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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, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 1-75
Household Finance Corporation
(Exact name of registrant as specified in its charter)
Delaware 36-1239445
(State of incorporation) (I.R.S. Employer Identification No.)
2700 Sanders Road 60070
Prospect Heights, Illinois (Zip Code)
(Address of principal executive
offices)
Registrant's telephone number, including area code: (847) 564-5000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
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9% Senior Subordinated Notes, due September 28, 2001 New York Stock Exchange
9 5/8% Senior Subordinated Notes, due July 15, 2000 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark 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. [_]
As of March 17, 1999, there were 1,000 shares of registrant's common stock
outstanding, all of which are owned by Household International, Inc.
The registrant meets the conditions set forth in General Instruction
I(1)(a) and (b) of Form 10-K and is therefore filing this Form 10-K with the
reduced disclosure format.
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TABLE OF CONTENTS
PART/Item No. Page
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PART I.
Item 1. Business...................................................... 3
Cautionary Statement on Forward-Looking Statements............ 3
Item 2. Properties.................................................... 4
Item 3. Legal Proceedings............................................. 4
Item 4. Submission of Matters to a Vote of Security Holders........... 4
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters....................................................... 4
Item 6. Selected Financial Data....................................... 5
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 5
Item 7A. Quantitative and Qualitative Disclosure About Market Risk..... 22
Item 8. Financial Statements and Supplementary Data................... 22
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................... 22
PART III.
Item 10. Directors and Executive Officers of the Registrant............ 22
Item 11. Executive Compensation........................................ 22
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................... 22
Item 13. Certain Relationships and Related Transactions................ 22
PART IV.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K........................................................... 22
Financial Statements.......................................... 22
Reports on Form 8-K........................................... 22
Exhibits...................................................... 23
Signatures............................................................... 24
Report of Independent Public Accountants................................. F-1
Consolidated Statements of Income........................................ F-2
Consolidated Balance Sheets.............................................. F-3
Consolidated Statements of Cash Flows.................................... F-4
Consolidated Statements of Changes in Preferred Stock and Common
Shareholder's Equity.................................................... F-5
Notes to Consolidated Financial Statements............................... F-7
Selected Quarterly Financial Data (Unaudited)............................ F-35
2
PART I.
Item 1. Business.
Household Finance Corporation ("HFC") is a wholly-owned subsidiary of
Household International, Inc. ("Household International" or the "parent
company"). HFC and its subsidiaries may also be referred to in this Form 10-K
as "we", "us" or "our." On June 30, 1998, Household International merged with
Beneficial Corporation ("Beneficial"), a consumer finance holding company
headquartered in Wilmington, Delaware. Upon completion of the merger,
substantially all of the net assets of Beneficial were contributed by
Household International to HFC. We primarily offer home equity loans, auto
finance loans, MasterCard* and VISA* credit cards, private label credit cards,
tax refund anticipation loans and other types of unsecured loans to consumers
in the United States. We also have commercial loans and leases, periodic
payment annuities, and corporate owned life insurance products which we no
longer offer. Prior to December 1998 when the holding company for Beneficial's
international operations was merged with an affiliate, we also provided our
consumer lending products to consumers in the United Kingdom and Canada. Loans
are marketed through branch lending offices, direct mail and telemarketing as
well as through dealer networks and retail stores in connection with our
private label business. We also purchase loans of a similar nature from other
lenders. Our subsidiaries generally service these loans, including loans made
by the credit card operations of Household International. Where applicable
laws permit, credit and specialty insurance is offered to our customers in
connection with our products in the United States and Canada, and prior to
December 1998, in the United Kingdom. Such insurance is generally written
directly by, or reinsured with one of our affiliates.
Our operations are divided into two reportable segments: Consumer, which
includes our branch-based consumer finance, private label and auto finance
businesses; and Credit Card, which includes our domestic MasterCard and Visa
business. Information about operating segments which are not individually
reportable includes our international, insurance, refund anticipation loan and
commercial businesses as well as our corporate and treasury activities which
are included in the "All Other" caption within our segment disclosure.
Cautionary Statement on Forward-Looking Statements
Certain matters discussed throughout this Form 10-K or in the information
incorporated herein by reference may constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995 and
as such may involve known and unknown risks, uncertainties and other factors
that may cause our actual results, performance or achievements to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Forward-looking
statements are based on our current views and assumptions, and involve risks
and uncertainties that could cause our results to be materially different than
those anticipated. The following important factors could affect our actual
results and could cause such results to vary materially from those expressed
herein or in any other document filed with the Securities and Exchange
Commission:
. changes in laws and regulations, including changes in accounting
standards;
. changes in overall economic conditions, including the interest rate
environment in which we operate, the capital markets in which we fund our
operations, recession and currency fluctuations;
. our ability and the ability of our key service providers, vendors or
suppliers to replace, modify or upgrade our business systems to
adequately address Year 2000 issues;
. consumer perception of the availability of credit, including price
competition in the market segments we target and the ramifications of
filing for personal bankruptcy;
. the effectiveness of models or programs to predict loan delinquency or
loss and initiatives to improve collections in all business areas;
. consumer acceptance and demand for our loan products;
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* MasterCard is a registered trademark of MasterCard International,
Incorporated and VISA is a registered trademark of VISA USA, Inc.
3
. inability to continue to integrate systems, operational functions and
cultures of Beneficial with those of Household; and
. the repositioning of our MasterCard/Visa business to successfully market
to selected consumer segments.
Item 2. Properties.
Substantially all of our branch offices and headquarters space is leased,
except for a credit card processing facility located in Las Vegas, Nevada and
a processing center in Tampa, Florida. We believe that such properties are in
good condition and are adequate to meet our current and reasonably anticipated
needs.
Item 3. Legal Proceedings.
We have developed and implemented compliance functions to monitor our
operations to ensure that we comply with all applicable laws. However, we are
parties to various legal proceedings resulting from ordinary business
activities. Certain of these actions are or purport to be class actions
seeking damages in very large amounts. Due to the uncertainties in litigation
and other factors, we cannot assure you that we will ultimately prevail in
each instance. We believe that we have meritorious defenses to these actions
and any adverse decision should not materially affect our consolidated
financial condition.
During the past several years, the press has widely reported certain
industry related concerns which may impact us. Some of these involve the
amount of litigation instituted against finance and insurance companies
operating in the state of Alabama and the large punitive awards obtained from
juries in that state. Like other companies in this industry, we and some of
our subsidiaries are involved in a number of lawsuits pending against us in
Alabama, many of which relate to the financing of satellite television
broadcast receivers. We discontinued financing such receivers in 1995. The
Alabama cases generally allege inadequate disclosure or misrepresentation of
financing terms. In many suits, other parties are also named as defendants.
Unspecified compensatory and punitive damages are sought. Several of these
suits purport to be class actions. The judicial climate in Alabama is such
that the outcome of all of these cases is unpredictable. Although we believe
we have substantive legal defenses to these claims and are prepared to defend
each case vigorously, a number of such cases have been settled or otherwise
resolved for amounts that in the aggregate are not material to our operations.
Appropriate insurance carriers have been notified of each claim, and a number
of reservations of rights letters have been received. Certain of these claims
have been partially covered by insurance.
Prior to Household International's merger with Beneficial, Beneficial was
involved in litigation with the Internal Revenue Service ("IRS") over matters
relating to a former insurance subsidiary that occurred in the mid- to late
1980's. In early 1999, a basis for settlement with the IRS was reached and
filed with the U.S. Tax Court. It is expected that this settlement will be
finalized in 1999 and will not result in any loss or charge to us in excess of
the amounts accrued for this matter by Beneficial.
Item 4. Submission of Matters to a Vote of Security Holders.
Omitted.
PART II.
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters.
All 1,000 shares of HFC's outstanding common stock are owned by Household
International. Consequently, there is no public market in HFC's common stock.
HFC paid cash dividends to Household International of $690 million in 1998
and $250 million in 1997. HFC did not pay any cash dividends to Household
International in 1996. Beneficial paid cash dividends of $75.4 million in
1998, $200.7 million (including $80.0 million of treasury share purchases) in
1997 and $110.5 million in 1996. In addition, HFC paid cash dividends on its
preferred stock of $4.6 million in 1997 and $7.2 million for the full year in
1996.
4
Item 6. Selected Financial Data.
Omitted.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
FINANCIAL HIGHLIGHTS
Household Finance Corporation and Subsidiaries
Year ended December 31,
unless otherwise indicated.(1)
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1998 1997 1996
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(All dollar amounts in millions)
Net income................................. $ 304.9 $ 767.1 $ 650.0
Operating net income(2).................... 937.4 767.1 650.0
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Key Performance Ratios
Return on average owned assets(2)(3)....... 2.24% 2.01% 1.88%
Return on average managed assets(2)(3)..... 1.64 1.42 1.39
Return on average common shareholder's
equity(2)(3).............................. 15.6 15.4 16.8
Managed net interest margin................ 8.09 8.03 7.98
Managed consumer net chargeoff ratio....... 4.21 3.69 2.79
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At December 31
Total assets:
Owned.................................... $ 42,363.0 $ 39,448.9 $ 36,324.9
Managed(4)............................... 55,062.2 57,491.9 51,159.1
Managed receivables(5)..................... 47,145.2 50,426.3 45,301.5
Debt to equity ratio....................... 5.9:1 5.3:1 6.7:1
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(1) On June 30, 1998, Household International merged with Beneficial
Corporation, a consumer finance holding company. Upon completion of the
merger, substantially all the net assets of Beneficial were contributed by
Household International to HFC. The merger was accounted for as a pooling
of interests, and accordingly, the consolidated financial statements have
been restated for all periods presented.
(2) Excludes merger and integration related costs of $751.0 million after-tax
related to the Beneficial merger and the gain on the sale of Beneficial
Canada of $118.5 million after-tax.
(3) Including the merger and integration related costs and the gain on sale of
Beneficial Canada for the year ended December 31, 1998, the return on
average owned assets was .73 percent, the return on average managed assets
was .53 percent and the return on average common shareholder's equity was
5.1 percent.
(4) Our managed data includes assets on our balance sheet and those assets
that we service for investors as part of our asset securitization program.
(5) Managed receivables decreased in 1998 due to the strategic repositioning
of our MasterCard and Visa business during the year, including the sale of
$1.9 billion of GM Card receivables to an affiliate.
In connection with the Beneficial merger, each outstanding share of
Beneficial common stock was converted into 3.0666 shares of Household
International's common stock, resulting in the issuance of approximately 168.4
million shares of common stock. Each share of Beneficial $5.50 Convertible
Preferred Stock (the "Beneficial Convertible Stock") was converted into the
number of shares of Household International common stock the holder would have
been entitled to receive in the merger had the Beneficial Convertible Stock
been converted into shares of Beneficial common stock immediately prior to the
merger. Additionally, each other share of Beneficial preferred stock
outstanding was converted into one share of a newly-created series of
Household International preferred stock with terms substantially similar to
those of existing Beneficial preferred stock. The merger was accounted for as
a pooling of interests. Upon completion of the merger, substantially all the
net assets
5
of Beneficial were contributed by Household International to HFC. Therefore,
the consolidated financial statements include the results of operations,
financial position and changes in cash flows of Beneficial for all periods
presented.
In connection with the merger, Household International and HFC established
an integration plan which identified activities that would not be continued as
a result of the merger and the related costs of exiting those activities. Our
plan also identified the number of employees who would be involuntarily
terminated and established the benefit levels those employees would receive
upon termination. These benefit levels were communicated to employees in April
1998. Pursuant to our plan, we accrued pretax merger and integration related
costs of approximately $1 billion ($751 million after-tax) which has been
reflected in the statement of income in total costs and expenses. As of
December 31, 1998, approximately $80 million remains in the merger and
restructuring reserve.
The merger and integration related costs were comprised of the following:
. Approximately $270 million (of which $86 million related to key
executives with pre-existing severance agreements) was accrued to cover
employee termination costs related to approximately 3,000 employees whose
functions were eliminated due to redundancy and consolidation of
branches, corporate staff and back office operations. As of December 31,
1998, substantially all identified employees have been severed and
approximately $240 million of severance payments have been made to
terminated employees. Most of the remaining $30 million is expected to be
paid in the first quarter of 1999 pursuant to our plan.
. Approximately $319 million was accrued related to planned costs to be
incurred in connection with the exiting of the Beneficial corporate
office lease, early termination of branch offices and other operating
facility leases and the cancellation of contracts with third party
vendors, primarily for technology. Of this amount, $100 million related
to the exiting of the Beneficial corporate office lease, $142 million
related to lease termination and other exit costs for closures of 335
duplicative branch offices and 8 redundant operating centers, $40 million
pertained to fixed asset writedowns, primarily related to closed
facilities, and $37 million related to termination penalties associated
with third party vendor contracts whose services would no longer be
required. In November 1998, we entered into an agreement to sublease the
Beneficial corporate offices to a third party to whom we paid total
consideration of approximately $100 million. As of December 31, 1998,
$115 million of lease termination and other costs for closed branch
offices and operating centers had been incurred. The remainder of the
estimated lease termination payments will be made in the first quarter of
1999. In addition, $14 million of charges were incurred due to early
termination of third party vendor contracts. Most of the remaining vendor
contracts will be terminated in the first quarter of 1999.
. We re-assessed Beneficial's existing business plans and assumptions used
in evaluating goodwill and other related intangibles associated with
various operations, loan products and acquired receivable portfolios. Our
plan identified modifications to these existing business plans. In
connection with these modifications, we utilized discounted cash flow
analyses to value the related goodwill and other intangible assets using
assumptions which reflected our modified business plans. As a result of
our analyses, we have written off approximately $183 million of goodwill
and other related intangible assets to their estimated fair values. In
addition, we wrote down real estate interests by $68 million to reflect
their net realizable values. Assets held for disposal are not material.
. We and Beneficial incurred investment banking fees of $75 million and
legal and other expenses of $25 million. In addition, in order to better
align the asset liability position of the combined company, we paid $60
million in prepayment premiums related to outstanding debt.
The merger and integration related costs included approximately $291
million in non-cash charges. Cash payments of approximately $709 million have
been and will continue to be funded through our existing operations. In
addition, we will receive tax benefits of approximately $249 million.
6
OPERATIONS SUMMARY
. Our operating net income (net income excluding merger and integration
related costs and the gain on the sale of Beneficial's Canadian
operations) increased 22 percent to $937.4 million in 1998. Net income in
1997 was $767.1 million, 18 percent higher than 1996 earnings of $650.0
million. Net income was $304.9 million in 1998.
. Managed consumer receivables, other than MasterCard and Visa, grew 7
percent during 1998 with the strongest growth coming in our secured
lending products. In total, in 1998 our managed consumer receivables
declined 4 percent, reflecting the sale of $1.9 billion in credit card
receivables to third parties and the sale of $1.9 billion of GM Card
receivables to an affiliate.
. Our return on average common shareholder's equity ("ROE"), excluding
merger and integration related costs and the gain on the sale of
Beneficial's Canadian operations, was 15.6 percent in 1998. This compares
to ROE of 15.4 percent in 1997 and 16.8 percent in 1996. Our return on
average owned assets ("ROA"), excluding the nonrecurring items, was 2.24
percent, up from 2.01 percent in 1997 and 1.88 percent in 1996. Our
operating net income and ROA increased over the past three years as a
result of our focus on higher-return businesses.
. During the first quarter of 1998, we completed the sale of Beneficial's
Canadian operations and recorded an after-tax gain of approximately
$118.5 million. In April 1998, the sale of Beneficial's German operations
was also completed. In 1997, Beneficial announced its intent to sell the
German operations and recorded an after-tax loss of approximately $27.8
million after consideration of a $31.0 million tax benefit. No additional
losses were realized in 1998 as a result of the sale.
. During 1998, our MasterCard and Visa business experienced declining
profitability due to higher credit losses and intensifying competitive
pressures. We took a number of steps during 1998 to minimize the impact
of these negative trends. In the first half of the year, we actively
repriced portions of our MasterCard and Visa portfolios and we also
reduced credit lines to minimize future losses. This resulted in
increased account attrition. Additionally, to consolidate GM Card
receivables into a single bank entity, we sold $1.9 billion of GM Card
receivables to a bank affiliate in May 1998. In mid-year, new senior
operating management joined our bankcard unit. The new management team
completed a comprehensive review of our bankcard strategy. Their
objective was to boost returns and improve this business's competitive
position. As a result, we reaffirmed our commitment to our major credit
card relationship, the Union Privilege program, representing our affinity
card relationship with the AFL-CIO labor federation. We intend to further
enhance this program during 1999 with the close collaboration of our
partner.
We also decided to refocus our bank subsidiary's branded portfolio to
target customers and prospects of our consumer finance business. In
addition, we will target other well-defined market segments offering
higher potential returns and consumers whose borrowing needs have not
been met by traditional lenders. To facilitate this effort, we have
entered into a proposed alliance with Renaissance Holdings, Inc.
("Renaissance"), a privately held issuer of secured and unsecured credit
cards to non-prime consumers. We intend to leverage Renaissance's
capabilities with our access to markets, customer information, technology
and other scale benefits. We will jointly originate new accounts which we
will fund and own. Renaissance will service the credit card accounts that
come under our joint program, and will be paid a servicing fee. As this
business grows, Renaissance will begin to earn a share of the revenue and
the servicing fee will decrease.
As part of our redefined strategy, we will continue to de-emphasize
undifferentiated credit card programs that do not offer the potential
returns of our other businesses. This repositioning of our bank
subsidiary's portfolio led to $1.9 billion in portfolio sales to third
parties in the second half of the year.
In connection with these portfolio sales, we received premiums totaling
approximately $200 million. Against these gains, we wrote off related
intangible assets and other costs of $159 million and related
securitization assets, net of related off-balance sheet loss reserves, of
$45 million. The net result of these three components, all of which are
included in other income, was a $4 million pretax loss.
7
. On December 22, 1998, BFC Insurance Agency of America ("BFCIAA"), the
holding company of Beneficial's foreign operations, was merged with and
into Household Global Funding, Inc. ("Global"), an affiliate of HFC and a
wholly-owned subsidiary of Household International. HFC received cash of
approximately $340.0 million from Global equal to the net book value of
the assets transferred and liabilities assumed. In accordance with the
guidance established for mergers involving affiliates under common
control, the financial statements of HFC exclude the results of
operations of BFCIAA subsequent to June 30, 1998, the date which BFCIAA
came under the control of Household International.
. In June 1997, Household International and a wholly-owned subsidiary of
HFC purchased Transamerica Financial Services Holding Company ("TFS"),
the branch-based consumer finance subsidiary of Transamerica Corporation,
for $1.1 billion. We also repaid $2.7 billion of debt that TFS owed to
affiliates of Transamerica Corporation. We added about $3.1 billion of
real estate secured receivables as a result of the acquisition. The
acquisition strengthened our consumer finance operations by adding new
markets, new customer accounts, seasoned employees and receivables
secured by collateral. This type of security helps to reduce the amount
of loss we might incur if borrowers do not pay off their loans.
In June 1997, we received a capital contribution from Household
International of $976.5 million which was used to repay short-term
borrowings related to the TFS acquisition.
In October 1997, Household International and its wholly-owned subsidiary
purchased all of the outstanding capital stock of ACC Consumer Finance
Corporation ("ACC"), an auto finance company, for about 4.2 million
shares of its common stock and cash. Upon completing this transaction,
Household International contributed its investment in ACC to HFC. The
acquisition of ACC expanded our business of making loans to non-prime
borrowers secured by automobiles, primarily used vehicles sold through
franchised dealers, and increased our market share in the non-prime auto
finance market.
In late December 1997, Beneficial acquired Endeavour Personal Finance
Ltd. ("Endeavour"), including receivables of approximately $250 million.
Each of these acquisitions were accounted for as purchases. Thus, our
statement of income for 1997 included the results of operations of TFS,
ACC and Endeavour from the closing dates of the transactions.
. On March 31, 1996, Beneficial's $957 million annuity portfolio was sold
through a co-insurance agreement. Approximately $900 million of
investment securities were sold as part of this disposition.
. The following summarizes operating results for our reportable operating
segments for 1998 compared to 1997 and 1996:
Results for our Consumer segment improved in 1998 from the prior year
periods. Return on average owned assets increased to 2.84 percent in 1998
from 2.42 percent in 1997 and 2.37 percent in 1996. Return on average
managed assets increased to 2.12 percent in 1998 from 1.70 percent in
both 1997 and 1996. The improvement in operating results from the prior
year periods reflect higher net interest margin and fee income due mainly
to higher average receivables. Managed receivables grew 11 percent to
$39.8 billion at year-end 1998, up from $35.9 billion in 1997 and $30.7
billion in 1996. The growth in managed receivables in 1998 and 1997 was
driven by solid growth in home equity, other unsecured and auto finance
receivables. The Consumer segment has also benefited from reduced
operating expenses from efficiencies achieved as Beneficial's branch
operations were consolidated in the second half of the year and continued
cost control efforts. The integration of Beneficial is proceeding on
target. Offsetting these favorable trends, the Consumer segment continued
to experience higher credit losses reflecting increased personal
bankruptcies as well as the maturing of promotional balances in our
private label business. The 1997 operating results were impacted by
higher provisions for credit losses. In 1996, Beneficial recorded a $65
million up-front loss provision for the strong private label receivables
growth experienced during the year.
Our Credit Card segment reported lower earnings in 1998. Return on
average owned assets was .94 percent in 1998, compared with 2.28 percent
in 1997 and 1.66 percent in 1996. Return on average managed assets was
.49 percent, compared with 1.19 percent in 1997 and 1.08 percent in 1996.
The decrease in operating results in 1998 was primarily due to lower
average receivables and higher credit
8
losses, partially offset by higher fee income. Managed receivables were
$7.1 billion at year-end 1998, compared to $10.9 billion in 1997 and
$11.3 billion in 1996. The decrease in managed receivables in 1998
reflects portfolio attrition, the sale of MasterCard and Visa receivables
to third parties totaling $1.9 billion during the year and the sale of
$1.9 billion of GM Card receivables to an affiliate. The improvement in
operating results for 1997 compared with 1996 was due to higher net
interest margin and fees and improved efficiency, partially offset by
higher credit losses.
. Our tax refund anticipation loan ("RAL") business reported lower profits
in 1998 due to measures taken by the Internal Revenue Service to delay
payment on the returns of selected taxpayers claiming an earned income
tax credit. The RAL program reported lower profits in 1997 compared with
1996, which benefited from very strong collections on loans previously
written off during the 1995 season. Additionally, 1997 earnings were
lower due to the July 1996 agreement with H&R Block Tax Services, Inc.,
which gave them a share in both the revenue and credit risk of certain
RALs.
. Our managed net interest margin was 8.09 percent in 1998, 8.03 percent in
1997 and 7.98 percent in 1996. Our margins have increased because we have
continued to raise the interest rates we charge on most of our products.
In addition, our margin increased in 1998 as a result of lower cost of
funds. The increase was slightly offset by lower margin from a higher mix
of secured loans in the portfolio which carry a lower yield compared to
unsecured products.
BALANCE SHEET REVIEW
. Managed assets (total assets on our balance sheet plus receivables
serviced with limited recourse) were $55.1 billion at December 31, 1998
compared with $57.5 billion at year-end 1997. Managed consumer
receivables, other than MasterCard and Visa, grew 7 percent in 1998. In
total, our managed consumer receivables declined 4 percent from the level
of a year ago. Growth was depressed by the sale of $1.9 billion in credit
card receivables to third parties during the year, the sale of $1.9
billion of GM Card receivables to an affiliate and the merger of the
United Kingdom operations with and into Global on December 22, 1998,
effective June 30, 1998. Owned assets totaled $42.4 billion at December
31, 1998, up from $39.4 billion at year-end 1997. Owned assets may vary
from period to period depending on the timing and size of asset
securitization transactions. We had initial securitizations, excluding
replenishments of prior securitizations, of $2.9 billion of receivables
in 1998 and $6.1 billion of receivables during 1997. We refer to the
securitized receivables that are serviced for investors and not on our
balance sheet as our off-balance sheet portfolio.
. Changes in our consumer receivables during 1998 are shown in the
following table:
December 31, Increase (Decrease) Increase (Decrease)
1998 in 1998/1997 in 1997/1996
------------ ------------------- -------------------
(All dollar amounts are stated in millions)
Managed receivables:
Home equity............. $20,796.1 12% 27%
Auto finance(1)......... 1,765.3 102 --
MasterCard/Visa......... 7,203.0 (39) (3)
Private label........... 7,852.9 (10) --
Other unsecured......... 8,845.8 3 11
--------- ---- ---
Total consumer(2)..... 46,463.1 (4) 12
--------- ---- ---
Commercial................ 682.1 (21) (13)
Discontinued products(3).. -- (100) (2)
--------- ---- ---
Total................. $47,145.2 (7)% 11%
========= ==== ===
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(1) Prior to 1997, auto finance receivables were not significant and were
included in other unsecured receivables.
(2) Consumer receivables growth from the prior year, excluding MasterCard and
Visa due to the strategic repositioning, was 7 percent in 1998.
(3) Discontinued products include receivables relating to Beneficial's
disposed Canadian operations in March 1998 and German operations in April
1998.
9
Our distribution channels and growth strategies vary across product
lines. The consumer branch business, which offers both real estate
secured and unsecured loans, originates its products through its retail
branch network, direct mail, telemarketing and correspondents and
brokers. The private label business generates loan volume through
merchant promotions, application displays, direct mail and telemarketing.
The auto finance business generates loan volume primarily through dealer
relationships from which installment contracts are purchased. The private
label and auto finance businesses concentrate on both increasing volume
from existing relationships and actively seeking new relationships. Our
MasterCard and Visa business generates loan volume primarily through
direct mail, telemarketing, application displays and promotional activity
associated with our co-branding and affinity relationships. We supplement
internally-generated receivables growth with opportunistic portfolio
acquisitions depending on the pricing and customer profile of the
portfolio.
Home equity receivables increased 12 percent during 1998, with new
originations up approximately 27 percent. Volumes were good in both the
HFC and Beneficial branches. Additionally, in the last half of the year,
we benefited from the fallout of some of the smaller home equity loan
players. This reduced competition contributed to improved pricing, which
we also took advantage of by increasing our correspondent business. The
level of refinancings also began to decrease in the second half of 1998.
The combination of reduced competitive pressures, prepayment penalties
and focus on customer service and retention have slowed portfolio runoff.
Growth in auto finance receivables in 1998 resulted from a continued
focus on underserved customers in the non-prime sector and benefited from
weakened competition and an expanded sales force.
Private label receivables were down in 1998 due to attrition at two major
retailers in the second quarter as the result of less promotional
activity.
Other unsecured receivables were up reflecting the purchase of an $850
million portfolio in the first quarter and steady growth during the year
in the consumer finance business.
Our MasterCard and Visa receivables declined from a year ago due to
attrition, the sale of $1.9 billion of our bank subsidiary's branded
credit card receivables and the sale of $1.9 billion of GM Card
receivables to an affiliate.
. The managed consumer two-months-and-over contractual delinquency ratio
increased to 5.41 percent at December 31, 1998 from 4.77 percent at
December 31, 1997. The 1998 managed consumer net chargeoff ratio was 4.21
percent compared with 3.69 percent in 1997 and 2.79 percent in 1996.
. Our managed credit loss reserves totaled $2.1 billion at December 31,
1998, essentially unchanged from 1997. Credit loss reserves as a percent
of managed receivables were 4.47 percent at year-end 1998 compared with
4.21 percent at year-end 1997. Reserves as a percent of nonperforming
managed receivables were 111.7 percent compared with 119.9 percent at
December 31, 1997.
. Our debt to equity ratio was 5.9 to 1 compared with 5.3 to 1 at December
31, 1997. The increase in the ratio was due to higher debt levels
primarily attributable to higher average owned receivables at December
31, 1998.
STATEMENT OF INCOME REVIEW
Net Interest Margin
Net interest margin was $2,622.4 million for 1998, up from $2,386.7 million
in 1997 and $2,238.5 million in 1996. As a percent of average owned interest-
earning assets, net interest margin was 7.53 percent in 1998, 7.49 percent in
1997 and 7.75 percent in 1996. The dollar increase over 1997 and 1996 was due
to growth in average owned home equity and auto finance receivables and higher
interest spreads. The interest spread
10
represents the difference between the yield earned on interest-earning assets
and the cost of the debt used to fund the assets.
Due to the securitization of assets over the past several years, the
comparability of net interest margin between years may be affected by the
level and type of assets securitized. As receivables are securitized rather
than held in our portfolio, net interest income is reclassified to
securitization income. Net interest margin on a managed basis, which assumes
receivables securitized were held in our portfolio, increased to $4.0 billion
for 1998 from $3.8 billion in 1997 and $3.3 billion in 1996. Net interest
margin on a managed basis as a percent of average managed interest-earning
assets increased to 8.09 percent from 8.03 percent in 1997 and 7.98 percent in
1996.
Provision for Credit Losses
The provision for credit losses includes current period credit losses. It
also includes an amount which, in our judgment, is sufficient to maintain
reserves for credit losses at a level that reflects known and inherent risks
in the portfolio. The managed basis provision for credit losses also includes
the over-the-life reserve requirement established on the off-balance sheet
portfolio when receivables are securitized.
The provision for credit losses on an owned basis totaled $1,253.1 million
in 1998, compared to $1,252.1 million in 1997 and $907.4 million in 1996. In
1996, Beneficial recorded a $65 million up-front loss provision for the strong
private label receivables growth experienced during the year. As a percent of
average owned receivables, the provision was 3.68 percent compared to 3.98
percent in 1997 and 3.23 percent in 1996. The decrease in this ratio in 1998
was due to a higher mix of secured loans as compared to 1997.
Other Revenues
Securitization income was $1,058.5 million in 1998, $1,232.0 million in
1997 and $912.4 million in 1996. Securitization income consists of income
associated with the securitization and sale of receivables with limited
recourse, including net interest margin, fee and other income, and provision
for credit losses related to those receivables. Securitization income was
lower in 1998 as we securitized fewer receivables than in 1997. Securitization
income increased in 1997 primarily due to growth in average securitized
receivables.
Insurance revenues were $352.9 million in 1998, unchanged from 1997 and up
from $336.6 million in 1996. The increases from 1996 were primarily due to
increased insurance sales on a larger portfolio.
Investment income includes interest income on investment securities in the
insurance business as well as realized gains and losses from the sale of
investment securities. Investment income was $146.7 million in 1998 compared
with $152.6 million in 1997 and $212.7 million in 1996. The decrease in 1998
and 1997 from each of the prior years was due to lower average investment
balances and lower yields on the securities in the portfolio.
Fee income on an owned basis includes revenues from fee-based products such
as credit cards. Fee income was $498.7 million in 1998, compared with $514.8
million in 1997 and $290.3 million in 1996. The decrease in fee income in 1998
was due to lower interchange income due to lower average owned credit card
receivables. The increase in 1997 reflected higher credit card fees as a
result of increased average owned credit card receivables compared to the
prior year and higher interchange income.
Other income was $239.2 million in 1998, $310.5 million in 1997 and $257.0
million in 1996. The decline in 1998 reflected a decrease in RAL income from
the prior year, as previously discussed. Other income in 1997 included gains
on the sales of MasterCard and Visa receivables from our non co-branded
portfolio and a gain from the sale of a Beneficial life insurance portfolio.
RAL income in 1996 benefited from very strong collections on loans previously
written off during the 1995 season. Other income in 1996 included the gain
related to the sale of our annuity portfolio in the first quarter.
Total other revenues in 1998 also included a pretax gain of $189.4 million
from the sale of Beneficial's Canadian operations, as previously discussed.
11
Expenses
Operating expenses, excluding the one-time merger related costs of
approximately $1.0 billion, were $2,188.0 million in 1998, $2,538.4 million in
1997 and $2,332.0 million in 1996. In 1998, operating expenses were down
sharply. During 1997, Beneficial recorded non-operating pretax charges of $90
million including a $59 million provision for the planned disposition of
Beneficial's German operations. Also included in 1997 were expenses related to
Beneficial's Canadian and German operations, which were sold in early 1998. In
addition, cost savings and operating efficiencies were achieved from the
consolidation of Beneficial's operations in the second half of the year and
continued cost control in our remaining businesses.
Salaries and fringe benefits were $921.7 million in 1998, compared to
$925.3 million in 1997 and $805.4 million in 1996. The decrease was mostly due
to Beneficial staff reductions, partially offset by higher sales incentives
for our consumer finance branch employees and a higher number of employees in
our auto finance business.
Occupancy and equipment expense was $266.3 million in 1998, compared to
$295.9 million in 1997 and $275.9 million in 1996. Expenses in 1998 were 10
percent lower due to the elimination of duplicative branch offices and
operating centers as a result of the Beneficial merger.
Other marketing expenses include payments for advertising, direct mail
programs and other marketing expenditures. These expenses were $205.8 million
in 1998, compared to $280.7 million in 1997 and $250.2 million in 1996.
Included in 1997 were marketing initiatives for several Beneficial private
label merchants.
Other servicing and administrative expenses were $417.8 million in 1998,
$656.5 million in 1997 and $592.6 million in 1996. Included in 1997 were
Beneficial's non-operating charge of $90 million and the expenses related to
Beneficial's Canadian and German operations sold in early 1998. During 1996,
we recorded charges of $78 million primarily related to settling legal matters
of a former subsidiary.
Amortization of acquired intangibles and goodwill was $168.8 million in
1998, $143.4 million in 1997 and $121.1 million in 1996. The increase reflects
our acquisitions of TFS and ACC in 1997 and the Union Privilege portfolio in
1996.
Policyholders' benefits were $207.6 million in 1998, $236.6 million in 1997
and $286.8 million in 1996. The lower expense in 1998 was due to fewer
policies in our life insurance business.
Income taxes. The 1998 effective tax rate, excluding merger and integration
related costs and the gain on sale of Beneficial Canada, was 36.5 percent
compared with 33.8 percent in 1997 and 35.5 percent in 1996. The effective
rate in 1997 recognized tax benefits related to the anticipated sale of
Beneficial's German operations.
CREDIT QUALITY
Our delinquency and net chargeoff ratios reflect, among other factors, the
quality of receivables, the average age of our loans, the success of our
collection efforts and general economic conditions. Specifically, the high
levels of personal bankruptcies over the last three years have had a direct
effect on the asset quality of our overall portfolio and others in our
industry.
During 1998 our delinquency and net chargeoff levels were affected by
higher consumer bankruptcies in our unsecured portfolios and the continued
maturing of our receivables.
We track delinquency and chargeoff levels on a managed basis. We include
the off-balance sheet portfolio since we apply the same credit and portfolio
management procedures as on our owned portfolio. This results in a similar
credit loss exposure. Our focus is to continue using risk-based pricing and
effective collection efforts for each loan. We have a process that gives us a
reasonable basis for predicting the asset quality of new accounts. This
process is based on our experience with numerous marketing, credit and risk
management tests. We also believe that our frequent and early contact with
delinquent customers is helpful in managing net credit losses. Despite these
efforts to manage the current credit environment, bankruptcies remain an
industry-wide issue and are unpredictable.
12
Our chargeoff policy for consumer receivables varies by product. Unsecured
receivables are written off at the following stages of contractual
delinquency: MasterCard and Visa--6 months; private label--9 months; and other
unsecured--9 months and no payment received in 6 months. For real estate
secured receivables, carrying values are written down to net realizable value
at the time of foreclosure. For loans secured by automobiles, carrying values
are written down to net realizable value when the loan becomes 5 months
contractually delinquent. Commercial receivables are written off when it
becomes apparent that an account is uncollectible.
The state of California accounts for 19 percent of our managed domestic
consumer portfolio and is the only state with more than 10 percent of this
portfolio. Because of our centralized underwriting collections and processing
functions, we can quickly change our credit standards and intensify collection
efforts in specific locations. This capability was leveraged to the Beneficial
branch network as the Beneficial branches were integrated with HFC in 1998.
Managed Consumer Two-Months-and-Over Contractual Delinquency Ratios
1998 Quarter End 1997 Quarter End
---------------------- ----------------------
4 3 2 1 4 3 2 1
---- ---- ---- ---- ---- ---- ---- ----
Home equity..................... 3.55% 3.59% 3.39% 3.59% 3.59% 3.03% 2.82% 3.05%
Auto finance(1)................. 2.29 2.05 1.67 1.84 1.97 -- -- --
MasterCard/Visa................. 5.19 4.67 4.35 3.32 3.28 3.42 3.39 3.34
Private label................... 7.38 7.32 6.27 6.22 6.01 5.85 5.25 4.82
Other unsecured................. 8.86 9.15 8.74 8.22 8.25 7.89 7.36 7.32
---- ---- ---- ---- ---- ---- ---- ----
Total......................... 5.41% 5.39% 5.03% 4.79% 4.77% 4.57% 4.24% 4.29%
==== ==== ==== ==== ==== ==== ==== ====
- --------
(1) Prior to the fourth quarter of 1997, delinquency statistics for auto
finance receivables were not significant. For prior periods, delinquency
data for these receivables were included in other unsecured receivables.
Our managed consumer delinquency ratio at year end was up slightly from the
third quarter level primarily due to seasoning of the private label portfolio.
Although dollars of MasterCard and Visa delinquency decreased $42 million in
the fourth quarter, the percentage of delinquency increased from the third
quarter due to lower average MasterCard and Visa receivables.
The increase in the managed delinquency ratio from a year ago was mainly
due to the seasoning of the MasterCard and Visa and other unsecured portfolios
and the maturing of certain special promotional balances in our private label
portfolio.
The owned consumer delinquency ratio was 5.74 percent at December 31, 1998
and 4.77 percent at December 31, 1997.
Managed Consumer Net Chargeoff Ratios
1998 Quarter 1997 Quarter
Annualized Annualized
Full Year ---------------------- Full Year ---------------------- Full Year
1998 4 3 2 1 1997 4 3 2 1 1996
--------- ---- ---- ---- ---- --------- ---- ---- ---- ---- ---------
Home equity............. .58% .65% .68% .40% .58% .58% .59% .47% .60% .69% .55%
Auto finance(1)......... 5.39 5.63 4.89 5.18 5.95 4.68 5.33 -- -- -- --
MasterCard/Visa......... 6.29 7.66 6.98 5.31 5.65 5.35 5.45 6.24 5.13 4.59 3.97
Private label........... 6.05 6.22 5.46 6.43 6.02 4.84 5.47 5.02 4.58 4.32 3.49
Other unsecured......... 7.90 7.89 8.66 8.13 6.91 6.37 6.76 6.48 6.04 6.02 5.07
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Total................... 4.21% 4.35% 4.36% 4.10% 4.04% 3.69% 3.83% 3.81% 3.61% 3.47% 2.79%
==== ==== ==== ==== ==== ==== ==== ==== ==== ==== ====
- --------
(1) Includes ACC net chargeoffs subsequent to our acquisition in October 1997.
Prior to the fourth quarter of 1997, chargeoff statistics for auto finance
receivables were not significant and were included in other unsecured
receivables.
13
The annualized fourth quarter chargeoff ratio was down slightly from the
third quarter. Excluding the effect of lower MasterCard and Visa receivables,
the fourth quarter chargeoff ratio was 4.26 percent.
The managed consumer net chargeoff ratio for full-year 1998 was 4.21
percent, up from 3.69 percent in 1997 and 2.79 percent in 1996. The increase
was due to higher bankruptcy chargeoffs and the continued seasoning of the
private label and other unsecured portfolios. The owned consumer net chargeoff
ratio was 3.90 percent in 1998, 3.46 percent in 1997 and 2.81 percent in 1996.
Nonperforming Assets
At December 31
----------------------------------------------
1998 1997 1996
-------------- -------------- --------------
(All dollar amounts are stated in millions)
Nonaccrual owned receivables... $ 822.7 $ 726.0 $ 511.6
Accruing owned consumer
receivables 90 or more days
delinquent.................... 602.6 433.6 382.5
Renegotiated commercial loans.. 12.3 12.4 12.9
-------------- -------------- --------------
Total nonperforming owned
receivables................... 1,437.6 1,172.0 907.0
Real estate owned.............. 235.1 187.8 212.3
-------------- -------------- --------------
Total nonperforming owned
assets........................ $ 1,672.7 $ 1,359.8 $ 1,119.3
============== ============== ==============
Nonaccrual managed receivables. $ 1,165.5 $ 1,121.3 $ 787.5
Accruing managed consumer
receivables 90 or more days
delinquent.................... 707.7 639.1 502.2
Renegotiated commercial loans.. 12.3 12.4 12.9
-------------- -------------- --------------
Total nonperforming managed
receivables................... 1,885.5 1,772.8 1,302.6
Real estate owned.............. 235.1 187.8 212.3
-------------- -------------- --------------
Total nonperforming managed
assets...................... $ 2,120.6 $ 1,960.6 $ 1,514.9
============== ============== ==============
Managed credit loss reserves as
a percent of nonperforming
managed receivables........... 111.7% 119.9% 134.0%
============== ============== ==============
CREDIT LOSS RESERVES
We maintain credit loss reserves to cover probable losses of principal and
interest in both our owned and off-balance sheet portfolios. We estimate
losses for consumer receivables based on delinquency status and past loss
experience. For securitized receivables, we also record a provision for
estimated probable losses that we will incur over the life of the transaction.
For commercial loans, we calculate probable losses by using expected amounts
and timing of future cash flows to be received on loans. In addition, we
provide for general loss reserves on consumer and commercial receivables to
reflect our assessment of portfolio risk factors. Loss reserve estimates are
reviewed periodically and adjustments are reported in earnings when they
become known. These estimates are influenced by factors outside of our
control, such as economic conditions and consumer payment patterns. As a
result, there is uncertainty inherent in these estimates, making it reasonably
possible that they could change.
Owned credit loss reserves were $1,448.9 million, compared to $1,417.5
million at December 31, 1997. The ratio of credit loss reserves to total owned
receivables was 4.21 percent, compared with 4.38 percent at December 31, 1997,
reflecting the growing percentage of secured loans.
Total managed credit loss reserves were $2,105.3 million, compared with
$2,125.3 million at December 31, 1997. The ratio of credit loss reserves to
total managed receivables was 4.47 percent, compared with 4.21 percent at
December 31, 1997. The ratio of total credit loss reserves to total
nonperforming managed receivables was 111.7 percent, compared with 119.9
percent at December 31, 1997.
Our credit loss reserves for managed receivables reflect the mix of
unsecured products and seasoning of receivables. Unsecured products
historically have higher chargeoff rates than secured products. In 1996,
14
Beneficial recorded a $65 million up-front loss provision for the strong
private label receivables growth experienced during the year. During 1998,
managed credit loss reserves reflected the impact of the growing percentage of
secured loans. We have continued to refine and improve our underwriting
standards and account management techniques to better manage our credit risk.
LIQUIDITY AND CAPITAL RESOURCES
Generally, we are funded independently from our parent. Cash flows,
liquidity and capital are monitored at both HFC and Household International
levels. In managing capital, HFC and its wholly-owned subsidiary, Beneficial,
develop targets for equity to managed assets based on discussions with rating
agencies, reviews of regulatory requirements and competitor capital positions,
credit loss reserve strength, risks inherent in the projected operating
environment and acquisition objectives. We also specifically consider the
level of intangibles arising from acquisitions. These targets include capital
levels against both on-balance sheet assets and our off-balance sheet
portfolio. We received capital contributions from our parent company of $250.0
million in 1998, $976.5 million in 1997 and $200.2 million in 1996. We paid
cash dividends to our parent company of $690 million in 1998 and $250 million
in 1997. We did not pay any cash dividends to Household International in 1996.
Beneficial paid cash dividends of $75.4 million in 1998, $200.7 million
(including $80.0 million of treasury share purchases) in 1997 and $110.5
million in 1996.
Our major use of cash is the origination or purchase of receivables,
purchases of investment securities or acquisitions of businesses. Our main
sources of cash are the collection of receivable balances, maturities or sales
of investment securities, proceeds from the issuance of debt and
securitization of consumer receivables, capital contributions from the parent
company, and cash provided by operations.
We fund our operations by issuing commercial paper, medium- and long-term
debt to mainly wholesale investors, securitizing consumer receivables and
receiving capital contributions from our parent. Outstanding commercial paper
totaled $7.1 billion at December 31, 1998 and $9.1 billion at December 31,
1997. We market our commercial paper through an in-house sales force. We
actively manage the level of commercial paper outstanding to ensure
availability to core investors and proper use of any excess capacity within
internally established targets.
During 1998, we issued approximately $5.2 billion of five year-and-over
debt to lengthen maturities on our funding in order to reduce reliance on
commercial paper and securitizations as well as preserve liquidity.
We also market domestic medium-term notes through investment banks and our
in-house sales force. A total of $6.5 billion was issued in 1998. To obtain a
broader investment base, HFC and its subsidiary, Household Bank (Nevada) N.A.,
a credit card bank issuing non-GM Cards, periodically issue medium-term notes
in European and Asian markets. These markets provide us with a broader
investor base beyond the domestic markets. During 1998, $2.1 billion in
medium-term notes were issued in European and Asian markets compared with $1.9
billion in 1997. These notes were issued in various European and Asian
currencies and currency swaps were used to convert the notes to U.S. dollars
to eliminate future foreign exchange risk. During 1998, we also issued $3.7
billion of long-term debt with a weighted average original maturity of 8.6
years. In August 1997, we redeemed, at par of $100 million, all outstanding
shares of our 7.25 percent term cumulative preferred Series 1992-A, for $100
per depositary share plus accrued and unpaid dividends.
We had committed back-up lines of credit totaling $9.1 billion at December
31, 1998, of which $400 million were also available to our parent company.
None of these back-up lines were in use at December 31, 1998. In addition,
none of these lines contained a material adverse change clause which could
restrict availability. These back-up lines expire on various dates from 1999
through 2003. The only financial covenant contained in the terms of our credit
agreements is the maintenance of minimum shareholder's equity of $1.5 billion.
It is expected, however, that this covenant will be modified in 1999 to
reflect the new size of HFC as a result of the merger with Beneficial.
In connection with the Beneficial merger, we repurchased approximately $.7
billion of senior and senior subordinated debt in order to better align the
asset/liability position of the combined company. These debt
15
repurchases were funded with senior debt and other borrowings. Cash payments
of approximately $709 million for merger and integration related costs have
been and will continue to be funded through existing operations.
In 1998, HFC's wholly-owned subsidiary, Beneficial, had foreign operating
subsidiaries located in the United Kingdom, Canada and Germany. These
operating subsidiaries represented Beneficial's operations in these countries
prior to its merger with Household International and subsequent contribution
to HFC. As previously discussed, Beneficial sold its Canadian and German
operations during the first and second quarters of 1998, respectively.
Additionally, the United Kingdom operations were merged with and into
Household Global Funding, Inc. on December 22, 1998, effective June 30, 1998,
as previously discussed.
In 1997, we paid $1.1 billion for the stock of TFS and repaid about $2.7
billion of TFS debt owed to affiliates of Transamerica Corporation. We funded
this acquisition through the issuance of commercial paper, bank and other
borrowings. In addition, in 1997, we received a capital contribution of $1.0
billion from our parent company to repay debt.
Asset Securitizations
Securitizations of consumer receivables have been, and will continue to be,
a source of liquidity and capital management for HFC. The market for
securities backed by receivables is a reliable and cost-effective source of
funds. During 1998, excluding replenishments of prior securitizations, we
securitized about $2.9 billion of auto finance, MasterCard and Visa and other
unsecured receivables, compared with $6.1 billion in 1997 and $8.1 billion in
1996. At December 31, 1998, HFC had $12.7 billion of receivables sold under
securitization transactions. At December 31, 1998, the expected weighted
average remaining life of these transactions was 1.8 years.
The following table summarizes the expected amortization of our
securitizations by type:
At December 31, 1998
---------------------------------------------------
1999 2000 2001 2002 2003 Thereafter
-------- -------- -------- ------ ------ ----------
(In millions)
Home equity................. $1,709.1 $ 926.8 $ 505.3 $418.8 $ 77.4 --
Auto finance................ 404.5 275.9 170.9 95.6 13.4 --
MasterCard/Visa............. 520.2 1,804.6 1,072.7 -- -- --
Private label............... 161.5 80.0 570.0 -- -- --
Other unsecured............. 796.5 1,440.1 434.3 381.2 555.4 $285.0
-------- -------- -------- ------ ------ ------
Total..................... $3,591.8 $4,527.4 $2,753.2 $895.6 $646.2 $285.0
======== ======== ======== ====== ====== ======
For MasterCard and Visa and private label securitizations, the issued
securities may pay off sooner than originally scheduled if certain events
occur. One example of such an event is if the annualized portfolio yield
(defined as the sum of finance income and applicable fees, less net
chargeoffs) for a certain period drops below a base rate (generally equal to
the sum of the rate paid to the investors and the servicing fee). For home
equity and other unsecured securitizations, early pay-off of the securities
begins if the annualized portfolio yield falls below various limits, or if
certain other events occur. We do not presently believe that any of these
events will take place. If any such event occurred, our funding requirements
would increase. These additional requirements could be met through
securitizations, issuance of various types of debt or borrowings under
existing back-up lines of credit. We believe we would continue to have
adequate sources of funds if an early pay-off event occurred.
We and our affiliate, Household Bank, f.s.b., have facilities with
commercial banks under which we may collectively securitize up to $7.5 billion
of receivables. These facilities are renewable on an annual basis. At December
31, 1998, $5.8 billion of receivables were securitized under these programs.
The amount available under these facilities will vary based on the timing and
volume of public securitization transactions.
At December 31, 1998, our long-term debt, the long-term debt of Beneficial
and the preferred stock of the parent company have been assigned an investment
grade rating by four rating agencies. Furthermore, these
16
agencies include our commercial paper in their highest rating category. Three
of these agencies also include our parent company's commercial paper in their
highest rating category. With our back-up lines of credit and securitization
programs, we believe we have sufficient funding capacity to refinance maturing
debts and fund business growth.
Capital Expenditures
During 1998 we made $108 million in capital expenditures compared to the
prior-year level of $114 million.
Year 2000
Our conversion of certain computer systems to permit continued use in the
Year 2000 ("Y2K") and beyond began in 1996. The Year 2000 issue exists because
many computer systems and applications currently use two-digit date fields to
designate a year. As the century date change occurs, date-sensitive systems
may recognize the year 2000 as 1900, or not at all. The inability to recognize
or properly treat the Y2K may cause systems to process critical financial and
operational information incorrectly.
To address this issue, Household International has a dedicated Year 2000
Project team, responsible for all Household International business entities.
The project team is led by a full time Director of Y2K Compliance. Our plan
for addressing the Year 2000 issue is divided into three major phases:
Business Systems Inventory and Assessment, Remediation and Replacement, and
Testing and Implementation. We have identified our Y2K issues and were
substantially complete with remediation and testing of our significant systems
at December 31, 1998.
Business Systems Inventory and Assessment. The internal inventory portion
of this phase, which commenced in 1997 and has since been completed, was
designed to identify internal business systems which could be susceptible to
processing errors as a result of the Y2K issue. The Year 2000 Project team,
working with business unit project leaders, has identified approximately 2,000
components, consisting of hardware, software, business application systems,
service providers, business partners, and various systems containing embedded
processors. Approximately 500 internally developed business systems ("IT
systems") have been identified, as well as 325 unique pieces of hardware and
430 packaged vendor applications. All of these systems must, at a minimum, be
tested for Y2K compliance. In addition, we have identified and assessed our
"non-IT" systems. The remediation and replacement of these systems, which
include security systems, heating, ventilation and air conditioning systems,
elevators, and water treatment systems, are included in the plans discussed
below. Also as part of this phase, significant service providers, vendors,
suppliers, customers, and government entities believed to be critical to
business operations after January 1, 2000, have been identified and steps have
been undertaken to ascertain their stage of Y2K readiness through
questionnaires, interviews, contract amendments and other available means.
Remediation and Replacement. Household International and HFC have developed
and are in the process of implementing their remediation and replacement plan
for all affected IT and non-IT systems. Our plan established priorities for
remediation or replacement. We have used internal and external resources to
execute the plan and were substantially complete with all remediation and
replacement of significant systems at December 31, 1998, and expect to be
substantially complete with our remaining systems by the second quarter of
1999. We are on schedule to meet this objective.
Testing and Implementation. This third phase of the project is ongoing as
systems are remediated and replaced. Our efforts in this phase include testing
by technical resources, users and determination by appropriate Y2K project
management that the systems are Y2K compliant. We were substantially complete
with testing of significant systems at December 31, 1998, and expect to be
substantially complete with our remaining IT and non-IT systems by the second
quarter of 1999. We are on schedule to meet this objective.
Because our Y2K compliance is dependent on key third parties also being Y2K
compliant on a timely basis, we cannot assure that the systems of certain of
our key third parties (RAL program being dependent on the Internal Revenue
Service), upon which we rely, will be converted in a timely manner, or that
their failure to convert would not have an adverse effect on our systems. In a
worst-case scenario, one or more of our significant
17
systems or key third parties would not be Year 2000 compliant by the end of
1999 which could potentially, among other things, delay the
collection/processing of customer loan payments, impact the timeliness of loan
approvals, or cause the loss of key credit history information which we use to
market our products and services. We are currently developing contingency
plans to address the potential noncompliance of each of our third-party
vendors, as well as for the potential failure of internal significant systems.
Such contingency plans will be implemented immediately, if necessary. For each
system or service provided by a key third party, there are alternative
suppliers of such systems in the marketplace. The economical and operational
costs of converting to such alternative vendors or service providers have not
been specifically quantified but would not be expected to have a material
impact on our operations or financial results.
The costs for Year 2000 compliance have not been, and are not expected to
be, material to our operations. Household International currently estimates
that the aggregate cost of the Y2K effort will be approximately $20 million
after-tax, of which approximately $15 million has been incurred as of December
31, 1998.
Risk Management
We have a comprehensive program to address potential financial risks, such
as interest rate, counterparty and currency risk. The Finance Committee of
Household International's Board of Directors sets acceptable limits for each
of these risks annually and reviews the limits semi-annually.
Interest rate risk is defined as the impact of changes of market interest
rates on our earnings. HFC utilizes simulation models to measure the impact on
net interest margin of changes in interest rates. The key assumptions used in
this model include the rate at which we expect our loans to pay off, loan
volumes and pricing, cash flows from derivative financial instruments and
changes in market conditions. The assumptions we make are based on our best
estimates of actual conditions. The model cannot precisely predict the actual
impact of changes in interest rates on net income because these assumptions
are highly uncertain. At December 31, 1998, our interest rate risk levels were
substantially below those allowed by our existing policy.
We generally fund our assets with liabilities that have similar interest
rate features. This reduces structural interest rate risk. Over time, customer
demand for our receivable products shifts between fixed rate and floating rate
products, based on market conditions and preferences. These shifts result in
different funding strategies and produce different interest rate risk
exposures. To manage these exposures, as well as our liquidity position, we
may use derivatives to synthetically alter the repricing terms of our assets
or liabilities, or off-balance sheet transactions. We do not use any exotic or
leveraged derivatives.
At December 31, 1998, we managed about $22 billion of domestic receivables
that have variable interest rates, including credit card, home equity and
other unsecured products. These receivables have been funded with $8.2 billion
of short-term debt, with the remainder funded by intermediate and long-term
liabilities. This position exposes us to interest rate risk. We primarily use
interest rate swaps to alter our exposure to interest rate risk. These
transactions have no impact on liquidity risk. Interest rate swaps also are
used sometimes to synthetically alter our exposure to basis risk. This type of
risk exists because the pricing of some of our assets is tied to the prime
rate, while the funding for these assets is tied to LIBOR. The prime rate and
LIBOR react differently to changes in market interest rates; that is, the
prime rate does not change as quickly as LIBOR. We assign all of our synthetic
alteration and hedge transactions to specific groups of assets, liabilities or
off-balance sheet items.
The economic risk related to our interest rate swap portfolio is minimal.
The face amount of a swap transaction is referred to as the notional amount.
The notional amount is used to determine the interest payment to be paid by
each counterparty, but does not result in an exchange of principal payments.
For example, let's assume we have entered into a swap with the counterparty
whom we will call Bank A. Bank A agrees to pay us a fixed interest rate while
we agree to pay a variable rate. If variable rates for the accrual period are
below the fixed rate in the swap, Bank A owes us the difference between the
fixed rate and variable rate multiplied by the notional amount.
The primary exposure on our interest rate swap portfolio is the risk that
the counterparty (Bank A in this example) does not pay us the money they owe
us. We protect ourselves against counterparty risk in several ways.
18
Counterparty limits have been set and are closely monitored as part of the
overall risk management process. These limits ensure that we do not have
significant exposure to any individual counterparty. Based on peak exposure at
December 31, 1998, virtually all of our derivative counterparties are rated A+
or better. We have never suffered a loss due to counterparty failure. Certain
swap agreements that we have entered into require that payments be made to, or
received from, the counterparty when the fair value of the agreement reaches a
certain level.
We also utilize interest rate futures and purchased put and call options in
our hedging strategy to reduce interest rate risk. We use these instruments to
hedge the changes in interest rates on our variable rate assets and
liabilities. For example, short-term borrowings expose us to interest rate
risk because the interest rate we must pay to others may change faster than
the rate we received from borrowers on the asset our borrowings are funding.
We use futures and options to fix our interest cost on these borrowings at a
desired rate. We hold these contracts until the interest rate on the variable
rate asset or liability changes. We then terminate, or close out the
contracts. These terminations are necessary because the date the interest rate
changes is usually not the same as the expiration date of the futures contract
or option.
At December 31, 1998 and 1997, we estimated that our earnings would decline
by about $26 and $40 million, respectively, following a gradual 200 basis
point increase in interest rates over a twelve month period and would increase
by about $28 and $48 million, respectively, following a gradual 200 basis
point decrease in interest rates. These estimates assume we would not take any
corrective action to lessen the impact and, therefore, exceed what most likely
would occur if rates were to change.
We enter into currency swaps in order to minimize currency risk. These
swaps convert both principal and interest payments on debt issued from one
currency to another. For example, we may issue debt based on the French franc
and then execute a currency swap to convert the obligation to U. S. dollars.
See Note 9, "Derivative Financial Instruments and Other Financial
Instruments With Off-Balance Sheet Risk," for additional information related
to interest rate risk management.
In the accompanying consolidated financial statements, Note 10, "Fair Value
of Financial Instruments," provides information regarding the fair value of
certain financial instruments.
19
GLOSSARY OF TERMS
Acquired Intangibles and Goodwill--Intangible assets reflected on our
consolidated balance sheet resulting from the market value premium
attributable to our credit card accounts in excess of the aggregate
outstanding managed credit card loans acquired. Goodwill represents the
purchase price over the fair value of identifiable assets acquired less
liabilities assumed from business combinations.
Affinity Credit Card--A MasterCard or Visa account jointly sponsored by the
issuer of the card and an organization whose members share a common interest
(e.g., the AFL-CIO Union Privilege Credit Card Program).
Asset Securitization--The process where interests in a pool of financial
assets, such as credit card or home equity receivables, are sold to investors.
Typically, the receivables are sold to a trust that issues interests that are
sold to investors.
Auto Finance Loans--Closed-end loans secured by a first lien on a vehicle.
Co-Branded Credit Card--A MasterCard or Visa account jointly sponsored by
the issuer of the card and another corporation. The account holder typically
receives some form of added benefit for using the card (e.g., the GM Card).
Consumer Net Chargeoff Ratio--Net chargeoffs of receivables divided by
average receivables outstanding.
Contractual Delinquency--A method of determining delinquent accounts based
on the contractual terms of the original loan agreement.
Fee Income--Income associated with interchange on credit cards and annual,
late and other fees and from the origination or acquisition of loans.
Foreign Exchange Contract--A contract used to minimize our exposure to
changes in foreign currency exchange rates.
Futures Contract--An exchange-traded contract to buy or sell a stated
amount of a financial instrument or index at a specified future date and
price.
Home Equity Loan--Closed-end loans and revolving lines of credit secured by
first or second mortgages on residential real estate.
Interchange Fees--Fees received for processing a credit card transaction
through the MasterCard or Visa network.
Interest Rate Swap--Contract between two parties to exchange interest
payments on a stated principal amount (notional principal) for a specified
period. Typically, one party makes fixed rate payments, while the other party
makes payments using a variable rate.
LIBOR--London Interbank Offered Rate. A widely-quoted market rate which is
frequently the index used to determine that rate at which we borrow funds.
Liquidity--A measure of how quickly we can convert assets to cash or raise
additional cash by issuing debt.
Managed Basis--Method of reporting whereby net interest margin, other
revenues and credit losses on securitized receivables are reported as if those
receivables were still held on our balance sheet.
Managed Net Interest Margin--Interest income from managed receivables and
noninsurance investment securities reduced by interest expense.
20
GLOSSARY OF TERMS--(Continued)
Managed Receivables--The sum of receivables on our balance sheet and those
that we service for investors as part of our asset securitization program.
MasterCard/Visa Receivables--Receivables generated through use of MasterCard
and Visa credit cards.
Nonaccrual Loans--Loans on which we no longer accrue interest because
ultimate collection is unlikely.
Options--A contract giving the owner the right, but not the obligation, to
buy or sell a specified item at a fixed price for a specified period.
Other Unsecured Receivables--Unsecured lines of credit or closed-end loans
made to individuals.
Over-the-Life Reserves--Credit loss reserves established for securitized
receivables to cover estimated probable losses that we expect to incur over the
life of the transaction.
Owned Receivables--Receivables held on our balance sheet.
Private Label Credit Card--A line of credit made available to customers of
retail merchants evidenced by a credit card bearing the merchant's name.
Promotional Account--A private label credit card account that allows for
limited or deferred interest and/or principal payments for a certain period.
RAL Program--A cooperative program with H&R Block Tax Services, Inc. and
certain of its franchises, along with other independent tax preparers, to
provide loans to customers who are entitled to tax refunds and who
electronically file their returns with the Internal Revenue Service.
Receivables Serviced with Limited Recourse--Receivables we have securitized
and for which we have some level of potential loss if defaults occur.
Return on Assets--Net income divided by average assets.
Return on Average Common Shareholder's Equity--Net income less dividends on
preferred stock divided by average common shareholder's equity.
Return on Managed Assets--Net income divided by average managed assets.
Synthetic Alteration--Process by which derivative financial instruments are
used to alter the risk characteristics of an asset, liability or off-balance
sheet item.
21
Item 7A. Quantitative and Qualitative Disclosure about Market Risk.
Reference is made to the information contained under the caption "Risk
Management" of Item 7 of this Form 10-K for the information required by this
Item.
Item 8. Financial Statements and Supplementary Data.
Reference is made to the list of financial statements under Item 14(a)
herein for the financial statements required by this Item.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
PART III.
Item 10. Directors and Executive Officers of the Registrant.
Omitted.
Item 11. Executive Compensation.
Omitted.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Omitted.
Item 13. Certain Relationships and Related Transactions.
Omitted.
PART IV.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) Financial Statements.
Report of Independent Public Accountants.
Consolidated Statements of Income for the Three Years Ended December
31, 1998.
Consolidated Balance Sheets, December 31, 1998 and 1997.
Consolidated Statements of Cash Flows for the Three Years Ended
December 31, 1998.
Consolidated Statements of Changes in Preferred Stock and Common
Shareholder's Equity for the Three Years Ended December 31, 1998.
Notes to Consolidated Financial Statements.
Selected Quarterly Financial Data (Unaudited).
(b) Reports on Form 8-K.
A Current Report on Form 8-K was filed on November 16, 1998 by HFC during
the three months ended December 31, 1998.
22
(c) Exhibits.
3(i) Restated Certificate of Incorporation of Household Finance
Corporation, as amended (incorporated by reference to Exhibit
3(i) of our Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997).
3(ii) Bylaws of Household Finance Corporation (incorporated by
reference to Exhibit 3(b) of our Annual Report on Form 10-K for
the fiscal year ended December 31, 1992).
4(a) Indenture dated as of May 15, 1989, between HFC and Bankers
Trust Company, as Trustee (incorporated by reference to Exhibit
4 of our Current Report on Form 8-K dated August 3,1989), as
supplemented by a First Supplemental Indenture dated as of June
15, 1989 (incorporated by reference to Exhibit 4 of our Current
Report on Form 8-K dated June 15, 1989), as amended by Amendment
No. 1 dated October 18, 1990 to the First Supplemental Indenture
dated as of June 15, 1989 (incorporated by reference to Exhibit
4 of our Current Report on Form 8-K dated October 18, 1990).
4(b) Standard Multiple-Series Indenture Provisions for Senior Debt
Securities dated as of June 1, 1992 (incorporated by reference
to Exhibit 4(b) of our Registration Statement on Form S-3, No.
33-48854).
4(c) Indenture dated as of December 1, 1993 for Senior Debt
Securities between HFC and The Chase Manhattan Bank (National
Association), as Trustee (incorporated by reference to Exhibit
4(b) of our Registration Statement on Form S-3, No. 33-55561).
4(d) The principal amount of debt outstanding under each other
instrument defining the rights of holders of our long-term debt
does not exceed 10 percent of our total assets on a consolidated
basis. We agree to furnish to the Securities and Exchange
Commission, upon request, a copy of each instrument defining the
rights of holders of our long-term debt.
12 Statement of Computation of Ratios of Earnings to Fixed Charges
and to Combined Fixed Charges and Preferred Stock Dividends.
23 Consent of Arthur Andersen LLP, Certified Public Accountants.
27 Financial Data Schedule.
99.1 Ratings of Household Finance Corporation and its significant
subsidiaries.
23
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Household Finance Corporation has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
Household Finance Corporation
Dated: March 30, 1999
/s/ G. D. Gilmer
By:__________________________________
G. D. Gilmer, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of Household
Finance Corporation and in the capacities and on the dates indicated.
Signature Title
--------- -----
/s/ G. D. Gilmer President and Chief
____________________________________ Executive Officer, Director
G. D. Gilmer
/s/ W. F. Aldinger Director
____________________________________
W. F. Aldinger
/s/ D. A. Schoenholz Vice President, Chief Dated: March 30,
____________________________________ Accounting Officer and 1999
D. A. Schoenholz Chief Financial
Officer, Director
/s/ J. A. Vozar Vice President and Director
____________________________________
J. A. Vozar
24
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Household Finance Corporation:
We have audited the accompanying consolidated balance sheets of Household
Finance Corporation (a Delaware corporation) and subsidiaries as of December
31, 1998 and 1997, and the related consolidated statements of income, changes
in preferred stock and common shareholder's equity and cash flows for each of
the three years in the period ended December 31, 1998. These financial
statements are the responsibility of Household Finance Corporation's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Household Finance Corporation and subsidiaries as of December 31, 1998 and
1997, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 1998 in
conformity with generally accepted accounting principles.
Arthur Andersen LLP
/s/ Arthur Andersen LLP
Chicago, Illinois
January 20, 1999
F-1
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Year ended December 31
--------------------------
1998 1997 1996
-------- -------- --------
(In millions)
Finance income...................................... $4,581.4 $4,205.1 $3,913.8
Other interest income............................... 36.5 35.1 48.6
Interest expense.................................... 1,995.5 1,853.5 1,723.9
-------- -------- --------
Net interest margin................................. 2,622.4 2,386.7 2,238.5
Provision for credit losses on owned receivables.... 1,253.1 1,252.1 907.4
-------- -------- --------
Net interest margin after provision for credit
losses............................................. 1,369.3 1,134.6 1,331.1
-------- -------- --------
Securitization income............................... 1,058.5 1,232.0 912.4
Insurance revenues.................................. 352.9 352.9 336.6
Investment income................................... 146.7 152.6 212.7
Fee income.......................................... 498.7 514.8 290.3
Other income........................................ 239.2 310.5 257.0
Gain on sale of Beneficial Canada................... 189.4 -- --
-------- -------- --------
Total other revenues.............................. 2,485.4 2,562.8 2,009.0
-------- -------- --------
Salaries and fringe benefits........................ 921.7 925.3 805.4
Occupancy and equipment expense..................... 266.3 295.9 275.9
Other marketing expenses............................ 205.8 280.7 250.2
Other servicing and administrative expenses......... 417.8 656.5 592.6
Amortization of acquired intangibles and goodwill... 168.8 143.4 121.1
Policyholders' benefits............................. 207.6 236.6 286.8
Merger and integration related costs................ 1,000.0 -- --
-------- -------- --------
Total costs and expenses.......................... 3,188.0 2,538.4 2,332.0
-------- -------- --------
Income before income taxes.......................... 666.7 1,159.0 1,008.1
Income taxes........................................ 361.8 391.9 358.1
-------- -------- --------
Net income...................................... $ 304.9 $ 767.1 $ 650.0
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
At December 31
-------------------
1998 1997
--------- ---------
(In millions,
except share data)
Assets
Cash...................................................... $ 428.4 $ 545.3
Investment securities..................................... 2,944.4 2,336.8
Receivables, net.......................................... 34,283.2 32,152.5
Advances to parent company and affiliates................. 494.0 10.5
Acquired intangibles and goodwill, net.................... 1,682.7 1,777.9
Properties and equipment, net............................. 376.9 464.8
Real estate owned......................................... 235.1 187.8
Other assets.............................................. 1,918.3 1,973.3
--------- ---------
Total assets.......................................... $42,363.0 $39,448.9
========= =========
Liabilities and Shareholder's Equity
Debt:
Deposits................................................ -- $ 555.3
Commercial paper, bank and other borrowings............. $ 7,143.1 9,547.1
Senior and senior subordinated debt (with original
maturities over one year).............................. 27,186.1 20,909.2
--------- ---------
Total debt................................................ 34,329.2 31,011.6
Insurance policy and claim reserves....................... 1,076.2 1,182.3
Other liabilities......................................... 1,147.2 1,451.3
--------- ---------
Total liabilities......................................... 36,552.6 33,645.2
Common shareholder's equity:
Common stock, $1.00 par value, 1,000 shares authorized,
issued and outstanding at December 31, 1998 and 1997,
and additional paid-in capital......................... 2,960.3 2,555.1
Retained earnings....................................... 2,836.4 3,296.9
Accumulated other comprehensive income, net of tax...... 13.7 (48.3)
--------- ---------
Total common shareholder's equity......................... 5,810.4 5,803.7
--------- ---------
Total liabilities and shareholder's equity............ $42,363.0 $39,448.9
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31
----------------------------------
1998 1997 1996
---------- ---------- ----------
(In millions)
Cash Provided by Operations
Net income................................. $ 304.9 $ 767.1 $ 650.0
Adjustments to reconcile net income to net
cash provided by operations:
Provision for credit losses on owned
receivables.............................. 1,253.1 1,252.1 907.4
Non-cash merger and integration related
costs.................................... 291.0 -- --
Provision for loss on German disposal..... -- 58.8 --
Insurance policy and claim reserves....... 28.6 102.5 (866.3)
Depreciation and amortization............. 291.9 272.8 245.6
Net realized gains from sales of assets... (156.9) (78.3) (11.3)
Deferred income tax provision............. 259.1 17.8 (98.1)
Other, net................................ (355.5) (470.1) 200.1
---------- ---------- ----------
Cash provided by operations............. 1,916.2 1,922.7 1,027.4
---------- ---------- ----------
Investments in Operations
Investment securities available-for-sale:
Purchased................................. (1,304.4) (1,863.7) (2,100.7)
Matured................................... 308.5 264.3 696.6
Sold...................................... 848.3 1,694.9 2,932.1
Short-term investment securities, net
change.................................... (597.8) (32.3) (63.1)
Receivables:
Originations, net......................... (12,975.2) (15,418.9) (15,479.3)
Purchases and related premiums............ (2,937.8) (1,668.8) (4,811.4)
Sold...................................... 10,267.8 17,210.4 14,490.0
Purchase of Transamerica Financial Services
Holding Company capital stock............. -- (1,059.6) --
Transfer of foreign subsidiary to
affiliate................................. 340.0 -- --
Disposition of portfolios, net............. -- -- (640.7)
Properties and equipment purchased......... (107.6) (114.0) (131.4)
Properties and equipment sold.............. 42.5 2.7 5.6
Advances to parent company and affiliates,
net....................................... 363.4 (18.1) 127.2
---------- ---------- ----------
Cash decrease from investments in
operations............................. (5,752.3) (1,003.1) (4,975.1)
---------- ---------- ----------
Financing and Capital Transactions
Short-term debt and deposits, net change... (2,718.3) (186.1) 1,167.4
Senior and senior subordinated debt issued. 12,645.8 7,401.0 8,071.4
Senior and senior subordinated debt
retired................................... (4,869.6) (5,775.0) (4,881.1)
Prepayment of debt......................... (767.2) -- --
Repayment of Transamerica Financial
Services Holding Company debt............. -- (2,679.7) --
Policyholders' benefits paid............... (119.8) (120.9) (510.4)
Cash received from policyholders........... 63.7 57.1 98.2
Dividends on preferred stock............... -- (4.6) (7.2)
Redemption of preferred stock.............. -- (100.0) --
Dividends paid to parent company........... (690.0) (250.0) --
Dividends paid--pooled affiliate........... (75.4) (200.7) (110.5)
Capital contributions from parent company.. 250.0 976.5 200.2
---------- ---------- ----------
Cash increase (decrease) from financing
and capital transactions............... 3,719.2 (882.4) 4,028.0
---------- ---------- ----------
Increase (decrease) in cash............. (116.9) 37.2 80.3
Cash at January 1....................... 545.3 508.1 427.8
---------- ---------- ----------
Cash at December 31..................... $ 428.4 $ 545.3 $ 508.1
========== ========== ==========
Supplemental Cash Flow Information:
Interest paid............................. $ 1,928.4 $ 1,827.3 $ 1,947.2
Income taxes paid......................... 156.9 315.6 541.3
---------- ---------- ----------
Supplemental Non-Cash Investing and
Financing Activities:
Contribution of acquired company from
parent................................... -- $ 187.0 --
---------- ---------- ----------
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN PREFERRED STOCK AND
COMMON SHAREHOLDER'S EQUITY
Common Shareholder's Equity
------------------------------------------------
Common Accumulated
Stock and Other
Additional Comprehensive Total Common
Preferred Paid-in Retained Income, Shareholder's
Stock Capital Earnings Net of Tax(1) Equity
--------- ---------- -------- ------------- -------------
(All dollar amounts are stated in millions)
Balance at December 31,
1995................... $100.0 $1,130.6 $2,452.8 $ 56.7 $3,640.1
Net income............. 650.0 650.0
Other comprehensive
income, net of tax
Foreign currency
translation
adjustments......... 1.1 1.1
Unrealized loss on
investments, net of
reclassification
adjustment.......... (122.2) (122.2)
------ -------- -------- ------- --------
Total comprehensive
income................. 528.9
Dividends--pooled
affiliate(2)........... (110.5) (110.5)
Dividends on preferred
stock.................. (7.2) (7.2)
Contribution of capital
from parent company.... 200.2 200.2
Contribution of
capital--pooled
affiliate(2)........... 36.1 36.1
------ -------- -------- ------- --------
Balance at December 31,
1996................... 100.0 1,366.9 2,985.1 (64.4) 4,287.6
------ -------- -------- ------- --------
Net income............. 767.1 767.1
Other comprehensive
income, net of tax
Foreign currency
translation
adjustments......... (2.2) (2.2)
Unrealized gain on
investments, net of
reclassification
adjustment.......... 18.3 18.3
------ -------- -------- ------- --------
Total comprehensive
income................. 783.2
Dividends to parent
company................ (250.0) (250.0)
Dividends--pooled
affiliate(2)........... (200.7) (200.7)
Dividends on preferred
stock.................. (4.6) (4.6)
Redemption of preferred
stock.................. (100.0)
Contribution of capital
from parent company.... 1,163.5 1,163.5
Contribution of
capital--pooled
affiliate(2)........... 24.7 24.7
------ -------- -------- ------- --------
Balance at December 31,
1997................... -- 2,555.1 3,296.9 (48.3) 5,803.7
------ -------- -------- ------- --------
Net income............. 304.9 304.9
Other comprehensive
income, net of tax
Foreign currency
translation
adjustments......... 48.2 48.2
Unrealized gain on
investments, net of
reclassification
adjustment.......... 13.8 13.8
------ -------- -------- ------- --------
Total comprehensive
income................. 366.9
Dividends to parent
company................ (690.0) (690.0)
Dividends--pooled
affiliate(2)........... (75.4) (75.4)
Contribution of capital
from parent company.... 250.0 250.0
Contribution of
capital--pooled
affiliate(2)........... 155.2 155.2
------ -------- -------- ------- --------
Balance at December 31,
1998................... -- $2,960.3 $2,836.4 $ 13.7 $5,810.4
====== ======== ======== ======= ========
- --------
(1) At December 31, 1998, 1997, 1996 and 1995 items in the accumulated other
comprehensive income column include cumulative adjustments for: foreign
currency translation adjustments of $(8.3), $(56.5), $(54.3) and $(55.4)
million, respectively, and unrealized gains (losses) on marketable equity
securities and available-for-sale investments of $22.0, $8.2, $(10.1) and
$112.1 million, respectively. The gross unrealized gain (loss) on
available-for-sale investments at December 31, 1998, 1997 and 1996 of
$33.7, $12.6 and $(15.7) million, respectively, is recorded net of income
taxes (benefit) of $11.7, $4.4 and $(5.6) million, respectively.
(2) Relates to previous equity transactions of Beneficial Corporation.
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
Comprehensive Income
The following discloses the related tax effects allocated to each component
of other comprehensive income and reclassification adjustments:
At December 31
-------------------------------
Tax
(Expense)
Before-Tax Benefit Net-of-Tax
---------- --------- ----------
(In millions)
1996
Foreign currency translation adjustments....... $ (4.1) $ 5.2 $ 1.1
Unrealized losses on investments:
Unrealized holding losses arising during the
period...................................... (141.5) 48.1 (93.4)
Less: Reclassification adjustment for gains
realized in net income...................... (43.6) 14.8 (28.8)
------- ------ -------
Net unrealized losses on investments......... (185.1) 62.9 (122.2)
------- ------ -------
Other comprehensive loss................... $(189.2) $ 68.1 $(121.1)
======= ====== =======
1997
Foreign currency translation adjustments....... $ 5.9 $ (8.1) $ (2.2)
Unrealized gains on investments:
Unrealized holding gains arising during the
period...................................... 52.3 (18.4) 33.9
Less: Reclassification adjustment for gains
realized in net income...................... (24.0) 8.4 (15.6)
------- ------ -------
Net unrealized gains on investments.......... 28.3 (10.0) 18.3
------- ------ -------
Other comprehensive income................. $ 34.2 $(18.1) $ 16.1
======= ====== =======
1998
Foreign currency translation adjustments....... $ 48.0 $ .2 $ 48.2
Unrealized gains on investments:
Unrealized holding gains arising during the
period...................................... 26.9 (9.4) 17.5
Less: Reclassification adjustment for gains
realized in net income...................... (5.8) 2.1 (3.7)
------- ------ -------
Net unrealized gains on investments.......... 21.1 (7.3) 13.8
------- ------ -------
Other comprehensive income................. $ 69.1 $ (7.1) $ 62.0
======= ====== =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Household Finance Corporation ("HFC") is a wholly-owned subsidiary of
Household International, Inc. ("Household International" or the "parent
company"). HFC is a leading provider of consumer lending products to middle-
market customers in the United States and prior to December 1998, to customers
in the United Kingdom and Canada, with $47.1 billion of managed receivables at
December 31, 1998. HFC may also be referred to in these notes to the
consolidated financial statements as "we," "us" or "our." Our lending products
include: home equity loans, auto finance loans, MasterCard* and Visa* credit
cards, private label credit cards, tax refund anticipation loans and other
types of unsecured loans. We also offer credit and specialty insurance in the
United States, Canada, and prior to December 1998, in the United Kingdom. We
have two reportable segments: Consumer, which includes our branch-based
consumer finance, private label and auto finance businesses; and Credit Card,
which includes our domestic MasterCard and Visa business. We also have
commercial loans and leases, periodic payment annuities, and corporate owned
life insurance products which we no longer offer.
1. Summary of Significant Accounting Policies
Basis of Presentation. The consolidated financial statements include the
accounts of Household Finance Corporation and all subsidiaries. All
significant intercompany accounts and transactions have been