments. When customer account management policies, or changes thereto, shift loans from a “higher” delinquency bucket to a “lower” delinquency bucket, this will be reflected in our roll rates statistics. To the extent that re-aged or modified accounts have a greater propensity to roll to higher delinquency buckets, this will be captured in the roll rates. Since the loss reserve is computed based on the composite of all these calculations, this increase in roll rate will be applied to receivables in all respective buckets, which will increase the overall reserve level. In addition, loss reserves on consumer receivables are maintained to reflect our judgment of portfolio risk factors which may not be fully reflected in the statistical roll rate calculation or when historical trends are not reflective of current inherent losses in the loan portfolio. Risk factors considered in establishing loss reserves on consumer receivables include product mix, unemployment rates, bankruptcy trends, geographic concentrations, loan product features such as adjustable rate loans, economic conditions such as national and local trends in unemployment, housing markets and interest rates, portfolio seasoning, account management policies and practices, current levels of charge-offs and delinquencies, changes in laws and regulations and other items which can affect consumer payment patterns on outstanding receivables, such as natural disasters.
 
While our credit loss reserves are available to absorb losses in the entire portfolio, we specifically consider the credit quality and other risk factors for each of our products. We recognize the different inherent loss characteristics in each of our products and for certain products their vintages, as well as customer account management policies and practices and risk management/collection practices. Charge-off policies are also considered when establishing loss reserve requirements. We also consider key ratios such as reserves as a percentage of nonperforming loans, reserves as a percentage of net charge-offs, reserves as a percentage of two-months-and-over contractual delinquency, and


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number of months charge-off coverage in developing our loss reserve estimate. In addition to the above procedures for the establishment of our credit loss reserves, our Risk Strategy and Finance Departments independently assess and approve the adequacy of our loss reserve levels.
 
For more information about our charge-off and customer account management policies and practices, see “Credit Quality – Delinquency and Charge-off Policies and Practices,” “Credit Quality – Changes to Real Estate Secured and Personal Non-Credit Card Receivable Charge-off Policies” and “Credit Quality – Customer Account Management Policies and Practices.”
 
Goodwill and Intangible Assets Goodwill and intangible assets with indefinite lives are not subject to amortization. Intangible assets with finite lives are amortized over their estimated useful lives. Intangible assets and goodwill recorded on our balance sheet are reviewed annually on July 1 for impairment using discounted cash flows, but impairment may also be reviewed at other interim dates if circumstances indicate that the carrying amount may not be recoverable. We consider significant and long-term changes in industry and economic conditions to be our primary indicators of potential impairment due to their impact on expected future cash flows. In addition, shorter-term changes may impact the discount rate applied to such cash flows based on changes in investor requirements or market uncertainties.
 
The impairment testing of our goodwill and intangibles has historically been a critical accounting estimate due to the level of goodwill and intangible assets recorded and the significant judgment required in the use of discounted cash flow models to determine fair value. Discounted cash flow models include such variables as revenue growth rates, expense trends, interest rates and terminal values. Based on an evaluation of key data and market factors, management’s judgment is required to select the specific variables to be incorporated into the models. Additionally, the estimated fair value can be significantly impacted by the risk adjusted cost of capital used to discount future cash flows. The risk adjusted cost of capital is generally derived from an appropriate capital asset pricing model, which itself depends on a number of financial and economic variables which are established on the basis of that used by market participants, which involves management judgment. Because our fair value estimate involves judgment and is influenced by factors outside our control, it is reasonably possible such estimates could change. When management’s judgment is that the anticipated cash flows have decreased and/or the risk adjusted cost of capital has increased, the effect will be a lower estimate of fair value. If the fair value is determined to be lower than the carrying value, an impairment charge may be recorded and net income will be negatively impacted.
 
Impairment testing of goodwill requires that the fair value of each reporting unit be compared to its carrying amount. A reporting unit is defined as any distinct, separately identifiable component of an operating segment for which complete, discrete financial information is available that management regularly reviews. For purposes of the annual goodwill impairment test and any interim test which may be required, we assign our goodwill to our reporting units. As a result of the continuing deterioration of economic conditions throughout 2008 and into 2009 as well as the adverse impact to our Insurance Services business which resulted from the closure of all of our Consumer Lending branches, we wrote off all of our remaining goodwill balance during 2009.
 
Impairment testing of intangible assets requires that the fair value of the asset be compared to its carrying amount. At July 1, 2010, the estimated fair value of each intangible asset exceeded its carrying value and, as such, none of our intangible assets were impaired.
 
Valuation of Financial Instruments A control framework has been established which is designed to ensure that fair values are either determined or validated by a function independent of the risk-taker. To that end, the ultimate responsibility for the determination of fair values rests with the HSBC Finance Valuation Committee. The HSBC Finance Valuation Committee establishes policies and procedures to ensure appropriate valuations.
 
Where available, we use quoted market prices to determine fair value. If quoted market prices are not available, fair value is determined using internally developed valuation models based on inputs that are either directly observable or derived from and corroborated by market data. Where neither quoted market prices nor observable market parameters are available, fair value is determined using valuation models that feature one or more significant unobservable inputs based on management’s expectation that market participants would use in determining the fair value of the asset or liability. However, these unobservable inputs must incorporate market participants’


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assumptions about risks in the asset or liability and the risk premium required by market participants in order to bear the risks. The determination of appropriate unobservable inputs requires exercise of management judgment. A significant majority of our assets and liabilities that are reported at fair value are measured based on quoted market prices and observable market-based or independently-sourced inputs.
 
We review and update our fair value hierarchy classifications quarterly. Changes from one quarter to the next related to the observability of inputs to a fair value measurement may result in a reclassification between hierarchy levels. While we believe our valuation methods are appropriate, the use of different methodologies or assumptions to determine the fair value of certain financial assets and liabilities could result in a different estimate of fair value at the reporting date.
 
Significant assets and liabilities recorded at fair value include the following:
 
Derivative financial assets and liabilities – We regularly use derivative instruments as part of our risk management strategy to protect the value of certain assets and liabilities and future cash flows against adverse interest rate and foreign exchange rate movements. All derivatives are recognized on the balance sheet at fair value. Related collateral that has been received or paid is netted against fair value for financial reporting purposes where a master netting arrangement with the counterparty exists that provides for the net settlement of all contracts through a single payment in a single currency in the event of default or termination on any one contract. We believe the valuation of derivative instruments is a critical accounting estimate because certain instruments are valued using discounted cash flow modeling techniques in lieu of observable market value quotes for identical or similar assets or liabilities in active and inactive markets. These modeling techniques require the use of estimates regarding the amount and timing of future cash flows and utilize independently-sourced market parameters, including interest rate yield curves, option volatilities, and currency rates, where available. Where market data is not available, fair value may be affected by the choice of valuation model and the underlying assumptions about the timing of cash flows and credit spreads. These estimates are susceptible to significant changes in future periods as market conditions evolve.
 
We may adjust certain fair value estimates determined using valuation models to ensure that those estimates appropriately represent fair value. These adjustments, which are applied consistently over time, are generally required to reflect factors such as market liquidity and counterparty credit risk. Assessing the appropriate level of liquidity adjustment requires management judgment and is often affected by the product type, transaction-specific terms and the level of liquidity for the product in the market. In assessing the credit risk relating to derivative assets and liabilities, we take into account the impact of risk mitigants including, but not limited to, master netting and collateral arrangements. We also consider the effect of our own non-performance credit risk on fair values. Imprecision in estimating these factors can impact the amount of revenue or loss recorded for a particular position.
 
We utilize HSBC Bank USA to determine the fair value of substantially all of our derivatives using these modeling techniques. Significant changes in the fair value can result in equity and earnings volatility as follows:
 
  •  Changes in the fair value of a derivative that has been designated and qualifies as a fair value hedge, along with the changes in the fair value of the hedged asset or liability (including losses or gains on firm commitments), are recorded in current period earnings.
 
  •  Changes in the fair value of a derivative that has been designated and qualifies as a cash flow hedge are recorded in other comprehensive income, net of tax, to the extent of its effectiveness, until earnings are impacted by the variability of cash flows from the hedged item.
 
  •  Changes in the fair value of a derivative that has not been designated as an effective hedge are reported in current period earnings.
 
A derivative designated as an effective hedge will be tested for effectiveness in all circumstances under the long haul method. For these transactions, we formally assess, both at the inception of the hedge and on a quarterly basis, whether the derivative used in a hedging transaction has been and is expected to continue to be


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highly effective in offsetting changes in fair values or cash flows of the hedged item. This assessment is conducted using statistical regression analysis.
 
If it is determined as a result of this assessment that a derivative is not expected to be a highly effective hedge or that it has ceased to be a highly effective hedge, we discontinue hedge accounting as of the beginning of the quarter in which such determination was made. We also believe the assessment of the effectiveness of the derivatives used in hedging transactions is a critical accounting estimate due to the use of statistical regression analysis in making this determination. Similar to discounted cash flow modeling techniques, statistical regression analysis also requires the use of estimates regarding the amount and timing of future cash flows, which are susceptible to significant change in future periods based on changes in market rates. Statistical regression analysis also involves the use of additional assumptions including the determination of the period over which the analysis should occur as well as selecting a convention for the treatment of credit spreads in the analysis. The statistical regression analysis for our derivative instruments is performed primarily by HSBC Bank USA.
 
The outcome of the statistical regression analysis serves as the foundation for determining whether or not the derivative is highly effective as a hedging instrument. This can result in earnings volatility as the mark-to-market on derivatives which do not qualify as effective hedges and the ineffectiveness associated with qualifying hedges are recorded in current period earnings. For example, a 10 percent adverse change in the value of our derivatives which do not qualify as effective hedges would have reduced revenue by approximately $141 million at December 31, 2010.
 
For more information about our policies regarding the use of derivative instruments, see Note 2, “Summary of Significant Accounting Policies and New Accounting Pronouncements,” and Note 17, “Derivative Financial Instruments,” to the accompanying consolidated financial statements.
 
Long-term debt carried at fair value – We have elected the fair value option for certain issuances of our fixed rate debt in order to align our accounting treatment with that of HSBC under IFRSs. We believe the valuation of this debt is a critical accounting estimate because valuation estimates obtained from third parties involve inputs other than quoted prices to value both the interest rate component and the credit component of the debt. In many cases, management can obtain quoted prices for identical or similar liabilities but the markets are not active, the prices are not current, or such price quotations vary substantially either over time or among market makers. Changes in such estimates, and in particular the credit component of the valuation, can be volatile from period to period and may markedly impact the total mark-to-market on debt designated at fair value recorded in our consolidated statement of income (loss). For example, a 10 percent change in the value of our debt designated at fair value could have resulted in a change to our reported mark-to-market of approximately $2.1 billion at December 31, 2010.
 
Debt securities – Debt securities, which include mortgage-backed securities and other asset-backed securities, are measured at fair value based on a third party valuation source using quoted market prices and if not available, based on observable quotes for similar securities or other valuation techniques (e.g., matrix pricing). Otherwise, for non-callable corporate securities, a credit spread scale is created for each issuer and these spreads are then added to the equivalent maturity U.S. Treasury yield to determine current pricing. The fair value measurements for mortgage-backed securities and other asset-backed securities are primarily obtained from independent pricing sources taking into account differences in the characteristics and the performance of the underlying collateral, such as prepayments and defaults. A determination will be made as to whether adjustments to the observable inputs are necessary as a result of investigations and inquiries about the reasonableness of the inputs used and the methodologies employed by the independent pricing sources.
 
Receivables held for sale – Receivables held for sale are carried at the lower of amortized cost or fair value. Accordingly, fair value for such receivables must be estimated to determine any required write down to fair value when the amortized cost of the receivables exceeds their current fair value. Where available, quoted market prices are used to estimate the fair value of these receivables. Where market quotes are not available, fair value is estimated using observable market prices of similar instruments with similar characteristics.


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Where quoted market prices and observable market parameters are not available, the fair value of receivables held for sale is based on contractual cash flows adjusted for management’s estimates of prepayments, defaults, and recoveries, discounted at management’s estimate of the rate of return that would be required by investors in the current market given the specific characteristics and inherent credit risk of the receivables. Management attempts to corroborate its estimates of prepayments, defaults, and recoveries using observable data by correlation or other means. Reduced liquidity in credit markets has resulted in a decrease in the availability of observable market data, which has in turn resulted in an increased level of management judgment required to estimate fair value for receivables held for sale. In certain cases, an independent third party is utilized to substantiate management’s estimate of fair value.
 
Deferred Tax Assets We recognize deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for tax credits and state net operating losses. Our deferred tax assets, net of valuation allowances, totaled $3.4 billion and $4.2 billion as of December 31, 2010 and 2009, respectively. We evaluate our deferred tax assets for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including our historical financial performance, projections of future taxable income, future reversals of existing taxable temporary differences and any carryback available. We are required to establish a valuation allowance for deferred tax assets and record a charge to income or shareholders’ equity if we determine, based on available evidence at the time the determination is made, that it is more-likely-than-not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, we estimate future taxable income based on management approved business plans, future capital requirements and ongoing tax planning strategies, including capital support from HSBC necessary as part of such plans and strategies. This process involves significant management judgment about assumptions that are subject to change from period to period. Because the recognition of deferred tax assets requires management to make significant judgments about future earnings, the periods in which items will impact taxable income and the application of inherently complex tax laws, we have included the assessment of deferred tax assets and the need for any related valuation allowance as a critical accounting estimate.
 
Since recent market conditions have created significant downward pressure on our near-term pretax book income, our analysis of the realizability of deferred tax assets significantly discounts any future taxable income expected from continuing operations and relies to a greater extent on continued liquidity and capital support from our parent, HSBC, including tax planning strategies implemented in relation to such support. We are included in HSBC North America’s consolidated Federal income tax return and in various combined state tax returns. As we have entered into tax allocation agreements with HSBC North America and its subsidiary entities included in the consolidated return which govern the current amount of taxes to be paid or received by the various entities, we look at HSBC North America and its affiliates, together with the tax planning strategies identified, in reaching conclusions on recoverability. Absent capital support from HSBC and implementation of the related tax planning strategies, we would be required to record a valuation allowance against our deferred tax assets.
 
The use of different estimates can result in changes in the amounts of deferred tax items recognized, which can result in equity and earnings volatility because such changes are reported in current period earnings. Furthermore, if future events differ from our current forecasts, valuation allowances may need to be established or adjusted, which could have a material adverse effect on our results of operations, financial condition and capital position. We will continue to update our assumptions and forecasts of future taxable income and assess the need for a valuation allowance.
 
Additional detail on our assumptions with respect to the judgments made in evaluating the realizability of our deferred tax assets and on the components of our deferred tax assets and deferred tax liabilities as of December 31, 2010 and 2009 can be found in Note 18, “Income Taxes” of this Form 10-K.
 
Contingent Liabilities Both we and certain of our subsidiaries are parties to various legal proceedings resulting from ordinary business activities relating to our current and/or former operations. Certain of these activities are or purport to be class actions seeking damages in significant amounts. These actions include assertions concerning violations of laws and/or unfair treatment of consumers.


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Litigation exposure represents a key area of judgment and is subject to uncertainty and certain factors outside of our control. Due to the uncertainties in litigation and other factors, we cannot be certain that we will ultimately prevail in each instance. Such uncertainties impact our ability to determine whether it is probable that a liability exists and whether the amount can be reasonably estimated. Also, as the ultimate resolution of these proceedings is influenced by factors that are outside of our control, it is reasonably possible our estimated liability under these proceedings may change. However, based upon our current knowledge, our defenses to these actions have merit and any adverse decision should not materially affect our consolidated financial condition, results of operations or cash flows.
 
Receivables Review
 
The table below summarizes receivables at December 31, 2010 and increases (decreases) over prior periods:
 
                                         
          Increases (Decreases) From  
          December 31,
    December 31,
 
    December 31,
    2009     2008  
    2010     $     %     $     %  
   
    (dollars are in millions)  
 
Receivables:
                                       
Core receivable portfolios:
                                       
Credit card(1)
  $ 9,897     $ (1,729 )     (14.9 )%   $ (3,334 )     (25.2 )%
Non-core receivable portfolios:
                                       
Real estate secured(2)(3)
    49,336       (10,199 )     (17.1 )     (22,330 )     (31.2 )
Private label(4)
    -       -       -       (65 )     (100.0 )
Personal non-credit card
    7,117       (3,369 )     (32.1 )     (8,451 )     (54.3 )
Commercial and other
    33       (17 )     (34.0 )     (60 )     (64.5 )
                                         
Total non-core receivable portfolios
    56,486       (13,585 )     (19.4 )     (30,906 )     (35.4 )
                                         
Total receivables
  $ 66,383     $ (15,314 )     (18.7 )%   $ (34,240 )     (34.0 )%
                                         
 
 
(1)  During 2009, $1.1 billion of credit card receivables held for sale were reclassified to held for investment.
 
(2)  Real estate secured receivables are comprised of the following:
 
                                         
          Increases (Decreases) From  
    December 31,
    December 31, 2009     December 31, 2008  
    2010     $     %     $     %  
   
    (dollars are in millions)  
 
Mortgage Services
  $ 15,982     $ (3,959 )     (19.9 )%   $ (9,472 )     (37.2 )%
Consumer Lending
    33,347       (6,239 )     (15.8 )     (12,855 )     (27.8 )
All other
    7       (1 )     (12.5 )     (3 )     (30.0 )
                                         
Total real estate secured
  $ 49,336     $ (10,199 )     (17.1 )%   $ (22,330 )     (31.2 )%
                                         
 
(3) At December 31, 2010 and 2009, real estate secured receivables includes outstanding principal balances of $5.1 billion and $3.4 billion, respectively, of receivables that have been written down to their net realizable value less cost to sell in accordance with our existing charge-off policy.
 
(4) Private label receivables consist primarily of the liquidating retail sales contracts in our Consumer Lending business with a receivable balance of $3 million, $12 million and $51 million at December 31, 2010, 2009 and 2008, respectively. Beginning in 2009, we began reporting this liquidating portfolio prospectively within our personal non-credit card portfolio.
 
Core Credit Card Receivables Credit card receivables have decreased as a result of actions taken beginning in the fourth quarter of 2007 to manage risk including tightening initial credit lines and sales authorization criteria, closing inactive accounts, decreasing credit lines, tightening underwriting criteria, tightening cash access and reducing


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marketing levels, as well as an increased focus and ability on the part of consumers to reduce outstanding credit card debt. In 2008, we identified certain segments of our credit card portfolio which have been the most impacted by the housing and economic conditions and we stopped all new account originations in those market segments. Based on performance trends which began in the second half of 2009, we have increased direct marketing mailings and new customer account originations for portions of our non-prime credit card receivable portfolio which will likely result in lower run-off of credit card receivables during 2011.
 
Non-Core Receivable Portfolios
 
Real estate secured receivables Real estate secured receivables can be further analyzed as follows:
 
                                         
          Increases (Decreases) From  
          December 31,
    December 31,
 
    December 31,
    2009     2008  
    2010     $     %     $     %  
   
    (dollars are in millions)  
 
Real estate secured(1):
                                       
Closed-end:
                                       
First lien
  $ 43,672     $ (8,105 )     (15.7 )%   $ (17,578 )     (28.7 )%
Second lien
    4,260       (1,605 )     (27.4 )     (3,620 )     (45.9 )
Revolving:
                                       
First lien
    187       (24 )     (11.4 )     (52 )     (21.8 )
Second lien
    1,217       (465 )     (27.6 )     (1,080 )     (47.0 )
                                         
Total real estate secured(2)
  $ 49,336     $ (10,199 )     (17.1 )%   $ (22,330 )     (31.2 )%
                                         
 
 
(1)  Receivable classification between closed-end and revolving receivables is based on the classification at the time of receivable origination and does not reflect any changes in the classification that may have occurred as a result of any loan modifications.
 
(2)  Excludes receivables held for sale. Real estate secured receivables held for sale included $4 million, $3 million and $323 million primarily of closed-end, first lien receivables at December 31, 2010, 2009 and 2008, respectively.
 
As previously discussed, real estate markets in a large portion of the United States have been and continue to be affected by stagnation or declines in property values. As such, the loan-to-value (“LTV”) ratios for our real estate secured receivable portfolios have generally deteriorated since origination. Receivables which have an LTV greater than 100 percent have historically had a greater likelihood of becoming delinquent, resulting in higher credit losses for us. Refreshed loan-to-value ratios for our real estate secured receivable portfolios are presented in the table below as of December 31, 2010 and 2009. The overall improvement in average refreshed LTVs in our first lien real estate secured receivable portfolio reflects the increase in receivables carried at their net realizable value less cost to sell since December 31, 2009.
 
                                                                 
    Refreshed LTVs(1)(2)
  Refreshed LTVs(1)(2)
    at December 31, 2010   at December 31, 2009
         
    Consumer Lending(3)   Mortgage Services   Consumer Lending(3)   Mortgage Services
    First
  Second
  First
  Second
  First
  Second
  First
  Second
    Lien   Lien   Lien   Lien   Lien   Lien   Lien   Lien
 
 
LTV<80%
    39 %     18 %     34 %     8 %     35 %     18 %     30 %     8 %
80%£LTV<90%
    18       13       18       11       18       12       18       12  
90%£LTV<100%
    17       20       21       19       19       22       23       20  
LTV³100%
    26       49       27       62       28       48       29       60  
Average LTV for portfolio
    87       100       89       109       88       100       91       109  
 
 
(1)  Refreshed LTVs for first liens are calculated using the receivable balance as of the reporting date (including any charge-offs recorded to reduce receivables to their net realizable value less cost to sell in accordance with our existing charge-off policies). Refreshed LTVs for


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second liens are calculated using the receivable balance as of the reporting date (including any charge-offs recorded to reduce receivables to their net realizable value less cost to sell in accordance with our existing charge-off policies) plus the senior lien amount at origination. For purposes of this disclosure, current estimated property values are derived from the property’s appraised value at the time of receivable origination updated by the change in the Office of Federal Housing Enterprise Oversight’s house pricing index (“HPI”) at either a Core Based Statistical Area (“CBSA”) or state level. The estimated value of the homes could vary from actual fair values due to changes in condition of the underlying property, variations in housing price changes within metropolitan statistical areas and other factors. As a result, actual property values associated with loans which end in foreclosure may be significantly lower than the estimated values used for purposes of this disclosure.
 
(2)  For purposes of this disclosure, current estimated property values are calculated using the most current HPI’s available and applied on an individual loan basis, which results in an approximately three month delay in the production of reportable statistics for the current period. Therefore, the December 31, 2010 and 2009 information in the table above reflects current estimated property values using HPIs as of September 30, 2010 and 2009, respectively. Given the recent declines in property values in certain markets, the refreshed LTVs of our portfolio may, in fact, be lower than reflected in the table.
 
(3)  Excludes the purchased receivable portfolios of our Consumer Lending business which totaled $1.2 billion and $1.5 billion at December 31, 2010 and 2009, respectively.
 
The following table summarizes various real estate secured receivables information (excluding receivables held for sale) for our Mortgage Services and Consumer Lending businesses:
 
                                                 
    December 31, 2010     December 31, 2009     December 31, 2008  
    Mortgage
    Consumer
    Mortgage
    Consumer
    Mortgage
    Consumer
 
    Services     Lending     Services     Lending     Services     Lending  
   
                (in millions)              
 
Fixed rate(3)
  $ 10,014 (1)   $ 31,827 (2)   $ 11,962 (1)   $ 37,717 (2)   $ 14,340 (1)   $ 43,882 (2)
Adjustable rate(3)
    5,968       1,520       7,979       1,869       11,114       2,320  
                                                 
Total
  $ 15,982     $ 33,347     $ 19,941     $ 39,586     $ 25,454     $ 46,202  
                                                 
First lien
  $ 13,821     $ 30,042     $ 16,979     $ 35,014     $ 21,198     $ 40,297  
Second lien
    2,161       3,305       2,962       4,572       4,256       5,905  
                                                 
Total
  $ 15,982     $ 33,347     $ 19,941     $ 39,586     $ 25,454     $ 46,202  
                                                 
Adjustable rate(3)
  $ 4,898     $ 1,520     $ 6,471     $ 1,869     $ 8,860     $ 2,320  
Interest only(3)
    1,070       -       1,508       -       2,254       -  
                                                 
Total adjustable rate(3)
  $ 5,968     $ 1,520     $ 7,979     $ 1,869     $ 11,114     $ 2,320  
                                                 
Total stated income
  $ 2,703     $ -     $ 3,677     $ -     $ 5,237     $ -  
                                                 
 
 
(1)  Includes fixed rate interest-only receivables of $235 million, $282 million and $344 million at December 31, 2010, 2009 and 2008, respectively.
 
(2)  Includes fixed rate interest-only receivables of $27 million, $36 million and $44 million at December 31, 2010, 2009 and 2008, respectively.
 
(3)  Receivable classification between fixed rate, adjustable rate, and interest-only receivables is based on the classification at the time of receivable origination and does not reflect any changes in the classification that may have occurred as a result of any loan modifications.
 
The decrease in our real estate secured receivable balances since December 31, 2009 and 2008 reflect the continuing liquidation of this portfolio which will continue going forward. The liquidation rates in our real estate secured receivable portfolios continue to be impacted by declines in loan prepayments as fewer refinancing opportunities for our customers exist and by the trends impacting the mortgage lending industry as discussed above.


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Personal non-credit card receivables Personal non-credit card receivables are comprised of the following:
 
                                         
          Increases (Decreases) From  
          December 31,
    December 31,
 
    December 31,
    2009     2008  
    2010     $     %     $     %  
   
    (dollars are in millions)  
 
Personal non-credit card
  $ 5,295     $ (2,801 )     (34.6 )%   $ (7,199 )     (57.6 )%
Personal homeowner loans (“PHLs”)
    1,822       (568 )     (23.8 )     (1,252 )     (40.7 )
                                         
Total personal non-credit card receivables
  $ 7,117     $ (3,369 )     (32.1 )%   $ (8,451 )     (54.3 )%
                                         
 
The decrease in personal non-credit card receivables since December 31, 2009 and 2008 reflect the continuing liquidation of this portfolio which will continue going forward.
 
PHLs typically have terms of 120 to 240 months and are subordinate lien, home equity loans with high (100 percent or more) combined loan-to-value ratios which we underwrote, priced and service like unsecured loans. The average PHL principal balance in our portfolio at December 31, 2010 is approximately $18,000. Because recovery upon foreclosure is unlikely after satisfying senior liens and paying the expenses of foreclosure, we do not consider the collateral as a source for repayment in our underwriting or in the establishment of credit loss reserves.
 
Distribution and Sales As discussed above, our current product offering primarily consists of credit card and private label receivables. Credit card receivables are generated primarily through direct mail, telemarketing, Internet applications, promotional activity associated with our co-branding and affinity relationships, mass media advertisements and merchant relationships. A portion of our new credit card receivables are sold on a daily basis to HSBC Bank USA and do not remain on our balance sheet. Private label receivables are generated through point of sale, merchant promotions, application displays, Internet applications, direct mail and telemarketing. All new private label originations are sold on a daily basis to HSBC Bank USA and do not remain on our balance sheet.
 
Real Estate Owned
 
We obtain real estate by taking possession of the collateral pledged as security for real estate secured receivables. REO properties are made available for sale in an orderly fashion with the proceeds used to reduce or repay the outstanding receivable balance. The following table provides quarterly information regarding our REO properties:
 
                                                 
        Three Months Ended
    Full Year
  Dec. 31,
  Sept. 30,
  June 30,
  Mar. 30,
  Full Year
    2010   2010   2010   2010   2010   2009
 
 
Number of REO properties at end of period
    10,749       10,749       9,629       8,249       6,826       6,060  
Number of properties added to REO inventory in the period
    20,112       5,657       5,316       4,996       4,143       14,476  
Average loss on sale of REO properties(1)
    8.9 %     15.3 %     10.1 %     4.2 %     3.9 %     11.6 %
Average total loss on foreclosed properties(2)
    51.1 %     53.6 %     52.1 %     48.9 %     49.0 %     51.6 %
Average time to sell REO properties (in days)
    161       165       158       156       170       193  
 
 
(1) Property acquired through foreclosure is initially recognized at its fair value less estimated costs to sell (“Initial REO Carrying Value”). The average loss on sale of REO properties is calculated as cash proceeds less the Initial REO Carrying Value divided by the Initial REO Carrying Value.
 
(2) The average total loss on foreclosed properties sold each quarter includes both the loss on sale of the REO property as discussed above and the cumulative write-downs recognized on the loans up to the time we took title to the property. This calculation of the average total loss on foreclosed properties uses the unpaid loan principal balance prior to write-down plus any other ancillary amounts owed (e.g., real estate tax advances) which were incurred prior to our taking title to the property.


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The number of REO properties at December 31, 2010 increased as compared to December 31, 2009 due to improved processing of foreclosures following backlogs in foreclosure proceedings and actions by local governments and certain states that lengthened the foreclosure process beginning in 2008. However, in the first half of 2011, we anticipate the number of REO properties will decrease as foreclosures are again delayed as a result of our suspension of foreclosures while we enhance foreclosure documentation and processes for foreclosures and re-file affidavits where necessary. Local governments and states may also require additional processes in the future which could slow the foreclosure process once resumed, again leading to a slowdown in growth of REO properties.
 
While the average total loss on foreclosed properties for full year 2010 was essentially flat as compared to full year 2009, home price stabilization in many markets and recovery in other markets which occurred during the first half of the year was offset by home price declines in the second half of the year. The decline in home prices in the second half of the year resulted from the continued elevated levels of foreclosed properties and the expiration of the homebuyer tax credit. The average loss on sale of REO properties also began to increase again during the second half of 2010 reflecting declines in home prices as discussed above as this ratio is negatively impacted by declines in home prices between the time we take title to the property and when the property is ultimately sold. The impact of the recent publicized foreclosure practices of certain servicers could ultimately result in increased severity of loss upon sale as there will likely be a dramatic and significant increase in the number of properties on the market once the industry implements the required changes.
 
Results of Operations
 
Unless noted otherwise, the following discusses amounts from continuing operations as reported in our consolidated statement of income.
 
Net Interest Income The following table summarizes net interest income:
 
                                                 
Year Ended December 31,   2010     %(1)     2009     %(1)     2008     %(1)  
   
    (dollars are in millions)  
 
Finance and other interest income
  $ 7,208       9.00 %   $ 8,887       8.93 %   $ 13,616       10.70 %
Interest expense
    3,023       3.77       3,829       3.85       5,680       4.46  
                                                 
Net interest income
  $ 4,185       5.23 %   $ 5,058       5.08 %   $ 7,936       6.24 %
                                                 
 
 
(1) % Columns: comparison to average interest-earning assets.
 
Net interest income decreased during 2010 primarily due to lower average receivables as a result of receivable liquidation, risk mitigation efforts and an increased focus and ability by consumers to reduce outstanding credit card debt, partially offset by higher overall receivable yields and lower interest expense. During 2010, we experienced higher yields for all receivable products as a result of lower levels of nonperforming receivables, including reduced levels of nonperforming modified real estate secured receivables, due to charge-off and declines in new modification volumes. Higher yields in our real estate secured receivable portfolio were partially offset by the impact of an increase in the expected lives of receivables in payment incentive programs. Higher yields in our credit card receivable portfolio were partially offset by the implementation of certain provisions of the Card Act including restrictions impacting repricing of delinquent accounts and periodic re-evaluation of rate increases. We anticipate credit card loan yields in future periods may continue to be negatively impacted by various provisions of the Card Act which require certain rate increases to be periodically re-evaluated. As receivable yields vary between receivable products, overall receivable yields were negatively impacted by a shift in receivable mix to higher levels of lower yielding first lien real estate secured receivables as higher yielding second lien real estate secured and personal non-credit card receivables have run-off at a faster pace than first lien real estate secured receivables. The decrease in net interest income during 2010 was partially offset by higher net interest income on our non-insurance investment portfolio reflecting higher levels of investments held and slightly higher yields. These decreases were partially offset by lower interest expense due to lower average borrowings and lower average rates.


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Net interest income during 2009 includes the impact of the December 2009 Charge-off Policy Changes and the impact of the adoption of a more bank-like income recognition policy relating to unrecorded interest on re-aged real estate secured receivables and PHLs both of which occurred in the fourth quarter of 2009 which reduced net interest income by $351 million and $190 million, respectively, as previously discussed. Excluding the impact of these items, net interest income remained lower in 2009 due to lower average receivables reflecting lower origination volumes due to our risk mitigation efforts, including our decisions to stop all new account originations in our Mortgage Services and Consumer Lending businesses, as well as lower consumer spending levels. The decrease in net interest income also reflects lower levels of performing receivables and lower overall yields on our receivable portfolio, partially offset by lower interest expense. Overall receivable yields were negatively impacted by a shift in mix to higher levels of real estate secured receivables as a result of the sale of $12.4 billion of credit card receivables, respectively, in January 2009 as credit card receivables generally have higher yields than real estate secured receivables.
 
Our real estate secured and personal non-credit card receivable portfolios reported lower yields during 2009, while our credit card receivable portfolio reported higher yields. Lower yields in our real estate secured and personal non-credit card receivable portfolios reflect high volumes of loan modifications, the impact of deterioration in credit quality, including the impact of lower levels of performing receivables, lower amortization of net deferred fee income due to lower loan prepayments and lower loan origination volumes. The higher yields on our credit card receivable portfolio during 2009 were due to a significant shift in mix to higher levels of non-prime receivables which carry higher rates as a result of the sale of GM and UP Portfolios. The higher credit card yields also reflect the impact of interest rate floors in portions of our credit card receivable portfolio which have now been removed, partially offset by decreases in rates on variable rate products which reflect market rate movements. We also experienced lower yields on our non-insurance investment portfolio held for liquidity management purposes. These investments are short term in nature and the lower yields reflect decreasing rates on overnight investments. The lower interest expense was due to lower average rates for floating rate borrowings on lower average borrowings. The lower average rates for floating rate borrowings reflect actions taken by the Federal Reserve Bank resulting in daily average Federal Fund Rates being 184 basis points lower during 2009 as compared to 2008.
 
Net interest margin was 5.23 percent in 2010, 5.08 percent in 2009 and 6.24 percent in 2008. Net interest margin in 2010 increased due to lower cost of funds as a percentage of average interest-earning assets and higher overall yields on our receivable portfolio as discussed above. Net interest margin in 2009 was negatively impacted by the December 2009 Charge-off Policy Change as well as the adoption of more bank-like income recognition policies related to unrecorded interest on re-aged receivables as previously discussed. Excluding these items, net interest margin remained lower in 2009 due to lower overall yields on our receivable portfolio as discussed above, partially


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offset by lower funding costs as a percentage of average interest earning assets. The following table shows the impact of these items on net interest income:
 
                                 
    2010(1)     2009  
   
 
Net interest income/net interest margin from prior year
  $ 5,058       5.08 %   $ 7,936       6.24 %
                                 
Impact to net interest income resulting from:
                               
Lower receivable levels
    (913 )             (1,730 )        
Receivable yields:
                               
Receivable pricing
    -               683          
Impact of nonperforming assets
    223               (538 )        
Impact of loan modifications
    65               (363 )        
Receivable mix
    (313 )             (850 )        
December 2009 Charge-off Policy Changes
    -               (351 )        
Policy change for unrecorded interest
    -               (190 )        
Non-insurance investment income
    6               (132 )        
Cost of funds
    66               596          
Other
    (7 )             (3 )        
                                 
Net interest income/net interest margin for current year
  $ 4,185       5.23 %   $ 5,058       5.08 %
                                 
 
 
(1) The presentation of net interest income for 2010 assumes that the December 2009 Charge-off Policy Changes and the policy change for unrecorded interest were in effect for both the full year of 2010 and 2009.
 
The varying maturities and repricing frequencies of both our assets and liabilities expose us to interest rate risk. When the various risks inherent in both the asset and the debt do not meet our desired risk profile, we use derivative financial instruments to manage these risks to acceptable interest rate risk levels. See “Risk Management” for additional information regarding interest rate risk and derivative financial instruments.
 
Provision for Credit Losses The provision for credit losses includes current period net credit losses and an amount which we believe is sufficient to maintain reserves for losses of principal, accrued interest and fees, including late, overlimit and annual fees, at a level that reflects estimated inherent losses in the portfolio. The provision for credit losses may vary from year to year depending on a variety of factors including product mix and the credit quality of the loans in our portfolio including historical delinquency roll rates, portfolio seasoning, customer account management policies and practices, risk management/collection policies and practices related to our loan products, economic conditions such as national and local trends in housing markets and interest rates, changes in laws and regulations.
 
The following table summarizes provision for credit losses by business:
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Provision for credit losses:
                       
Credit card
  $ 840     $ 1,756     $ 3,346  
Mortgage Services
    1,575       1,917       3,399  
Consumer Lending:
                       
Real estate secured
    2,339       2,997       3,264  
Personal non-credit card
    1,426       2,980       2,401  
                         
Total Consumer Lending
    3,765       5,977       5,665  
                         
    $ 6,180     $ 9,650     $ 12,410  
                         


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Our provision for credit losses decreased significantly during 2010 as discussed below.
 
  •  Provision for credit losses for our core credit card receivable portfolio decreased $916 million during 2010. The decrease reflects lower receivable levels as a result of actions taken beginning in the fourth quarter of 2007 to manage risk as well as an increased focus and ability by consumers to reduce outstanding credit card debt. The decrease also reflects improvement in the underlying credit quality of the portfolio including continuing improvements in early stage delinquency roll rates and lower delinquency levels as customer payment rates have been strong throughout 2010. The impact on credit card receivable losses from the current economic environment, including high unemployment levels, has not been as severe as originally expected due in part to improved customer payment behavior.
 
  •  The provision for credit losses for the real estate secured receivable portfolios in our Consumer Lending and Mortgage Services business decreased $658 million and $342 million, respectively, during 2010. The decrease reflects lower receivable levels as the portfolios continue to liquidate, lower delinquency levels, improved loss severities and improvements in economic conditions since 2009. The decrease also reflects lower loss estimates on TDR Loans, partially offset by the impact of continued high unemployment levels, lower receivable prepayments, higher loss estimates on recently modified loans and for real estate secured receivables in our Consumer Lending business, portfolio seasoning. Improvements in loss severities reflect an increase in the number of properties for which we accepted a deed-in-lieu and an increase in the number of short sales, both of which result in lower losses compared to loans which are subject to a formal foreclosure process for which average loss severities in 2010 have remained relatively flat to 2009 levels.
 
  •  The provision for credit losses for our personal non-credit card receivables decreased $1.6 billion reflecting lower receivable levels, lower delinquency levels and improvements in economic conditions since 2009, partially offset by higher reserve requirements on TDR Loans.
 
Net charge-off dollars totaled $8.8 billion during 2010 compared to $12.6 billion in 2009 driven by lower delinquency levels as a result of lower average receivable levels, improvements in the U.S. economic conditions since year-end 2009 and as it relates to credit card receivables, higher recoveries. See “Credit Quality” for further discussion of our net charge-offs.
 
In 2010, we decreased our credit loss reserves as the provision for credit losses was $2.6 billion less than net charge-offs. Lower credit loss reserve levels reflect lower receivable levels, improved economic and credit conditions since 2009 including lower delinquency levels and overall improvements in loss severities as discussed above. The provision as a percent of average receivables was 8.43 percent in 2010 and 10.28 percent in 2009.
 
We anticipate delinquency and charge-off levels will remain under pressure during 2011 as the U.S. economic environment continues to impact our businesses and as foreclosures are again delayed as a result of our suspension of foreclosure while we enhance our foreclosure documentation and processes for foreclosures and re-file affidavits where necessary. The magnitude of these trends will largely be dependent on the nature and extent of the economic recovery, including unemployment rates and a recovery in the housing markets, which to some extent will be offset by the impact of actions we have already taken to reduce risk in these portfolios.
 
Our provision for credit losses declined significantly in 2009 compared to 2008 as discussed more fully below. The provision for credit losses in 2009 reflects an incremental provision of $1 million as a result of the December 2009 Charge-off Policy Changes.
 
  •  Provision for credit losses in our credit card receivable portfolio decreased significantly in 2009 due to lower receivable levels primarily due to the impact of the transfer of the GM and UP Portfolios to receivables held for sale in June 2008 and November 2008, respectively, as well as $2.0 billion of non-prime credit card receivables to receivables held for sale in June 2008. Excluding the impact of these transferred receivables from the prior year periods as applicable, our provision for credit losses remained significantly lower due to lower non-prime receivable levels as a result of lower consumer spending levels and actions taken beginning in the fourth quarter of 2007 and continuing through 2009 to manage risk. In addition, an improved outlook on future loss estimates as the impact of higher unemployment rates on losses has not been as severe as


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  previously anticipated due in part to lower gas prices and improved cash flow from government stimulus activities that meaningfully benefit our non-prime customers. These lower credit loss estimates have been partially offset by lower recovery rates on defaulted receivables.
 
  •  The provision for credit losses for real estate secured receivables decreased in 2009 reflecting a lower provision for real estate secured receivables in our Mortgage Services business and for second lien real estate secured receivables in our Consumer Lending business, partially offset by higher provisions for first lien real estate secured receivables in our Consumer Lending business. The overall decrease in the provision for real estate secured receivables reflects the continued liquidation in these portfolios which has resulted in lower charge-off levels. The lower provision also reflects a reduction to provision of $192 million as a result of the December 2009 Charge-off Policy changes, which includes the reserve impact of the policy change related to accrued interest. Accrued interest written off as part of this policy change was reflected as a reduction of finance and other interest income, while the release of loss reserves associated with principal and accrued interest was reflected in provision. Additionally, for real estate secured receivables in our Consumer Lending business, the lower overall provisions for real estate secured receivables reflect a reduction in portfolio risk factors, principally an improved outlook on current inherent losses for first lien real estate secured receivables originated in 2005 and earlier as the current trends for deterioration in delinquencies and charge-offs in these vintages began to stabilize during 2009. The decrease in the provision for credit losses for real estate secured receivables was partially offset by lower receivable prepayments, higher loss severities relative to 2008 due to deterioration in real estate values in some markets, higher reserve requirements for real estate secured TDR Loans and portfolio seasoning in our Consumer Lending real estate secured receivable portfolio.
 
  •  The provision for credit losses for personal non-credit card receivables increased during 2009, including an increase in provision for credit losses of $193 million related to the December 2009 Charge-off Policy Change which reflects the reserve impact of the policy change to accrued interest as discussed above and the charge-off of the total receivable balance, ignoring future recoveries while the corresponding release of credit loss reserves considered future recoveries, unlike real estate secured receivables which are written down to net realizable value less cost to sell. Excluding the incremental impact of the December 2009 Charge-off Policy Changes, our provision for credit losses in our personal non-credit card portfolio remained higher in 2009 due to higher levels of charge-off resulting from deterioration in the 2006 and 2007 vintages which was more pronounced in certain geographic regions, partially offset by lower receivable levels.
 
The provision for credit losses for all products in 2009 was negatively impacted by rising unemployment rates in an increasing number of markets, continued deterioration in the U.S. economy and housing markets and higher levels of personal bankruptcy filings.
 
Net charge-off dollars totaled $12.6 billion during 2009, including incremental charge-offs of $3.5 billion related to the December 2009 Charge-off Policy Changes as previously discussed, compared to $9.3 billion in 2008. Excluding these incremental charge-offs, dollars of net charge-offs decreased to $9.1 billion due to the impact of lower receivable levels and local government delays in processing foreclosures, which were partially offset by the continued deterioration in the U.S. economy and housing markets, rising unemployment rates, higher levels of personal bankruptcy filings and portfolio seasoning. We continued to experience delays in processing foreclosures as a result of backlogs in foreclosure proceedings and actions by local governments and certain states that have lengthened the foreclosure process resulting in higher levels of late stage delinquency. The impact of these delays on charge-off trends has been minimized as a result of the aforementioned charge-off policy changes. See “Credit Quality” for further discussion of our net charge-offs.
 
For further discussion of the changes to our charge-off policies implemented in December 2009, see “Credit Quality” in this MD&A as well as Note 8, “Changes in Charge-off Policies During 2009,” in the accompanying consolidated financial statements.
 
In 2009, we decreased our credit loss reserves as the provision for credit losses was $2.9 billion less than net charge-offs primarily as a result of the December 2009 Charge-off Policies Changes discussed above. Excluding the impact


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of the December 2009 Charge-off Policies Changes, credit loss reserves increased to $12.6 billion at December 31, 2009 from $12.0 billion at December 31, 2008 as the provision for credit losses during 2009 was $533 million in excess of net charge-offs. This increase in credit loss reserves in 2009 was driven by increased levels of troubled debt restructures and the higher reserve requirements associated with these receivables as well as higher dollars of delinquency driven by our Consumer Lending real estate secured receivables. These increases were partially offset by lower receivable levels for all products due to lower origination volumes, lower consumer spending levels, an improved outlook for future loss estimates on credit card receivables as the impact of higher unemployment rates was not as severe as previously anticipated as well as an improved outlook on current inherent losses for first lien real estate secured receivables originated in 2005 and earlier as current trends in delinquencies and charge-offs in these vintages began to stabilize. The provision as a percent of average receivables was 10.28 percent in 2009 and 10.05 percent in 2008.
 
See “Critical Accounting Policies,” “Credit Quality” and “Analysis of Credit Loss Reserves Activity” for additional information regarding our loss reserves. See Note 9, “Credit Loss Reserves” in the accompanying consolidated financial statements for additional analysis of loss reserves.
 
Other Revenues The following table summarizes other revenues:
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Insurance revenue
  $ 274     $ 334     $ 417  
Investment income
    99       109       124  
Net other-than-temporary impairment losses
    -       (25 )     (54 )
Derivative related income (expense)
    (379 )     300       (306 )
Gain (loss) on debt designated at fair value and related derivatives
    741       (2,125 )     3,160  
Fee income
    188       650       1,687  
Enhancement services revenue
    404       484       700  
Gain on bulk sale of receivables to HSBC affiliate
    -       50       -  
Gain on receivable sales to HSBC affiliates
    540       469       260  
Servicing and other fees from HSBC affiliates
    666       748       545  
Lower of cost or fair value adjustment on receivables held for sale
    2       (374 )     (514 )
Other income (expense)
    32       92       (68 )
                         
Total other revenues
  $ 2,567     $ 712     $ 5,951  
                         
 
Insurance revenue decreased in 2010 and 2009 as a result of lower credit related premiums due largely to the decision in late February 2009 to discontinue all new customer account originations in our Consumer Lending business. As a result of this decision, we no longer issue credit insurance policies in this business segment. However, we continue to collect premiums on existing policies as well as issue specialty insurance products in Canada.
 
Investment income includes interest income on securities available-for-sale as well as realized gains and losses from the sale of securities. Investment income decreased in 2010 due to lower gains on sales of securities and lower yields on money market funds as well as lower average investment balances. In 2009, the decrease reflects the impact of lower yields and lower average investment balances, partially offset by higher gains on sales of securities.
 
Net other-than temporary impairment (“OTTI”) losses During 2010, OTTI on securities available-for-sale were less than $1 million. In 2009, OTTI reflects $20 million of OTTI recorded during the first quarter of 2009 on our portfolio of perpetual preferred securities which was subsequently sold during the second quarter of 2009. Additionally, during the fourth quarter of 2009, $16 million of gross other-than-temporary impairment (“OTTI”) losses on securities available-for-sale were recognized, of which $5 million was recorded as a component of other revenues in the consolidated income statement and $11 million was recognized in accumulated other comprehensive income (loss) (“AOCI”). For further information regarding


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other-than-temporary impairment losses, see Note 6, “Securities,” in the accompanying consolidated financial statements.
 
Derivative related income (expense) includes realized and unrealized gains and losses on derivatives which do not qualify as effective hedges under hedge accounting principles as well as the ineffectiveness on derivatives which are qualifying hedges. Designation of swaps as effective hedges reduces the volatility that would otherwise result from mark-to-market accounting. All derivatives are economic hedges of the underlying debt instruments regardless of the accounting treatment. Derivative related income (expense) is summarized in the table below:
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Net realized gains (losses)
  $ (206 )   $ (290 )   $ (31 )
Mark-to-market on derivatives which do not qualify as effective hedges
    (188 )     487       (305 )
Ineffectiveness
    15       103       30  
                         
Total
  $ (379 )   $ 300     $ (306 )
                         
 
Derivative related income decreased significantly during 2010. As previously discussed, the deterioration in marketplace and economic conditions has resulted in our Consumer Lending and Mortgage Services real estate secured receivables remaining on the balance sheet longer due to lower prepayment rates. At December 31, 2010, we had $11.3 billion of interest rate swaps outstanding for the purpose of offsetting the increase in the duration of these receivables and the corresponding increase in interest rate risk as measured by the present value of a basis point (“PVBP”). While these positions acted as economic hedges by lowering our overall interest rate risk by more closely matching both the structure and duration of our liabilities to the structure and duration of our assets, they did not qualify as effective hedges under hedge accounting principles. As a result, these positions are carried at fair value and are marked-to-market through income while the item being hedged is not carried at fair value and no offsetting fair value adjustment is recorded. Of these non-qualifying hedges, $6.3 billion were longer-dated pay fixed/receive variable interest rate swaps, which represented an increase of $1.1 billion during 2010, and $5.0 billion were shorter-dated receive fixed/pay variable interest rate swaps. Market value movements for these non-qualifying hedges may be volatile during periods in which long term interest rates fluctuate, but they effectively lock in fixed interest rates for a set period of time which results in funding that is better aligned with longer term assets. Falling long-term interest rates during 2010 had a significant negative impact on the mark-to-market on this portfolio of swaps. Should interest rates continue to decline, we will incur additional losses, although losses could reverse if interest rates increase. Over time, we may elect to further reduce our exposure to rising interest rates through the execution of additional pay fixed/receive variable interest rate swaps Net realized losses were lower during 2010 as a result of lower losses on terminations of non-qualifying hedges due to changes in rates during 2010 as well as changes in the timing of the non-qualifying hedge terminations. During 2010, ineffectiveness was largely due to the impact of falling U.S. long term rates on our cross currency cash flow hedges, partially offset by falling long-term foreign interest rates, while during 2009, long term U.S. rates and long-term foreign interest rates increased.
 
The increase in derivative related income in 2009 primarily reflects the impact of rising long term U.S. interest rates on a larger portfolio of non-qualifying hedges during 2009 as discussed above. During 2009 an average of $5.6 billion of interest rate swaps were outstanding of which $5.1 billion relates to longer dated pay fixed/receive variable interest rate swaps and $407 million relates to shorter dated receive fixed, pay variable interest rate swaps. Net realized losses increased significantly in 2009 as a result of the termination of $2.6 billion in notional of non-qualifying hedges in a loss position and losses resulting from falling short-term interest rates. These terminated positions were replaced with longer duration pay fixed swaps to offset the risk created by the increase in duration realized in our real estate secured receivable portfolio. The favorable mark-to-market results reflected above are attributable to these positions in combination with a rise in intermediate and long term interest rates during the latter half of 2009. Ineffectiveness income was primarily driven by changes in the market value of our cross currency cash flow hedges due to the increase in long term U.S. and foreign interest rates throughout 2009.


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Net income volatility, whether based on changes in interest rates for swaps which do not qualify for hedge accounting or ineffectiveness recorded on our qualifying hedges under the long haul method of accounting, impacts the comparability of our reported results between periods. Accordingly, derivative related income for the year ended December 31, 2010 should not be considered indicative of the results for any future periods.
 
Gain (loss) on debt designated at fair value and related derivatives reflects fair value changes on our fixed rate debt accounted for under FVO as well as the fair value changes and realized gains (losses) on the related derivatives associated with debt designated at fair value. The gain on debt designated at fair value and related derivatives during 2010 primarily reflects a widening of our credit spreads and falling long-term interest rates during the year. In 2009, the loss on debt designated at fair value and related derivatives reflects rising long-term U.S. interest rates as well as a tightening of our credit spreads during 2009. See Note 16, “Fair Value Option,” in the accompanying consolidated financial statements for additional information, including a break out of the components of the gain (loss) on debt designated at fair value and related derivatives.
 
Fee income, which includes revenues from fee-based products such as credit cards, decreased in 2010 as a result of lower late, overlimit and interchange fees due to lower volumes and lower delinquency levels, changes in customer behavior and impacts from changes required by the Card Act. The Card Act has resulted in significant decreases in late fees due to limits on fees that can be assessed and overlimit fees as customers must now opt-in for such overlimit fees as well as restrictions on fees charged to process on-line and telephone payments. The decrease in 2009 was primarily a result of the sale of the GM and UP Portfolios in January 2009 to HSBC Bank USA, higher fee charge-offs due to increased loan defaults and lower late, overlimit and interchange fees due to lower volumes and customer behavior changes.
 
Enhancement services revenue, which consists of ancillary credit card revenue from products such as Account Secure Plus (debt protection) and Identity Protection Plan, decreased in 2010 as a result of the impact of lower new origination volumes and lower receivable levels. The decrease in 2009 was driven by the sale of the GM and UP Portfolios as previously discussed as well as the impact of lower new origination volumes.
 
We are currently considering making changes to our pricing policies for the credit card products discussed above. In the event we make material changes to our pricing policies, enhancement services revenue in future periods may decrease significantly.
 
Gain on bulk sale of receivables to HSBC Bank USA during 2009 reflects gains on the January 2009 sales of the GM and UP Portfolios, with an outstanding receivable balance of $12.4 billion at the time of sale. These gains were partially offset by a loss recorded on the termination of cash flow swaps associated with $6.1 billion of indebtedness transferred to HSBC Bank USA as part of these transactions. No similar transaction occurred during 2010.
 
Gains on receivable sales to HSBC affiliates consists primarily of daily sales of private label receivable originations and certain credit card account originations to HSBC Bank USA. The increase in 2010 reflects higher overall premiums partially offset by lower overall origination volumes. The higher overall premium reflects the impact of contract renegotiation with certain merchants, repricing initiatives in certain portfolios as well as the impact of improving credit quality during 2010, partially offset by the impact of the Card Act. The increase in 2009 is primarily a result of higher sales volumes as a result of the sales of new receivable originations in the GM and UP Portfolios beginning in January 2009 and higher premiums on co-brand credit card accounts.
 
Servicing and other fees from HSBC affiliates represents revenue received under service level agreements under which we service real estate secured, credit card and private label receivables as well as rental revenue from HSBC Technology & Services (USA) Inc. (“HTSU”) for certain office and administrative costs. The decrease in 2010 reflects lower levels of receivables being serviced for HSBC Bank USA as well as the transfer to HTSU of certain services we previously provided to other HSBC affiliates. The increases in 2009 primarily relate to higher levels of receivables being serviced on behalf of HSBC Bank USA as a result of the sale of the GM and UP Portfolios to HSBC Bank USA in January 2009 which we continue to service.
 
Lower of cost or fair value adjustment on receivables held for sale includes the non-credit portion of the lower of cost or fair value adjustment recorded on receivables at the date they are transferred to held for sale as well as the


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credit and non-credit portion of all lower of cost or fair value adjustments recorded on receivables held for sale subsequent to the transfer. During 2009, we had higher levels of receivables held for sale and the lower of cost or fair value adjustments on receivables held for sale reflects the impact of the current market conditions on pricing at that time.
 
Other income decreased during 2010 but increased during 2009. The following table summarizes significant components of other income for the years presented:
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Gains (loss) on real estate secured receivable sales
  $ -     $ -     $ (13 )
Gains on miscellaneous asset sales, including real estate investments
    22       38       65  
Gain on sale of Low Income Housing Tax Credit Investment Funds to HSBC Bank USA
    -       20       -  
Gain on sale of Visa Class B shares
    -       -       11  
Other, net
    10       34       (131 )
                         
    $ 32     $ 92     $ (68 )
                         
 
The decrease in other income during 2010 reflects lower gains on miscellaneous asset sales. Additionally, other income in 2009 included a $20 million gain on the sale of Low Income Housing Tax Credit Investment Funds to HSBC Bank USA with no similar transaction in 2010. The increase in other income during 2009 reflects the gain on sale of the Low Income Housing Tax Credit Investment Funds discussed above as well as a reduction in losses from low income housing tax credits as a result of this sale which is included as a component of other, net. This was partially offset by lower gains on miscellaneous asset sales during 2009. Other, net in 2008 includes a $82 million translation loss on affiliate preferred stock received in the sale of the U.K. credit card business which is denominated in pounds sterling.
 
Operating Expenses The following table summarizes operating expenses:
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Salaries and employee benefits
  $ 597     $ 1,119     $ 1,594  
Occupancy and equipment expenses
    92       182       238  
Other marketing expenses
    314       184       350  
Real estate owned expenses
    274       199       342  
Other servicing and administrative expenses
    814       947       1,020  
Support services from HSBC affiliates
    1,092       925       922  
Amortization of intangibles
    143       157       178  
Policyholders’ benefits
    152       197       199  
Goodwill and other intangible asset impairment charges
    -       2,308       329  
                         
Operating expenses
  $ 3,478     $ 6,218     $ 5,172  
                         
 
Salaries and employee benefits were lower during 2010 and 2009 as a result of the reduced scope of our business operations, including the change in the number of employees from the strategic decisions implemented, the impact of entity-wide initiatives to reduce costs, and the centralization of additional shared services in North America, including, among other things, legal, compliance, tax and finance. The decrease in 2010 also reflects the impact of the transfer of certain employees to a subsidiary of HSBC Bank USA during the third quarter of 2010 although this decrease was offset by an increase in support services from HSBC affiliates. Salaries and employee benefits during 2009 included severance costs of $73 million, primarily related to our decision in February 2009 to discontinue new account originations for all products in our Consumer Lending business and close all branch offices. See Note 5,


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“Strategic Initiatives,” in the accompanying consolidated financial statements for a complete description of the decisions made in each year.
 
Occupancy and equipment expenses in both 2010 and 2009 reflect the impact of strategic initiatives. During 2010, occupancy and equipment expenses were reduced by $14 million as a result of a reduction in the lease liability associated with an office of our Mortgage Services business which has now been fully subleased. During 2009, occupancy and equipment expenses included $53 million related to the decision to close the Consumer Lending branch offices. Excluding the impact of the items discussed above, occupancy and equipment expenses remained lower in 2010 and 2009 as a result of the reduction of the scope of our business operations since mid-2007.
 
Other marketing expenses include payments for advertising, direct mail programs and other marketing expenditures. Other marketing expenses increased during 2010 as we have increased direct marketing mailings and new customer account originations for portions of our non-prime credit card receivable portfolio based on recent performance trends in this portfolio as well as increased compliance mailings in the second quarter of 2010 of $35 million related to the implementation of the Card Act. Although marketing expenses have increased, overall marketing levels remain low as compared to historical levels. Current marketing levels should not be considered indicative of marketing expenses for any future periods. The decrease in 2009 reflects the decision to reduce credit card and personal non-credit card receivable marketing expenses in an effort to manage risk in these portfolios as well as the decision in late February 2009 to discontinue originations of personal non-credit card receivables.
 
Real estate owned expenses increased in 2010 as a result of higher average number of REO properties held during 2010, higher overall expenses on REO properties held and higher losses on REO properties as home prices began to decline during the second half of 2010. During periods in which home prices deteriorate, the reduction in value between the date we take title to the property and when the property is ultimately sold results in higher losses. REO expenses decreased in 2009 as a result of lower levels of real estate owned due to backlogs in foreclosures proceedings and actions taken by local governments and certain states that lengthen the foreclosure process. The decrease in 2009 also reflects lower losses on sales of REO properties during 2009 as home prices began to stabilize during the second half of 2009.
 
Other servicing and administrative expenses decreased during 2010 as a result of the reduction of the scope of our business operations since March 2009 as well as the impact of entity wide initiatives to reduce costs, partially offset by higher legal costs. The decrease in 2009 reflects the reduction of the scope of our business operations. These decreases were partially offset by lower origination cost deferrals due to lower origination volumes, fixed asset write-downs of $29 million during 2009 related to the decision to close the Consumer Lending branch offices and the write-off of miscellaneous assets related to the decision in late February 2009 to close substantially all of the Consumer Lending branch offices.
 
Support services from HSBC affiliates increased during 2010 as beginning in January 2010 additional shared services were charged to us by HTSU, including legal, compliance, tax and finance, which were previously recorded in salaries and employee benefits. Additionally, the increase in 2010 reflects the impact of the transfer of certain employees to a subsidiary of HSBC Bank USA in July 2010 as discussed above. Support services from HSBC affiliates also includes services charged to us by an HSBC affiliate located outside of the United States which provides operational support to our businesses, including among other areas, customer service, systems, collection and accounting functions. Support services from HSBC affiliates was essentially flat during 2009 as the reduction in the scope of our business operations discussed above was largely offset by human resources, corporate affairs and other shared services which began being provided by HTSU in January 2009.
 
Amortization of intangibles decreased in both 2010 and 2009 due to lower amortization for technology and customer lists due to the write off of a portion of these intangibles during the first quarter of 2009 as a result of the decision to discontinue all new account originations in our Consumer Lending business, with the remainder becoming fully amortized during the first quarter of 2010.
 
Policyholders’ benefits decreased during 2010 due to lower claims on credit insurance policies since we are no longer issuing these policies in relation to Consumer Lending loans and there are fewer such policies in place. Policyholders’ benefits were essentially flat in 2009 as declines in life and disability claims on credit insurance


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policies as discussed above were largely offset by both higher unemployment claims due to rising unemployment rates and higher claims on a new term life product due to growth in this product offering since its introduction in 2007.
 
Goodwill and other intangible asset impairment charges The following table summarizes the impairment charges for our Mortgage Services, Consumer Lending, Card and Retail Services and Insurance businesses in 2009 and 2008:
 
                         
          Intangible
       
    Goodwill     Assets     Total  
   
    (in millions)  
 
Year Ended December 31, 2009
                       
Card and Retail Services
  $ 2,034     $ -     $ 2,034  
Insurance Services
    260       -       260  
Consumer Lending
    -       14       14  
                         
    $ 2,294     $ 14     $ 2,308  
                         
Year Ended December 31, 2008
                       
Card and Retail Services
  $ 329     $ -     $ 329  
                         
 
All goodwill was written off during 2009. See “Critical Accounting Policies and Estimates” in this MD&A and Note 13, “Goodwill,” and Note 12, “Intangible Assets,” in the accompanying consolidated financial statement for additional information.
 
Efficiency Ratio Our efficiency ratio from continuing operations was 50.4 percent in 2010 compared to 108.0 percent in 2009 and 36.3 percent in 2008. Our efficiency ratio from continuing operations during all periods was impacted by the change in the fair value of debt for which we have elected fair value option accounting. Additionally, the efficiency ratio in 2009 and 2008 were also significantly impacted by goodwill and intangible asset impairment charges and in 2009, the Consumer Lending closure costs, as discussed above. Excluding these items from the periods presented, our efficiency ratio deteriorated significantly during 2010 reflecting significantly lower net interest income and other revenues driven by receivable portfolio liquidation, lower derivative-related income and lower fee income which outpaced the decrease in operating expenses. Excluding the items discussed above from the periods presented, in 2009 our efficiency ratio deteriorated 216 basis points as a result of lower net interest income and lower fee and enhancement services revenues as a result of the sale of the GM and UP Portfolios in January 2009, partially offset by increased revenues associated with the bulk gain and daily sales of receivables to HSBC Bank USA.
 
Income taxes Our effective tax rates for continuing operations were as follows:
 
         
Year Ended December 31,   Effective Tax Rate
 
 
2010
    (34.7) %
2009
    (26.1)  
2008
    (29.4)  
 
The effective tax rate for continuing operations in 2010 was primarily impacted by state taxes, including states where we file combined unitary state tax returns with other HSBC affiliates and amortization of purchase accounting adjustments on leveraged leases that matured in December 2010. The effective tax rate for continuing operations in 2009 was significantly impacted by the non-tax deductible impairment of goodwill, the relative level of pretax book loss, increase in the state and local income tax valuation allowance which is included in the state and local taxes, and a decrease in low income housing credits. See Note 18, “Income Taxes,” for a reconciliation of our effective tax rate.


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Segment Results – IFRS Management Basis
 
We have two reportable segments: Card and Retail Services and Consumer. Our segments are managed separately and are characterized by different middle-market consumer lending products, origination processes and locations. Our segment results are reported on a continuing operations basis.
 
Our Card and Retail Services segment includes our MasterCard, Visa, private label and other credit card operations. The Card and Retail Services segment offers these products throughout the United States primarily via strategic affinity and co-branding relationships, merchant relationships and direct mail. We also offer products and provide customer service through the Internet.
 
Our Consumer segment consists of our run-off Consumer Lending and Mortgage Services businesses. The Consumer segment provided real estate secured and personal non-credit card loans. Loans were offered with both revolving and closed-end terms and with fixed or variable interest rates. Loans were originated through branch locations and direct mail. Products were also offered and customers serviced through the Internet. Prior to the first quarter of 2007, we acquired loans through correspondent channels and prior to September 2007 we also originated loans sourced through mortgage brokers. While these businesses are operating in run-off mode, they have not been reported as discontinued operations because we continue to generate cash flow from the ongoing collections of the receivables, including interest and fees.
 
The “All Other” caption includes our Insurance business. It also includes our Commercial business which is no longer considered core to our operations. Each of these businesses fall below the quantitative threshold tests under segment reporting rules for determining reportable segments. The “All Other” caption also includes our corporate and treasury activities, which includes the impact of FVO debt. Certain fair value adjustments related to purchase accounting resulting from our acquisition by HSBC and related amortization have been allocated to corporate, which is included in the “All Other” caption within our segment disclosure. Goodwill which was established as a result of our acquisition by HSBC was not allocated to or included in the reported results of our reportable segments as the acquisition by HSBC was outside of the ongoing operational activities of our reportable segments, consistent with management’s view of our reportable segment results. During 2009, the remainder of this goodwill totaling $2.4 billion was impaired. Goodwill relating to acquisitions subsequent to our acquisition by HSBC were included in the reported respective segment results as those acquisitions specifically related to the business, consistent with management’s view of the segment results.
 
As discussed in Note 3, “Discontinued Operations,” in the accompanying consolidated financial statements, our Auto Finance business, which was previously reported in our Consumer segment, and our Taxpayer Financial Services business which was previously included in the “All Other” caption, are now reported as discontinued operations and are no longer included in our segment presentation.
 
There have been no significant changes in our measurement of segment profit (loss) and no changes in the basis of segmentation as compared with the presentation in our 2009 Form 10-K.
 
We report results to our parent, HSBC, in accordance with its reporting basis, IFRSs. Our segment results are presented on an IFRS Management Basis (a non-U.S. GAAP financial measure) as operating results are monitored and reviewed, trends are evaluated and decisions about allocating resources such as employees are made almost exclusively on an IFRS Management Basis. Accordingly, our segment reporting is on an IFRS Management Basis. IFRS Management Basis results are IFRSs results which assume that the GM and UP credit card portfolios and the private label and real estate secured receivables transferred to HSBC Bank USA have not been sold and remain on our balance sheet and the revenues and expenses related to these receivables remain on our income statement. IFRS Management Basis also assumes that the purchase accounting fair value adjustments relating to our acquisition by HSBC have been “pushed down” to HSBC Finance Corporation. Operations are monitored and trends are evaluated on an IFRS Management Basis because the receivable sales to HSBC Bank USA were conducted primarily to fund prime customer loans more efficiently through bank deposits and such receivables continue to be managed by us. However, we continue to monitor capital adequacy, establish dividend policy and report to regulatory agencies on a U.S. GAAP legal entity basis. A summary of the significant differences between U.S. GAAP and IFRSs as they


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impact our results are summarized in Note 24, “Business Segments,” in the accompanying consolidated financial statements.
 
We are currently in the process of re-evaluating the financial information used to manage our business, including the scope and content of the financial data being reported to our Management and our Board. To the extent we make changes to this reporting in 2011, we will evaluate any impact such changes may have to our segment reporting.
 
Card and Retail Services Segment The following table summarizes the IFRS Management Basis results for our Card and Retail Services segment for the years ended December 31, 2010, 2009 and 2008.
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (dollars are in millions)  
 
Net interest income
  $ 4,739     $ 5,201     $ 5,083  
Other operating income
    1,392       2,367       3,185  
                         
Total operating income
    6,131       7,568       8,268  
Loan impairment charges
    2,180       5,064       5,292  
                         
      3,951       2,504       2,976  
Operating expenses, excluding goodwill impairment charges
    1,912       1,863       2,139  
                         
Profit before tax and goodwill impairment charges
    2,039       641       837  
Goodwill impairment charges(1)
    -       530       -  
                         
Profit before tax(1)
  $ 2,039     $ 111     $ 837  
                         
Net interest margin
    13.87 %     12.49 %     10.74 %
Efficiency ratio
    31.19       31.62       25.87  
Return (after-tax) on average assets
    4.05       (.37 )     1.15  
Balances at end of period:
                       
Customer loans
  $ 32,991     $ 38,873     $ 46,730  
Assets
    31,178       37,178       44,160  
 
 
(1) Goodwill impairment charges of $530 million recorded in 2009 were not deductible for tax purposes which resulted in a net loss of $148 million during 2009.
 
2010 profit before tax compared to 2009 Our Card and Retail Services segment reported a higher profit before tax during 2010 driven by lower loan impairment charges and lower goodwill impairment charges, partially offset by lower other operating income, lower net interest income and higher operating expenses, excluding goodwill impairment charges.
 
On May 22, 2009, the Credit Card Accountability Responsibility and Disclosure Act of 2009 was signed into law and we have implemented all of its applicable provisions. The Card Act has required us to make changes to our business practices, and will likely require us and our competitors to manage risk differently than has historically been the case. Pricing, underwriting and product changes have either been implemented or are under continuing analysis to partially mitigate the impact of the new legislation and implementing regulations. Although implementation of the new rules has had a significant financial impact on us, the full impact of the Card Act remains uncertain at this time as it will ultimately depend upon successful implementation of our strategies, consumer behavior and the actions of our competitors. We estimate that the impact of the Card Act including the mitigating actions referred to above resulted in a reduction in revenue net of credit loss provision of approximately $200 million during 2010.
 
Loan impairment charges decreased during 2010 reflecting lower loan levels as a result of actions taken beginning in the fourth quarter of 2007 to manage risk, fewer active customer accounts and an increased focus and ability by consumers to reduce outstanding credit card debt. The decrease also reflects the impact of improvement in the


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underlying credit quality of the portfolio including continuing improvements in early stage delinquency roll rates and lower delinquency levels as customer payment rates have been strong throughout 2010 and higher recoveries on defaulted loans. The impact on credit card loan losses from the current economic environment, including high unemployment levels, has not been as severe as originally expected due in part to improved customer payment behavior. During 2010, we decreased credit loss reserves to $2.2 billion as loan impairment charges were $1.8 billion lower than net charge-offs.
 
Net interest income decreased during 2010 due to lower overall loan levels as discussed above, partially offset by higher yields on our loan portfolio and lower interest expense due to lower average borrowings and lower average rates. Loan yields increased during 2010 as a result of lower levels of nonperforming receivables and higher yields on private label loans driven by the benefits from contract renegotiation with certain merchants which were partially offset by the implementation of certain provisions of the Card Act including restrictions impacting repricing of delinquent accounts and periodic re-evaluation of rate increases. We anticipate credit card loan yields in future periods may continue to be negatively impacted by various provisions of the Card Act which require certain rate increases to be periodically re-evaluated. Net interest margin increased in 2010 due to higher loan yields as discussed above and a lower cost of funds.
 
The decrease in other operating income was primarily due to lower late, overlimit and interchange fees due to lower volumes, lower delinquency levels, changes in customer behavior and impacts from changes required by Card Act. The Card Act has resulted in significant decreases in late fees due to limits on fees that can be assessed and overlimit fees as customers must now opt-in for such overlimit fees as well as restrictions on fees charged to process on-line and telephone payments. Additionally, other operating income reflects lower enhancement services revenue due to lower new origination volumes and lower loan levels.
 
Excluding the goodwill impairment charges in the prior year period which is discussed more fully below, operating expenses increased during 2010 due to higher marketing expenses, higher third party collection costs and higher support services from affiliates, partially offset by lower salary expenses and lower pension expenses driven by a curtailment gain. While marketing expenses were higher as compared to the prior year, overall marketing levels continue to remain low as compared to historical levels.
 
The efficiency ratio for 2009 was significantly impacted by the goodwill impairment recorded in the prior year. Excluding the impact of the goodwill impairment in the prior year period, the efficiency ratio deteriorated 657 basis points during 2010 driven by the decrease in other operating income, primarily due to lower fee income as a result of the Card Act and lower delinquency levels, as well as the impact of lower net interest income and higher operating expenses as previously discussed.
 
ROA during 2009 was significantly impacted by the goodwill impairment recorded during the prior year. Excluding the impact of the goodwill impairment in the prior year period, ROA improved 309 basis points during 2010 primarily due to the impact of the higher profit before tax in 2010, driven by the lower loan impairment charges as well as the impact of lower average loan levels as discussed below.
 
2009 profit before tax compared to 2008 Our Card and Retail Services segment reported a lower profit before tax during 2009 due to lower other operating income and higher goodwill impairment charges, partially offset by lower loan impairment charges, lower operating expenses and higher net interest income.
 
Loan impairment charges decreased during 2009 due to lower loan levels and more stable credit conditions as well as an improved outlook on future loss estimates as the impact of higher unemployment rates on losses has not been as severe as previously anticipated due in part to lower gas prices and improved cash flow from government stimulus activities that meaningfully benefit our non-prime customers. Lower loan levels reflect lower consumer spending and actions taken beginning in the fourth quarter of 2007 and continuing through 2009 to manage risk. These decreases in loan impairment charges were partially offset by portfolio seasoning, continued deterioration in the U.S. economy including higher unemployment rates, higher levels of personal bankruptcy filings and lower recovery rates on defaulted loans. In 2009, we decreased credit loss reserves to $4.0 billion as loan impairment charges were $361 million lower than net charge-offs.


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Net interest income increased due to lower interest expense, partially offset by lower interest income. The lower interest income reflects the impact of lower overall loan levels, partially offset by higher loan yields. Loan yields during 2009 were positively impacted by repricing initiatives, interest rate floors and lower levels of promotional balances, partially offset by the impact of deterioration in credit quality. Net interest margin increased primarily due to a lower cost of funds, repricing initiatives, the impact of interest rate floors in portions of the loan portfolio which have now been removed and lower levels of promotional balances, partially offset by the impact of deterioration in credit quality. The decrease in other operating income was primarily due to lower cash advance, interchange fees, late and overlimit fees and enhancement services revenue due to lower volumes and changes in customer behavior. Operating expenses decreased due to lower marketing expenses in our effort to manage risk in our credit card loan portfolio as well as lower salary expenses. These decreases were partially offset by restructuring costs in 2009 and 2008 of $4 million and $15 million, respectively. Goodwill impairment charges in 2009 reflect the impairment of all remaining goodwill recorded at the segment level in the first half of the year as a result of continual deterioration of economic and credit conditions in the United States. See Note 5, “Strategic Initiatives,” in the accompanying consolidated financial statements for additional information on the restructuring activities in 2009 and 2008.
 
The efficiency ratio for 2009 was impacted by the goodwill impairment charges. Excluding the goodwill impairment charges, the efficiency ratio improved as the decrease in operating expenses and the higher net interest income more than offset the impact of lower other revenues.
 
The deterioration in the ROA ratio during 2009 was primarily a result of the goodwill impairment charge and lower total operating income, partially offset by the impact of lower loan impairment charges and lower average assets.
 
Customer loans Customer loans for our Card and Retail Services segment can be analyzed as follows:
 
                                         
          Increases (Decreases) From  
          December 31,
    December 31,
 
    December 31,
    2009     2008  
    2010     $     %     $     %  
   
    (dollars are in millions)  
 
Credit card
  $ 19,277     $ (3,867 )     (16.7 )%   $ (9,369 )     (32.7 )%
Private label
    13,639       (1,986 )     (12.7 )     (4,302 )     (24.0 )
Other
    75       (29 )     (27.9 )     (68 )     (47.6 )
                                         
Total loans
  $ 32,991     $ (5,882 )     (15.1 )%   $ (13,739 )     (29.4 )%
                                         
 
Customer loans decreased 15 percent to $33.0 billion at December 31, 2010 as compared to $38.9 billion at December 31, 2009 reflecting fewer active customer accounts, primarily in our prime credit card and private label loan portfolios and the impact of actions previously taken to manage risk. The decrease also reflects an increased focus and ability by consumers to reduce outstanding credit card debt. In 2008, we identified certain segments of our credit card portfolio which have been the most impacted by the housing and economic conditions and we stopped all new account originations in those market segments. In the second half of 2009, we began increasing direct marketing mailings and new customer account originations for portions of our non-prime credit card portfolio which will likely result in lower run-off of credit card loans during 2011. However, we expect a certain level of attrition will continue as credit card loans at December 31, 2010 include $4.3 billion associated with certain segments of our portfolio for which we no longer originate new accounts and private label loans include $911 million associated with merchants for which we no longer finance new purchases.
 
Customer loans decreased to $38.9 billion at December 31, 2009 compared to $46.7 billion at December 31, 2008 reflecting the aforementioned actions taken beginning in the fourth quarter of 2007 to manage risk. Lower private label loan levels also reflect the termination of certain unprofitable retail partners.
 
See “Receivables Review” in this MD&A for additional discussion of the decreases in our receivable portfolios.
 
Performance trends The following is additional key performance data related to our Card and Retail Services portfolios. The information is based on IFRS Management Basis results.


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Our Cards and Retail Services portfolios consist of three key segments. The non-prime portfolios are primarily originated through direct mail channels (the “Non-prime Portfolio”). The prime portfolio consists primarily of General Motors, Union Privilege and Retail Services loans (the “Prime Portfolio”). These loans are primarily considered prime at origination, however the credit profile of some customers will subsequently change due to changes in customer circumstances. The other portfolio is comprised of several run-off portfolios and loans originated under alternative marketing programs such as third party turndown programs (the “Other Portfolio”). The Other Portfolio includes certain adjustments not allocated to either the Non-prime or Prime Portfolios. The Other Portfolio contains both prime and non-prime loans.
 
The following table includes key financial metrics for our Card and Retail Services business:
 
                                                 
                                  Change between
 
                                  Dec. 31, 2010
 
    Quarter Ended     and
 
    Dec. 31, 2010     Sept. 30, 2010     June 30, 2010     Mar. 31, 2010     Dec. 31, 2009     Dec. 31, 2009  
   
    (dollars are in millions)  
 
Loans:
                                               
Non-prime
  $ 8,070     $ 8,056     $ 8,235     $ 8,632     $ 9,462       (14.7 )%
Prime
    22,850       22,079       22,831       24,068       26,806       (14.8 )
Other
    2,071       2,089       2,171       2,287       2,605       (20.5 )
                                                 
Total
  $ 32,991     $ 32,224     $ 33,237     $ 34,987     $ 38,873       (15.1 )%
                                                 
Net Interest Margin:
                                               
Non-prime
    20.74 %     20.81 %     20.03 %     21.04 %     20.18 %     2.8 %
Prime
    10.91       10.84       10.49       10.84       9.67       12.8  
Other
    18.53       20.04       24.44       20.15       17.68       4.8  
                                                 
Total
    13.85 %     13.93 %     13.77 %     13.97 %     12.85 %     7.8 %
                                                 
Delinquency Dollars:
                                               
Non-prime
  $ 493     $ 539     $ 603     $ 787     $ 975       (49.4 )%
Prime
    730       819       921       1,027       1,222       (40.3 )
Other
    122       138       152       195       241       (49.4 )
                                                 
Total
  $ 1,345     $ 1,496     $ 1,676     $ 2,009     $ 2,438       (44.8 )%
                                                 
 
As previously discussed, customer loans have decreased by 15 percent as compared to December 31, 2009. During the fourth quarter of 2010, however, the Prime Portfolio increased reflecting seasonal trends as a result of higher spending levels.
 
Net interest margin for both the Non-prime and Prime Portfolios continues to remain strong as compared to the prior year as a result of the impact of lower levels of nonperforming loans, partially offset by the implementation of certain provisions of the Card Act. While the increase in net interest margin for both portfolios has been impacted by the implementation of certain provisions of the Card Act, including restrictions on the repricing of delinquent accounts and periodic re-evaluation of rate increases, the impact of these restrictions has been more pronounced in the Non-prime Portfolio as a greater proportion of account holders in this portfolio have benefited from these restrictions.
 
While we have seen improvements in credit performance across the Cards and Retail Services segment during 2010, the Non-prime Portfolio credit performance has shown improvements to a greater degree relative to our Prime Portfolio for the last couple of years. Dollars of delinquency and net charge-off dollars in the Non-prime Portfolio have improved at a faster rate than in our Prime Portfolio as non-prime customers typically have lower home ownership and smaller credit lines which have lower minimum payment requirements.


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The trends discussed above are at a point in time. Given the volatile economic conditions, there can be no certainty such trends will continue in the future.
 
Consumer Segment The following table summarizes the IFRS Management Basis results for our Consumer segment for the years ended December 31, 2010, 2009 and 2008.
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (dollars are in millions)  
 
Net interest income
  $ 2,338     $ 2,594     $ 4,585  
Other operating income
    (39 )     64       (99 )
                         
Total operating income
    2,299       2,658       4,486  
Loan impairment charges
    5,714       8,002       9,212  
                         
      (3,415 )     (5,344 )     (4,726 )
Operating expenses
    883       1,280       1,563  
                         
Loss before tax
  $ (4,298 )   $ (6,624 )   $ (6,289 )
                         
Net interest margin
    3.61 %     3.15 %     4.73 %
Efficiency ratio
    38.41       48.16       34.84  
Return (after-tax) on average assets
    (4.29 )     (5.41 )     (4.84 )
Balances at end of period:
                       
Customer loans
  $ 58,179     $ 71,971     $ 89,475  
Assets
    58,990       73,042       83,044  
 
2010 loss before tax compared to 2009 Our Consumer segment reported a lower loss before tax during 2010 due to lower loan impairment charges and lower operating expenses, partially offset by lower net interest income and lower other operating income.
 
Loan impairment charges decreased significantly during 2010 as discussed below.
 
  •  Loan impairment charges for the real estate secured loan portfolios in our Consumer Lending and Mortgage Services business decreased during 2010. The decrease reflects lower loan levels as the portfolios continue to liquidate, lower delinquency levels, improved loss severities and improvements in economic conditions since 2009. The decrease also reflects lower loss estimates on TDR Loans, partially offset by the impact of continued high unemployment levels, lower loan prepayments, higher loss estimates on recently modified loans and for real estate secured loans in our Consumer Lending business, portfolio seasoning. Improvements in loss severities reflect an increase in the number of properties for which we accepted a deed-in-lieu and an increase in the number of short sales, both of which result in lower losses compared to loans which are subject to a formal foreclosure process for which average loss severities in 2010 remained relatively flat to 2009 levels.
 
  •  Loan impairment charges for our personal non-credit card loan portfolio reflects lower loan levels, lower delinquency levels and improvements in economic conditions since 2009, partially offset by higher reserve requirements on TDR Loans.
 
During 2010, credit loss reserves decreased to $5.6 billion as loan impairment charges were $1.6 billion lower than net charge-offs reflecting lower loan levels and lower delinquency levels as discussed above as well as lower reserve requirements on real estate secured TDR Loans, partially offset by higher reserve requirements on personal non-credit card TDR Loans.
 
Net interest income decreased in 2010 due to lower average loans as a result of liquidation, risk mitigation efforts, partially offset by lower interest expense and higher overall loan yields. During 2010, we experienced higher overall yields for all products as a result of lower levels of nonperforming receivables and reduced levels of nonperforming modified loans due to charge-off and declines in new modification volumes. Higher yields in our real estate secured loan portfolio were partially offset by a shift in loan mix to higher levels of lower yielding first lien real estate secured loans as higher yielding second lien real estate secured and personal non-credit card loans have run-off at a


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faster pace than first lien real estate secured loans. Net interest margin increased in 2010 as compared to 2009 reflecting the higher loan yields as discussed above.
 
Other operating income decreased during 2010 due to lower credit insurance commissions and higher losses on REO properties reflecting an increase in the number of REO properties sold and declines in home prices during the second half of 2010.
 
Operating expenses decreased during 2010 due to the reductions in the scope of our business operations as well as other cost containment measures and lower pension expense driven by a curtailment gain, partially offset by higher collection costs and higher REO expense as a result of a higher average number of REO properties held during the year and higher overall expenses on the REO properties held. Operating expenses during 2009 included $133 million of costs related to the decision to discontinue new originations for all products in our Consumer Lending business and closure of the Consumer Lending branch offices. In addition, we were required to perform an interim intangible asset impairment test for our remaining Consumer Lending intangible asset which resulted in an impairment charge of $5 million during 2009. See Note 5, “Strategic Initiatives,” in the accompanying consolidated financial statements for additional information regarding this decision.
 
The efficiency ratio during 2009 was impacted by the $133 million in restructuring and impairment charges discussed above. Excluding the impact of the restructuring charges from the prior year, the efficiency ratio improved 474 basis points during 2010 as the decrease in operating expenses outpaced the decrease in net interest income due to lower loan levels and lower yields.
 
ROA improved during 2010 primarily due to a lower net loss as discussed above and the impact of lower average assets.
 
2009 loss before tax compared to 2008 Our Consumer segment reported a higher loss before tax during 2009 due to lower net interest income, partially offset by lower loan impairment charges, lower operating expenses and higher other operating income. As previously discussed, in December 2009 we changed our charge-off policies for our real estate secured and personal non-credit card loans. On an IFRSs Management Basis the impact of these policy changes was not material to net interest income, loan impairment charges or loss before tax.
 
Loan impairment charges decreased significantly in 2009 as discussed below:
 
  •  Loan impairment charges for real estate secured loans decreased in 2009 reflecting a lower provision for real estate secured loans in our Mortgage Services business and for second lien real estate secured loans in our Consumer Lending business, partially offset by higher provisions for first lien real estate secured receivables in our Consumer Lending business. The overall decrease in loan impairment charges for real estate secured loans reflects the continued liquidation in these portfolios which has resulted in lower charge-off levels. Additionally, for real estate secured receivables in our Consumer Lending business, the lower overall provisions for real estate secured receivables reflect a reduction in portfolio risk factors, principally an improved outlook on current inherent losses.
 
  •  Loan impairment charges for personal non-credit card loans increased during 2009 due to higher levels of charge-off resulting from deterioration in the 2006 and 2007 vintages which was more pronounced in certain geographic regions, partially offset by lower receivable levels.
 
Loan impairment charges for all products in 2009 were negatively impacted by rising unemployment rates in an increasing number of markets, continued deterioration in the U.S. economy and housing markets, higher levels of personal bankruptcy filings and portfolio seasoning. On an IFRS Management Basis, the impact of the December 2009 Charge-off Policy Changes was not material.
 
Excluding the impact of the December 2009 Charge-off Policy Changes, credit loss reserves increased during 2009 as loan impairment charges were $798 million greater than net charge-offs reflecting higher reserve requirements in our Consumer Lending real estate secured loan portfolio including higher levels of troubled debt restructurings in both Consumer Lending and Mortgage Services, partially offset by lower loan levels as discussed below.


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Net interest income decreased due to lower average customer loans, lower origination volumes, lower levels of performing receivables, the impact of changes in the income recognition policy related to unrecorded interest on re-aged real estate secured and personal non-credit card receivables as discussed previously and lower overall yields partially offset by lower interest expense. Overall yields decreased due to increased levels of loan modifications, the impact of deterioration in credit quality and lower amortization of net deferred fee income due to lower loan prepayments and lower loan origination volumes. The decrease in net interest margin was primarily a result of lower overall yields as discussed above.
 
Other operating income increased primarily due to lower losses on sales of REO properties, partially offset by lower credit insurance commissions. Lower losses on sales during 2009 reflect a stabilization of home prices during the second half of 2009 which resulted in less deterioration in value between the date we take title to the property and when the property is ultimately sold.
 
Operating expenses in 2009 included $133 million of costs, net of a curtailment gain of $34 million related to other post-retirement benefits, related to the decision to discontinue new originations for all products in our Consumer Lending business and close the Consumer Lending branch offices. See Note 5, “Strategic Initiatives,” in the accompanying consolidated financial statements for additional information. In addition, we were required to perform an interim intangible asset impairment test for our remaining Consumer Lending intangible asset which resulted in an impairment charge of $5 million during 2009. Excluding these items, operating expenses decreased by 27 percent due to the reductions in the scope of our business operations as well as other cost containment measures, and lower REO expenses.
 
The efficiency ratio in 2009 was impacted by $133 million in restructuring charges related to the decision to cease new account originations and close the Consumer Lending branch network. Excluding the impact of the restructuring charges, the efficiency ratio deteriorated 831 basis points due to the decrease in total operating income during the year as discussed above.
 
ROA deteriorated during 2009 primarily due to lower net interest income, partially offset by lower loan impairment charges and lower average assets.
 
Customer loans Customer loans for our Consumer segment can be analyzed as follows:
 
                                         
          Increases (Decreases) From  
          December 31,
    December 31,
 
    December 31,
    2009     2008  
    2010     $     %     $     %  
   
    (dollars are in millions)  
 
Real estate secured(1)
  $ 50,838     $ (10,423 )     (17.0 )%   $ (22,981 )     (31.1 )%
Private label
    -       -       -       (51 )     (100.0 )
Personal non-credit card
    7,341       (3,369 )     (31.5 )     (8,264 )     (53.0 )
                                         
Total customer loans
  $ 58,179     $ (13,792 )     (19.2 )%   $ (31,296 )     (35.0 )%
                                         
 
 
(1) Real estate secured receivables are comprised of the following:
 
                                         
          Increases (Decreases) From  
          December 31,
    December 31,
 
    December 31,
    2009     2008  
    2010     $     %     $     %  
   
    (dollars are in millions)  
 
Mortgage Services
  $ 17,569     $ (4,195 )     (19.3 )%   $ (10,058 )     (36.4 )%
Consumer Lending
    33,269       (6,228 )     (15.8 )     (12,923 )     (28.0 )
                                         
Total real estate secured
  $ 50,838     $ (10,423 )     (17.0 )%   $ (22,981 )     (31.1 )%
                                         


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Customer loans decreased 19 percent to $58.2 billion at December 31, 2010 reflecting the continued liquidation of these portfolios which will continue to decline going forward. The liquidation rates in our real estate secured loan portfolio continues to be impacted by declines in loan prepayments as fewer refinancing opportunities for our customers exist and the trends impacting the mortgage lending industry as previously discussed.
 
Customer loans decreased to $72.0 billion at December 31, 2009 as compared to $89.5 billion at December 31, 2008. Real estate secured and personal non-credit card receivables decreased for the reasons discussed above as well as the impact of the December 2009 Charge-off Policy Changes previously discussed which resulted in an incremental $2.4 billion and $914 million of delinquent real estate secured and personal non-credit card loans, respectively, being charged-off.
 
See “Receivables Review” for a more detail discussion of the decreases in our receivable portfolios.
 
Reconciliation of Segment Results As previously discussed, segment results are reported on an IFRS Management Basis. See Note 24, “Business Segments,” in the accompanying consolidated financial statements for a discussion of the differences between IFRSs and U.S. GAAP. For segment reporting purposes, intersegment transactions have not been eliminated. We generally account for transactions between segments as if they were with third parties. Also see Note 24, “Business Segments,” in the accompanying consolidated financial statements for a reconciliation of our IFRS Management Basis segment results to U.S. GAAP consolidated totals.
 
Credit Quality
 
Credit Loss Reserves We maintain credit loss reserves to cover probable incurred losses of principal, accrued interest and fees, including late, overlimit and annual fees. Credit loss reserves are based on a range of estimates and are intended to be adequate but not excessive. We estimate probable losses for consumer receivables using a roll rate migration analysis that estimates the likelihood that a loan will progress through the various stages of delinquency, or buckets, and ultimately charge-off based upon recent historical performance experience of other loans in our portfolio. This analysis considers delinquency status, loss experience and severity and takes into account whether loans are in bankruptcy, have been re-aged, or are subject to forbearance, an external debt management plan, hardship, modification, extension or deferment. Our credit loss reserves take into consideration the expected loss severity based on the underlying collateral, if any, for the loan in the event of default based on recent trends. Delinquency status may be affected by customer account management policies and practices, such as the re-age of accounts, forbearance agreements, extended payment plans, modification arrangements, external debt management programs and deferments. When customer account management policies or changes thereto, shift loans from a “higher” delinquency bucket to a “lower” delinquency bucket, this will be reflected in our roll rate statistics. To the extent that re-aged or modified accounts have a greater propensity to roll to higher delinquency buckets, this will be captured in the roll rates. Since the loss reserve is computed based on the composite of all of these calculations, this increase in roll rate will be applied to receivables in all respective delinquency buckets, which will increase the overall reserve level. In addition, loss reserves on consumer receivables are maintained to reflect our judgment of portfolio risk factors that may not be fully reflected in the statistical roll rate calculation or when historical trends are not reflective of current inherent losses in the portfolio. Portfolio risk factors considered in establishing loss reserves on consumer receivables include product mix, unemployment rates, bankruptcy trends, the credit performance of modified loans, geographic concentrations, loan product features such as adjustable rate loans, economic conditions, such as national and local trends in housing markets and interest rates, portfolio seasoning, account management policies and practices, current levels of charge-offs and delinquencies, changes in laws and regulations and other factors which can affect consumer payment patterns on outstanding receivables, such as natural disasters.
 
While our credit loss reserves are available to absorb losses in the entire portfolio, we specifically consider the credit quality and other risk factors for each of our products. We recognize the different inherent loss characteristics in each of our products as well as customer account management policies and practices and risk management/collection practices. We also consider key ratios in developing our overall loss reserve estimate, including reserves to nonperforming loans, reserves as a percentage of net charge-offs, reserves as a percentage of two-months-and-


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over contractual delinquency and months coverage ratios. Loss reserve estimates are reviewed periodically and adjustments are reported in earnings when they become known. As these estimates are influenced by factors outside of our control such as consumer payment patterns and economic conditions, there is uncertainty inherent in these estimates, making it reasonably possible that they could change.
 
In establishing reserve levels, given the general decline in home prices that have occurred over the past three years in the U.S., we anticipate that losses in our real estate secured receivable portfolios will continue to be incurred with greater frequency and severity than experienced prior to 2007. There is currently little secondary market liquidity for subprime mortgages. As a result of these conditions, lenders have significantly tightened underwriting standards, substantially limiting the availability of alternative and subprime mortgages. As fewer financing options currently exist in the marketplace for home buyers, properties in certain markets are remaining on the market for longer periods of time which contributes to home price depreciation. For many of our customers, the ability to refinance and access equity in their homes is no longer an option as home prices remain stagnant in many markets and have depreciated in others. These housing market trends were exacerbated by the recent economic downturn, including high levels of unemployment, and these industry trends continue to impact our portfolio. While we have noted signs of improvement or stability in some of these trends during 2010 as previously discussed, it is impossible to predict whether such will continue in future periods. It is generally believed that a sustained recovery of the housing market, as well as unemployment conditions, is not expected to begin to occur at the earliest until late 2011. We have considered these factors in establishing our credit loss reserve levels, as appropriate.
 
The following table sets forth credit loss reserves for our continuing operations for the periods indicated:
 
                                                 
At December 31,   2010   2009(3)   2008   2007   2006    
 
    (dollars are in millions)
 
Credit loss reserves
  $ 6,491     $ 9,091     $ 12,030     $ 10,127     $ 5,980          
Reserves as a percentage of:
                                               
Receivables(2)
    9.78 %     11.13 %     11.96 %     7.63 %     4.31 %        
Net charge-offs(1)
    73.9       72.2       136.4       175.8       168.0          
Nonperforming receivables(1)(2)
    88.5       102.4       110.0       125.3       121.6          
Two-months-and-over contractual delinquency(2)
    67.9       75.5       79.7       94.5       91.2          
 
 
(1) Ratio excludes nonperforming receivables and charge-offs associated with receivable portfolios which are considered held for sale as these receivables are carried at the lower of cost or fair value with no corresponding credit loss reserves. Reserves as a percentage of net charge-off includes any charge-off recorded on receivables prior to the transfer to receivables held for sale.
 
(2) The ratios for 2010 and 2009 have been significantly impacted by the increase in the level of real estate secured receivables which have been written down to the lower of cost or net realizable value less cost to sell as a result of our adoption of new charge-off policies in December 2009 as discussed more fully below. Real estate secured receivables which have been written down to net realizable value less cost to sell typically do not require credit loss reserves. The following table shows these ratios excluding the receivables written down to net realizable value less cost to sell:
 
                 
At December 31,   2010   2009
 
 
Reserves as a percentage of:
               
Receivables
    10.60 %     11.62 %
Nonperforming loans
    198.6       161.6  
Two-months-and-over contractual delinquency
    121.0       103.8  


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(3) The December 2009 Charge-off Policy Changes as discussed above, have resulted in an acceleration of charge-off for certain real estate secured and personal non-credit card receivables. Had these charge-offs not been accelerated, credit loss reserves and the related ratios would have been as follows:
 
                 
    As
  Excluding
December 31, 2009   Reported   Policy Change
 
 
Credit loss reserves
  $ 9,091     $ 12,563  
Reserves as a percentage of:
               
Receivables
    11.13 %     14.75 %
Net charge-offs
    72.2       137.8  
Nonperforming loans
    102.4       101.7  
Two-months-and-over contractual delinquency
    75.5       81.0  
 
Credit loss reserves at December 31, 2010 decreased as we recorded provision for credit losses less than net charge-offs of $2.6 billion during 2010. Credit loss reserves were lower for all products as discussed below.
 
  •  The decrease in credit loss reserves in our core credit card receivable portfolio reflects lower loss estimates due to lower receivable levels as a result of the actions previously taken to reduce risk which has led to improved credit quality including lower delinquency levels. In addition, there has been an increased focus and ability by consumers to reduce outstanding credit card debt. The decrease in credit loss reserves also reflects continuing improvements in early stage delinquency roll rates.
 
  •  The decrease in credit loss reserve levels in our real estate secured receivable portfolio reflects lower receivable levels as the portfolio continues to liquidate and as compared to December 31, 2009, improvements in total loss severities largely as a result of an increase in the number of properties for which we accepted a deed-in-lieu and an increase in the number of short sales, both of which result in lower losses compared to loans which are subject to a formal foreclosure process for which average loss severities in 2010 have remained relatively flat to 2009 levels. The decrease also reflects the impact of an increase of $1.7 billion during 2010 of real estate secured receivables which have been written down to net realizable value less cost to sell and, therefore, generally do not have credit loss reserves associated with them. Real estate secured receivables which have been written down to net realizable value less cost to sell are generally in the process of foreclosure and will remain in our delinquency totals until we obtain title to the property. Credit loss reserves also reflect lower delinquency levels as the delinquent balances migrate to charge-off and are replaced by lower levels of newly delinquent loans as the portfolio seasons, partially offset by higher loss estimates on recently modified loans. Additionally, reserve requirements for real estate secured TDR Loans decreased as compared to December 31, 2009 due to lower new TDR Loan volumes and lower expected loss rates as a larger percentage of our real estate TDR Loans are performing due to an increase in charge-off of non-performing real estate secured TDR Loans.
 
  •  Credit loss reserve levels in our personal non-credit card portfolio decreased as a result of lower receivable levels including lower delinquency levels, partially offset by slightly higher reserve requirements on personal non-credit card TDR Loans due to increases in expected loss rates, partially offset by lower new TDR Loan volumes.
 
At December 31, 2010, approximately $5.1 billion, or 10 percent of our real estate secured receivable portfolio has been written down to net realizable value less cost to sell and, therefore, typically do not have credit loss reserves associated with them. In addition, approximately $7.9 billion of real estate secured receivables which have not been written down to net realizable value less cost to sell are considered TDR Loans and $1.1 billion of credit card and personal non-credit card receivables are considered TDR Loans, which are reserved using a discounted cash flow analysis which generally results in a higher reserve requirement. As a result, 26 percent of our real estate secured receivable portfolio and 21 percent of our total receivable portfolio have either been written down to net realizable value less cost to sell or are reserved for using the TDR Loan discounted cash flow analysis.
 
Credit loss estimates for our core credit card receivable portfolio relate primarily to our non-prime credit card receivable portfolio. Our non-prime credit card receivable product is structured for customers with low credit scores. The products have lower credit lines and are priced for higher risk. The deterioration of the housing markets


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in the U.S. over the past few years has affected the credit performance of our entire credit card portfolio, particularly in states which previously had experienced the greatest home price appreciation. Our non-prime credit card receivable portfolio concentration in these states is approximately proportional to the U.S. population, but a substantial majority of our non-prime customers are renters who have, on the whole, demonstrated a better payment history on their loans during the recent economic downturn than homeowners in the portfolio as a whole. Furthermore, our lower credit scoring customers within our non-prime portfolio, which have an even lower home ownership rate, have shown the least deterioration through this stage of the economic cycle. Through December 31, 2010, our non-prime credit card portfolios have shown less credit deterioration as a result of the continuing high unemployment levels than in our prime credit card portfolios. Should these trends continue, credit loss reserves for our credit card receivables will continue to decrease. However, there can be no certainty that these trends will continue.
 
Credit loss reserves decreased significantly in 2009, largely as a result of the December 2009 Charge-off Policy Changes which reduced loss reserve levels by $3.5 billion. Excluding the impact of this policy change, reserve levels would have increased modestly to $12.6 billion in 2009, driven by higher loss estimates for Consumer Lending real estate secured receivables driven by higher delinquency levels and the impact of higher real estate secured troubled debt restructurings and higher reserve requirements associated with these receivables at both Consumer Lending and Mortgage Services. Excluding the impact of the December 2009 Charge-off Policy Changes, we recorded provision in excess of charge-off of $533 million in 2009. Excluding the impact of the December 2009 Charge-off Policy Changes, with the exception of our Consumer Lending real estate secured receivable portfolio, credit loss reserves were lower for all products as compared to December 31, 2008 reflecting lower dollars of delinquency and lower receivable levels in our Mortgage Services real estate secured, credit card and personal non-credit card receivable portfolios as discussed more fully below. The decrease in credit loss reserves also reflects lower loss estimates in our credit card receivable portfolio due to more stable credit conditions and an improved outlook for future losses as the impact of higher unemployment levels on losses has not been as severe as previously anticipated due in part to lower gas prices and improved cash flow from government stimulus activities that meaningfully benefit our non-prime customers. The decrease also reflects lower loss estimates in our Mortgage Services portfolio as this portfolio, which ceased all receivable originations in 2007, continues to liquidate and contains a higher percentage of first lien receivables. These decreases were partially offset by higher credit loss reserves in our Consumer Lending real estate secured receivable portfolio during 2009 due to the continued deterioration in the U.S. economy and housing markets, significantly higher unemployment rates, portfolio seasoning, higher loss severities and delays in processing foreclosures for real estate secured receivables as a result of backlogs in foreclosure proceedings and actions by local governments and certain states that have lengthened the foreclosure process. Prior to the acceleration of charge-offs in December 2009, delays in processing foreclosures for real estate secured receivables resulted in significantly higher late stage delinquency than at December 31, 2008. This was partially offset by an improved outlook for current inherent losses for first lien real estate secured receivables originated in 2005 and earlier as the current trends for deterioration in delinquencies and charge-offs in these vintages began to stabilize.
 
Credit loss reserve levels in 2009 reflect higher loss estimates related to TDR Loans. We use certain assumptions and estimates to compile our TDR balances and future cash flow estimates. In the fourth quarter of 2009, we received updated performance data on loan modifications which included activity associated with the recent increases in volume since late 2008 through mid-2009. Based on this data, we completed an update of the assumptions reflected in the cash flow models used to estimate credit losses associated with TDR Loans, including payment speeds and default rates. The update of these assumptions resulted in an increase to the provision for credit losses and an increase in the component of credit loss reserves specifically related to TDR of approximately $400 million net of reclassifications from other components of credit loss reserves.
 
Credit loss reserves at December 31, 2008 increased significantly as compared to December 31, 2007 as we recorded loss provision in excess of net charge-offs of $2.9 billion (excluding additional provision recorded as part of the lower of cost or fair value adjustment recorded on receivables transferred to held for sale). The increase was primarily as a result of higher delinquency and credit loss estimates in all of our receivable portfolios, the continued deterioration of the U.S. economy and housing markets during 2008, significantly higher unemployment rates,


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portfolio seasoning, higher personal bankruptcy filings; and delays in foreclosure activity as discussed above. Increases in credit loss reserves levels at December 31, 2008 were partially offset by the reclassification of $1.4 billion in credit loss reserves associated with the transfer of receivables to held for sale as well as the impact of lower overall receivables.
 
Credit loss reserves at December 31, 2007 increased as compared to December 31, 2006 as we recorded loss provision in excess of net charge-offs of $4.2 billion. The increase was primarily a result of the higher delinquency and loss estimates in all of our receivable portfolios. In addition, the higher credit loss reserve levels reflected higher dollars of delinquency driven by portfolio seasoning and increased levels of personal bankruptcy filings as compared to the exceptionally low levels experienced in 2006 following enactment of new bankruptcy legislation in the United States in October 2005, partially offset by lower overall receivables. Higher credit loss reserves at December 31, 2007 also reflected a higher mix of non-prime credit card receivables.
 
Credit loss reserve levels at December 31, 2006 reflect higher delinquency and loss estimates at our Mortgage Services business as previously discussed where we recorded provision in excess of net charge-offs of $1.7 billion. In addition, credit loss reserve levels also reflect higher levels of receivables due in part to lower securitization levels and higher dollars of delinquency in our other businesses driven by growth and portfolio seasoning including the Metris credit card receivable portfolio acquired in December 2005. Reserve levels also increased due to weakening early stage performance in certain Consumer Lending real estate secured loans originated since late 2005. These increases were partially offset by significantly lower personal bankruptcy levels in the United States, a reduction in the estimated loss exposure relating to Hurricane Katrina and the benefit of stable unemployment in the United States.
 
Reserve ratios Following is a discussion of changes in the reserve ratios we consider in establishing reserve levels. The reserve ratios for the year ended December 31, 2009 were significantly impacted by the December 2009 Charge-off Policy changes described above. When noted, the discussion of the change between years excludes the impact of the adoption of these new charge-off policies on the ratios at December 31, 2009.
 
Reserves as a percentage of receivables were lower at December 31, 2010 as compared to December 31, 2009 driven by significantly lower dollars of delinquency for all products as discussed more fully below which resulted in decreases in our credit loss reserves outpacing the decreases in receivable levels. This ratio was also impacted by increases in the level of real estate secured receivables which have been written down to net realizable value less cost to sell and typically do not require corresponding credit loss reserves. These written down receivables increased by $1.7 billion as compared to December 31, 2009. Additionally, the decrease also reflects a shift in mix in our receivable portfolio to higher levels of first lien real estate secured receivables which generally carry lower reserve requirements as second lien real estate secured and personal non-credit card receivables have run-off or charged-off at a faster pace. Reserves as a percentage of receivables at December 31, 2009 (excluding the impact of the December 2009 Charge-off Policy Changes) increased as compared to December 31, 2008 due to the lower receivable levels in 2009 as well as the impact of additional reserve requirements in our Consumer Lending business due to higher delinquency levels in our real estate secured receivable portfolios resulting from the economic conditions in 2009 and backlogs in foreclosure proceedings and actions by local governments and certain states which resulted in delays in processing foreclosures. Also contributing to the increase was the impact of higher real estate secured TDR Loans including higher reserve requirements associated with these receivables at both Consumer Lending and Mortgage Services. Additionally, for 2009 as compared to 2008, reserves as a percentage of receivables were higher as a result of a shift in mix to higher levels of non-prime credit card receivables which carry a higher reserve requirement than prime credit card receivables. Reserves as a percentage of receivables at December 31, 2008 were higher than at December 31, 2007 due to the impact of additional reserve requirements as discussed above. Additionally, reserves as a percentage of receivables for 2008 was impacted by the transfer of receivables, with an outstanding principal balance of $16.6 billion at the time of transfer, to receivables held for sale as these were primarily current receivables with lower associated reserves at the time of transfer. Reserves as a percentage of receivables at December 31, 2007 were higher than at December 31, 2006 due to the impact of additional reserve requirements for all our receivable products as a result of the deterioration of the marketplace conditions in 2007.


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Reserves as a percentage of net charge-offs at December 31, 2010 increased slightly as compared to December 31, 2009 as dollars of net charge-offs decreased at a faster pace than reserves largely due to higher reserve requirements on modified loans. Reserves as a percentage of net charge-offs for December 31, 2009 (excluding the impact of the December 2009 Charge-off Policy Changes) increased as compared to December 31, 2008 as the increase in reserve requirements in our Consumer Lending business outpaced the increase in charge-offs in our Consumer Lending real estate secured receivable portfolio largely due to the delays and backlogs in foreclosure proceedings discussed above. Reserves as a percentage of net charge-offs were lower in 2008 than 2007 as the increase in charge-offs outpaced the increase in reserve levels. This is primarily due to a significant increase in reserves during 2007 due to growing delinquency in our Consumer Lending and Mortgage Services real estate secured portfolios which migrated to charge-off in 2008. This decrease in 2008 was further impacted by the transfer of $1.2 billion of credit loss reserves to receivables held for sale as previously discussed. Reserves as a percentage of net charge-offs were higher in 2007 as the increase in reserve levels outpaced the increase in net charge-off during the year primarily due to the significant increases in reserve levels in 2007 as discussed above.
 
Reserves as a percentage of nonperforming loans (excluding nonperforming loans held for sale) decreased as compared to December 31, 2009 reflecting higher levels of nonperforming real estate secured receivables carried at net realizable value less cost to sell which typically do not require corresponding credit loss reserves. Excluding receivables carried at net realizable value less cost to sell from this ratio for both periods, reserves as a percentage of nonperforming loans increased during 2010 due to nonperforming personal non-credit card receivables decreasing at a faster pace than reserve levels due to higher loss estimates on bankrupt and TDR Loans as well as higher loss estimates for all products on recently modified loans. Reserves as a percentage of nonperforming loans at December 31, 2009 (excluding the impact of the December 2009 Charge-off Policy Changes) were lower as compared to December 31, 2008 as the majority of the increase in non-performing loans was in the first lien portion of Consumer Lending’s real estate secured receivable portfolio. First lien real estate secured receivables typically carry lower reserve requirements than second lien real estate secured and unsecured receivables. The decrease also reflects the impact of lower levels of nonperforming credit card receivables as a result of the sale of the GM and UP Portfolios to HSBC Bank USA in January 2009. Reserves as a percentage of nonperforming loans decreased in 2008 as compared to 2007 as the majority of the increase in nonperforming loans was from the first lien real estate secured receivable portfolios in our Consumer Lending and Mortgage Services businesses which typically carry lower reserve requirements than second lien real estate secured and unsecured receivables. Reserves as a percentage of nonperforming loans increased in 2007 as reserve levels increased at a higher rate than the increase in nonperforming loans driven by higher loss estimates in our Consumer Lending and Mortgage Services business and in our credit card receivable portfolios due to the marketplace and broader economic conditions.
 
Reserves as a percentage of two-months-and-over contractual delinquency (excluding delinquency on receivables held for sale which do not have any associated reserves) decreased as compared to December 31, 2009. This ratio has been significantly impacted by the increase in the level of real estate secured receivables which are carried at net realizable value less cost to sell and typically do not require corresponding credit loss reserves. Excluding receivables carried at net realizable value less cost to sell from this ratio for both periods, reserves as a percentage of two-months-and-over contractual delinquency totaled 121.0 percent at December 31, 2010 as compared to 103.8 percent at December 2009 as dollars of delinquency decreased at a faster pace than reserve levels. This increase was largely driven by dollars of delinquency for personal non-credit card receivables decreasing at a faster pace than reserve levels due to higher loss estimates on bankrupt and TDR Loans as well as higher loss estimates for all products on recently modified loans. Reserves as a percentage of two-months-and-over contractual delinquency at December 31, 2009 (excluding the impact of the December 2009 Charge-off Policy Changes) as compared to December 31, 2008 increased 130 basis points due the increase in reserve requirements in our Consumer Lending business discussed above, partially offset by the lower dollars of delinquency for Mortgage Services real estate secured, credit card, and personal non-credit card receivables. Reserves as a percentage of two-months-and-over contractual delinquency were 79.7 percent and 94.5 percent at December 31, 2008 and 2007, respectively. The decrease in 2008 reflects the shift to significantly higher levels of contractually delinquent first lien real estate secured receivables which typically carry lower reserve requirements than second lien real estate secured and unsecured receivables.


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The following table summarizes the changes in credit loss reserves for continuing operations by product during the years ended December 31, 2010, 2009 and 2008:
 
                                                         
    Real Estate Secured                 Personal
             
    First
    Second
    Credit
    Private
    Non-Credit
    Comm’l
       
    Lien     Lien     Card     Label     Card     and Other     Total  
   
    (in millions)  
 
Year ended December 31, 2010:
                                                       
Balances at beginning of period
  $ 3,997     $ 1,430     $ 1,816     $ -     $ 1,848     $ -     $ 9,091  
Provision for credit losses