<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 8-K
CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED):
SEPTEMBER 1, 1998
HOUSEHOLD FINANCE CORPORATION
(Exact Name of Registrant as Specified in Charter)
DELAWARE
(State or Other Jurisdiction of Incorporation)
1-75 36-1239445
(Commission File Number) (IRS 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
================================================================================
<PAGE> 2
ITEM 5. OTHER EVENTS.
As previously reported by Household Finance Corporation on its Current
Report on Form 8-K dated and filed on June 30, 1998, subject to the terms and
conditions of the Agreement and Plan of Merger (the "Merger Agreement") dated as
of April 7, 1998 between Household International, Inc. ("Household"), the parent
of the Registrant, Household Acquisition Corporation II, a wholly-owned
subsidiary of Household, and Beneficial Corporation ("Beneficial"), Household
Acquisition Corporation II was merged with and into Beneficial, with Beneficial
being the surviving corporation (the "Merger"). In accordance with the Merger
Agreement, each share of the common stock, par value $1.00 per share, of
Beneficial ("Beneficial Common Stock") outstanding immediately prior to the
effective time of the Merger was converted into the right to receive 3.0666
shares of the common stock, $1.00 par value, of Household ("Household Common
Stock"), resulting in the issuance of approximately 168.4 million shares of
Household Common Stock. Upon completion of the Merger, substantially all of
Beneficial's net assets were contributed to the Registrant. The Merger was
accounted for as a "pooling of interests" under generally accepted accounting
principles.
The following consolidated financial statements of Household Finance
Corporation restate Household Finance Corporation's historical consolidated
financial statements as of and for the three years ended December 31, 1997 to
reflect the Merger and are filed as Exhibit 99.1 hereto. These consolidated
financial statements are intended to supersede the supplemental consolidated
financial statements of Household Finance Corporation previously included under
Item 5 in its Current Report on Form 8-K dated and filed on June 30, 1998.
1. Management's Discussion and Analysis.
2. Consolidated Balance Sheets as of December 31, 1997 and 1996.
3. Consolidated Statements of Income for the three years ended December 31,
1997.
4. Consolidated Statements of Changes in Stockholder's Equity for the three
years ended December 31, 1997.
5. Consolidated Statements of Cash Flows for the three years ended December
31, 1997.
6. Notes to the Consolidated Financial Statements.
The report of Arthur Andersen LLP, independent accountants, on the
consolidated financial statements of Household Finance Corporation as of
December 31, 1997 and 1996 and for the three years ended December 31, 1997 is
filed herewith as part of Exhibit 99.1 and the related consent is filed herewith
as Exhibit 23. Both the opinion and the consent are incorporated herein by
reference.
Household Finance Corporation's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1998 is also incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
(a) Financial Statements of Businesses Acquired.
Not applicable.
(b) Pro Forma Financial Information.
Not applicable.
(c) Exhibits.
<TABLE>
<S> <C>
Exhibit 12 Statement on the Computation of Ratio of Earnings to Fixed
Charges and to Combined Fixed Charges and Preferred Stock
Dividends.
Exhibit 23 Consent of Arthur Andersen LLP.
Exhibit 27 Restated Financial Data Schedule.
Exhibit 99.1 Consolidated Financial Statements of Household Finance
Corporation as of December 31, 1997 and 1996 and for the
three years ended December 31, 1997.
</TABLE>
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SIGNATURE
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
HOUSEHOLD FINANCE CORPORATION
Dated: September 1, 1998
By: /s/ JOHN W. BLENKE
-----------------------------------
John W. Blenke
Assistant Secretary
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EXHIBIT 12
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND
TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Income from continuing operations $ 767.1 $ 650.0 $ 412.3 $ 434.1 $ 406.4
Income taxes 391.9 358.1 295.3 252.0 236.6
-------- -------- -------- -------- --------
Income before income taxes 1,159.0 1,008.1 707.6 686.1 643.0
Fixed charges:
Interest expense (1) 1,863.0 1,727.9 1,675.9 1,330.2 1,166.1
Interest portion of rentals (2) 46.8 45.2 37.1 24.9 20.7
-------- -------- -------- -------- --------
Total fixed charges 1,909.8 1,773.1 1,713.0 1,355.1 1,186.8
Total earnings as defined $3,068.8 $2,781.2 $2,420.6 $2,041.2 $1,829.8
======== ======== ======== ======== ========
Ratio of earnings to fixed charges 1.61 1.57 1.41 1.51 1.54
======== ======== ======== ======== ========
Preferred stock dividends (3) $ 14.6 $ 19.4 $ 21.3 $ 19.6 $ 21.7
======== ======== ======== ======== ========
Ratio of earnings to combined fixed
charges and preferred stock dividends 1.59 1.55 1.40 1.48 1.51
======== ======== ======== ======== ========
</TABLE>
(1) For financial statement purposes, these amounts are reduced for income
earned on temporary investment of excess funds, generally resulting from
over-subscriptions of commercial paper issuances.
(2) Represents one-third of rentals, which approximates the portion
representing interest.
(3) Preferred stock dividends are grossed up to their pre-tax equivalents.
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
of our report dated June 30, 1998, included in this Current Report on Form 8-K
of Household Finance Corporation for the year ended December 31, 1997, into the
Company's previously filed Registration Statements No. 33-64175, 333-47945,
333-60543 and 333-59453 on Form S-3.
ARTHUR ANDERSEN LLP
Chicago, Illinois
September 1, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> YEAR YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1997<F1> DEC-31-1996<F1> DEC-31-1995<F1>
<PERIOD-END> DEC-31-1997 DEC-31-1996 DEC-31-1995
<CASH> 545,300 508,100 427,800
<SECURITIES> 2,336,800 2,281,000 4,724,400
<RECEIVABLES> 32,383,300 30,467,300 25,715,800
<ALLOWANCES> 2,125,300 1,745,900 1,280,100
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 0<F2> 0<F2> 0<F2>
<PP&E> 1,112,000 1,121,300 1,090,900
<DEPRECIATION> 647,200 647,700 621,600
<TOTAL-ASSETS> 39,448,900 36,324,900 33,297,600
<CURRENT-LIABILITIES> 0<F2> 0<F2> 0<F2>
<BONDS> 20,909,200 19,279,400 16,050,000
0 0 0
0 100,000 100,000
<COMMON> 1 1 1
<OTHER-SE> 5,803,700 4,287,600 3,640,100
<TOTAL-LIABILITY-AND-EQUITY> 39,448,900 36,324,900 33,297,600
<SALES> 0 0 0
<TOTAL-REVENUES> 6,803,000 5,971,400 5,474,400
<CGS> 0 0 0
<TOTAL-COSTS> 2,538,400 2,332,000 2,351,200
<OTHER-EXPENSES> 0 0 0
<LOSS-PROVISION> 1,252,100 907,400 774,800
<INTEREST-EXPENSE> 1,853,500 1,723,900 1,640,800
<INCOME-PRETAX> 1,159,000 1,008,100 707,600
<INCOME-TAX> 391,900 358,100 295,300
<INCOME-CONTINUING> 767,100 650,000 412,300
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 767,100 650,000 412,300
<EPS-PRIMARY> 0 0 0
<EPS-DILUTED> 0 0 0
<FN>
<F1>RESTATED
<F2>FINANCIAL STATEMENTS OF THE COMPANY WERE PREPARED IN ACCORDANCE WITH FINANCIAL
INSTITUTION INDUSTRY STANDARDS. ACCORDINGLY, THE COMPANY'S BALANCE SHEETS WERE
NON-CLASSIFIED.
</FN>
</TABLE>
<PAGE> 1
EXHIBIT 99.1
HOUSEHOLD FINANCE CORPORATION
INDEX TO FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Introduction................................................ 2
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 3
Glossary of Terms........................................... 16
Selected Quarterly Financial Data........................... 18
Report of Independent Public Accountants.................... 19
Consolidated Financial Statements........................... 20
Notes to Consolidated Financial Statements.................. 24
</TABLE>
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INTRODUCTION
Effective June 30, 1998, Household International, Inc. ("Household")
completed its merger with Beneficial Corporation ("Beneficial") bringing
together two of the oldest brands in the consumer finance industry which we
believe will create a preeminent branch based consumer finance company. Upon
completion of the merger, substantially all the net assets of Beneficial were
contributed by Household to Household Finance Corporation. At June 30, 1998, the
combined company had assets of $42.4 billion.
The merger has been accounted for as a pooling of interests and,
accordingly, the amounts for all periods reported in this filing are reported on
a combined basis including both Household Finance Corporation and Beneficial.
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HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Current Report on Form 8-K contains certain estimates and projections
regarding Household Finance Corporation and Household International, Inc., our
parent company, and its merger with Beneficial Corporation ("Beneficial"), that
may be forward-looking in nature, as defined by the Private Securities
Litigation Reform Act of 1995. A variety of factors may cause actual results to
differ materially from the results discussed in these forward-looking
statements. Factors that might cause such a difference are discussed herein and
in Household International's and Beneficial Corporation's Annual Reports on
Forms 10-K, for the year ended December 31, 1997, all filed with the Securities
and Exchange Commission.
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
UNLESS OTHERWISE INDICATED
-----------------------------------
1997 1996 1995
--------- --------- ---------
(ALL DOLLAR AMOUNTS IN MILLIONS)
<S> <C> <C> <C>
NET INCOME.................................................. $ 767.1 $ 650.0 $ 412.3
--------- --------- ---------
KEY PERFORMANCE RATIOS
Return on average owned assets.............................. 2.01% 1.88% 1.15%
Return on average common shareholder's equity............... 15.4 16.8 11.9
Managed net interest margin................................. 8.03 7.98 7.82
Managed consumer net chargeoff ratio(1)..................... 3.69 2.79 2.48
--------- --------- ---------
AT DECEMBER 31
Total assets:
Owned..................................................... $39,448.9 $36,324.9 $33,297.6
Managed (2)............................................... 57,491.9 51,159.1 43,622.6
Managed receivables (2)..................................... 50,426.3 45,301.5 36,040.9
Debt to equity ratio........................................ 5.3:1 6.7:1 6.6:1
--------- --------- ---------
</TABLE>
- ---------------
(1) Following the contribution of Beneficial, we adopted Beneficial's
presentation of chargeoffs related to private label receivables to reflect
interest and fee chargeoffs as a reversal against the respective line items
on the statement of income rather than as a reduction to the allowance for
credit losses. As a result, the managed consumer net chargeoff ratios have
been restated for all periods presented.
(2) Managed data includes receivables on our balance sheet and those that we
service for investors as part of our asset securitization program.
Household Finance Corporation ("HFC") is a wholly-owned subsidiary of
Household International, Inc. ("Household International" or the "parent
company"). We are a leading provider of consumer lending products to
middle-market customers primarily in the United States, Canada and the United
Kingdom, with $50.4 billion of managed receivables at December 31, 1997. Our
lending products include: home equity loans, auto finance loans, MasterCard* and
Visa* and private label credit cards, tax refund anticipation loans and other
unsecured loans. We offer credit and specialty insurance in the United States,
Canada and the United Kingdom. We also have commercial loans and leases,
periodic payment annuities, and corporate owned life insurance products, which
we no longer offer.
On June 30, 1998, Household International completed its merger with
Beneficial, a consumer finance holding company headquartered in Wilmington,
Delaware. 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
- ---------------
* MasterCard is a registered trademark of MasterCard International, Incorporated
and Visa is a registered trademark of VISA USA, Inc.
3
<PAGE> 4
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 of Beneficial were contributed by
Household International to HFC. Therefore, these 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 incurred
pre-tax merger and integration related costs of approximately $1 billion ($751
million after-tax) during the quarter ended June 30, 1998. These costs included
approximately $305 million in lease exit costs, $50 million in fixed asset
write-offs related to closed facilities, $255 million in severance and change in
control payments, $230 million in asset writedowns to reflect modified business
plans, $75 million in investment banking fees, $25 million in legal and other
expenses, and $60 million in prepayment premiums related to debt.
The merger and integration related costs included approximately $291
million in non-cash charges. Cash payments of approximately $709 million will be
funded through our existing operations, senior debt and other borrowings. In
addition, we expect to receive tax benefits of approximately $249 million.
Substantially all of the cash payments are expected to be made by the end of
1998.
OPERATIONS SUMMARY
- - Our net income in 1997 was $767.1 million, an increase of 18 percent over
1996. Net income in 1996 was $650.0 million, 58 percent higher than 1995
earnings of $412.3 million. Results in 1997 were impacted by an after-tax
provision of $27.8 million for the disposition of Beneficial's German
operations, an $8.2 million after-tax addition to Beneficial's litigation
reserves and a $10.6 million after-tax charge to write down Beneficial's real
estate holdings in Tampa, Florida and Houston, Texas that are being sold and
other reorganization and restructuring efforts. In addition, the tax
anticipation refund loan business ("RAL") profits decreased in 1997 compared
with 1996 which benefited from strong collections of previously written off
loans. Results in 1996 were impacted from the turnaround of the RAL business
whose results were severely impacted in 1995 due to the Internal Revenue
Service releasing certain portions of refunds directly to taxpayers.
Our return on average common shareholder's equity ("ROE") was 15.4 percent in
1997, compared to 16.8 percent in 1996, and up from 11.9 percent in 1995. The
decrease in 1997 was due to the capital contribution from Household
International in June 1997 to fund the purchase of Transamerica Financial
Services Holding Company, as discussed below, which decreased our leverage,
resulting in more of our assets being funded by equity as compared to the
prior year. Our return on average owned assets ("ROA") was 2.01 percent, up
from 1.88 percent in 1996 and 1.15 percent in 1995. Our net income and ROA
increased over the past three years due to growth in our consumer receivables
and because we have focused on our higher return businesses.
- - In June, 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. The integration of TFS is complete. We closed all
redundant branches and consolidated back office operations.
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. ACC makes loans to non-prime borrowers secured by
automobiles, primarily used vehicles sold through franchised dealers. Upon
completing this transaction, Household International contributed its
investment in ACC to HFC. The acquisition of ACC increased our market share in
the non-prime auto finance market and added key managers to grow this
business.
In late December 1997, Beneficial acquired Endeavour Personal Finance Ltd.,
including receivables of approximately $250 million, expanding our presence in
the United Kingdom.
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We accounted for each of these acquisitions as purchases. Thus, we have
included the results of operations of TFS, ACC and Endeavour in our statement
of income for 1997 from the closing dates of the transactions. These
acquisitions were not material to our financial statements.
In 1997, Beneficial announced its intent to sell its German operations and
recorded an after-tax loss of approximately $27.8 million after consideration
of a $31.0 million tax benefit primarily generated by the expected utilization
of capital losses. The sale of Beneficial's German operations was completed in
April 1998. No additional losses were realized as a result of the sale. During
the first quarter of 1998, the sale of Beneficial's Canadian operations was
completed. An after-tax gain of approximately $118.5 million was recorded. As
of December 31, 1997, the net assets of these sold operations were $121.5
million for Canada and $15.7 million for Germany. In 1997, the sold Canadian
operations reported pre-tax earnings of $21.2 million, while the German
operating pre-tax loss was $6.7 million.
- - In 1996 and 1995, we also exited several businesses that were providing
insufficient returns on our investment.
On March 31, 1996, Beneficial sold a $957 million annuity portfolio through a
co-insurance agreement. Approximately $900 million of investment securities
were sold as part of this disposition.
In October 1995, we sold certain of the individual life and annuity product
lines of our individual life insurance business. However, we retained our
credit life insurance business, which complements our consumer lending and
provides us additional revenue. We sold $6.1 billion of assets, which were
virtually all investment securities. We retained two product lines of the
individual life insurance business, but are no longer pursuing new business in
this area.
In the second quarter of 1995, we sold our purchased mortgage servicing rights
to a third party. The sale did not have a material impact on our operating
results.
- - The following summarizes operating results for our key businesses for 1997
compared to 1996 and 1995:
Our consumer finance business reported higher earnings due mainly to higher
levels of average managed receivables, particularly in unsecured loans. These
loans typically carry higher rates than secured products because they carry
more risk. More receivables, coupled with higher interest rates charged on
loans, resulted in higher net interest margin. The increase in margin was
partially offset by higher credit losses because more of our borrowers
declared personal bankruptcy. Personal bankruptcy filings in the U.S. were at
an all-time high in 1997.
Our MasterCard and Visa credit card business achieved higher earnings due to
higher net interest margin and fee income, and improved efficiency. These
factors were offset to some degree by higher credit losses resulting primarily
from increased personal bankruptcy filings. In late 1996 we started a program
designed to increase the return on our MasterCard and Visa portfolio. We sold
certain non-strategic portfolios, increased fees, and systematically
eliminated unprofitable accounts. This business continued to benefit from our
co-branding and affinity relationship strategies. This includes our alliance
with General Motors Corporation ("GM") to issue the GM Card, a co-branded
credit card. The GM Card continues to represent a substantial portion of our
credit card portfolio. The MasterCard and Visa business also includes the
AFL-CIO's Union Privilege affinity relationship which we acquired in June
1996. Union Privilege was created by the AFL-CIO to market benefits to union
members.
Our private label credit card business reported higher income resulting from a
wider net interest margin and higher late fees, partially offset by higher
credit losses due to the end of certain special promotions and increased
personal bankruptcies. Results in 1997 also benefited from the renegotiation
of contracts with several merchant partners. Additionally, in 1997, we began
to implement various initiatives to control the mix and increase the
profitability of promotional activity. Results in 1996 were impacted by
Beneficial's $65 million up-front loan loss provision on strong receivables
growth and $10 million in start-up costs relating to two of its merchants.
The RAL program reported lower profits in 1997 as compared with 1996, which
benefited from very strong collections on loans previously written off during
the 1995 season. Additionally, 1997 earnings were reduced by the July 1996
agreement with H&R Block Tax Services Inc. that gave them a share in both the
revenue and credit risk of certain RALs. RAL program fundamentals, however,
remained strong as the number of loans made in 1997 increased by 12% to 2.96
million from 2.65 million in 1996, while gross revenues grew
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31%. The RAL business incurred a pre-tax loss in 1995, which was severely
impacted by the Internal Revenue Service sending certain refunds directly to
taxpayers.
Our United Kingdom operation's net income increased because of revenue growth
from a larger receivable base. Owned receivables increased to $1.9 billion at
year-end 1997, up 45 percent from the end of 1996. The acquisition of
Endeavour Personal Finance Ltd. during the year contributed to this increase
in receivables.
Profits from our Canadian operation were down from 1996 as higher net interest
margin was offset by higher credit losses and higher operating expenses from
Beneficial's Canadian operations which were sold during the first quarter of
1998.
Harbour Island, Inc., our real estate subsidiary in Tampa, Florida, recorded
pre-tax losses in each of the prior three years, representing interest cost to
carry and non cash depreciation charges. The 1997 results reflected the sale
of the Athletic Club and residential land, and a writedown from the
anticipated loss on the sale of a People Mover System and its infrastructure.
Our commercial operations benefited from gains on the disposition of assets
while continuing to minimize credit losses.
- - Our managed net interest margin expanded to 8.03 percent in 1997 from 7.98
percent in 1996 and 7.82 percent in 1995. Our margins have increased over the
past three years because we have continued to raise the interest rates we
charge on most of our products. In addition, HFC's product mix has shifted
towards unsecured receivables, which have higher rates than secured products
because they carry more risk. The overall rate of increase has been tempered
by the impact of Beneficial's product mix which carries a higher percentage of
real estate secured receivables 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) increased to $57.5 billion at December 31, 1997 from
$51.2 billion at year-end 1996. The increase was due to receivable growth in
our consumer finance business. Owned assets totaled $39.4 billion at December
31, 1997, up from $36.3 billion at year-end 1996. Owned assets may vary from
period to period depending on the timing and size of asset securitization
transactions. We securitized $6.1 billion of receivables in 1997 and $8.1
billion of receivables during 1996. We refer to the securitized receivables
that are serviced for investors and not on our balance sheet as our
off-balance sheet portfolio.
- - Our consumer receivables grew during 1997, as shown in the following table:
<TABLE>
<CAPTION>
INCREASE (DECREASE) INCREASE (DECREASE)
DECEMBER 31, 1997 IN 1997/1996 IN 1996/1995
----------------- ------------------- -------------------
(ALL DOLLAR AMOUNTS ARE STATED IN MILLIONS)
<S> <C> <C> <C>
MANAGED RECEIVABLES:
Home equity................................. $18,512.7 27% 5%
Auto finance(1)............................. 872.4 -- --
MasterCard/Visa............................. 11,828.1 (3) 78
Private label............................... 8,679.5 -- 33
Other unsecured............................. 8,594.7 11 25
--------- --- ---
TOTAL CONSUMER......................... 48,487.4 12 29
--------- --- ---
Commercial.................................. 863.4 (13) (25)
Discontinued products(2).................... 1,075.5 (2) (1)
--------- --- ---
Total.................................. $50,426.3 11% 26%
========= === ===
</TABLE>
- ---------------
(1) Prior to 1997, auto finance receivables were not significant and were
included in other unsecured receivables.
(2) Discontinued products include receivables relating to Beneficial's disposed
Canadian operations in March 1998 and German operations in April 1998.
Growth in home equity and auto finance receivables benefited from
acquisitions during 1997. MasterCard and Visa receivables were down somewhat
from 1996 due to the sale and planned runoff of non-strategic and less
profitable receivables. Private label credit card receivables were flat
compared to last year. Other unsecured receivables were up from 1996 as we
experienced steady growth in our consumer finance business.
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<PAGE> 7
- - The managed consumer two-months-and-over contractual delinquency ratio
increased to 4.77 percent at December 31, 1997 from 3.96 percent at December
31, 1996. The 1997 managed consumer net chargeoff ratio was 3.69 percent
compared to 2.79 percent in 1996 and 2.48 percent in 1995.
- - We increased managed credit loss reserves 24 percent in 1997, to $2.1 billion
compared to $1.7 billion at December 31, 1996. This compares to an increase of
11 percent in total managed receivables in 1997. The increase in managed
reserves was due to continuing uncertainty about consumer payment patterns,
the maturing of our unsecured loan portfolios and the increase in our
off-balance sheet portfolio. Credit loss reserves as a percent of managed
receivables increased to 4.21 percent at year-end 1997 from 3.85 percent a
year ago.
- - Our debt to equity ratio was 5.3 to 1 compared to 6.7 to 1 at December 31,
1996. The decrease in the ratio was primarily due to the capital contribution
from Household International in June to fund the TFS acquisition.
STATEMENT OF INCOME REVIEW
Net Interest Margin. Net interest margin was $2,386.7 million for 1997, up
from $2,238.5 million in 1996 and $2,011.6 million in 1995. As a percent of
average owned interest-earning assets, net interest margin was 7.49 percent in
1997, 7.75 percent in 1996 and 8.05 percent in 1995. The decrease in the net
interest margin percentage in 1997 was the result of the change in product mix
in the owned portfolio due to asset securitizations, as discussed below. The
dollar increase over 1996 and 1995 was due to an increase in average owned home
equity loans and growth in private label receivables.
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 $3.8 billion for 1997 from $3.3 billion
in 1996. Net interest margin on a managed basis as a percent of average managed
interest-earning assets increased to 8.03 percent from 7.98 percent in 1996 and
7.82 percent in 1995.
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 $1,252.1 million
in 1997, compared to $907.4 million in 1996 and $774.8 million in 1995. As a
percent of average owned receivables, the provision was 3.98 percent compared to
3.23 percent in 1996 and 3.17 percent in 1995. The increase in 1997 was due to
higher chargeoffs on our unsecured portfolios. Over the past three years, we
recorded provisions for credit losses in excess of chargeoffs because of
continued uncertainty regarding consumer payment patterns, high levels of
personal bankruptcies and the maturing of our unsecured products. In 1996,
Beneficial recorded a $65 million up-front loan loss provision for the strong
private label receivables growth experienced during the year. The maturing or
seasoning of a product is the effect of a growing portfolio reaching expected
levels of chargeoffs as loans age. Owned provision in excess of owned chargeoffs
was $194.5 million in 1997, $151.0 million in 1996 and $108.5 million in 1995.
Other Revenues. Securitization income was $1,232.0 million in 1997, $912.4
million in 1996 and $548.2 million in 1995. 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 increased over
the three year period because of growth in average securitized receivables.
Insurance revenues of $352.9 million in 1997 were up from $336.6 million in
1996 but down from $404.4 million in 1995. The increase in 1997 was primarily
due to increased insurance sales on a larger portfolio. The
7
<PAGE> 8
decrease in 1996 from 1995 was due to the sale of Beneficial's annuity product
line in the first quarter of 1996 and HFC's individual life and annuity product
lines in the fourth quarter of 1995.
Investment income includes interest income on investment securities in the
retained insurance business as well as realized gains and losses from the sale
of investment securities. Investment income was $152.6 million in 1997 compared
to $212.7 million in 1996 and $508.4 million in 1995. The decrease in 1997 from
1996 was due to lower average investment balances and lower yields on the
securities in the portfolio. The large decline in 1996 from 1995 was because of
the sale of our insurance businesses.
Fee income on an owned basis includes revenues from fee-based products such
as credit cards. Fee income was $514.8 million in 1997, up from $290.3 million
in 1996 and $221.3 million in 1995. The increase in fee income in 1997 reflected
higher credit card fees as a result of increased average owned credit card
receivables compared to the prior years and higher interchange income.
Other income was $310.5 million in 1997, $257.0 million in 1996 and $139.7
million in 1995. Other income includes earnings from the RAL program, gains and
losses from the disposition of assets and businesses and, in 1995, income from
servicing receivable portfolios without recourse. Other income was up in 1997
reflecting gains on sales of certain non-strategic assets which included the
sale of certain non co-branded MasterCard and Visa receivables somewhat offset
by a decrease in RAL income as compared to the prior year. RAL income in 1996
benefited from very strong collections on loans previously written off during
the 1995 season. Other income in 1996 also included the gain related to the sale
of our annuity portfolio in the first quarter.
Expenses. Salaries and fringe benefits and other operating expenses were
$2,158.4 million in 1997, up from $1,924.1 million in 1996 and $1,747.9 million
in 1995. The increases were due to a higher number of sales people in our
consumer finance branch network and a higher number of collectors. Additionally,
we had higher expenses associated with growth in our managed receivable
portfolio. Average managed receivables grew 18 percent in 1997 compared to 1996
and 43 percent compared to 1995. Also contributing to the increase in 1997 were
higher expenses related to the TFS and ACC acquisitions. The overall combined
normalized managed efficiency ratio was 41.2% in 1997. Excluding the impact of
Beneficial, our normalized managed efficiency ratio was 34.5% in 1997.
During 1997, we recorded non-operating pretax charges of $90 million. These
charges included a $59 million provision for the planned disposition of
Beneficial's German operations, a $13 million addition to Beneficial's
litigation reserves, a $14 million writedown of Beneficial's real estate
holdings in both Tampa, Florida, and Houston, Texas, that are being sold, and a
$4 million charge for various Beneficial reorganization and restructuring
efforts. During 1996, we recorded non-operating charges of $19 million related
to closing office space, settling litigation and other matters. In 1995, we
recorded non-operating charges of $25 million. These charges included a $15
million provision for Beneficial's additional potential losses relating to a
significant liquidating loan portfolio in Germany and a $10 million
restructuring charge related to Beneficial's annuity business.
Amortization of acquired intangibles and goodwill was $143.4 million in
1997, $121.1 million in 1996 and $70.6 million in 1995. The increase reflects
our acquisitions of TFS in mid-1997 and ACC in late 1997, and the Union
Privilege portfolio in mid-1996.
Policyholders' benefits were $236.6 million in 1997, $286.8 million in 1996
and $532.7 million in 1995. Expense was lower in 1997 compared to 1996 because
we have fewer policies in our retained life insurance business. The decrease in
1996 from 1995 was due to the sale of our annuity product lines in 1996 and late
1995.
Income taxes. The 1997 effective tax rate was 33.8 percent compared to 35.5
percent in 1996 and 41.7 percent in 1995. The effective rate in 1997 recognized
tax benefits related to the anticipated sale of Beneficial's German operations.
The 1995 effective rate was affected by additional taxes on the sale of certain
of our insurance operations.
8
<PAGE> 9
In 1992, the Internal Revenue Service ("IRS") completed its examination of
Beneficial's federal income tax returns for 1984 through 1987. The IRS proposed
$142 million in adjustments that relate principally to activities of a former
subsidiary, American Centennial Insurance Company ("ACIC"), prior to its sale in
1987.
In order to limit the further accrual of interest on the proposed
adjustments, Beneficial paid $105.5 million of tax and interest during 1992.
The issues were not resolved during the administrative appeals process, and
the IRS issued a statutory Notice of Deficiency asserting the unresolved
adjustments and increased the disallowance to $195 million in 1996.
Beneficial has initiated litigation in the United States Tax Court to
oppose the disallowance. While the conclusion of this matter in its entirety
cannot be predicted with certainty, we do not anticipate the ultimate resolution
to differ materially from amounts accrued.
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 experienced by our industry over the last two
years has had a direct effect on the asset quality of our overall portfolio.
During 1997 our delinquency and net chargeoff levels were impacted by
higher consumer bankruptcies in our unsecured portfolios and the continued
maturing of our receivables. We continued to tighten and refine our credit
standards throughout the year and increased the number of collectors.
Until June 1997, when we acquired virtually all secured loans from TFS, the
percentage of unsecured loans in our portfolio had been increasing. Unsecured
loans were 60 percent of our managed consumer receivables at year-end 1997
compared to 66 percent in 1996 and 58 percent in 1995. Generally, unsecured
loans have higher delinquency and chargeoff rates than secured loans. The high
proportion of unsecured receivables increases the delinquency and chargeoff
statistics of the entire portfolio. We compensate for this by charging higher
interest rates and fees on these loans, which benefits our revenue.
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 for us. 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.
Our chargeoff policy for consumer receivables varies by product.
Receivables for HFC are written off, or for secured products written down to net
realizable value, at the following stages of contractual delinquency: auto
finance--5 months; first mortgage, home equity and MasterCard and Visa--6
months; private label--9 months; and other unsecured--9 months and no payment
received in 6 months. Beneficial, in general, charges off unsecured receivables
after no payment has been made for six months and secured receivables are
written down to net realizable value at the time of foreclosure. Commercial
receivables are written off when it becomes apparent that an account is
uncollectible.
The state of California accounts for 21 percent of our managed domestic
consumer portfolio. It 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. We will be able to extend this capability as the
centralization of underwriting, collections and processing functions contained
within the Beneficial branch network is completed.
9
<PAGE> 10
Our foreign consumer operations located in the United Kingdom and Canada
accounted for 4 and 2 percent, respectively, of managed consumer receivables at
December 31, 1997. German receivables accounted for less than one percent of
managed consumer receivables at year-end 1997.
MANAGED CONSUMER TWO-MONTHS-AND-OVER CONTRACTUAL DELINQUENCY RATIOS
<TABLE>
<CAPTION>
1997 QUARTER END 1996 QUARTER END
---------------------------------- ----------------------------------
4 3 2 1 4 3 2 1
---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Home equity.............................. 3.59% 3.03% 2.82% 3.05% 2.82% 3.14% 2.94% 2.87%
Auto finance(1).......................... 1.97 -- -- -- -- -- -- --
MasterCard/Visa.......................... 3.28 3.42 3.39 3.34 2.91 2.73 2.01 2.52
Private label............................ 6.01 5.85 5.25 4.82 4.69 4.73 4.35 4.05
Other unsecured.......................... 8.25 7.89 7.36 7.32 6.83 6.92 6.54 6.40
---- ---- ---- ---- ---- ---- ---- ----
Total............................... 4.77% 4.57% 4.24% 4.29% 3.96% 4.04% 3.60% 3.71%
==== ==== ==== ==== ==== ==== ==== ====
</TABLE>
- ---------------
(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 20 basis points
higher than the third quarter level. This increase was lower than the third
quarter increase of 33 basis points. The increases in these two quarters were
due to the expiration of certain special no-interest and no-payment promotions
in our private label portfolio, and seasoning of the other unsecured portfolio.
Home equity delinquency was up due to the maturing of acquired receivables.
MasterCard and Visa delinquency was down in the quarter.
The increase in the managed delinquency ratio from a year ago was mainly
due to the seasoning of all portfolios and the expiration of certain special
no-interest and no-payment promotions in our private label portfolio.
The owned consumer delinquency ratio was 4.77 percent at December 31, 1997
and 4.00 percent at December 31, 1996.
MANAGED CONSUMER NET CHARGEOFF RATIOS
<TABLE>
<CAPTION>
FULL 1997 QUARTER ANNUALIZED FULL 1996 QUARTER ANNUALIZED FULL
YEAR ---------------------------------- YEAR ---------------------------------- YEAR
1997 4 3 2 1 1996 4 3 2 1 1995
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Home equity........... .58% .59% .47% .60% .69% .55% .73% .54% .47% .47% .59%
Auto finance(1)....... 4.68 5.33 -- -- -- -- -- -- -- -- --
MasterCard/Visa....... 5.35 5.45 6.24 5.13 4.59 3.97 3.82 3.80 4.14 4.30 4.32
Private label(2)...... 4.84 5.47 5.02 4.58 4.32 3.49 3.97 3.78 3.84 4.14 3.91
Other unsecured....... 6.37 6.76 6.48 6.04 6.02 5.07 5.45 5.46 4.41 4.88 4.03
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Total............ 3.69% 3.83% 3.81% 3.61% 3.47% 2.79% 3.07% 2.92% 2.69% 2.78% 2.48%
==== ==== ==== ==== ==== ==== ==== ==== ==== ==== ====
</TABLE>
- ---------------
(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.
(2) Following the contribution of Beneficial, we adopted Beneficial's
presentation of chargeoffs related to private label receivables to reflect
interest and fee chargeoffs as a reversal against the respective line items
on the statement of income rather than as a reduction to the allowance for
credit losses. As a result, the managed consumer net chargeoff ratios have
been restated for all periods presented.
The annualized fourth quarter chargeoff ratio was up slightly from the
third quarter. In the private label portfolio, increased chargeoffs reflected
the maturing of promotional balances and higher personal bankruptcies. In our
other unsecured portfolio, higher chargeoffs resulted from continued seasoning
and high levels of
10
<PAGE> 11
personal bankruptcies. For the MasterCard and Visa portfolio, actual dollars of
chargeoffs were down over $20 million in the quarter, reflecting reductions in
both bankruptcies and credit chargeoffs. This resulted in a 79 basis point
decline in the MasterCard and Visa chargeoff ratio to 5.45 percent.
The managed consumer net chargeoff ratio for full year 1997 was 3.69
percent, up from 2.79 percent in 1996 and 2.48 percent in 1995. The increase was
due to higher bankruptcy chargeoffs in our MasterCard and Visa portfolio, the
expiration of certain private label promotional programs and seasoning of other
unsecured receivables. The owned consumer net chargeoff ratio was 3.46 percent
in 1997, 2.81 percent in 1996 and 2.89 percent in 1995.
NONPERFORMING ASSETS
<TABLE>
<CAPTION>
AT DECEMBER 31
--------------------------------
1997 1996 1995
-------- -------- --------
(ALL DOLLAR AMOUNTS ARE
STATED IN MILLIONS)
<S> <C> <C> <C>
Nonaccrual owned receivables................................ $ 726.0 $ 511.6 $ 654.5
Accruing owned consumer receivables 90 or more days
delinquent................................................ 433.6 382.5 145.9
Renegotiated commercial loans............................... 12.4 12.9 21.2
-------- -------- --------
Total nonperforming owned receivables.................. 1,172.0 907.0 821.6
Real estate owned........................................... 187.8 212.3 206.8
-------- -------- --------
Total nonperforming owned assets....................... $1,359.8 $1,119.3 $1,028.4
======== ======== ========
Nonaccrual managed receivables.............................. $1,121.3 $ 787.5 $ 831.3
Accruing managed consumer receivables 90 or more days
delinquent................................................ 639.1 502.2 202.8
Renegotiated commercial loans............................... 12.4 12.9 21.2
-------- -------- --------
Total nonperforming managed receivables................ 1,772.8 1,302.6 1,055.3
Real estate owned........................................... 187.8 212.3 206.8
-------- -------- --------
Total nonperforming managed assets.......................... $1,960.6 $1,514.9 $1,262.1
======== ======== ========
Managed credit loss reserves as a percent of nonperforming
managed receivables....................................... 119.9% 134.0% 121.3%
-------- -------- --------
</TABLE>
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 increased 21 percent to $1,417.5 million from
$1,169.7 million at December 31, 1996. The ratio of credit loss reserves to
total owned receivables was 4.38 percent, up from 3.84 percent at December 31,
1996.
Total managed credit loss reserves increased 22 percent to $2,125.3 million
from $1,745.9 million at December 31, 1996. The ratio of credit loss reserves to
total managed receivables was 4.21 percent, up from 3.85 percent at December 31,
1996. We increased credit loss reserves because of seasoning of unsecured
products and increased personal bankruptcies. Additionally, in 1996, Beneficial
recorded a $65 million up-front loan loss provision for the strong private label
receivables growth experienced during the year.
11
<PAGE> 12
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 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. HFC paid cash dividends to Household
International of $250 million in 1997 and $155 million in 1995. HFC did not pay
any cash dividends to Household International in 1996. Beneficial paid cash
dividends of $200.7 million (including $80.0 million of treasury share
purchases) in 1997, $110.5 million in 1996 and $99.7 million in 1995.
Our major use of cash is the origination or purchase of receivables or
purchases of investment securities. 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; and cash
provided by operations.
HFC, along with its wholly-owned subsidiary, Beneficial Corporation, funds
its 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 $8.3 billion
at December 31, 1997 and $8.5 billion at December 31, 1996. HFC markets its
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 utilization of any excess capacity within internally established targets.
We also market domestic medium-term notes through investment banks and our
in-house sales force, issuing a total of $5.1 billion in 1997. To obtain a
broader investment base, HFC and a subsidiary, Household Bank (Nevada) N.A.,
periodically issue medium-term notes in European and Asian markets. These
markets provide us with a broader investor base as compared with domestic
markets. During 1997, $1.9 billion in medium-term notes were issued in European
and Asian markets compared to $.9 billion in European markets in 1996. These
notes were issued in various European and Asian currencies and currency swaps
were used to convert the notes to U.S. dollars in order to eliminate future
foreign exchange risk. During 1997, we also issued $300 million of long-term
debt with an original maturity of 10 years. In August 1997, we redeemed, at par
of $100 million, all outstanding shares of our 7.25% 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 $10.5 billion at December
31, 1997, of which $400 million were available to our parent company. These
back-up lines include Beneficial's $3 billion syndicated revolving credit
agreement which supports its commercial paper issuances. None of these back-up
lines were used by us or our parent at December 31, 1997. 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 1998 through
2002. The only financial covenants contained in the terms of our credit
agreements are the maintenance of minimum shareholder's equity of $1.5 billion
as well as a $1 billion net worth test for Beneficial.
In connection with the Beneficial merger, we have repurchased or have
commitments to repurchase approximately $.7 billion of senior and senior
subordinated debt and bank and other borrowings. We funded the debt repurchase
with senior debt and other borrowings. Cash payments of approximately $709
million for merger and integration related costs will be funded through our
existing operations, senior debt and other borrowings.
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, we received a capital contribution of approximately $1.0 billion
from the parent company to repay debt.
HFC's wholly-owned subsidiary, Beneficial Corporation, has foreign
operating subsidiaries located in the United Kingdom, Canada and Germany. These
operating subsidiaries are directly owned by Beneficial
12
<PAGE> 13
Corporation, a wholly-owned subsidiary of HFC, and represent Beneficial's
operations in these countries prior to its merger with Household International,
HFC's parent, and subsequent contribution to HFC. Consolidated shareholder's
equity reflects the increase or decrease from translating our foreign
subsidiaries' assets, liabilities and operating results from their local
currency into U.S. dollars. We have entered into foreign exchange contracts to
hedge our investment in foreign subsidiaries to protect ourselves from
fluctuations in foreign currencies that are beyond our control. The potential
loss in net income associated with a 10% adverse change in the British pound/US
dollar or Canadian dollar/US dollar exchange rates is not material.
Each foreign subsidiary conducts its operations using its local currency,
raising funds chiefly on its own, with the guarantee of Beneficial Corporation
attached to maximize market depth and minimize cost. The Canadian and United
Kingdom subsidiaries both issue commercial paper through dealers. Canadian
commercial paper outstandings totaled $346 million at year-end 1997 and $230
million at year-end 1996. United Kingdom commercial paper outstandings totaled
$181 million at year-end 1997 and $267 million at year-end 1996. During 1997,
the Canadian and United Kingdom subsidiaries issued $110 million and $315
million, respectively, in medium-term notes and other public debt offerings. The
German subsidiary obtains funding primarily through deposits.
As previously discussed, Beneficial sold its Canadian and German operations
during the first and second quarters of 1998.
ASSET SECURITIZATIONS
Securitizations of consumer receivables have been, and will continue to be,
an important source of funds for HFC. The market for securities backed by
receivables is a reliable and cost-effective source of funds, which we plan to
use in the future. During 1997 we securitized about $6.1 billion of home equity,
MasterCard and Visa, private label and other unsecured receivables. As of
December 31, 1997, we have not securitized new auto loan originations subsequent
to the acquisition of ACC. The 1997 total securitization volume compares to $8.1
billion in sales in 1996 and $5.2 billion in 1995. At December 31, 1997, we had
$18.0 billion of receivables sold under securitization transactions. At December
31, 1997, the expected weighted average remaining life of these transactions was
2.3 years.
The following table summarizes the expected amortization of our
securitizations by type:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
------------------------------------------------------------------------------
1998 1999 2000 2001 2002 THEREAFTER
-------- -------- -------- -------- ------ ----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Home equity.................... $1,985.8 $1,374.7 $ 823.9 $ 577.8 $458.8 $ 817.6
Auto finance(1)................ 144.8 124.6 79.2 36.7 10.6 --
MasterCard/Visa................ 500.0 4,100.0 1,575.7 600.0 -- --
Private label.................. 213.5 161.5 -- 650.0 -- --
Other unsecured................ 863.2 628.9 502.3 466.7 460.3 886.4
-------- -------- -------- -------- ------ --------
Total..................... $3,707.3 $6,389.7 $2,981.1 $2,331.2 $929.7 $1,704.0
======== ======== ======== ======== ====== ========
</TABLE>
- ---------------
(1) Auto finance receivables were previously securitized by ACC before its
acquisition in October 1997.
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 payoff
event occurred.
13
<PAGE> 14
We and our affiliate, Household Bank, f.s.b., have facilities with
commercial banks under which we may collectively securitize up to $6.6 billion
of receivables. These facilities are renewable on an annual basis. At December
31, 1997, these facilities were fully utilized, of which we had securitized $5.6
billion. The amount available under these facilities will vary based on the
timing and volume of public securitization transactions.
At December 31, 1997, our long-term debt, the long-term debt of Beneficial
and preferred stock of our parent company have been assigned an investment grade
rating by four rating agencies. Furthermore, these agencies included 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 1997 we made $114 million in capital
expenditures compared to the prior-year level of $131 million.
Year 2000. The conversion of certain computer systems to permit continued
use in the Year 2000 and beyond began in prior years. 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 Year 2000 may cause systems to process critical
financial and operational information incorrectly. We have identified our Year
2000 issues and are scheduled to complete conversion and substantially complete
testing of our significant systems by the end of 1998. The costs for Year 2000
compliance have not been, and are not expected to be, material to our
operations. We currently estimate these costs on a consolidated Household
International level to be approximately $20 million after taxes. While we are
reviewing our third-party vendors' Year 2000 compliance, we cannot assure that
the systems of our vendors (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 third-party vendors would not be Year
2000 compliant by the end of 1998. We are currently developing contingency
plans, which we expect to have completed by the end of 1998, to address the
potential noncompliance of each of our third-party vendors. Such contingency
plans will be implemented immediately, if necessary. For each system provided by
a third-party vendor, there are alternative suppliers of such systems in the
marketplace. The economical and operational costs of converting to such
alternative vendors have not been specifically quantified but would not be
expected to have a material impact on our operations or financial results.
RISK MANAGEMENT
We have a comprehensive program to address potential financial risks. These
risks include 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, 1997, the combined company's interest rate
risk levels were substantially below those allowed by HFC's 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 terms of our assets or liabilities, or
off-balance sheet transactions. We do not use any exotic or leveraged
derivatives.
14
<PAGE> 15
At December 31, 1997, we managed about $26 billion of domestic receivables
that have variable interest rates, including credit card, home equity and other
unsecured products. These receivables have been funded with $8.3 billion of
short-term debt, with the remainder funded by 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 while still controlling 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. 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, 1997,
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 change. 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, 1997, we estimate that our earnings would decline by about
$40 million following a gradual 200 basis point increase in interest rates over
a twelve month period and would increase by about $48 million 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 supplemental consolidated financial statements, Note
11, "Fair Value of Financial Instruments," provides information regarding the
fair value of certain financial instruments.
15
<PAGE> 16
HOUSEHOLD FINANCE CORPORATION
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 that is jointly
sponsored by an organization that has a membership with 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 that is 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.
CREDIT LIFE INSURANCE--Insurance products that either pay off or continue
repaying a debt in the event of death, or temporary or permanent disability of
the borrower.
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.
16
<PAGE> 17
HOUSEHOLD FINANCE CORPORATION
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 customer usage
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 the estimated probable losses that we expect to incur over
the life of the transaction.
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 OWNED--Those receivables held on our balance sheet.
RECEIVABLES SERVICED WITH LIMITED RECOURSE--Those receivables that 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.
SYNTHETIC ALTERATION--Process by which derivative financial instruments are
used to alter the risk characteristics of an asset, liability or off-balance
sheet item.
17
<PAGE> 18
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
1997--THREE MONTHS ENDED 1996--THREE MONTHS ENDED
--------------------------------------------- -----------------------------------------
DECEMBER SEPTEMBER JUNE MARCH DECEMBER SEPTEMBER JUNE MARCH
-------- --------- -------- -------- -------- --------- ------ ------
(ALL DOLLAR AMOUNTS ARE STATED IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Finance income.......... $1,077.2 $1,084.8 $1,019.7 $1,023.4 $1,055.6 $1,005.9 $924.5 $927.8
Other interest income... 5.3 7.3 14.6 7.9 8.7 8.5 22.1 9.3
Interest expense........ 471.1 482.2 452.3 447.9 456.4 441.9 422.0 403.6
-------- -------- -------- -------- -------- -------- ------ ------
Net interest margin..... 611.4 609.9 582.0 583.4 607.9 572.5 524.6 533.5
Provision for credit
losses on owned
receivables........... 326.7 313.2 293.6 318.6 288.5 205.2 208.1 205.6
-------- -------- -------- -------- -------- -------- ------ ------
Net interest margin
after provision for
credit losses......... 284.7 296.7 288.4 264.8 319.4 367.3 316.5 327.9
-------- -------- -------- -------- -------- -------- ------ ------
Securitization income... 302.6 350.3 314.8 264.3 229.6 245.9 257.3 179.6
Insurance revenues...... 92.3 86.0 86.8 87.8 89.7 83.3 79.7 83.9
Investment income....... 37.5 41.3 36.5 37.3 34.1 44.1 45.2 89.3
Fee income.............. 176.9 135.1 106.6 96.2 82.6 78.8 67.7 61.2
Other income............ 22.1 65.5 56.7 166.2 25.3 46.7 64.1 120.9
-------- -------- -------- -------- -------- -------- ------ ------
Total other
revenues.......... 631.4 678.2 601.4 651.8 461.3 498.8 514.0 534.9
-------- -------- -------- -------- -------- -------- ------ ------
Salaries and fringe
benefits.............. 241.9 236.2 223.6 212.7 221.1 202.3 190.1 191.9
Other operating
expenses.............. 402.4 276.8 259.9 304.9 273.7 289.1 292.4 263.5
Amortization of acquired
intangibles and
goodwill.............. 38.4 38.6 33.3 33.1 33.0 32.1 34.0 22.0
Policyholders'
benefits.............. 56.9 56.9 57.9 64.9 59.7 69.9 66.9 90.3
-------- -------- -------- -------- -------- -------- ------ ------
Total costs and
expenses.......... 739.6 608.5 574.7 615.6 587.5 593.4 583.4 567.7
-------- -------- -------- -------- -------- -------- ------ ------
Income before income
taxes................. 176.5 366.4 315.1 301.0 193.2 272.7 247.1 295.1
Income taxes............ 36.9 132.7 111.1 111.2 59.5 99.4 90.5 108.7
-------- -------- -------- -------- -------- -------- ------ ------
Net income.............. $ 139.6 $ 233.7 $ 204.0 $ 189.8 $ 133.7 $ 173.3 $156.6 $186.4
======== ======== ======== ======== ======== ======== ====== ======
</TABLE>
18
<PAGE> 19
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,
1997 and 1996, and the related consolidated statements of income, consolidated
statements of changes in preferred stock and common shareholder's equity and
cash flows for each of the three years in the period ended December 31, 1997.
The consolidated statements give retroactive effect to the merger of Household
International, Inc. (parent company of Household Finance Corporation) and
Beneficial Corporation on June 30, 1998, which has been accounted for as a
pooling of interests as described in Note 2. These financial statements are the
responsibility of the Company'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 audits 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, 1997 and 1996,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 1997, after giving
retroactive effect to the merger of Household International, Inc., and
Beneficial Corporation as described in Note 2, in conformity with generally
accepted accounting principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois
June 30, 1998
19
<PAGE> 20
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------
1997 1996 1995
-------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Finance income.............................................. $4,205.1 $3,913.8 $3,605.3
Other interest income....................................... 35.1 48.6 47.1
Interest expense............................................ 1,853.5 1,723.9 1,640.8
-------- -------- --------
Net interest margin......................................... 2,386.7 2,238.5 2,011.6
Provision for credit losses on owned receivables............ 1,252.1 907.4 774.8
-------- -------- --------
Net interest margin after provision for credit losses....... 1,134.6 1,331.1 1,236.8
-------- -------- --------
Securitization income....................................... 1,232.0 912.4 548.2
Insurance revenues.......................................... 352.9 336.6 404.4
Investment income........................................... 152.6 212.7 508.4
Fee income.................................................. 514.8 290.3 221.3
Other income................................................ 310.5 257.0 139.7
-------- -------- --------
Total other revenues................................... 2,562.8 2,009.0 1,822.0
-------- -------- --------
Salaries and fringe benefits................................ 914.4 805.4 683.5
Other operating expenses.................................... 1,244.0 1,118.7 1,064.4
Amortization of acquired intangibles and goodwill........... 143.4 121.1 70.6
Policyholders' benefits..................................... 236.6 286.8 532.7
-------- -------- --------
Total costs and expenses............................... 2,538.4 2,332.0 2,351.2
-------- -------- --------
Income before income taxes.................................. 1,159.0 1,008.1 707.6
Income taxes................................................ 391.9 358.1 295.3
-------- -------- --------
Net income.................................................. $ 767.1 $ 650.0 $ 412.3
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
20
<PAGE> 21
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AT DECEMBER 31
----------------------
1997 1996
--------- ---------
(IN MILLIONS,
EXCEPT SHARE DATA)
<S> <C> <C>
ASSETS
Cash........................................................ $ 545.3 $ 508.1
Investment securities....................................... 2,336.8 2,281.0
Receivables, net............................................ 32,152.5 30,335.0
Advances to parent company and affiliates................... 10.5 --
Acquired intangibles and goodwill, net...................... 1,777.9 952.8
Properties and equipment, net............................... 464.8 473.6
Real estate owned........................................... 187.8 212.3
Other assets................................................ 1,973.3 1,562.1
--------- ---------
Total assets......................................... $39,448.9 $36,324.9
========= =========
LIABILITIES AND SHAREHOLDER'S EQUITY
Debt:
Deposits.................................................. $ 555.3 $ 635.0
Commercial paper, bank and other borrowings............... 9,547.1 9,392.8
Senior and senior subordinated debt (with original
maturities over one year).............................. 20,909.2 19,279.4
--------- ---------
Total debt........................................... 31,011.6 29,307.2
Insurance policy and claim reserves......................... 1,182.3 1,183.2
Borrowings from parent company and affiliates............... -- 7.6
Other liabilities........................................... 1,451.3 1,439.3
--------- ---------
Total liabilities.................................... 33,645.2 31,937.3
Preferred stock............................................. -- 100.0
Common shareholder's equity:
Common stock, $1.00 par value, 1,000 shares authorized,
issued and outstanding at December 31, 1997 and 1996,
and additional paid-in capital........................ 2,555.1 1,366.9
Retained earnings...................................... 3,296.9 2,985.1
Foreign currency translation adjustments............... (56.5) (54.3)
Unrealized gain (loss) on investments, net............. 8.2 (10.1)
--------- ---------
Total common shareholder's equity.................... 5,803.7 4,287.6
--------- ---------
Total liabilities and shareholder's equity........... $39,448.9 $36,324.9
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
21
<PAGE> 22
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------------
1997 1996 1995
---------- ---------- ----------
(IN MILLIONS)
<S> <C> <C> <C>
CASH PROVIDED BY OPERATIONS
Net income.................................................. $ 767.1 $ 650.0 $ 412.3
Adjustments to reconcile net income to net cash provided by
operations:
Provision for credit losses on owned receivables.......... 1,252.1 907.4 774.8
Provision for loss on German disposal..................... 58.8 -- 15.0
Insurance policy and claim reserves....................... 102.5 (866.3) 589.0
Depreciation and amortization............................. 272.8 245.6 225.6
Net realized gains from sales of assets................... (78.3) (11.3) (36.4)
Deferred income tax provision............................. 17.8 (32.5) (8.2)
Other, net................................................ (470.1) 134.5 193.2
---------- ---------- ----------
Cash provided by operations................................. 1,922.7 1,027.4 2,165.3
---------- ---------- ----------
INVESTMENTS IN OPERATIONS
Investment securities available-for-sale:
Purchased................................................. (1,863.7) (2,100.7) (3,490.7)
Matured................................................... 264.3 696.6 271.4
Sold...................................................... 1,694.9 2,932.1 2,525.9
Investment securities held-to-maturity:
Purchased................................................. -- -- (420.0)
Matured................................................... -- -- 263.8
Sold...................................................... -- -- 31.9
Short-term investment securities, net change................ (32.3) (63.1) 273.6
Receivables:
Originations, net......................................... (15,418.9) (15,479.3) (11,098.1)
Purchased................................................. (1,668.8) (4,811.4) (1,669.4)
Sold...................................................... 17,210.4 14,490.0 9,146.3
Purchase of Transamerica Financial Services Holding Company
capital stock............................................. (1,059.6) -- --
Disposition of product lines of life insurance business..... -- -- 575.0
(Acquisition) disposition of portfolios, net................ -- (640.7) (135.0)
Properties and equipment purchased.......................... (114.0) (131.4) (82.7)
Properties and equipment sold............................... 2.7 5.6 3.4
Advances to parent company and affiliates, net.............. (18.1) 127.2 362.7
---------- ---------- ----------
Cash decrease from investments in operations................ (1,003.1) (4,975.1) (3,441.9)
---------- ---------- ----------
FINANCING AND CAPITAL TRANSACTIONS
Short-term debt, net change................................. (186.1) 1,167.4 880.6
Senior and senior subordinated debt issued.................. 7,401.0 8,071.4 5,595.8
Senior and senior subordinated debt retired................. (5,775.0) (4,881.1) (4,709.2)
Repayment of Transamerica Financial Services Holding Company
debt...................................................... (2,679.7) -- --
Policyholders' benefits paid................................ (120.9) (510.4) (741.7)
Cash received from policyholders............................ 57.1 98.2 652.6
Dividends on preferred stock................................ (4.6) (7.2) (7.2)
Redemption of preferred stock............................... (100.0) -- --
Dividends paid to parent company............................ (250.0) -- (155.0)
Dividends paid--pooled affiliate............................ (200.7) (110.5) (99.7)
Capital contributions from parent company................... 976.5 200.2 1.4
---------- ---------- ----------
Cash increase (decrease) from financing and capital
transactions.............................................. (882.4) 4,028.0 1,417.6
---------- ---------- ----------
Increase in cash............................................ 37.2 80.3 141.0
Cash at January 1........................................... 508.1 427.8 286.8
---------- ---------- ----------
Cash at December 31......................................... $ 545.3 $ 508.1 $ 427.8
========== ========== ==========
Supplemental Cash Flow Information:
Interest paid............................................... $ 1,827.3 $ 1,947.2 $ 1,563.8
Income taxes paid........................................... 315.6 541.3 44.5
---------- ---------- ----------
Supplemental Non-Cash Investing and Financing Activities:
Contribution of acquired company from parent................ $ 187.0 -- --
---------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
22
<PAGE> 23
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN PREFERRED STOCK
AND COMMON SHAREHOLDER'S EQUITY
<TABLE>
<CAPTION>
COMMON SHAREHOLDER'S EQUITY
---------------------------------------------------
COMMON
STOCK AND TOTAL
ADDITIONAL COMMON
PREFERRED PAID-IN RETAINED SHAREHOLDER'S
STOCK CAPITAL EARNINGS OTHER(1) EQUITY
--------- ---------- -------- -------- -------------
(ALL DOLLAR AMOUNTS ARE STATED IN MILLIONS)
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1994............... $ 100.0 $1,105.1 $2,302.4 $(148.1) $3,259.4
Net income................................. 412.3 412.3
Dividends to parent company................ (155.0) (155.0)
Dividends--pooled affiliate(2)............. (.1) (99.7) (99.8)
Dividends on preferred stock............... (7.2) (7.2)
Contribution of capital from parent
company.................................. 1.4 1.4
Contribution of capital--pooled
affiliate(2)............................. 24.2 24.2
Foreign currency translation adjustments... .5 .5
Unrealized gain on investments, net........ 204.3 204.3
------- -------- -------- ------- --------
BALANCE AT DECEMBER 31, 1995............... 100.0 1,130.6 2,452.8 56.7 3,640.1
Net income................................. 650.0 650.0
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
Foreign currency translation adjustments... 1.1 1.1
Unrealized loss on investments, net........ (122.2) (122.2)
------- -------- -------- ------- --------
BALANCE AT DECEMBER 31, 1996............... 100.0 1,366.9 2,985.1 (64.4) 4,287.6
Net income................................. 767.1 767.1
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
Foreign currency translation adjustments... (2.2) (2.2)
Unrealized gain on investments, net........ 18.3 18.3
------- -------- -------- ------- --------
BALANCE AT DECEMBER 31, 1997............... $ -- $2,555.1 $3,296.9 $ (48.3) $5,803.7
======= ======== ======== ======= ========
</TABLE>
- ---------------
(1) At December 31, 1997, 1996, 1995 and 1994 items in the other column include
cumulative adjustments for unrealized gains (losses) on available-for-sale
investments of $8.2, $(10.1), $112.1 and $(92.2) million, respectively. The
gross unrealized gain (loss) on available-for-sale investments at December
31, 1997, 1996 and 1995 of $12.6, $(15.7) and $169.4 million, respectively,
is recorded net of income taxes (benefit) of $4.4, $(5.6) and $57.3 million,
respectively.
(2) Relates to previous equity transactions of Beneficial Corporation.
The accompanying notes are an integral part of these consolidated financial
statements.
23
<PAGE> 24
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Household Finance Corporation ("HFC" or the "company") is a wholly-owned
subsidiary of Household International, Inc. ("Household International" or the
"parent company"). The company is a leading provider of consumer lending
products to middle-market customers primarily in the United States, Canada and
the United Kingdom, with $50.4 billion of managed receivables at December 31,
1997. The company's lending products include: home equity loans, auto finance
loans, MasterCard* and Visa* and private label credit cards, tax refund
anticipation loans and other unsecured loans. The company also offers credit and
specialty insurance in the United States, Canada and the United Kingdom. The
company also has commercial loans and leases, periodic payment annuities, and
corporate owned life insurance products, which it no longer offers.
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 eliminated. Certain prior year
amounts have been reclassified to conform with the current year's presentation.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Investment Securities. The company maintains investment portfolios in both
its noninsurance and insurance operations. These portfolios are comprised
primarily of debt securities. The company's entire investment securities
portfolio was classified as available-for-sale at December 31, 1997 and 1996.
Available-for-sale investments are intended to be invested for an indefinite
period but may be sold in response to events reasonably expected in the
foreseeable future. These investments are carried at fair value. Unrealized
holding gains and losses on available-for-sale investments are recorded as
adjustments to common shareholder's equity, net of income taxes. Any decline in
the fair value of investments which is deemed to be other than temporary is
charged against current earnings.
Cost of investment securities sold is determined using the specific
identification method. Interest income earned on the noninsurance investment
portfolio is classified in the statements of income in net interest margin.
Realized gains and losses from the investment portfolio and investment income
from the insurance portfolio are recorded in investment income. Accrued
investment income is classified with investment securities.
Receivables. Receivables are carried at amortized cost. The company
periodically sells receivables from its home equity, auto finance, MasterCard
and Visa, private label and other unsecured portfolios. Because these
receivables were originated with variable rates of interest or rates comparable
to those currently offered by the company, carrying value approximates fair
value.
Finance income is recognized using the effective yield method. Origination
fees are deferred and amortized to finance income over the estimated life of the
related receivables, except to the extent they offset directly related lending
costs. Annual fees are netted with direct lending costs associated with the
issuance of MasterCard and Visa receivables and are deferred and amortized on a
straight-line basis over one year. Net deferred lending costs related to these
receivables totaled $8.6 and $1.2 million at December 31, 1997 and 1996,
respectively. Premiums and discounts on purchased receivables are recognized as
adjustments of the yield of the related receivables.
Insurance reserves applicable to credit risks on consumer receivables are
treated as a reduction of receivables in the balance sheets, since payments on
such policies generally are used to reduce outstanding receivables.
- ---------------
* MasterCard is a registered trademark of MasterCard International, Incorporated
and Visa is a registered trademark of VISA USA, Inc.
24
<PAGE> 25
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Provision and Credit Loss Reserves. Provision for credit losses on owned
receivables is made in an amount sufficient to maintain credit loss reserves at
a level considered adequate to cover probable losses of principal and interest
in the existing owned portfolio. Probable losses are estimated for consumer
receivables based on contractual delinquency status and historical loss
experience. For commercial loans, probable losses are calculated using estimates
of amounts and timing of future cash flows expected to be received on loans. In
addition, general loss reserves on consumer and commercial receivables are
maintained to reflect management's judgment of portfolio risk factors. Loss
reserve estimates are reviewed periodically and adjustments are reported in
earnings when they become known. As these estimates are influenced by factors
outside the company's control, such as consumer payment patterns and economic
conditions, there is uncertainty inherent in these estimates, making it
reasonably possible that they could change.
The company's chargeoff policy for consumer receivables varies by product.
Receivables for HFC are written off, or for secured products written down to net
realizable value, at the following stages of contractual delinquency: auto
finance--5 months; home equity and MasterCard and Visa--6 months; private label
- --9 months; and other unsecured--9 months and no payment received in 6 months.
Beneficial, in general, charges off unsecured receivables after no payment has
been made for six months and secured receivables are written down to net
realizable value at the time of foreclosure. Commercial receivables are written
off when it becomes apparent that an account is uncollectible.
Nonaccrual Loans. Nonaccrual loans are loans on which accrual of interest
has been suspended. Interest income is suspended on all loans when principal or
interest payments are more than three months contractually past due, except for
MasterCard and Visa and private label credit cards and auto finance receivables.
On credit card receivables, interest continues to accrue until the receivable is
charged off. On auto finance receivables, accrual of interest income is
discontinued when payments are more than two months contractually past due.
There were no commercial loans at December 31, 1997 which were 90 days or more
past due which remained on accrual status. Accrual of income on nonaccrual
consumer receivables is not resumed until such receivables become less than
three months contractually past due (two months for auto finance receivables).
Accrual of income on nonaccrual commercial loans is not resumed until such loans
become contractually current. Cash payments received on nonaccrual commercial
loans are either applied against principal or reported as interest income,
according to management's judgment as to the collectibility of principal.
Receivables Sold and Serviced with Limited Recourse and Securitization
Income. Certain home equity, auto finance, MasterCard and Visa, private label
and other unsecured receivables have been securitized and sold to investors with
limited recourse. The servicing rights to these receivables have been retained
by the company. Upon sale, the receivables are removed from the balance sheet,
and a gain on sale is recognized for the difference between the carrying value
of the receivables and the adjusted sales proceeds. The adjusted sales proceeds
are based on a present value estimate of future cash flows to be received over
the lives of the receivables. Future cash flows are based on estimates of
prepayments, the impact of interest rate movements on yields of receivables sold
and securities issued, delinquency of receivables sold, servicing fees,
operating expenses and other factors. The resulting gain is adjusted by
establishing a reserve for estimated probable losses under the recourse
provisions. Gains on sale, recourse provisions and servicing cash flows on
receivables sold are reported in the accompanying consolidated statements of
income as securitization income. Unamortized securitization assets are reviewed
for impairment whenever events indicate that the carrying value may not be
recovered.
Effective January 1, 1997, the company adopted Statement of Financial
Accounting Standards No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" ("FAS No. 125"), which
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishment of liabilities based on a derecognition
approach that focuses on control of the assets and extinguishment of the
liabilities. The statement was effective for securitization transactions
occurring
25
<PAGE> 26
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
subsequent to December 31, 1996. The adoption of FAS No. 125 did not have a
material impact on the company's consolidated financial statements.
Properties and Equipment. Properties and equipment, which include leasehold
improvements, are recorded at cost, net of accumulated depreciation and
amortization of $647.2 and $647.7 million at December 31, 1997 and 1996,
respectively. Depreciation is provided on a straight-line basis over the
estimated useful lives of the assets for financial reporting purposes. Leasehold
improvements are amortized over the lesser of the economic useful life of the
improvement or the term of the lease.
Repossessed Collateral. Real estate owned is valued at the lower of cost or
fair value less estimated costs to sell. These values are periodically reviewed
and reduced, if appropriate. Costs of holding real estate, and related gains and
losses on disposition, are credited or charged to operations as incurred.
Vehicles acquired for nonpayment of indebtedness are recorded at the lower
of the estimated fair market value or the outstanding receivable balance. Such
assets are generally sold within 60 days of repossession and any difference
between the sales price, net of expenses, and the carrying value is credited or
charged to operations as incurred.
Insurance. Insurance revenues on revolving credit insurance policies are
recognized when billed. Insurance revenues on the remaining insurance contracts
are recorded as unearned premiums and recognized into income based on the nature
and term of the underlying contracts. Liabilities for credit insurance policies
are based upon estimated settlement amounts for both reported and incurred but
not yet reported losses. Liabilities for future benefits on annuity contracts
and specialty and corporate owned life insurance products are based on actuarial
assumptions as to investment yields, mortality and withdrawals.
Acquired Intangibles and Goodwill. Acquired intangibles consist of acquired
credit card relationships which are amortized on a straight-line basis over
their estimated remaining lives, not to exceed 10 years.
Goodwill represents the purchase price over the fair value of identifiable
assets acquired less liabilities assumed from business combinations and is
amortized over 25 years on a straight-line basis. Goodwill is reviewed for
impairment whenever events indicate that the carrying amount may not be
recoverable.
Interest Rate Contracts. The nature and composition of the company's assets
and liabilities and off-balance sheet items expose the company to interest rate
risk. The company enters into a variety of interest rate contracts for managing
its interest rate exposure. Interest rate swaps are the principal vehicle used
to manage interest rate risk; however, interest rate futures, options, caps and
floors, and forward contracts also are utilized. The company also has entered
into currency swaps to convert both principal and interest payments on debt
issued from one currency to the appropriate functional currency.
Interest rate swaps are designated, and effective, as synthetic alterations
of specific assets or liabilities (or specific groups of assets or liabilities)
and off-balance sheet items. The interest rate differential to be paid or
received on these contracts is accrued and included in net interest margin in
the statements of income. Interest rate futures, forwards, options, and caps and
floors used in hedging the company's exposure to interest rate fluctuations are
designated, and effective, as hedges of balance sheet items.
Correlation between all interest rate contracts and the underlying asset,
liability or off-balance sheet item is direct because the company uses interest
rate contracts which mirror the underlying item being hedged/synthetically
altered. If correlation between the hedged/synthetically altered item and
related interest rate contract would cease to exist, the interest rate contract
would be recorded at fair value and the associated unrealized gain or loss would
be included in net interest margin, with any future realized and unrealized
gains or losses recorded in other income.
Interest rate contracts are recorded at amortized cost. If interest rate
contracts are terminated early, the realized gains and losses are deferred and
amortized over the life of the hedged/synthetically altered item as
26
<PAGE> 27
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
adjustments to net interest margin. These deferred gains and losses are recorded
on the accompanying consolidated balance sheets as adjustments to the carrying
value of the hedged items. In circumstances where the underlying assets or
liabilities are sold, any remaining carrying value adjustments or cumulative
change in value on any open positions are recognized immediately as a component
of the gain or loss upon disposition. Any remaining interest rate contracts
previously designated to the sold hedged/synthetically altered item are recorded
at fair value with realized and unrealized gains and losses included in other
income.
Income Taxes. The company and its subsidiaries are included in Household
International's consolidated federal income tax return and in various
consolidated state income tax returns. Beneficial Corporation will be included
in Household International's consolidated federal and state income tax returns
for periods subsequent to the merger. In addition, the company files some
unconsolidated state tax returns. Federal income taxes are accounted for
utilizing the liability method. Deferred tax assets and liabilities are
determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
2. HOUSEHOLD INTERNATIONAL MERGER WITH BENEFICIAL CORPORATION
On June 30, 1998, Household International ("Household"), our parent
company, completed its merger with Beneficial Corporation ("Beneficial"), a
consumer finance holding company headquartered in Wilmington, Delaware.
Beneficial's total assets were $16.1 billion and common shareholders' equity was
$2.0 billion on the date of the merger, excluding the impact of the merger and
integration related costs. Each outstanding share of Beneficial common stock was
converted into 3.0666 shares of Household's common stock, resulting in the
issuance of approximately 168.4 million common shares to the former Beneficial
shareholders. Each share of Beneficial $5.50 Convertible Preferred Stock was
converted into the number of shares of Household common stock the holder would
have been entitled to receive in the merger had the holder converted his or her
shares of Beneficial $5.50 Convertible Preferred Stock into shares of Beneficial
common stock immediately prior to the merger. Additionally, each other share of
preferred stock of Beneficial outstanding immediately prior to the merger has
been converted into one share of a newly-created series of preferred stock of
Household 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 of Beneficial were
contributed by Household to HFC. Therefore, these consolidated financial
statements include the results of operations, financial position, and changes in
cash flows of Beneficial for all periods presented.
The separate results of operations for HFC and Beneficial were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
-------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Net interest margin and other revenues(1)
HFC....................................... $2,713.2 $2,115.9 $1,820.7
Beneficial................................ 1,999.7 1,844.8 1,480.2
-------- -------- --------
Total............................. $4,712.9 $3,960.7 $3,300.9
======== ======== ========
Net Income
HFC....................................... $ 513.4 $ 369.0 $ 261.8
Beneficial................................ 253.7 281.0 150.5
-------- -------- --------
Total............................. $ 767.1 $ 650.0 $ 412.3
======== ======== ========
</TABLE>
- ---------------
(1) Policyholder's benefits have been netted against other revenues.
In connection with the merger, Household and HFC incurred pre-tax merger
and integration related costs of approximately $1 billion ($751 million
after-tax) during the quarter ended June 30, 1998. These costs
27
<PAGE> 28
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
included approximately $305 million in lease exit costs, $50 million in fixed
asset write-offs related to closed facilities, $255 million in severance and
change in control payments, $230 million in asset writedowns to reflect modified
business plans, $75 million in investment banking fees, $25 million in legal and
other expenses, and $60 million in prepayment premiums related to debt.
3. OTHER BUSINESS COMBINATIONS AND DIVESTITURES
On April 28, 1998, the sale of Beneficial's German operations was
completed. An after tax loss of $27.8 million was recorded in the fourth quarter
of 1997. This loss was recorded after consideration of a $31.0 million tax
benefit, primarily generated by the expected utilization of capital losses to
cover the expected loss associated with disposing of the German operations. No
additional losses were realized in 1998 as a result of the sale.
On March 2, 1998, the sale of Beneficial's Canadian operations was
completed. An after tax gain of $118.5 million was recorded upon consummation of
the transaction.
On June 23, 1997, Household International and a wholly-owned subsidiary of
HFC acquired the capital stock of Transamerica Financial Services Holding
Company ("TFS"), the branch-based consumer finance subsidiary of Transamerica
Corporation ("TA"). The company paid $1.1 billion for the stock of TFS and
repaid approximately $2.7 billion of TFS debt owed to affiliates of TA. The
acquisition added approximately $3.1 billion of real estate secured receivables.
The acquisition of TFS was accounted for as a purchase, and accordingly,
earnings from TFS' operations have been included in the company's results of
operations from June 24, 1997. The acquisition of TFS was not material to the
company's consolidated financial statements.
In June 1997, the company received a capital contribution from Household
International of $976.5 million which was used to repay certain short-term
borrowings in connection with the acquisition of TFS.
On October 21, 1997, Household International and its wholly-owned
subsidiary acquired the capital stock of ACC Consumer Finance Corporation
("ACC"), a non-prime auto finance company, for approximately 4.2 million shares
of its common stock and cash. Upon the consummation of this transaction,
Household International contributed the investment in ACC to HFC. The
acquisition of ACC was accounted for as a purchase, and accordingly, earnings
from ACC's operations have been included in the company's results of operations
from October 22, 1997. The acquisition of ACC was not material to the company's
consolidated financial statements.
In December 1997, Beneficial acquired Endeavour Personal Finance Ltd,
("Endeavour") a consumer lending business in the United Kingdom with
approximately $250 million in receivables for cash. The acquisition of Endeavour
was accounted for as a purchase, and accordingly earnings from Endeavour's
operations have been included in the company's results of operations from the
acquisition date. The acquisition of Endeavour was not material to the company's
consolidated financial statements.
28
<PAGE> 29
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. INVESTMENT SECURITIES
<TABLE>
<CAPTION>
AT DECEMBER 31
-------------------
1997 1996
-------- --------
(IN MILLIONS)
<S> <C> <C>
AVAILABLE-FOR-SALE INVESTMENTS
Marketable equity securities................................ $ 132.5 $ 213.7
Corporate debt securities................................... 1,594.0 1,382.9
U.S. government and federal agency debt securities.......... 370.0 391.1
Other....................................................... 206.9 258.4
-------- --------
Subtotal.................................................... 2,303.4 2,246.1
Accrued investment income................................... 33.4 34.9
-------- --------
Total investment securities............................ $2,336.8 $2,281.0
======== ========
</TABLE>
Proceeds from the sale of available-for-sale investments totaled
approximately $1.7, $3.4 and $2.5 billion in 1997, 1996 and 1995, respectively.
Gross gains of $27.3, $48.9 and $10.8 million in 1997, 1996 and 1995,
respectively, and gross losses of $3.3 and $5.3 million in 1997 and 1996,
respectively, were realized on those sales.
The gross unrealized gains (losses) of investment securities were as
follows:
<TABLE>
<CAPTION>
AT DECEMBER 31
-----------------------------------------------------------------------------------------------
1997 1996
---------------------------------------------- ----------------------------------------------
GROSS GROSS GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
--------- ---------- ---------- -------- --------- ---------- ---------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
AVAILABLE-FOR-SALE
INVESTMENTS
Marketable equity
securities............ $ 129.0 $ 3.7 $ (.2) $ 132.5 $ 213.3 $ 1.9 $ (1.5) $ 213.7
Corporate debt
securities............ 1,575.4 36.8 (18.2) 1,594.0 1,392.0 22.2 (31.3) 1,382.9
U.S. government and
federal agency debt
securities............ 380.2 2.9 (13.1) 370.0 398.6 2.8 (10.3) 391.1
Other................... 206.2 .8 (.1) 206.9 257.9 .6 (.1) 258.4
-------- ----- ------ -------- -------- ----- ------ --------
Total
available-for-sale
investments....... $2,290.8 $44.2 $(31.6) $2,303.4 $2,261.8 $27.5 $(43.2) $2,246.1
======== ===== ====== ======== ======== ===== ====== ========
</TABLE>
See Note 11, "Fair Value of Financial Instruments," for further discussion
of the relationship between the fair value of the company's assets, liabilities
and off-balance sheet financial instruments.
29
<PAGE> 30
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Contractual maturities of and yields on investments in debt securities were
as follows:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
-----------------------------------------------------------
U.S. GOVERNMENT AND FEDERAL
CORPORATE DEBT SECURITIES AGENCY DEBT SECURITIES
----------------------------- ---------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE YIELD* COST VALUE YIELD*
--------- -------- ------ --------- ------ ------
(ALL DOLLAR AMOUNTS ARE STATED IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Due within 1 year......................... $ 175.6 $ 175.3 6.21% $ 30.3 $ 30.3 5.49%
After 1 but within 5 years................ 184.0 186.2 6.87 69.8 71.0 6.70
After 5 but within 10 years............... 433.1 439.5 6.82 145.8 146.0 6.64
After 10 years............................ 782.7 793.0 7.64 134.3 122.7 6.49
-------- -------- ---- ------ ------ ----
Total................................ $1,575.4 $1,594.0 7.17% $380.2 $370.0 6.49%
======== ======== ==== ====== ====== ====
</TABLE>
- ---------------
* Computed by dividing annualized interest by the amortized cost of the
respective investment securities.
5. RECEIVABLES
<TABLE>
<CAPTION>
AT DECEMBER 31
----------------------
1997 1996
--------- ---------
(IN MILLIONS)
<S> <C> <C>
Home equity................................................. $12,806.1 $ 8,401.2
Auto finance(1)............................................. 476.5 --
MasterCard/Visa............................................. 5,052.4 7,099.7
Private label............................................... 8,039.2 8,472.5
Other unsecured............................................. 5,071.3 5,501.8
Commercial.................................................. 937.8 992.1
--------- ---------
Total owned receivables................................ 32,383.3 30,467.3
Accrued finance charges..................................... 400.1 371.5
Credit loss reserve for owned receivables................... (1,417.5) (1,169.7)
Unearned credit insurance premiums and claims reserves...... (344.2) (279.8)
Amounts due and deferred from receivables sales............. 1,838.6 1,521.9
Reserve for receivables serviced with limited recourse...... (707.8) (576.2)
--------- ---------
Total owned receivables, net........................... 32,152.5 30,335.0
Receivables serviced with limited recourse.................. 18,043.0 14,834.2
--------- ---------
Total managed receivables, net......................... $50,195.5 $45,169.2
========= =========
</TABLE>
- ---------------
(1) Prior to the fourth quarter of 1997, auto finance receivables were not
significant and were included in other unsecured receivables.
At December 31, 1997 net receivables relating to Beneficial's disposed
Canadian and German operations were $775.1 and $271.6 million, respectively.
30
<PAGE> 31
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Foreign receivables included in owned receivables were as follows:
<TABLE>
<CAPTION>
AT DECEMBER 31
------------------------------------------------------------
UNITED KINGDOM CANADA GERMANY
-------------------- ---------------- ----------------
1997 1996 1997 1996 1997 1996
-------- -------- ------ ------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Home equity.............................. $ 626.5 $ 313.9 $311.1 $300.3 $ 20.9 $145.2
MasterCard/Visa.......................... 699.2 520.0 -- -- .5 --
Private label............................ 197.3 165.8 250.7 201.9 134.3 112.2
Other unsecured.......................... 403.7 332.5 230.4 203.8 53.3 131.7
Commercial............................... -- -- -- -- 74.4 --
-------- -------- ------ ------ ------ ------
Total............................... $1,926.7 $1,332.2 $792.2 $706.0 $283.4 $389.1
======== ======== ====== ====== ====== ======
</TABLE>
Foreign managed receivables represented 6 and 5 percent of total managed
receivables at December 31, 1997 and 1996, respectively.
The company has securitized certain receivables which it services with
limited recourse. Securitizations of receivables, including replenishments of
certificate holder interests, were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------
1997 1996 1995
--------- --------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Home equity................................................. $ 1,920.4 $ 3,675.2 $2,239.0
MasterCard/Visa............................................. 10,036.1 7,875.1 4,755.8
Private label............................................... 2,270.2 697.4 644.0
Other unsecured............................................. 2,428.5 2,255.1 1,074.8
--------- --------- --------
Total.................................................. $16,655.2 $14,502.8 $8,713.6
========= ========= ========
</TABLE>
The outstanding balance of receivables serviced with limited recourse
consisted of the following:
<TABLE>
<CAPTION>
AT DECEMBER 31
----------------------
1997 1996
--------- ---------
(IN MILLIONS)
<S> <C> <C>
Home equity................................................. $ 6,038.6 $ 6,662.3
Auto finance(1)............................................. 395.9 --
MasterCard/Visa............................................. 6,775.7 5,043.5
Private label............................................... 1,025.0 517.0
Other unsecured............................................. 3,807.8 2,611.4
--------- ---------
Total.................................................. $18,043.0 $14,834.2
========= =========
</TABLE>
- ---------------
(1) Auto finance receivables were previously securitized by ACC before its
acquisition in October 1997.
At December 31, 1997, the expected weighted average remaining life of these
securitization transactions was 2.3 years.
31
<PAGE> 32
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The combination of receivables owned and receivables serviced with limited
recourse, which the company considers its managed portfolio, is shown below:
<TABLE>
<CAPTION>
AT DECEMBER 31
----------------------
1997 1996
--------- ---------
(IN MILLIONS)
<S> <C> <C>
Home equity................................................. $18,844.7 $15,063.5
Auto finance(1)............................................. 872.4 --
MasterCard/Visa............................................. 11,828.1 12,143.2
Private label............................................... 9,064.2 8,989.5
Other unsecured............................................. 8,879.1 8,113.2
Commercial.................................................. 937.8 992.1
--------- ---------
Managed receivables......................................... $50,426.3 $45,301.5
========= =========
</TABLE>
- ---------------
(1) Prior to the fourth quarter of 1997, auto finance receivables were not
significant and were included in other unsecured receivables.
At December 31, 1997 and 1996, the amounts due and deferred from
receivables sales of $1,838.6 and $1,521.9 million, respectively, included
unamortized securitization assets and funds established pursuant to the recourse
provisions for certain sales totaling $1,583.1 and $1,166.0 million,
respectively. The amounts due and deferred also included customer payments not
yet remitted by the securitization trustee to the company of $209.6 and $140.5
million at December 31, 1997 and 1996, respectively. The company made guarantees
relating to certain securitizations of $90.2 million plus unpaid interest at
December 31, 1996. The company made no such guarantees at December 31, 1997. The
company has subordinated interests in certain transactions, which were recorded
as receivables, of $888.7 and $388.5 million at December 31, 1997 and 1996,
respectively. The company has agreements with a "AAA"-rated third party who will
indemnify the company for up to $21.2 million in losses related to certain
securitization transactions. The company maintains credit loss reserves pursuant
to the recourse provisions for receivables serviced with limited recourse which
are based on estimated probable losses under such provisions. These reserves
totaled $707.8 and $576.2 million at December 31, 1997 and 1996, respectively,
and represent the company's best estimate of probable losses on receivables
serviced with limited recourse.
The providers of the credit enhancements have no recourse to the company.
The company maintains facilities with third parties which provide for the
securitization of receivables on a revolving basis totaling $6.6 billion through
the issuance of commercial paper. At December 31, 1997, these facilities were
fully utilized, of which HFC had securitized $5.6 billion. The amount available
under these facilities will vary based on the timing and volume of public
securitization transactions.
Contractual maturities of owned receivables were as follows:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
------------------------------------------------------------------------------------
1998 1999 2000 2001 2002 THERE-AFTER TOTAL
-------- -------- -------- -------- -------- ----------- ---------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C>
Home equity............. $2,959.5 $2,100.0 $1,700.0 $1,481.9 $1,282.9 $ 3,281.8 $12,806.1
Auto finance............ 78.0 92.1 104.1 107.5 82.2 12.6 476.5
MasterCard/Visa......... 758.3 437.4 365.1 331.3 306.7 2,853.6 5,052.4
Private label........... 2,630.6 780.1 605.8 474.0 441.2 3,107.5 8,039.2
Other unsecured......... 2,052.6 1,430.9 792.2 284.3 230.5 280.8 5,071.3
Commercial.............. 202.4 101.4 55.4 68.1 44.7 465.8 937.8
-------- -------- -------- -------- -------- --------- ---------
Total.............. $8,681.4 $4,941.9 $3,622.6 $2,747.1 $2,388.2 $10,002.1 $32,383.3
======== ======== ======== ======== ======== ========= =========
</TABLE>
32
<PAGE> 33
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A substantial portion of consumer receivables, based on the company's
experience, will be renewed or repaid prior to contractual maturity. The above
maturity schedule should not be regarded as a forecast of future cash
collections. The ratio of annual cash collections of principal to average
principal balances, excluding MasterCard and Visa receivables, approximated 63
and 54 percent in 1997 and 1996, respectively.
The following table summarizes contractual maturities of owned receivables
due after one year by repricing characteristic:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
-------------------------
OVER 1
BUT WITHIN OVER
5 YEARS 5 YEARS
---------- --------
(IN MILLIONS)
<S> <C> <C>
Receivables at predetermined interest rates............ $ 8,540.1 $4,872.5
Receivables at floating or adjustable rates............ 6,956.4 3,868.4
--------- --------
Total............................................. $15,496.5 $8,740.9
========= ========
</TABLE>
Nonaccrual owned consumer receivables totaled $701.9 and $471.8 million at
December 31, 1997 and 1996, respectively, including $79.4 and $70.8 million,
respectively, relating to foreign operations. Interest income that would have
been recorded in 1997 and 1996 if such nonaccrual receivables had been current
and in accordance with contractual terms was approximately $105.9 and $73.4
million, respectively, including $13.6 and $12.2 million, respectively, relating
to foreign operations. Interest income that was included in net income for 1997
and 1996, prior to these loans being placed on nonaccrual status, was
approximately $59.3 and $39.8 million, respectively, including $6.4 and $5.6
million, respectively, relating to foreign operations.
The following table sets forth the activity in the company's credit loss
reserves for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------------
1997 1996 1995
--------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Credit loss reserves for owned receivables at January 1..... $ 1,169.7 $ 937.9 $ 745.3
Provision for credit losses-owned receivables............... 1,252.1 907.4 774.8
Owned receivables charged off............................... (1,199.1) (877.5) (786.1)
Recoveries on owned receivables............................. 141.5 121.1 119.8
Portfolio acquisitions, net................................. 53.3 80.8 84.1
--------- -------- --------
Total credit loss reserves for owned receivables at
December 31.......................................... 1,417.5 1,169.7 937.9
--------- -------- --------
Credit loss reserves for receivables serviced with limited
recourse at January 1..................................... 576.2 342.2 186.8
Provision for credit losses-receivables serviced with
limited recourse.......................................... 738.9 575.8 326.1
Receivables charged off..................................... (695.4) (357.1) (182.0)
Recoveries.................................................. 43.7 17.1 8.5
Other, net.................................................. 44.4 (1.8) 2.8
--------- -------- --------
Total credit loss reserves for receivables serviced
with limited recourse at December 31................. 707.8 576.2 342.2
--------- -------- --------
Total credit loss reserves for managed receivables at
December 31.......................................... $ 2,125.3 $1,745.9 $1,280.1
========= ======== ========
</TABLE>
33
<PAGE> 34
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. DEPOSITS
<TABLE>
<CAPTION>
AT DECEMBER 31
----------------------------------------------
1997 1996
-------------------- --------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
------ -------- ------ --------
(ALL DOLLAR AMOUNTS ARE STATED IN MILLIONS)
<S> <C> <C> <C> <C>
DOMESTIC
Time certificates....................... $ 98.9 5.1% $125.1 5.2%
Savings accounts........................ 45.7 3.1 47.7 3.4
Demand accounts......................... 59.8 -- 57.8 --
------ --- ------ ---
Total domestic deposits............ 204.4 3.3 230.6 3.6
------ --- ------ ---
FOREIGN
Time certificates....................... 306.2 5.4 349.8 5.5
Savings accounts........................ 27.7 2.9 39.2 3.1
Demand accounts......................... 17.0 2.9 15.4 2.6
------ --- ------ ---
Total foreign deposits.................. 350.9 5.1 404.4 5.1
------ --- ------ ---
Total deposits..................... $555.3 4.4% $635.0 4.6%
====== === ====== ===
</TABLE>
Average deposits and related weighted average interest rates for 1997, 1996
and 1995 were as follows:
<TABLE>
<CAPTION>
AT DECEMBER 31
---------------------------------------------------------------
1997 1996 1995
------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
DEPOSITS RATE DEPOSITS RATE DEPOSITS RATE
-------- -------- -------- -------- -------- --------
(ALL DOLLAR AMOUNTS ARE STATED IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
DOMESTIC
Time certificates......... $ 70.9 5.2% $ 89.0 5.6% $ 92.0 5.7%
Savings and demand
accounts................ 147.3 1.0 150.9 1.0 137.8 1.1
------ --- ------ --- ------ ---
Total domestic
deposits........... 218.2 2.3 239.9 2.7 229.8 2.9
------ --- ------ --- ------ ---
FOREIGN
Time certificates......... 331.7 5.3 337.5 5.9 340.5 6.5
Savings and demand
accounts................ 45.3 3.5 52.7 3.5 45.0 3.9
------ --- ------ --- ------ ---
Total foreign
deposits........... 377.0 5.1 390.2 5.6 385.5 6.2
------ --- ------ --- ------ ---
Total deposits....... $595.2 4.1% $630.1 4.5% $615.3 5.0%
====== === ====== === ====== ===
</TABLE>
Interest expense on deposits was $26.8, $29.9 and $30.6 million for 1997,
1996 and 1995, respectively. Interest expense on domestic deposits was $7.8,
$9.5 and $9.4 million for 1997, 1996 and 1995, respectively.
34
<PAGE> 35
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Maturities of time certificates in amounts of $100,000 or more were:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
----------------------------------
DOMESTIC FOREIGN TOTAL
-------- ------- -----
(ALL DOLLAR AMOUNTS ARE
STATED IN MILLIONS)
<S> <C> <C> <C>
3 months or less................................. $10.1 $36.5 $46.6
Over 3 months through 6 months................... 4.3 2.0 6.3
Over 6 months through 12 months.................. 4.8 5.6 10.4
Over 12 months................................... 8.6 -- 8.6
----- ----- -----
Total....................................... $27.8 $44.1 $71.9
===== ===== =====
</TABLE>
Contractual maturities of time certificates within each interest rate range
were as follows:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
----------------------------------------------------------------------
1998 1999 2000 2001 2002 THEREAFTER TOTAL
------ ----- ----- ---- ---- ---------- ------
(ALL DOLLAR AMOUNTS ARE STATED IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C>
INTEREST RATE
< 4.00%.............. $107.9 -- -- -- -- -- $107.9
4.00% - 5.99%.............. 98.7 $17.0 $ 7.7 $5.4 $5.3 $ .6 134.7
6.00% - 7.99%.............. 45.6 22.8 88.0 -- 2.3 2.9 161.6
8.00% - 9.99%.............. -- .9 -- -- -- -- .9
------ ----- ----- ---- ---- ---- ------
Total................. $252.2 $40.7 $95.7 $5.4 $7.6 $3.5 $405.1
====== ===== ===== ==== ==== ==== ======
</TABLE>
35
<PAGE> 36
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. COMMERCIAL PAPER, BANK AND OTHER BORROWINGS
<TABLE>
<CAPTION>
AT DECEMBER 31
-----------------------------------
BANK AND
COMMERCIAL OTHER
PAPER BORROWINGS TOTAL
---------- ---------- ---------
(ALL DOLLAR AMOUNTS ARE
STATED IN MILLIONS)
<S> <C> <C> <C>
1997
Balance..................................................... $8,349.0 $1,198.1 $ 9,547.1
Highest aggregate month-end balance......................... 10,378.1
Average borrowings.......................................... 8,480.8 748.1 9,228.9
Weighted average interest rate:
At year end............................................... 5.8% 7.1% 6.0%
Paid during year.......................................... 5.7 6.2 5.7
-------- -------- ---------
1996
Balance..................................................... $8,520.6 $ 872.2 $ 9,392.8
Highest aggregate month-end balance......................... 10,378.0
Average borrowings.......................................... 8,273.5 542.5 8,816.0
Weighted average interest rate:
At year end............................................... 5.5% 6.5% 5.6%
Paid during year.......................................... 5.4 6.2 5.5
-------- -------- ---------
1995
Balance..................................................... $7,548.6 $ 629.5 $ 8,178.1
Highest aggregate month-end balance......................... 8,178.1
Average borrowings.......................................... 7,155.1 581.9 7,737.0
Weighted average interest rate:
At year end............................................... 5.8% 6.6% 5.9%
Paid during year.......................................... 6.0 6.9 6.1
-------- -------- ---------
</TABLE>
Interest expense for commercial paper, bank and other borrowings totaled
$514.1, $479.5 and $467.7 million for 1997, 1996 and 1995, respectively.
The company maintains various bank credit agreements primarily to support
commercial paper borrowings. At December 31, 1997 and 1996, the company had
committed back-up lines of $10.5 and $9.4 billion, respectively, $400 million of
which were available to the parent company. Of these amounts, $10.1 and $9.0
billion, respectively were unused. These lines included a $3 billion syndicated
revolving credit agreement. Formal credit lines are reviewed annually, and
expire at various dates from 1998 to 2004. Borrowings under these lines
generally are available at a surcharge over LIBOR. Annual commitment fee
requirements to support availability of these lines at December 31, 1997 totaled
$9.0 million.
36
<PAGE> 37
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. SENIOR AND SENIOR SUBORDINATED DEBT (WITH ORIGINAL MATURITIES OVER ONE YEAR)
<TABLE>
<CAPTION>
AT DECEMBER 31
-----------------------
1997 1996
---------- ----------
(ALL DOLLAR AMOUNTS ARE
STATED IN MILLIONS)
<S> <C> <C>
SENIOR DEBT
3.50% to 6.49%; due 1998 to 2009............................ $ 1,923.0 $ 2,359.8
6.50% to 6.99%; due 1998 to 2013............................ 3,306.4 2,295.0
7.00% to 7.49%; due 1998 to 2023............................ 1,664.3 1,340.8
7.50% to 7.99%; due 1998 to 2012............................ 1,361.6 1,668.0
8.00% to 8.99%; due 1998 to 2005............................ 1,736.1 1,770.3
9.00% and greater; due 1998 to 2013......................... 1,061.0 1,460.9
Variable interest rate debt; 5.25% to 8.50%; due 1998 to
2015...................................................... 9,438.4 7,989.7
SENIOR SUBORDINATED DEBT
9.00% to 9.63%; due 2000 to 2001............................ 400.0 400.0
10.25%; due 2003............................................ 20.0 --
Unamortized discount........................................ (1.6) (5.1)
--------- ---------
Total senior and senior subordinated debt................... $20,909.2 $19,279.4
========= =========
</TABLE>
Weighted average coupon interest rates were 6.7 percent at December 31,
1997 and 1996. Interest expense for senior and senior subordinated debt was
$1,312.5, $1,209.6 and $1,125.5 million for 1997, 1996 and 1995, respectively.
The only financial covenants contained in the terms of the company's debt
agreements are the maintenance of minimum shareholder's equity of $1.5 billion,
and a $1 billion net worth test for an HFC subsidiary.
Maturities of senior and senior subordinated debt were:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
--------------------
<S> <C>
1998........................................................ $ 4,175.1
1999........................................................ 4,342.1
2000........................................................ 2,695.9
2001........................................................ 2,513.2
2002........................................................ 2,133.0
Thereafter.................................................. 5,049.9
---------
Total....................................................... $20,909.2
=========
</TABLE>
9. DERIVATIVE FINANCIAL INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS WITH
OFF-BALANCE SHEET RISK
In the normal course of business and in connection with its asset/liability
management program, the company enters into various transactions involving
derivative and other off-balance sheet financial instruments. These instruments
primarily are used to manage the company's exposure to fluctuations in interest
rates and foreign exchange rates. The company does not serve as a financial
intermediary to make markets in any derivative financial instruments. For
further information on the company's strategies for managing interest rate and
foreign exchange rate risk, see Risk Management on page 14.
The financial instruments used by the company include interest rate
contracts and foreign exchange rate contracts and have varying degrees of credit
risk and/or market risk.
Credit Risk. Credit risk is the possibility that a loss may occur because
the counterparty to a transaction fails to perform according to the terms of the
contract. The company's exposure to credit loss related to
37
<PAGE> 38
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
interest rate swaps, cap and floor transactions, forward and futures contracts
and options is the amount of uncollected interest or premium related to these
instruments. These interest rate related instruments are generally expressed in
terms of notional principal or contract amounts which are much larger than the
amounts potentially at risk for nonpayment by counterparties. The company
controls the credit risk of its off-balance sheet financial instruments through
established credit approvals, risk control limits and ongoing monitoring
procedures. The company has never experienced nonperformance by any derivative
instrument counterparty.
Market Risk. Market risk is the possibility that a change in interest rates
or foreign exchange rates will cause a financial instrument to decrease in value
or become more costly to settle. The company mitigates this risk by establishing
limits for positions and other controls.
Interest Rate and Foreign Exchange Contracts. The following table
summarizes the activity in interest rate and foreign exchange contracts for
1997, 1996 and 1995:
<TABLE>
<CAPTION>
NON-EXCHANGE TRADED
EXCHANGE TRADED --------------------------------------------
-------------------------------------------
INTEREST RATE
FUTURES CONTRACTS OPTIONS INTEREST FOREIGN EXCHANGE RATE
--------------------- ------------------- RATE CURRENCY CONTRACTS
PURCHASED SOLD PURCHASED WRITTEN SWAPS SWAPS PURCHASED SOLD
--------- --------- --------- ------- --------- -------- --------- ---------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
HEDGING/SYNTHETIC ALTERATION
INSTRUMENTS
1995
Notional amount, 1994....... -- $ (93.0) -- -- $15,847.4 $ 457.3 $ 457.9 $ (617.7)
New contracts............... $ 2,003.0 (1,850.0) $ 300.0 $(300.0) 2,678.0 -- 1,952.1 (2,275.2)
Matured or expired
contracts................. -- 290.0 -- -- (5,845.6) (52.0) (1,245.3) 1,510.8
Terminated contracts........ -- -- -- -- (4,275.3) -- -- --
In-substance
maturities(1)............. (1,653.0) 1,653.0 (300.0) 300.0 -- -- (773.2) 913.3
--------- --------- ------- ------- --------- -------- --------- ---------
NOTIONAL AMOUNT, 1995....... $ 350.0 -- -- -- $ 8,404.5 $ 405.3 $ 391.5 $ (468.8)
========= ========= ======= ======= ========= ======== ========= =========
Fair value, 1995(2)......... $ .1 -- -- -- $ 113.0 $ 80.2 $ 4.0 $ (2.9)
========= ========= ======= ======= ========= ======== ========= =========
1996
Notional amount, 1995....... $ 350.0 -- -- -- $ 8,404.5 $ 405.3 $ 391.5 $ (468.8)
New contracts............... 6,611.9 $(4,202.9) $ 440.0 $(440.0) 4,418.5 900.3 649.7 (1,092.0)
Matured or expired
contracts................. (1,471.0) 50.0 -- -- (2,715.5) (117.0) (875.2) 1,298.2
Terminated contracts........ -- -- -- -- (1,215.0) -- -- --
In-substance
maturities(1)............. (4,152.9) 4,152.9 (440.0) 440.0 -- -- -- --
--------- --------- ------- ------- --------- -------- --------- ---------
NOTIONAL AMOUNT, 1996....... $ 1,338.0 -- -- -- $ 8,892.5 $1,188.6 $ 166.0 $ (262.6)
========= ========= ======= ======= ========= ======== ========= =========
Fair value, 1996(2)......... -- -- -- -- $ 33.7 $ (45.4) -- $ (19.7)
========= ========= ======= ======= ========= ======== ========= =========
1997
Notional amount, 1996....... $ 1,338.0 -- -- -- $ 8,892.5 $1,188.6 $ 166.0 $ (262.6)
New contracts............... 8,584.0 $(7,350.0) -- -- 3,448.3 1,036.6 884.6 (944.0)
Matured or expired
contracts................. (2,020.0) 120.0 -- -- (2,777.9) (57.6) (642.9) 732.0
Terminated contracts........ -- -- -- -- (762.0) (102.4) -- --
In-substance
maturities(1)............. (7,030.0) 7,030.0 -- -- -- -- -- --
--------- --------- ------- ------- --------- -------- --------- ---------
NOTIONAL AMOUNT, 1997....... $ 872.0 $ (200.0) -- -- $ 8,800.9 $2,065.2 $ 407.7 $ (474.6)
========= ========= ======= ======= ========= ======== ========= =========
Fair value, 1997 (2)........ -- -- -- -- $ 138.1 $ (69.5) $ 4.4 $ (12.5)
========= ========= ======= ======= ========= ======== ========= =========
<CAPTION>
NON-EXCHANGE TRADED
-----------------------
INTEREST
RATE
FORWARD OTHER RISK
CONTRACTS MANAGEMENT
PURCHASED INSTRUMENTS
--------- -----------
(IN MILLIONS)
<S> <C> <C>
HEDGING/SYNTHETIC ALTERATION
INSTRUMENTS
1995
Notional amount, 1994....... $ 180.0 $ 100.0
New contracts............... 27.0 --
Matured or expired
contracts................. -- --
Terminated contracts........ (180.0) --
In-substance
maturities(1)............. -- --
------- --------
NOTIONAL AMOUNT, 1995....... $ 27.0 $ 100.0
======= ========
Fair value, 1995(2)......... -- $ .8
======= ========
1996
Notional amount, 1995....... $ 27.0 $ 100.0
New contracts............... -- 1,250.0
Matured or expired
contracts................. (27.0) --
Terminated contracts........ -- --
In-substance
maturities(1)............. -- --
------- --------
NOTIONAL AMOUNT, 1996....... -- $1,350.0
======= ========
Fair value, 1996(2)......... -- $ 7.0
======= ========
1997
Notional amount, 1996....... -- $1,350.0
New contracts............... -- --
Matured or expired
contracts................. -- --
Terminated contracts........ -- --
In-substance
maturities(1)............. -- --
------- --------
NOTIONAL AMOUNT, 1997....... -- $1,350.0
======= ========
Fair value, 1997 (2)........ -- $ .5
======= ========
</TABLE>
- ---------------
(1) Represent contracts terminated as the market execution technique of closing
the transaction either (a) just prior to maturity to avoid delivery of the
underlying instrument, or (b) at the maturity of the underlying items being
hedged.
(2) (Bracketed) unbracketed amounts represent amounts to be (paid) received by
the company had these positions been closed out at the respective balance
sheet date. Bracketed amounts do not necessarily represent risk of loss for
hedging instruments, as the fair value of the hedging instrument and the
items being hedged must be evaluated together. See Note 11, "Fair Value of
Financial Instruments" for further discussion of the relationship between
the fair value of the company's assets, liabilities and off-balance sheet
financial instruments.
38
<PAGE> 39
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The company operates in three functional currencies, the US dollar, the
British pound and the Canadian dollar. Of the above instruments the US dollar is
the functional currency for exchange traded interest rate futures and options.
The remaining instruments are restated in US dollars by country as follows:
<TABLE>
<CAPTION>
INTEREST EXCHANGE INTEREST RATE
INTEREST FUTURES CONTRACTS FORWARD CONTRACTS OTHER RISK
RATE CURRENCY ------------------- ------------------- MANAGEMENT
SWAPS SWAPS PURCHASED SOLD PURCHASED SOLD INSTRUMENTS
-------- -------- --------- ------- --------- ---- -----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C>
1995
United States.............. $7,992.7 $ 297.3 $391.5 $(468.8) -- -- $ 100.0
Canada..................... 14.7 -- -- -- -- -- --
United Kingdom............. 397.1 108.0 -- -- $27.0 -- --
-------- -------- ------ ------- ----- -- --------
$8,404.5 $ 405.3 $391.5 $(468.8) $27.0 -- $ 100.0
======== ======== ====== ======= ===== == ========
1996
United States.............. $8,335.4 $1,080.6 $166.0 $(262.6) -- -- $1,350.0
Canada..................... -- -- -- -- -- -- --
United Kingdom............. 557.1 108.0 -- -- -- -- --
-------- -------- ------ ------- ----- -- --------
$8,892.5 $1,188.6 $166.0 $(262.6) -- -- $1,350.0
======== ======== ====== ======= ===== == ========
1997
United States.............. $8,115.4 $1,861.0 $407.7 $(474.6) -- -- $1,350.0
Canada..................... -- -- -- -- -- -- --
United Kingdom............. 685.5 204.2 -- -- -- -- --
-------- -------- ------ ------- ----- -- --------
$8,800.9 $2,065.2 $407.7 $(474.6) -- -- $1,350.0
======== ======== ====== ======= ===== == ========
</TABLE>
Interest rate swaps are contractual agreements between two counterparties
for the exchange of periodic interest payments generally based on a notional
principal amount and agreed-upon fixed or floating rates. The company primarily
enters into interest rate swap transactions to synthetically alter balance sheet
items. These transactions are specifically designated to a particular
asset/liability, off-balance sheet item or anticipated transaction of a similar
characteristic. Specific assets or liabilities may consist of groups of
individually small dollar homogeneous assets or liabilities of similar economic
characteristics. Credit and market risk exists with respect to these
instruments. The following table reflects the items so altered at December 31,
1997:
<TABLE>
<CAPTION>
(IN MILLIONS)
-------------
<S> <C>
Investment securities....................................... $ 70.7
Receivables:
Home equity............................................... 775.0
MasterCard/Visa........................................... 550.0
Other unsecured........................................... 19.3
--------
Total owned receivables.............................. 1,344.3
Commercial paper, bank and other borrowings................. 2,312.5
Senior and senior subordinated debt......................... 5,040.0
Receivables serviced with limited recourse.................. 33.4
--------
Total items synthetically altered with interest rate
swaps............................................... $8,800.9
========
</TABLE>
- ---------------
Note: In all instances, the notional amount is not greater than the carrying
value of the related asset/liability or off-balance sheet item.
39
<PAGE> 40
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The company manages its exposure to interest rate risk primarily through
the use of interest rate swaps. These swaps synthetically alter the interest
rate risk inherent in balance sheet assets, liabilities or off-balance sheet
items. The majority of the company's interest rate swaps are used to convert
floating rate assets to fixed rate, fixed rate debt to floating rate, floating
rate assets or debt from one floating rate index to another, fixed rate assets
to a floating rate, or floating rate debt to fixed rate. Interest rate swaps
also are used to synthetically alter interest rate characteristics on certain
receivables that are sold and serviced with limited recourse. These off-balance
sheet items expose the company to the same interest rate risk as on-balance
sheet items. Interest rate swaps are used to synthetically alter the interest
rate provisions of the securitization transaction whereby the underlying
receivables pay a fixed (floating) rate and the pass-through rate to the
investor is floating (fixed). The company also has entered into currency swaps
to convert both principal and interest payments on debt issued from one currency
to the appropriate functional currency.
The following table summarizes the maturities and related weighted average
receive/pay rates of interest rate swaps outstanding at December 31, 1997:
<TABLE>
<CAPTION>
1998 1999 2000 2001 2002 2003 THEREAFTER TOTAL
-------- -------- ------ ------ ------ ------ ---------- --------
(ALL DOLLAR AMOUNTS ARE STATED IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Pay a fixed rate/receive a
floating rate:
Notional value............... $ 704.4 $ 699.4 $343.0 $173.4 $181.7 -- -- $2,101.9
Weighted average receive
rate....................... 6.15% 6.11% 6.66% 7.55% 7.54% -- -- 6.46%
Weighted average pay rate.... 6.42 6.83 6.98 7.35 7.07 -- -- 6.78
Pay a floating rate/receive a
fixed rate:
Notional value............... $ 526.4 $ 229.9 $150.0 $622.5 $177.4 $300.0 $1,887.8 $3,894.0
Weighted average receive
rate....................... 7.09% 6.65% 6.59% 6.55% 6.58% 6.74% 6.93% 6.83%
Weighted average pay rate.... 5.93 6.22 5.83 5.98 5.99 5.97 5.93 5.96
Pay a floating rate/receive a
different floating rate:
Notional value............... $ 955.0 $1,548.0 $237.0 $ 55.0 $ 10.0 -- -- $2,805.0
Weighted average receive
rate....................... 5.70% 6.02% 5.85% 6.05% 6.50% -- -- 5.90%
Weighted average pay rate.... 5.87 5.97 5.91 6.02 5.81 -- -- 5.93
-------- -------- ------ ------ ------ ------ -------- --------
Total notional
value............... $2,185.8 $2,477.3 $730.0 $850.9 $369.1 $300.0 $1,887.8 $8,800.9
======== ======== ====== ====== ====== ====== ======== ========
Total weighted average
rates on swaps:
Receive rate................... 6.18% 6.11% 6.38% 6.73% 7.05% 6.74% 6.93% 6.45%
-------- -------- ------ ------ ------ ------ -------- --------
Pay rate....................... 6.06 6.23 6.40 6.26 6.52 5.97 5.93 6.14
-------- -------- ------ ------ ------ ------ -------- --------
</TABLE>
The floating rates paid or received by the company are based on spot rates
from independent market sources for the index contained in each interest rate
swap contract, which generally are based on either 1-, 3-or 6-month LIBOR. These
current floating rates are different than the floating rates in effect when the
contracts were initiated. Changes in spot rates impact the variable rate
information disclosed above. However, these changes in spot rates also impact
the interest rate on the underlying assets or liabilities. Hedging/ synthetic
alteration instruments are used by the company to manage the volatility of net
interest margin resulting from changes in interest rates on the underlying
hedged/synthetically altered items. Owned net interest margin would have
declined by 13 and 19 basis points in 1997 and 1996, respectively, had these
instruments not been utilized. These instruments had a negligible impact on
owned net interest margin in 1995.
40
<PAGE> 41
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Forwards and futures are agreements between two parties, committing one to
sell and the other to buy a specific quantity of an instrument on some future
date. The parties agree to buy or sell at a specified price in the future, and
their profit or loss is determined by the difference between the arranged price
and the level of the spot price when the contract is settled. Foreign exchange
contracts have been utilized by the company to reduce its exposure to foreign
currency exchange risk. Interest rate forward and futures contracts are used to
hedge resets of interest rates on the company's floating rate assets and
liabilities. The company's exposure to credit risk for futures is limited, as
these contracts are traded on organized exchanges. Each day, changes in contract
values are settled in cash. In contrast, forward contracts have credit risk
relating to the performance of the counterparty. These instruments also are
subject to market risk. Cash requirements for forward contracts include the
receipt or payment of cash upon the sale or purchase of the instrument.
Purchased options grant the purchaser the right, but not the obligation, to
either purchase or sell a financial instrument at a specified price within a
specified period. The seller of the option has written a contract which creates
an obligation to either sell or purchase the financial instrument at the
agreed-upon price if, and when, the purchaser exercises the option.
Other risk management instruments consist of caps and floors. Caps and
floors written expose the company to market risk but not to credit risk. Market
risk associated with caps and floors purchased is limited to the premium paid
which is recorded on the balance sheets in other assets.
Deferred gains of $37.8 and $43.6 million and deferred losses of $2.4 and
$8.5 million from hedging/ synthetic alteration instruments were recorded on the
balance sheets at December 31, 1997 and 1996, respectively. The weighted average
amortization period associated with the deferred gains was 5.4 and 6.8 years at
December 31, 1997 and 1996, respectively. The weighted average amortization
period for the deferred losses was 1.6 and 1.5 years at December 31, 1997 and
1996, respectively.
At December 31, 1997 and 1996, the accrued interest, unamortized premium
and other assets recorded for agreements which would be written off should all
related counterparties fail to meet the terms of their contracts was $54.7 and
$48.1 million, respectively.
Concentrations of Credit Risk. A concentration of credit risk is defined as
a significant credit exposure with an individual or group engaged in similar
activities or affected similarly by economic conditions.
Because the company primarily lends to consumers, it does not have
receivables from any industry group that equal or exceed 10 percent of total
managed receivables at December 31, 1997 and 1996. The company lends nationwide,
with the following geographic areas comprising more than 10 percent of total
managed domestic receivables at December 31, 1997: California -21 percent;
Midwest (IL, IN, IA, KS, MI, MN, MO, NE, ND, OH, SD, WI) -23 percent; Middle
Atlantic (DE, DC, MD, NJ, PA, VA, WV) -14 percent; Northeast (CT, ME, MA, NH,
NY, RI, VT) -13 percent; and Southeast (AL, FL, GA, KY, MS, NC, SC, TN) -15
percent.
10. PREFERRED STOCK
<TABLE>
<CAPTION>
AT DECEMBER 31
-----------------------
1997 1996
------- ---------
(ALL DOLLAR AMOUNTS
ARE STATED IN MILLIONS)
<S> <C> <C>
7.25% term cumulative preferred, Series 1992-A,
1,000,000 depositary shares............................... -- $100.0
</TABLE>
On August 15, 1997, the company redeemed, at par, all outstanding shares of
its 7.25 percent term cumulative preferred Series 1992-A, for $100 per
depositary share plus accrued and unpaid dividends.
41
<PAGE> 42
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
The company has estimated the fair value of its financial instruments in
accordance with Statement of Financial Accounting Standards No. 107,
"Disclosures About Fair Value of Financial Instruments" ("FAS No. 107"). Fair
value estimates, methods and assumptions set forth below for the company's
financial instruments are made solely to comply with the requirements of FAS No.
107 and should be read in conjunction with the financial statements and notes in
this Annual Report.
For a significant portion of the company's financial instruments, fair
values for items lacking a quoted market price were estimated by discounting
estimated future cash flows at estimated current market discount rates.
Assumptions used to estimate future cash flows are consistent with management's
assessments regarding ultimate collectibility of assets and related interest and
with estimates of product lives and repricing characteristics used in the
company's asset/liability management process. All assumptions are based on
historical experience adjusted for future expectations. Assumptions used to
determine fair values for financial instruments for which no active market
exists are inherently judgmental, and changes in these assumptions could
significantly affect fair value calculations.
As required under generally accepted accounting principles, a number of
other assets recorded on the balance sheets (such as acquired credit card
relationships) and other intangible assets not recorded on the balance sheets
(such as the value of consumer lending relationships for originated receivables
and the franchise values of the company's business units) are not considered
financial instruments and, accordingly, are not valued for purposes of this
disclosure. The company believes there is substantial value associated with
these assets based on current market conditions and historical experience.
Accordingly, the estimated fair value of financial instruments, as disclosed,
does not fully represent the entire value, nor the changes in the entire value,
of the company.
42
<PAGE> 43
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is a summary of the carrying value and estimated fair value
of the company's financial instruments:
<TABLE>
<CAPTION>
AT DECEMBER 31
----------------------------------------------------------------------------
1997 1996
------------------------------------ ------------------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
VALUE FAIR VALUE DIFFERENCE VALUE FAIR VALUE DIFFERENCE
-------- ---------- ---------- -------- ---------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Cash.............................. $ 545 $ 545 -- $ 508 $ 508 --
Investment securities............. 2,337 2,337 -- 2,281 2,281
Receivables....................... 32,153 33,438 $1,285 30,335 31,776 $1,441
Advances to parent company and
affiliates...................... 11 11 -- -- -- --
-------- -------- ------ -------- -------- ------
Subtotal.......................... 35,046 36,331 1,285 33,124 34,565 1,441
-------- -------- ------ -------- -------- ------
Deposits.......................... (555) (555) -- (635) (635) --
Commercial paper, bank and other
borrowings...................... (9,547) (9,547) -- (9,393) (9,393) --
Senior and senior subordinated
debt............................ (20,909) (21,235) (326) (19,279) (19,587) (308)
Insurance reserves................ (1,182) (1,411) (229) (1,183) (1,399) (216)
Borrowings from parent company and
affiliates...................... -- -- -- (8) (8) --
-------- -------- ------ -------- -------- ------
Subtotal.......................... (32,193) (32,748) (555) (30,498) (31,022) (524)
-------- -------- ------ -------- -------- ------
Interest rate and foreign exchange
contracts....................... 37 62 25 34 (24) (58)
Commitments to extend credit and
guarantees...................... -- 50 50 -- 40 40
-------- -------- ------ -------- -------- ------
Subtotal.......................... 37 112 75 34 16 (18)
-------- -------- ------ -------- -------- ------
Total........................ $ 2,890 $ 3,695 $ 805 $ 2,660 $ 3,559 $ 899
======== ======== ====== ======== ======== ======
</TABLE>
The following methods and assumptions were used to estimate the fair value
of the company's financial instruments:
Cash: The carrying value approximates fair value for this instrument due to
its liquid nature.
Investment securities: Investment securities are classified as
available-for-sale and are carried at fair value on the balance sheets.
Receivables: The fair value of adjustable rate consumer receivables was
determined to approximate existing carrying value because interest rates on
these receivables adjust with changing market interest rates. The fair value of
fixed rate consumer receivables was estimated by discounting future expected
cash flows at interest rates approximating those offered by the company on such
products at the respective valuation dates. This approach to estimating fair
value for fixed rate receivables results in a disclosed fair value that is less
than amounts the company believes could be currently realizable on a sale of
these receivables. These receivables are relatively insensitive to changes in
overall market interest rates and, therefore, have additional value compared to
alternative uses of funds. The fair value of commercial receivables was
determined by discounting estimated future cash flows at estimated market
interest rates.
The fair value of consumer receivables also included an estimate, on a
present value basis, of cash flows associated with securitizations of certain
home equity, auto finance, MasterCard and Visa, private label and other
unsecured receivables.
43
<PAGE> 44
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Advances to parent company and affiliates: The carrying value approximates
fair value for this instrument due to its short-term nature.
Commercial paper, bank and other borrowings: The fair value of these
instruments was determined to approximate existing carrying value because
interest rates on these instruments adjust with changes in market interest rates
due to their short-term maturity or repricing characteristics.
Senior and senior subordinated debt: The estimated fair value of these
instruments was computed by discounting future expected cash flows at interest
rates offered for similar types of debt instruments.
Insurance reserves: The fair value of insurance reserves for periodic
payment annuities was estimated by discounting future expected cash flows at
estimated market interest rates at December 31, 1997 and 1996. The fair value of
other insurance reserves is not required to be determined in accordance with FAS
No. 107.
Borrowings from parent company and affiliates: The fair value of this
instrument was determined to approximate existing carrying value due to its
short-term nature.
Interest rate and foreign exchange contracts: Where practical, quoted
market prices were used to determine fair value of these instruments. For
non-exchange traded contracts, fair value was determined through the use of
accepted and established valuation methods (including input from independent
third parties) which consider the terms of the contracts and market expectations
on the valuation date for forward interest rates (for interest rate contracts)
or forward foreign currency exchange rates (for foreign exchange contracts). See
Note 9, "Derivative Financial Instruments and Other Financial Instruments with
Off-Balance Sheet Risk," for a discussion of the nature of these items.
Commitments to extend credit and guarantees: These commitments were valued
by considering the company's relationship with the counterparty, the
creditworthiness of the counterparty and the difference between committed and
current interest rates.
12. LEASES
The company leases certain offices, buildings and equipment for periods of
up to 47 years with various renewal options. The office space leases generally
require the company to pay certain operating expenses. The majority of the
company's leases are noncancelable operating leases. Net rental expense under
operating leases was $124.4, $109.4 and $104.3 million for 1997, 1996 and 1995,
respectively.
Future net minimum lease commitments under noncancelable operating lease
arrangements were:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
--------------------
(IN MILLIONS)
<S> <C>
1998........................................................ $115.9
1999........................................................ 95.4
2000........................................................ 75.6
2001........................................................ 59.8
2002........................................................ 51.3
Thereafter.................................................. 332.6
------
Net minimum lease commitments............................... $730.6
======
</TABLE>
13. EMPLOYEE BENEFIT PLANS
Household International is now in the process of reviewing its pension and
postretirement benefit plans with a view to providing uniform benefits.
Completion and approval is expected sometime in 1999.
44
<PAGE> 45
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The company and certain U.S. subsidiaries participate in Household
International's Retirement Income Plan ("RIP"). In addition, HFC's wholly owned
subsidiary, Beneficial, currently has its own defined benefit pension plan
("Beneficial Plan"). The plans cover substantially all U.S. full-time employees.
No separate actuarial valuation has been made for the company's
participation in RIP. At December 31, 1997, Household International's plan
assets included an investment in 1,258,807 shares of its common stock with a
fair value of $160.7 million. Dividends declared by Household International on
theses shares in 1997 totaled approximately $2 million. The fair value of plan
assets in RIP exceeded Household International's projected benefit obligation by
$313.9 and $284.2 million at December 31, 1997 and 1996, respectively. The 1997
and 1996 projected benefit obligations for RIP were determined using an assumed
weighted average discount rate of 7.50 percent and an assumed compensation
increase of 4.00 percent. The assumed weighted average long-term rate of return
on plan assets was 10.00 percent in 1997, 1996 and 1995. At December 31, 1997
and 1996, the company's estimated share of prepaid pension cost was $137.2 and
$130.0 million, respectively. Plan benefits are based primarily on years of
service. The company's share of total pension income due to the overfunded
status of RIP was $9.0, $8.6 and $8.2 million for 1997, 1996 and 1995,
respectively.
A separate actuarial valuation has been made for the Beneficial plan. The
benefits under the Beneficial plan are based primarily on years of service. The
Beneficial Plan's funded status and amounts recognized in the Company's balance
sheet are as follows:
<TABLE>
<CAPTION>
AT DECEMBER 31
--------------
1997 1996
----- ------
(IN MILLIONS)
<S> <C> <C>
Actuarial present value of benefit obligation:
Vested benefits........................................... $51.5 $ 45.4
Nonvested benefits........................................ 12.5 15.0
----- ------
Accumulated benefit obligation.............................. 64.0 60.4
Effects of future salary increases.......................... 48.8 43.5
----- ------
Projected benefit obligation................................ 112.8 103.9
Less plan assets at fair value.............................. 78.9 65.0
----- ------
Projected benefit obligation in excess of plan assets....... 33.9 38.9
Less unrecognized net loss.................................. 17.1 20.5
----- ------
Accrued pension cost included in accounts payable and
accrued liabilities....................................... $16.8 $ 18.4
===== ======
</TABLE>
The 1997 and 1996 projected benefit obligations were determined using an
assumed discount rate of 7.0% (compared with 7.5% in 1996), an assumed long-term
rate of return on assets of 9.0%, and an assumed long-term rate of increase in
future compensation levels of 4.5%.
The following table details the components of net pension expense for the
Beneficial Plan:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1997 1996 1995
------ ----- ------
(IN MILLIONS)
<S> <C> <C> <C>
Service cost -- benefits earned during the period........... $ 5.5 $ 5.4 $ 4.4
Interest cost on projected benefit obligation............... 7.3 7.6 7.6
Actual return on plan assets................................ (13.3) (7.1) (12.3)
Net amortization and deferral............................... 7.9 1.6 7.1
------ ----- ------
Net periodic pension cost................................... $ 7.4 $ 7.5 $ 6.8
====== ===== ======
</TABLE>
45
<PAGE> 46
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The company participates in Household International's defined contribution
plan where each participant's contribution is matched by the company up to a
maximum of 6 percent of the participant's compensation. For 1997, 1996 and 1995
the company's costs totaled $13.9, $7.1 and $6.4 million, respectively.
The company also participates in the existing Beneficial defined
contribution plan, which provides for annual employer contributions up to 2.5%
of each eligible employee's compensation. For 1997, 1996 and 1995 total expenses
for this plan was $5.4, $4.8 and $4.6 million, respectively.
The company also participates in Household International's and Beneficial's
plans which provide medical, dental and life insurance benefits to retirees and
eligible dependents. The plans are funded on a pay-as-you-go basis and cover
substantially all employees who meet certain age and vested service
requirements. The Plans have instituted dollar limits on its payments under the
plans to control the cost of future medical benefits.
Household International recognizes the expected postretirement costs on an
accrual basis, similar to pension accounting. The expected cost of
postretirement benefits is required to be recognized over the employees' years
of service with the company instead of the period in which the benefits are
paid. Household International is recognizing the transition obligation over a
period of 20 years. The transition obligation represents the unfunded and
unrecognized accumulated postretirement benefit obligation.
While no separate actuarial valuation has been made for the company's
participation in Household International's plans for postretirement medical,
dental and life benefits, its share of the liability and expense has been
estimated. Household International's accumulated postretirement benefit
obligation was $111.7 and $104.9 million at December 31, 1997 and 1996,
respectively. The company's estimated share of Household International's accrued
postretirement benefit obligation was $51.3 and $42.5 million at December 31,
1997 and 1996, respectively. In addition, the company's estimated share of
postretirement benefit expense recognized in 1997, 1996 and 1995 was $12.1,
$11.7 and $14.0 million, respectively.
Household International's accumulated postretirement benefit obligation at
December 31, 1997 and 1996 was determined using an assumed weighted average
discount rate of 7.50 percent and an assumed annual compensation increase of 4.0
percent. A 10.0 and 11.0 percent annual rate of increase in the gross cost of
covered health care benefits was assumed for 1998 and 1997, respectively. This
rate of increase is assumed to decline by 1 percent in each year after 1998.
Separate actuarial valuations have been made for the Beneficial plans for
post retirement, medical, dental and life benefits. The company recognizes the
expected postretirement costs on an accrual basis, similar to pension
accounting, over the employees' years of service with the company. Under the
plans, the transition obligation was recognized up front at the time Statement
of Financial Accounting Standards No. 106 was adopted.
The net postretirement benefit cost of the Beneficial Plans included the
following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1997 1996 1995
----- ----- -----
(IN MILLIONS)
<S> <C> <C> <C>
Postretirement benefit costs:
Service cost-benefits attributable to service during the
year................................................... $2.0 $2.0 $1.5
Interest cost on accumulated benefit obligation............. 4.2 4.1 4.2
Amortization of deferred gain............................... (.8) (.3) (.8)
---- ---- ----
Total.................................................. $5.4 $5.8 $4.9
==== ==== ====
</TABLE>
46
<PAGE> 47
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The actuarial and recorded liabilities for the Beneficial postretirement
benefit plans were as follows:
<TABLE>
<CAPTION>
AT DECEMBER 31
--------------
1997 1996
----- -----
(IN MILLIONS)
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees.................................................. $45.1 $38.8
Fully eligible active participants........................ 12.4 10.3
Other active plan participants............................ 14.7 12.0
----- -----
Total.................................................. $72.2 $61.1
===== =====
</TABLE>
For measurement purposes, a 10.2% pre-65 trend rate was used for 1997 and
1996, with an ultimate rate of 5.0% in 2013. An 11% pre-65 trend rate was used
in 1995, with an ultimate rate of 5% in 2012. In addition, a 9.7% post-64 trend
rate was used for 1997 and 1996, with an ultimate rate of 5.0% in 2018. A 10%
post-64 trend rate was used for 1995, with an ultimate rate of 5.0% in 2017. The
discount rate was 7.0% at December 31, 1997, 7.50% at December 31, 1996 and
7.25% at December 31, 1995.
The health care cost trend rate assumption has an effect on the amounts
reported. To illustrate, increasing the assumed health care cost trend rate by 1
percent would have increased the company's 1997 and 1996 net periodic
postretirement benefit cost including its share under the Household
International plans by $1.1 and $1.5 million, respectively, and the accumulated
postretirement benefit obligation at December 31, 1997 and 1996 by $9.8 and
$12.2 million, respectively. A 1 percentage point increase would have increased
Household International's accumulated postretirement benefit obligation at
December 31, 1997 and 1996 by $6.1 and $7.5 million, respectively.
Employees of the company may participate in Household International's
Employee Stock Purchase Plan (the "ESPP"). The ESPP provides a means for
employees to purchase shares of the parent company's common stock at 85 percent
of the lesser of its market price at the beginning or end of a one year
subscription period. Beneficial previously maintained an Employee Stock Purchase
Plan ("BESPP") whereby participants could elect to purchase stock subject to
certain limitations, which were eligible to be matched by Beneficial up to
certain levels. The matching contributions vested over a 3 year period. This
plan has been terminated effective with the merger of Household and Beneficial.
Key officers and employees of the company participate in Household
International's executive compensation plans which provide for the issuance of
nonqualified stock options and restricted stock rights ("RSRs"). Stock options
permit the holder to purchase, under certain limitations, the parent company's
common stock at a price not less than 100 percent of the market value of the
stock on the date the option is granted. Stock options vest equally over four
years and expire 10 years from the date of grant. RSRs entitle an employee to
receive a stated number of shares of the parent company's common stock if the
employee satisfies the conditions set by Household International's Compensation
Committee for the award.
Household International accounts for options and shares issued under the
ESPP in accordance with Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," pursuant to which no compensation cost has been
recognized. Under the BESPP, compensation costs on matching contributions have
been recognized.
47
<PAGE> 48
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. INCOME TAXES
Total income taxes were allocated as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------
1997 1996 1995
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Provision for income taxes related to operations............ $391.9 $358.1 $295.3
Income taxes related to adjustments included in common
shareholder's equity:
Unrealized gain (loss) on investments, net................ 10.0 (62.9) 106.7
Foreign currency translation adjustments.................... 8.1 (5.2) (3.9)
------ ------ ------
Total.................................................. $410.0 $290.0 $398.1
====== ====== ======
</TABLE>
Provisions for income taxes related to operations were:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------
1997 1996 1995
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
CURRENT
United States............................................... $354.9 $438.8 $284.1
Foreign..................................................... 19.2 17.4 19.4
------ ------ ------
Total current.......................................... 374.1 456.2 303.5
------ ------ ------
DEFERRED
United States............................................... 18.0 (98.4) (7.4)
Foreign..................................................... (.2) .3 (.8)
------ ------ ------
Total deferred......................................... 17.8 (98.1) (8.2)
------ ------ ------
Total income taxes..................................... $391.9 $358.1 $295.3
====== ====== ======
</TABLE>
The significant components of deferred income tax provisions attributable
to income from operations were:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------
1997 1996 1995
----- ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Deferred income tax provision............................... $17.1 $(84.7) $ 4.3
Adjustment of valuation allowance........................... (4.7) (8.1) (12.5)
Operating loss carryforwards................................ 5.4 (5.3) --
----- ------ ------
Deferred income tax provision............................... $17.8 $(98.1) $ (8.2)
===== ====== ======
</TABLE>
Income before income taxes from foreign operations was $(15.4), $58.5 and
$30.6 million in 1997, 1996 and 1995, respectively.
48
<PAGE> 49
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Effective tax rates are analyzed as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31
------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Statutory federal income tax rate........................... 35.0% 35.0% 35.0%
Increase (decrease) in rate resulting from:
State and local taxes, net of federal benefit............. 2.8 2.3 2.7
Capital losses--Germany................................... (2.5) -- --
Leveraged lease tax benefits.............................. (2.4) (1.4) (2.0)
Recapture of life insurance policyholders' surplus account
balance................................................ -- -- 4.1
Other..................................................... .9 (.4) 1.9
---- ---- ----
Effective tax rate.......................................... 33.8% 35.5% 41.7%
==== ==== ====
</TABLE>
Provision for U.S. income taxes had not been made at December 31, 1997 and
1996 on $19.0 and $35.1 million, respectively, of undistributed earnings of
foreign subsidiaries. If this amount was distributed, the additional income tax
payable would be approximately $1.0 and $1.7 million, respectively. In addition,
provision for U.S. income taxes had not been made at December 31, 1997 and 1996
on $77.8 million of undistributed earnings of life insurance subsidiaries
accumulated as policyholders' surplus under tax laws in effect prior to 1984. If
this amount was distributed, the additional income tax payable would be
approximately $27.2 million.
Temporary differences which gave rise to a significant portion of deferred
tax assets and liabilities were as follows:
<TABLE>
<CAPTION>
AT DECEMBER 31
-----------------
1997 1996
-------- ------
(IN MILLIONS)
<S> <C> <C>
DEFERRED TAX LIABILITIES
Receivables sold............................................ $ 408.3 $240.0
Leveraged lease transactions, net........................... 312.7 383.3
Pension plan assets......................................... 54.7 51.9
Other....................................................... 259.2 175.0
-------- ------
Total deferred tax liabilities......................... 1,034.9 850.2
-------- ------
DEFERRED TAX ASSETS
Credit loss reserves........................................ 799.6 636.9
Other....................................................... 320.0 311.9
-------- ------
Total deferred tax assets.............................. 1,119.6 948.8
VALUATION ALLOWANCE......................................... (3.3) (8.0)
-------- ------
TOTAL DEFERRED TAX ASSETS NET OF VALUATION ALLOWANCE... 1,116.3 940.8
-------- ------
NET DEFERRED TAX ASSETS AT END OF YEAR...................... $ 81.4 $ 90.6
======== ======
</TABLE>
49
<PAGE> 50
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
15. TRANSACTIONS WITH PARENT COMPANY AND AFFILIATES
HFC periodically advances funds to Household International and affiliates
or receives amounts in excess of the parent company's current requirements.
Advances to (from) parent company and affiliates consisted of the following:
<TABLE>
<CAPTION>
AT DECEMBER 31
---------------
1997 1996
------ ------
(IN MILLIONS)
<S> <C> <C>
Parent company and other subsidiaries....................... $ 76.2 $ 73.9
Household Bank, f.s.b....................................... (70.5) (79.8)
Household Global Funding, Inc............................... 4.8 (1.7)
------ ------
Advances to (from) parent company and affiliates............ $ 10.5 $ (7.6)
====== ======
</TABLE>
These advances bear interest at various market interest rates. Net interest
income on advances to (from) parent company and affiliates was as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------
1997 1996 1995
----- ----- ------
(IN MILLIONS)
<S> <C> <C> <C>
Parent company and other subsidiaries....................... $20.8 $13.3 $ 26.6
Household Bank, f.s.b. ..................................... .1 (3.6) (10.9)
----- ----- ------
Net interest income on advances to (from and affiliates)
parent company............................................ $20.9 $ 9.7 $ 15.7
===== ===== ======
</TABLE>
Household Bank, f.s.b. ("the Bank") has agreements with certain
wholly-owned bank subsidiaries of the company to provide loans of up to $450
million to fund their credit card operations. The outstanding balance at
December 31, 1997 and 1996 was $250 and $15 million, respectively, and was
included in commercial paper, bank and other borrowings for financial statement
purposes. Interest expense on these borrowings totaled $5.8, $3.9 and $13.9
million during 1997, 1996 and 1995, respectively.
Under the GM Card program, Household International designates the issuer of
the GM Card under a written contractual arrangement. From June 1994 to May 1997,
Household International designated the company's wholly-owned bank subsidiary as
the issuer of the new GM Card accounts for customers who previously did not have
an account with the previous designated issuer. In effect, Household
International licensed to the bank subsidiary, the GM Card account relationships
and GM's obligation to administer its rebate program in an arrangement similar
to an operating lease. Under this arrangement, the bank subsidiary pays a
licensing fee to Household International for each open account for the privilege
of maintaining the account relationship. Fees paid to Household International
under this arrangement were $27.6, $27.2 and $19.1 million in 1997, 1996 and
1995, respectively, and are recorded in other operating expenses on the
consolidated statements of income.
Household International has a Regulatory Capital Maintenance/Dividend
Agreement with the Office of Thrift Supervision. Under this agreement, as
amended, as long as Household International is the parent company of the Bank,
Household International and the company agree to maintain the capital of the
Bank at the required levels. The agreement also requires that any capital
deficiency be cured by Household International and/or the company within thirty
days. There were no cash capital contributions made by Household International
to the Bank in 1997 and 1996.
In July 1995 the company acquired from Household International an
affiliated entity that provides certain support services, such as item
processing, collections and billings, accounts payable and payroll processing,
primarily for Household International's domestic credit card portfolio. The
company acquired this servicing
50
<PAGE> 51
HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
subsidiary, including approximately $125 million of property and equipment, at
net book value. HFC and this servicing subsidiary have negotiated a market rate
agreement with the Bank for services such as underwriting, data processing, item
processing, check clearing, bank operations, accounts payable, and payroll
processing. Fees for these services totaled $47.8, $50.9 and $89.0 million
during 1997, 1996 and 1995, respectively.
The company was allocated costs incurred on its behalf by Household
International for administrative expenses, including insurance, credit
administration, legal and other fees. These administrative expenses were
recorded in other operating expenses and totaled approximately $58, $55 and $56
million in 1997, 1996 and 1995, respectively.
16. COMMITMENTS AND CONTINGENT LIABILITIES
In 1992, the Internal Revenue Service ("IRS") completed its examination of
Beneficial's federal income tax returns for 1984 through 1987. The IRS proposed
$142.0 million in adjustments that relate principally to activities of a former
subsidiary, American Centennial Insurance Company ("ACIC"), prior to its sale in
1987.
In order to limit the further accrual of interest on the proposed
adjustments, Beneficial paid $105.5 million of tax and interest during the third
quarter of 1992.
The issues were not resolved during the administrative appeals process, and
the IRS issued a statutory Notice of Deficiency asserting the unresolved
adjustments and increased the disallowance to $195.0 million in the third
quarter of 1996.
Beneficial has initiated litigation in the United States Tax Court to
oppose the disallowance. While the conclusion of this matter in its entirety
cannot be predicted with certainty, management does not anticipate the ultimate
resolution to differ materially from amounts accrued.
The company and subsidiaries are involved in various other legal
proceedings in the normal course of business. Management believes the aggregate
liabilities, if any, resulting from such actions would not have a material
adverse effect on the consolidated financial position of the company. However,
as the ultimate resolution of these proceedings is influenced by factors that
are outside of the company's control, it is reasonably possible the company's
estimated liability under these proceedings may change. See Note 12 for
discussion of lease commitments.
17. GEOGRAPHIC DATA
The following is a summary of assets, revenues and operating profit of the
company by country:
<TABLE>
<CAPTION>
IDENTIFIABLE ASSETS REVENUES OPERATING PROFIT
--------------------------------- ------------------------------ ----------------------------
1997 1996 1995 1997 1996 1995 1997 1996 1995
--------- --------- --------- -------- -------- -------- -------- -------- ------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
United States........ $36,052.0 $33,735.2 $31,078.4 $6,355.0 $5,571.9 $5,093.8 $1,175.6 $ 973.5 $688.9
United Kingdom....... 2,137.1 1,432.0 1,077.5 245.3 195.6 185.8 23.1 16.5 25.7
Canada............... 789.8 706.4 676.1 137.7 130.8 122.7 21.2 23.6 20.3
Germany.............. 401.0 413.7 455.1 31.2 55.2 67.4 (65.5) (2.0) (26.2)
Ireland.............. 69.0 37.6 10.5 33.8 17.9 4.7 4.6 (3.5) (1.1)
--------- --------- --------- -------- -------- -------- -------- -------- ------
Total............ $39,448.9 $36,324.9 $33,297.6 $6,803.0 $5,971.4 $5,474.4 $1,159.0 $1,008.1 $707.6
========= ========= ========= ======== ======== ======== ======== ======== ======
</TABLE>
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HOUSEHOLD FINANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
18. ACCOUNTING PRONOUNCEMENTS
In March 1998, Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"), was
issued. This statement, effective for financial statements issued for fiscal
years beginning after December 15, 1998, provides guidance on accounting for the
costs of computer software developed or obtained for internal use. We do not
expect the adoption of SOP 98-1 to have a material impact on our consolidated
financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("FAS No. 133"). FAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. FAS
No. 133 requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. FAS No.
133 is effective for fiscal years beginning after June 15, 1999, and can be
implemented as of the beginning of any fiscal quarter after issuance (that is,
fiscal quarters beginning June 16, 1998 and thereafter). FAS No. 133 cannot be
applied retroactively. We expect to adopt FAS No. 133 on January 1, 2000 and
have not yet quantified the impacts of adopting this statement on our financial
statements.
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