HSBC Credit Card Services Segment
The following table summarizes the IFRS Management Basis results for our Credit Card Services segment for the years ended December 31, 2006, 2005 and 2004.
Year Ended December 31, 2006 2005 2004
(dollars are in millions)
$ 1,386 $ 813 $ 521
Net interest income
3,151 2,150 2,226
Other operating income
2,360 1,892 1,581
20 21 25
Loan impairment charges
1,500 1,453 1,786
1,841 1,315 1,205
28,221 25,979 19,615
28,780 28,453 19,702
Net interest margin
11.85 % 10.42 % 10.78 %
Return on average assets
5.18 4.13 2.55
2006 compared to 2005 Our Credit Card Services segment reported higher net income in 2006. The increase in net income was primarily due to higher net interest income and higher other operating income, partially offset by higher operating expenses and higher loan impairment charges. The acquisition of Metris, which was completed in December 2005, contributed $147 million of net income during 2006 as compared to $4 million in 2005.
Net interest income increased in 2006 largely as a result of the Metris acquisition, which contributed to higher overall yields due in part to higher levels of non-prime customer loans, partially offset by higher interest expense. Net interest income in 2006 also benefited from the implementation in the second quarter of 2006 of a methodology for calculating the effective interest rate for introductory rate credit card customer loans under IFRSs over the expected life of the product which increased net interest income by $154 million for the year. Net interest margin increased primarily due to higher overall yields due to increases in non-prime customer loans, including the customer loans acquired as part of Metris, higher pricing on variable rate products and other repricing initiatives. These increases were partially offset by a higher cost of funds. Net interest margin in 2006 was also positively impacted by the adjustments recorded for the effective interest rate for introductory rate MasterCard/ Visa customer loans discussed above. Although our non-prime customer loans tend to have smaller balances, they generate higher returns both in terms of net interest margin and fee income.
Increases in other operating income resulted from portfolio growth, including the Metris portfolio acquired in December 2005 which has resulted in higher late fees, higher interchange revenue and higher enhancement services revenue from products such as Account Secure Plus (debt waiver) and Identity Protection Plan. This increase in fee income was partially offset by adverse impacts of limiting certain fee billings on non-prime credit card accounts as discussed below.
Higher operating expenses were incurred to support receivable growth, including the Metris portfolio acquisition, and increases in marketing expenses. The increase in marketing expenses in 2006 was primarily due to the Metris portfolio acquired in December 2005 and increased investment in our non-prime portfolio.
Loan impairment charges were higher in 2006. Loan impairment charges in 2005 were impacted by incremental credit loss provisions relating to the spike in bankruptcy filings experienced in the period leading up to October 17, 2005, which was the effective date of new bankruptcy laws in the United States and higher provisions relating to Katrina. Excluding these items, provisions in 2006 nonetheless increased, reflecting receivable growth and portfolio seasoning, including the full year impact of the Metris portfolio, partially offset by the impact of lower levels of bankruptcy filings following the enactment of new bankruptcy laws in October 2005, higher recoveries as a result of better rates available in the non-performing asset sales market and a reduction of our estimate of incremental credit loss exposure related to Katrina of approximately $26 million. We increased loss reserves by recording loss provision greater than net charge-off of $328 million in 2006. Customer loans increased 9 percent to $28.2 billion at December 31, 2006 compared to $26.0 billion at December 31, 2005. The increase reflects strong domestic organic growth in our Union Privilege as well as other non-prime portfolios including Metris.
The increase in ROA in 2006 is primarily due to the higher net income as discussed above, partially offset by higher average assets. In accordance with FFIEC guidance, our Credit Card Services business adopted a plan to phase in changes to the required minimum monthly payment amount and limit certain fee billings for non-prime credit card accounts. The implementation of these new requirements began in July 2005 with the requirements fully phased in by December 31, 2005. These changes resulted in lower non-prime credit card fee income in 2006. In addition, roll rate trends in the prime book have been slightly higher than those experienced prior to the changes in minimum payment. These changes have resulted in fluctuations in loan impairment charges as credit loss provisions for prime accounts has increased as a result of higher required monthly payments while the non-prime provision decreased due to lower levels of fees incurred by customers. The impact of these changes has not had a material impact on our consolidated results, but has had a material impact to the Credit Card Services segment in 2006. 2005 compared to 2004 Our Credit Card Services segment reported higher net income in 2005. The increase in net income was primarily due to higher other operating income and lower loan impairment charges, partially offset by higher operating expenses and lower net interest income. The acquisition of Metris, which was completed in December 2005, did not have a significant impact to the results of the Credit Card Services segment in 2005. Increases in other operating income resulted from portfolio growth, higher late and overlimit fees and improved interchange rates.
Loan impairment charges decreased in 2005 due to improved credit quality, partially offset by receivable growth as well as the increased credit loss provision relating to the impact of Katrina and the increased bankruptcy filings resulting from the new bankruptcy law in the United States. We experienced higher dollars of net charge-offs in our portfolio due to higher receivable levels as well as the increased credit card charge-offs in the fourth quarter of 2005 which resulted from the spike in bankruptcy filings prior to the October 2005 effective date of the new bankruptcy law. We had been maintaining credit loss reserves in anticipation of the impact this new law would have on net charge-offs. However, the magnitude of the spike in bankruptcies experienced immediately before the new law became effective was larger than anticipated which resulted in an additional $100 million credit loss provision being recorded during the third quarter of 2005. Our fourth quarter of 2005 results included an estimated $125 million in incremental charge-offs of principal, interest and fees attributable to bankruptcy reform which was offset by a release of our owned credit loss reserves of $125 million. As expected, the number of bankruptcy filings subsequent to the enactment of this new law has decreased dramatically. In 2005, we increased our loss reserves by recording loss provision greater than net charge-offs of $20 million.
Loan impairment charges in 2005 also reflects an estimate of incremental credit loss exposure relating to Katrina. The incremental provision for credit losses for Katrina in the Credit Card Services segment in 2005 was $55 million and represented our best estimate of KatrinaÃ¢Âs impact on our loan portfolio. In an effort to assist our customers affected by the disaster, we initiated various programs including extended payment arrangements and interest and fee waivers for up to 90 days or more depending upon customer circumstances. These interest and fee waivers were not material to the Credit Card Services segmentÃ¢Âs 2005 results.
Higher operating expenses were to support receivable growth and increases in marketing expenses. The increase in marketing expenses was due to higher non-prime marketing expense, investments in new marketing initiatives and changes in contractual marketing responsibilities in July 2004 associated with the domestic co-branded GM credit card.
Net interest income decreased due to higher interest expense in 2005 due to a higher cost of funds, partially offset by increases in finance and interest income. The increase in finance and interest income from our credit card customer loans reflects increased pricing on variable yield products and higher receivable balances. Yields increased in 2005 primarily due to increases in non-prime receivable levels, higher pricing on variable rate products as well as other repricing initiatives. Lower average interest earning assets due to lower levels of low yielding investment securities and the impact of lower amortization from receivable origination costs resulting from changes in the contractual marketing responsibilities in July 2004 associated with the co-branded GM credit card also contributed to the increase in yield. These increases to net interest margin were offset by higher interest expense resulting in lower net interest margin. Although our non-prime customer loans tend to have smaller balances, they generate higher returns both in terms of net interest margin and fee income.
Customer loans increased 32 percent to $26.0 billion at December 31, 2005 compared to $19.6 billion at December 31, 2004. As discussed above, the increase was primarily due to the acquisition of Metris in December 2005 which increased customer loans by $5.3 billion on an IFRS Management Basis. Organic growth in our HSBC branded prime, Union Privilege and non-prime portfolios, partially offset by the continued decline in certain older acquired portfolios, also contributed to the increase.
The increase in ROA in 2005 was primarily due to the higher net income discussed above as well as the impact of lower average assets. The decrease in average assets was due to lower investment securities during 2005 as a result of the elimination of investments dedicated to our credit card bank in 2003 resulting from our acquisition by HSBC.
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