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HSBC Finance Corp – ‘10-Q’ for 9/30/17

On:  Monday, 10/30/17, at 6:02am ET   ·   For:  9/30/17   ·   Accession #:  354964-17-29   ·   File #:  1-08198

Previous ‘10-Q’:  ‘10-Q’ on 7/31/17 for 6/30/17   ·   Latest ‘10-Q’:  This Filing   ·   4 References:   

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  As Of               Filer                 Filing    For·On·As Docs:Size

10/30/17  HSBC Finance Corp                 10-Q        9/30/17   79:10M

Quarterly Report   —   Form 10-Q   —   Sect. 13 / 15(d) – SEA’34
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-Q        Quarterly Report                                    HTML    814K 
 2: EX-12       Statement re: Computation of Ratios                 HTML     33K 
 3: EX-31       Certification -- §302 - SOA'02                      HTML     40K 
 4: EX-32       Certification -- §906 - SOA'02                      HTML     31K 
11: R1          Document and Entity Information                     HTML     51K 
12: R2          Consolidated Statement of Income (Loss)             HTML    112K 
                (Unaudited)                                                      
13: R3          Consolidated Statement of Comprehensive Income      HTML     44K 
                (Loss) (Unaudited)                                               
14: R4          Consolidated Balance Sheet (Unaudited)              HTML    108K 
15: R5          Consolidated Balance Sheet (Unaudited)              HTML     51K 
                (Parenthetical)                                                  
16: R6          Consolidated Statement of Changes in Equity         HTML     71K 
                (Unaudited)                                                      
17: R7          Consolidated Statement of Cash Flows (Unaudited)    HTML    134K 
18: R8          Consolidated Statement of Cash Flows (Unaudited)    HTML     28K 
                (Parenthetical)                                                  
19: R9          Organization and Basis of Presentation              HTML     32K 
20: R10         Receivables Held for Sale                           HTML    177K 
21: R11         Troubled Debt Restructures and Nonperforming        HTML     65K 
                Receivables                                                      
22: R12         Credit Loss Reserves                                HTML     71K 
23: R13         Fair Value Option                                   HTML     79K 
24: R14         Derivative Financial Instruments                    HTML    160K 
25: R15         Accumulated Other Comprehensive Income (Loss)       HTML     81K 
26: R16         Pension and Other Postretirement Benefits           HTML     69K 
27: R17         Related Party Transactions                          HTML    107K 
28: R18         Variable Interest Entities                          HTML     50K 
29: R19         Fair Value Measurements                             HTML    295K 
30: R20         Litigation and Regulatory Matters                   HTML     33K 
31: R21         New Accounting Pronouncements                       HTML     38K 
32: R22         Receivables Held for Sale (Tables)                  HTML    177K 
33: R23         Troubled Debt Restructures and Nonperforming        HTML     67K 
                Receivables (Tables)                                             
34: R24         Credit Loss Reserves (Tables)                       HTML     70K 
35: R25         Fair Value Option (Tables)                          HTML     75K 
36: R26         Derivative Financial Instruments (Tables)           HTML    154K 
37: R27         Accumulated Other Comprehensive Income (Loss)       HTML     80K 
                (Tables)                                                         
38: R28         Pension and Other Postretirement Benefits (Tables)  HTML     70K 
39: R29         Related Party Transactions (Tables)                 HTML     85K 
40: R30         Variable Interest Entities (Tables)                 HTML     50K 
41: R31         Fair Value Measurements (Tables)                    HTML    281K 
42: R32         Organization and Basis of Presentation (Details)    HTML     37K 
43: R33         Receivables Held for Sale - Real Estate Secured     HTML     37K 
                Receivables (Details)                                            
44: R34         Receivables Held for Sale - Receivables Sold to     HTML     38K 
                Third Party Investors (Details)                                  
45: R35         Receivables Held for Sale - Summary of Activity in  HTML     48K 
                Receivables Held for Sale (Detail)                               
46: R36         Receivables Held for Sale - Additional Information  HTML     59K 
                (Detail)                                                         
47: R37         Receivables Held For Sale - Allowance for Credit    HTML     36K 
                Losses Rollforward (Details)                                     
48: R38         Receivables Held for Sale - Summary of Components   HTML     57K 
                of Cumulative Lower of Amortized Cost or Fair                    
                Value Adjustment (Detail)                                        
49: R39         Troubled Debt Restructures and Nonperforming        HTML     34K 
                Receivables - TDR Loans (Details)                                
50: R40         Troubled Debt Restructures and Nonperforming        HTML     28K 
                Receivables - Additional Information Related to                  
                TDR Loans (Details)                                              
51: R41         Troubled Debt Restructures and Nonperforming        HTML     37K 
                Receivables - Nonperforming Portfolio (Details)                  
52: R42         Troubled Debt Restructures and Nonperforming        HTML     28K 
                Receivables - Additional Information on Nonaccrual               
                Receivables (Details)                                            
53: R43         Credit Loss Reserves - Summarizes Changes in        HTML     64K 
                Credit Loss Reserves by Product/Class and Related                
                Receivable Balance by Product (Detail)                           
54: R44         Fair Value Option - Fair Value Option on            HTML     34K 
                Liabilities (Details)                                            
55: R45         Fair Value Option - Components of Gain (Loss) on    HTML     46K 
                Debt Designated at Fair Value and Related                        
                Derivatives (Detail)                                             
56: R46         Fair Value Option - Additional Information          HTML     26K 
                (Detail)                                                         
57: R47         Derivative Financial Instruments - Additional       HTML     44K 
                Information (Detail)                                             
58: R48         Derivative Financial Instruments - Schedule of      HTML     68K 
                Derivative Instruments (Details)                                 
59: R49         Derivative Financial Instruments - Gain or Loss     HTML     59K 
                Recorded on Our Cash Flow Hedging Relationships                  
                (Detail)                                                         
60: R50         Derivative Financial Instruments - Gain or Loss     HTML     30K 
                Recorded on Our Non-Qualifying Hedges (Detail)                   
61: R51         Derivative Financial Instruments - Gain or Loss     HTML     33K 
                Recorded on Derivatives Related to Fair Value                    
                Option Debt Primarily Due to Changes in Interest                 
                Rates (Detail)                                                   
62: R52         Derivative Financial Instruments - Notional Values  HTML     31K 
                of Derivative Contracts (Detail)                                 
63: R53         Accumulated Other Comprehensive Income (Loss) -     HTML     96K 
                Summary of Changes in Accumulated Other                          
                Comprehensive Loss (Detail)                                      
64: R54         Pension and Other Postretirement Benefits -         HTML     38K 
                Components of Pension Expense for Defined Benefit                
                Pension Plan (Detail)                                            
65: R55         Pension and Other Postretirement Benefits-Post      HTML     38K 
                Retirement Benefit Cost (Details)                                
66: R56         Related Party Transactions - Related Party          HTML     86K 
                Balances and Income and (Expense) Generated by                   
                Related Party Transactions (Detail)                              
67: R57         Related Party Transactions - Schedule of due to     HTML     34K 
                Affiliated entities (Details)                                    
68: R58         Related Party Transactions - Additional             HTML    103K 
                Information (Detail)                                             
69: R59         Variable Interest Entities - Summary of Assets and  HTML     39K 
                Liabilities of Consolidated Secured Financing VIEs               
                (Detail)                                                         
70: R60         Fair Value Measurements - Carrying and Estimated    HTML     87K 
                Fair Value (Detail)                                              
71: R61         Fair Value Measurements - Fair Value of Assets and  HTML    105K 
                Liabilities Measured on Recurring Basis (Detail)                 
72: R62         Fair Value Measurements - Assets and Liabilities    HTML     85K 
                Recorded at Fair Value on Non-recurring Basis                    
                (Detail)                                                         
73: R63         Fair Value Measurements - Quantitative Information  HTML     46K 
                for Non-Recurring Fair Value Measurements (Detail)               
74: R64         Fair Value Measurements - Additional Information    HTML     34K 
                (Detail)                                                         
75: R65         Litigation and Regulatory Matters - Additional      HTML     26K 
                Information (Detail)                                             
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‘10-Q’   —   Quarterly Report
Document Table of Contents

Page (sequential)   (alphabetic) Top
 
11st Page  –  Filing Submission
"Consolidated Statement of Income (Loss)
"Consolidated Statement of Comprehensive Income (Loss)
"Consolidated Balance Sheet
"Consolidated Statement of Changes in Equity
"Consolidated Statement of Cash Flows
"Notes to Consolidated Financial Statements
"Organization and Basis of Presentation
"Receivables Held for Sale
"Troubled Debt Restructures and Nonperforming Receivables
"Credit Loss Reserves
"Fair Value Option
"Derivative Financial Instruments
"Accumulated Other Comprehensive Income (Loss)
"Pension and Other Postretirement Benefits
"Related Party Transactions
"Variable Interest Entities
"Fair Value Measurements
"Litigation and Regulatory Matters
"New Accounting Pronouncements
"Forward-Looking Statements
"Executive Overview
"Balance Sheet Review
"Results of Operations
"Credit Quality
"Liquidity and Capital Resources
"Fair Value
"Risk Management
"Quantitative and Qualitative Disclosures About Market Risk
"Controls and Procedures
"Legal Proceedings

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UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C. 20549
___________________

FORM 10-Q
___________________

(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017

OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 001-08198
___________________

HSBC FINANCE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
 
86-1052062
(State of incorporation)
 
(I.R.S. Employer Identification No.)
1421 W. Shure Drive, Suite 100, Arlington Heights, IL
 
(Address of principal executive offices)
 
(Zip Code)

(224) 880-7000
Registrant’s telephone number, including area code
___________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
x
Smaller reporting company
o
Emerging growth company
o
 
 
 
 
(Do not check if a smaller
reporting company)
 
 
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý

At October 27, 2017, there were 68 shares of the registrant’s common stock outstanding, all of which are owned by HSBC North America Holdings Inc.
 



HSBC Finance Corporation

Form 10-Q
TABLE OF CONTENTS
Part/Item No
 
Part I
 
Page
Item 1.
Financial Statements (Unaudited):
 
 
 
 
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations:
 
 
 
 
 
 
 
 
 
Item 3.
Item 4.
 
 
Part II
 
Page
Item 1.
Item 5.
Item 6.



2


HSBC Finance Corporation

PART I

Item 1.    Financial Statements.
 
 

CONSOLIDATED STATEMENT OF INCOME (LOSS) (UNAUDITED)
 
Three Months Ended
September 30,
 
Nine Months Ended

2017
 
2016
 
2017
 
2016
 
(in millions)
Interest income
$
33

 
$
217

 
$
226

 
$
845

Interest expense on debt held by:
 
 
 
 
 
 
 
Non-affiliates
47

 
65

 
167

 
266

HSBC affiliates
10

 
43

 
49

 
148

Interest expense
57

 
108

 
216

 
414

Net interest income (expense)
(24
)
 
109

 
10

 
431

Provision for credit losses

 
572

 

 
621

Net interest income (expense) after provision for credit losses
(24
)
 
(463
)
 
10

 
(190
)
Other revenues:
 
 
 
 
 
 
 
Derivative related income (expense)
1

 
3

 
4

 
(109
)
Gain (loss) on debt designated at fair value and related derivatives
8

 
(8
)
 
24

 
32

Servicing and other fees from HSBC affiliates

 
1

 
1

 
7

Lower of amortized cost or fair value adjustment on receivables held for sale
(16
)
 
(8
)
 
155

 
(119
)
Gain (loss) on sale of real estate secured receivables
139

 
(5
)
 
754

 
418

Loss on extinguishment of debt held by:
 
 
 
 
 
 
 
Non-affiliates
(174
)
 

 
(174
)
 

HSBC affiliates
(85
)
 

 
(113
)
 

Other income
14

 
6

 
23

 
19

Total other revenues
(113
)
 
(11
)
 
674

 
248

Operating expenses:
 
 
 
 
 
 
 
Salaries and employee benefits
43

 
56

 
79

 
128

Occupancy and equipment expenses, net
2

 
3

 
9

 
13

Real estate owned expenses

 
1

 
1

 
6

Support services from HSBC affiliates
15

 
40

 
59

 
120

Provision for securities litigation liability

 

 

 
575

Other expenses
21

 
35

 
61

 
144

Total operating expenses
81

 
135

 
209

 
986

Income (loss) from continuing operations before income tax
(218
)
 
(609
)
 
475

 
(928
)
Income tax expense (benefit)
(84
)
 
(203
)
 
174

 
(322
)
Income (loss) from continuing operations
(134
)
 
(406
)
 
301

 
(606
)
Discontinued operations:
 
 
 
 
 
 
 
Income (loss) from discontinued operations before income tax
4

 
(2
)
 
7

 
(11
)
Income tax expense (benefit)
1

 
(4
)
 
2

 
(5
)
Income (loss) from discontinued operations
3

 
2

 
5

 
(6
)
Net income (loss)
$
(131
)
 
$
(404
)
 
$
306

 
$
(612
)

The accompanying notes are an integral part of the consolidated financial statements.

3


HSBC Finance Corporation

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,

2017
 
2016
 
2017
 
2016
 
(in millions)
Net income (loss)
$
(131
)
 
$
(404
)
 
$
306

 
$
(612
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Net change in unrealized gains (losses), net of tax, on:
 
 
 
 
 
 
 
Fair value option debt attributable to our own credit spread
23

 

 
18

 

Derivatives designated as cash flow hedges

 

 

 
15

Pension and postretirement benefit plan adjustments

 

 
(10
)
 
(3
)
Other comprehensive income (loss), net of tax
23

 

 
8

 
12

Total comprehensive income (loss)
$
(108
)
 
$
(404
)
 
$
314

 
$
(600
)

The accompanying notes are an integral part of the consolidated financial statements.


4


HSBC Finance Corporation

CONSOLIDATED BALANCE SHEET (UNAUDITED)
 
 
 
(in millions,
except share data)
Assets
 
 
 
Cash
$
26

 
$
128

Interest bearing deposits with banks

 
1,500

Securities purchased under agreements to resell
4,040

 
2,392

Receivables held for sale (including $195 million and $750 million at September 30, 2017 and December 31, 2016, respectively, collateralizing long-term debt)
256

 
5,674

Real estate owned
10

 
31

Deferred income taxes, net
1,863

 
2,897

Bank owned life insurance
827

 
817

Other assets
983

 
427

Assets of discontinued operations
19

 
16

Total assets
$
8,024

 
$
13,882

Liabilities
 
 
 
Debt:
 
 
 
Due to affiliates (including $- million and $485 million at September 30, 2017 and December 31, 2016, respectively, carried at fair value)
$

 
$
3,300

Long-term debt (including $253 million and $1.3 billion at September 30, 2017 and December 31, 2016, respectively, carried at fair value and $76 million and $404 million at September 30, 2017 and December 31, 2016, respectively, collateralized by receivables)
1,836

 
4,340

Total debt
1,836

 
7,640

Derivative related liabilities
1

 
12

Liability for postretirement benefits
126

 
129

Other liabilities
344

 
610

Liabilities of discontinued operations
33

 
57

Total liabilities
2,340

 
8,448

Equity
 
 
 
Redeemable preferred stock:
 
 
 
Series C ($0.01 par value, 1,000 shares authorized; 1,000 shares issued and outstanding at September 30, 2017 and December 31, 2016)
1,000

 
1,000

Common equity:
 
 
 
Common stock ($0.01 par value, 100 shares authorized; 68 shares issued and outstanding at September 30, 2017 and December 31, 2016)

 

Additional paid-in capital
23,070

 
23,138

Accumulated deficit
(18,399
)
 
(18,728
)
Accumulated other comprehensive income (loss)
13

 
24

Total common equity
4,684

 
4,434

Total equity
5,684

 
5,434

Total liabilities and equity
$
8,024

 
$
13,882


The accompanying notes are an integral part of the consolidated financial statements.

5


HSBC Finance Corporation

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (UNAUDITED)
Nine Months Ended September 30,
2017
 
2016
 
(in millions)
Preferred stock
 
 
 
Balance at beginning of period
$
1,000

 
$
1,575

Redemption of Series B preferred stock

 
(575
)
Balance at end of period
1,000

 
1,000

Common equity
 
 
 
Common stock
 
 
 
Balance at beginning and end of period

 

Additional paid-in capital
 
 
 
Balance at beginning of period
23,138

 
23,245

Dividends on preferred stock
(64
)
 
(84
)
Employee benefit plans, including transfers and other
(4
)
 

Balance at end of period
23,070

 
23,161

Accumulated deficit
 
 
 
Balance at beginning of period, as previously reported
(18,728
)
 
(18,199
)
Reclassification to accumulated other comprehensive income (loss) of cumulative effect adjustment to initially apply new accounting guidance for fair value option debt, net of tax
19

 

Cumulative effect adjustment to initially apply new accounting guidance for previously unrecognized tax benefits on share based plans, net of tax
4

 

Balance at beginning of period, adjusted
(18,705
)
 
(18,199
)
Net income (loss)
306

 
(612
)
Balance at end of period
(18,399
)
 
(18,811
)
Accumulated other comprehensive income (loss)
 
 
 
Balance at beginning of period, as previously reported
24

 
14

Reclassification from accumulated deficit of cumulative effect adjustment to initially apply new accounting guidance for fair value option debt, net of tax
(19
)
 

Balance at beginning of period, adjusted
5

 
14

Other comprehensive income (loss)
8

 
12

Balance at end of period
13

 
26

Total common equity at end of period
4,684

 
4,376

Total equity at end of period
$
5,684

 
$
5,376


The accompanying notes are an integral part of the consolidated financial statements.

6


HSBC Finance Corporation

CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
Nine Months Ended September 30,
2017
 
2016
 
(in millions)
Cash flows from operating activities
 
 
 
Net income (loss)
$
306

 
$
(612
)
Income (loss) from discontinued operations
5

 
(6
)
Income (loss) from continuing operations
301

 
(606
)
Adjustments to reconcile income (loss) from continuing operations to net cash used in operating activities:
 
 
 
Provision for credit losses

 
621

Lower of amortized cost or fair value adjustment on receivables held for sale
(155
)
 
119

Gain on sale of real estate secured receivables
(754
)
 
(418
)
Loss on extinguishment of debt
287

 

Provision for securities litigation liability

 
575

Mark-to-market on debt designated at fair value and related derivatives
(7
)
 
6

Foreign exchange and derivative movements on long-term debt and net change in non-fair value option related derivative assets and liabilities
51

 
26

Net change in other assets
460

 
(264
)
Net change in other liabilities
(271
)
 
(1,918
)
Other, net
(6
)
 
11

Cash used in operating activities – continuing operations
(94
)
 
(1,848
)
Cash used in operating activities – discontinued operations
(23
)
 
(27
)
Cash used in operating activities
(117
)
 
(1,875
)
Cash flows from investing activities
 
 
 
Net change in securities purchased under agreements to resell
(1,648
)
 
1,900

Net change in interest bearing deposits with banks
1,500

 

Receivables:
 
 
 
Net collections
248

 
1,322

Proceeds from sales of receivables
6,059

 
5,382

Proceeds from sales of real estate owned
39

 
99

Sales of properties and equipment, net

 
2

Cash provided by investing activities – continuing operations
6,198

 
8,705

Cash provided by investing activities – discontinued operations

 

Cash provided by investing activities
6,198

 
8,705

 
 
 
 

7


HSBC Finance Corporation

CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (Continued)
Nine Months Ended September 30,
2017
 
2016
 
(in millions)
Cash flows from financing activities
 
 
 
Debt:
 
 
 
Net change in due to affiliates
(3,234
)
 
(1,102
)
Long-term debt retired
(2,584
)
 
(5,074
)
Debt extinguishment fees
(303
)
 

Redemption of preferred stock

 
(575
)
Dividends
(64
)
 
(84
)
Cash used in financing activities – continuing operations
(6,185
)
 
(6,835
)
Cash used in financing activities – discontinued operations

 

Cash used in financing activities
(6,185
)
 
(6,835
)
Net change in cash
(104
)
 
(5
)
Cash at beginning of period(1)
135

 
136

Cash at end of period(2)
$
31

 
$
131

Supplemental Noncash Investing and Capital Activities:
 
 
 
Fair value of properties added to real estate owned
$
15

 
$
55

Transfer of receivables to held for sale

 
7,574

 
(1) 
Cash at beginning of period includes $7 million and $12 million for discontinued operations at January 1, 2017 and 2016, respectively.
(2) 
Cash at end of period includes $5 million and $11 million for discontinued operations at September 30, 2017 and 2016, respectively.

The accompanying notes are an integral part of the consolidated financial statements.

8


HSBC Finance Corporation


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note
 
Page
 
Note
 
Page
1
 
8
2
 
9
3
 
10
4
 
11
5
 
12
6
 
13
7
 
 
 
 

1.
Organization and Basis of Presentation
 
HSBC Finance Corporation is a wholly owned subsidiary of HSBC North America Holdings Inc. ("HSBC North America"), which is an indirect, wholly-owned subsidiary of HSBC Holdings plc ("HSBC" and, together with its subsidiaries, "HSBC Group"). The accompanying unaudited interim consolidated financial statements of HSBC Finance Corporation and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all normal and recurring adjustments considered necessary for a fair presentation of financial position, results of operations and cash flows for the interim periods have been made. HSBC Finance Corporation and its subsidiaries may also be referred to in this Form 10-Q as "we," "us" or "our." These unaudited interim consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2016 (the "2016 Form 10-K"). Certain reclassifications have been made to prior period amounts to conform to the current period presentation.
The consolidated financial statements have been prepared on the basis that we will continue as a going concern. Such assertion contemplates our receivable sales program, the significant losses recognized in recent years and the challenges we anticipate to our operating results under prevailing and forecasted economic and business conditions. HSBC continues to be fully committed and has the capacity to continue to provide the necessary capital and liquidity to fund continuing operations.
The preparation of financial statements in conformity with U.S. GAAP 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. At September 30, 2017, our consolidated balance sheet was impacted by a reclassification associated with an out of period adjustment that was recorded in the first quarter of 2017 which increased our current tax asset and reduced our deferred tax asset balance by $36 million. There was no impact to our consolidated statement of income (loss). During the three and nine months ended September 30, 2017, our results were impacted by an out of period adjustment to our estimated liability associated with certain employee medical benefits provided to employees on long-term disability which increased salaries and employee benefits expense by approximately $22 million.
In June 2017, we received an interest payment from the Internal Revenue Service ("IRS") of $37 million related to the resolution of an IRS appeals matter involving the netting of under-payments and over-payments for tax years 1995 through 2009. The interest payment was recorded in the second quarter of 2017 as a component of interest income.
Unless otherwise noted, information included in these notes to the consolidated financial statements relates to continuing operations for all periods presented. See Note 3, "Discontinued Operations," in our 2016 Form 10-K for further details of our discontinued operations. Interim results should not be considered indicative of results in future periods.
We have one segment, Consumer, which consists of the run-off real estate secured receivable portfolio of our Consumer Lending and Mortgage Services businesses. As there are no reporting differences between our consolidated results and our segment results, we do not separately report segment results.


9


HSBC Finance Corporation

2.
Receivables Held for Sale
 
As discussed in prior filings, we established a receivable sales program in 2013 and have been engaged in an on-going evaluation of our operations as we seek to optimize our risk profile and cost structure as well as our liquidity, capital and funding requirements. As part of this on-going evaluation, in September 2016, we transferred all remaining real estate secured receivables classified as held for investment to held for sale. As a result, at September 30, 2017 and December 31, 2016, our entire receivable portfolio is classified as held for sale. Receivables held for sale, which are carried at the lower of amortized cost or fair value, are comprised of the following:
 
 
 
(in millions)
Real estate secured receivables held for sale:
 
 
 
First lien
$
235

 
$
4,699

Second lien
21

 
975

Total real estate secured receivables held for sale(1)
$
256

 
$
5,674

 
(1) 
At September 30, 2017 and December 31, 2016, contractually delinquent real estate secured receivables held for sale includes $14 million and $235 million, respectively, that are in the process of foreclosure.
At September 30, 2017 and December 31, 2016, receivables held for sale includes $195 million and $750 million, respectively, of closed-end real estate secured receivables which are part of a collateralized funding transaction. These receivables will be sold when they are contractually released as collateral under the public trust and become available for sale. See Note 10, "Variable Interest Entities," for further discussion of our collateralized funding transactions.
We continue to make progress in our strategy to run-off and sell our real estate secured receivable portfolio. The following table summarizes receivables sold to third party investors during the three and nine months ended September 30, 2017 and 2016.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,

2017
 
2016
 
2017
 
2016
 
(in millions)
Unpaid principal balance at the time of sale
$
1,244

 
$
930

 
$
6,228

 
$
5,652

 
 
 
 
 
 
 
 
Aggregate cash consideration received
$
1,196

 
$
715

 
$
6,059

 
$
5,382

Aggregate carrying value at the time of sale
1,048

 
714

 
5,267

 
4,933

Transaction costs
9

 
6

 
38

 
31

Gain (loss) on sale of real estate secured receivables
$
139

 
$
(5
)
 
$
754

 
$
418


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HSBC Finance Corporation

The following table summarizes the activity in receivables held for sale during the three and nine months ended September 30, 2017 and 2016:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,

2017
 
2016
 
2017
 
2016
 
(in millions)
Real estate secured receivables held for sale at beginning of period
$
1,346

 
$
3,796

 
$
5,674

 
$
8,265

Transfer of real estate secured receivables into held for sale at the lower of amortized cost or fair value(1)(2)

 
7,281

 

 
7,574

Real estate secured receivable sales
(1,048
)
 
(714
)
 
(5,267
)
 
(4,933
)
Lower of amortized cost or fair value adjustment on real estate secured receivables held for sale subsequent to initial transfer to held for sale
(16
)
 
(3
)
 
155

 
(108
)
Carrying value of real estate secured receivables held for sale transferred to real estate owned ("REO")
(2
)
 
(11
)
 
(19
)
 
(45
)
Carrying value of real estate secured receivables held for sale settled through short sale
(2
)
 
(8
)
 
(17
)
 
(26
)
Change in real estate secured receivable balance, including collections
(22
)
 
(193
)
 
(270
)
 
(579
)
Real estate secured receivables held for sale at end of period(3)
$
256

 
$
10,148

 
$
256

 
$
10,148

 
(1) 
During the three and nine months ended September 30, 2016, the initial lower of amortized cost or fair value adjustment recorded on receivables transferred into held for sale totaled $562 million and $587 million, respectively.
(2) 
Amount includes any accrued interest associated with the receivable.
(3) 
Real estate secured receivables held for sale in the table above are presented net of the valuation allowance.
During the three and nine months ended September 30, 2016, we transferred real estate secured receivables to held for sale with an unpaid principal balance (excluding accrued interest) of approximately $8,219 million and $8,577 million, respectively, at the time of transfer. The carrying value of these receivables prior to transfer after considering the fair value of the property less cost to sell was approximately $8,087 million and $8,429 million, respectively, including accrued interest. Credit loss reserves associated with these receivables totaled $244 million and $268 million, respectively, at the time of transfer to held for sale. During the three and nine months ended September 30, 2016, we recorded an initial lower of amortized cost or fair value adjustment of $562 million and $587 million, respectively. Of this amount, $557 million and $576 million, respectively, were attributed to credit factors and recorded as a component of the provision for credit losses in the consolidated statement of income (loss) and $5 million and $11 million, respectively, were attributable to non-credit factors and recorded as a component of other revenues in the consolidated statement of income (loss).
The following table provides a rollforward of our valuation allowance for the three and nine months ended September 30, 2017 and 2016. See Note 11, "Fair Value Measurements," for a discussion of the factors impacting the fair value of these receivables.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,

2017
 
2016
 
2017
 
2016
 
(in millions)
Balance at beginning of period
$
3

 
$
150

 
$
174

 
$
13

Initial valuation allowance for real estate secured receivables transferred to held for sale during the period

 
5

 

 
11

Increase (decrease) in valuation allowance resulting from changes in fair value
10

 
15

 
(153
)
 
145

Change in valuation allowance for receivables sold
(5
)
 
(81
)
 
(5
)
 
(81
)
Change in valuation allowance for collections, charged-off, transferred to REO or short sale
(1
)
 
(1
)
 
(9
)
 

Balance at end of period
$
7

 
$
88

 
$
7

 
$
88


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HSBC Finance Corporation

The following table summarizes the components of the lower of amortized cost or fair value adjustment during the three and nine months ended September 30, 2017 and 2016:
 
Lower of Amortized Cost or Fair Value Adjustments Associated With
 
 
(Income)/Expense
Fair Value
 
Settlement(1)
 
Total
 
(in millions)
Three Months Ended September 30, 2017:
 
 
 
 
 
Lower of amortized cost or fair value adjustment recorded through other revenues(2)
$
10

 
$
6

 
$
16

Total lower of amortized cost or fair value adjustment
$
10

 
$
6

 
$
16

Three Months Ended September 30, 2016:
 
 
 
 
 
Lower of amortized cost or fair value adjustments recorded as a component of:
 
 
 
 
 
Provision for credit losses(3)
$
557

 
$

 
$
557

Other revenues:
 
 
 
 
 
Initial lower of amortized cost or fair value adjustment(4)
5

 

 
5

Subsequent to initial transfer to held for sale
15

 
(12
)
 
3

Lower of amortized cost or fair value adjustment recorded through other revenues
20

 
(12
)
 
8

Total lower of amortized cost or fair value adjustment
$
577

 
$
(12
)
 
$
565

Nine Months Ended September 30, 2017:
 
 
 
 
 
Lower of amortized cost or fair value adjustment recorded through other revenues(2)
$
(153
)
 
$
(2
)
 
$
(155
)
Total lower of amortized cost or fair value adjustment
$
(153
)
 
$
(2
)
 
$
(155
)
Nine Months Ended September 30, 2016:
 
 
 
 
 
Lower of amortized cost or fair value adjustments recorded as a component of:
 
 
 
 
 
Provision for credit losses(3)
$
576

 
$

 
$
576

Other revenues:
 
 
 
 
 
Initial lower of amortized cost or fair value adjustment(4)
11

 

 
11

Subsequent to initial transfer to held for sale
145

 
(37
)
 
108

Lower of amortized cost or fair value adjustment recorded through other revenues
156

 
(37
)
 
119

Total lower of amortized cost or fair value adjustment
$
732

 
$
(37
)
 
$
695

 
(1) 
Reflects receivable settlements due to either receivable charge-off or payoff (including short sales) or transfer of receivables to REO and reflects either a reversal of the non-credit fair value adjustment previously recorded on these receivables or an additional lower of amortized cost or fair value adjustment required at the time of settlement.
(2) 
As all of our receivables are classified as held for sale at September 30, 2017 and December 31, 2016, for the three and nine months ended September 30, 2017 and for all future periods, any lower of amortized cost or fair value adjustments will relate to either changes in fair value subsequent to classification as held for sale or settlements of receivables as discussed above.
(3) 
Represents the portion of the initial lower of amortized cost or fair value adjustment attributable to credit factors which are recorded as provision for credit losses in the consolidated statement of income (loss).
(4) 
Represents the portion of the initial lower of amortized cost or fair value adjustment attributable to non-credit factors which are recorded as a component of total other revenues in the consolidated statement income (loss) as it reflects the impact on value caused by current marketplace conditions including changes in interest rates.
During the three months ended September 30, 2017, we recorded an additional lower of amortized cost or fair value adjustment of $10 million related to a change in fair value resulting from a change in the estimated pricing on a specific pool of receivables. During the nine months ended September 30, 2017, we reversed $153 million of the lower of amortized cost or fair value adjustment recorded in prior periods related to changes in fair value. This reversal reflects fair value changes resulting from aggregating all receivables held for sale into pools based on the marketing strategy for the remainder of 2017 as well as improvements in the fair value of these receivables during the first nine months of 2017. The fair value of receivables held for sale is determined based on an aggregation of receivables into pools either by similar risk characteristics or by receivable pools being marketed.
During the three and nine months ended September 30, 2016, we recorded an additional lower of amortized cost or fair value adjustment of $15 million and $145 million, respectively, related to changes in fair value as a result of a change in the estimated pricing on specific pools of receivables.


12


HSBC Finance Corporation

3.
Troubled Debt Restructures and Nonperforming Receivables
 
Troubled Debt Restructurings  We report substantially all loans modified as a result of a financial difficulty as troubled debt restructurings ("TDR Loans"), regardless of whether the modification was permanent or temporary, including all modifications with trial periods. Additionally, we report as TDR Loans all re-ages, except first time early stage delinquency re-ages where the customer has not been granted a prior re-age or modification. TDR Loans also include loans discharged under Chapter 7 bankruptcy and not re-affirmed. TDR Loans are considered to be impaired loans regardless of their accrual status.
Modifications for real estate secured receivables include changes to the terms of the loan and have historically included, but were not limited to, a change in interest rate, an extension of the amortization period, a reduction in payment amount, partial forgiveness or deferment of principal or other loan covenants. Beginning May 1, 2017, we revised our modification program to only include changes in interest rates. Interest rate reductions lower the amount of interest income we are contractually entitled to receive for a period of time in future periods. By lowering the interest rate, we believe we are able to increase the amount of cash flow that we expect to ultimately collect from the loan, given the borrower's financial condition. Re-aging is an account management action that results in the resetting of the contractual delinquency status of an account to current which generally requires the receipt of two qualifying payments.
As previously discussed, as of September 30, 2017 we have sold substantially all of our receivables held for sale and expect that the remaining receivables will be sold before December 31, 2017. As a result, beginning October 1, 2017 we ceased offering modifications and modifications re-ages. We will continue to offer collection re-ages to borrowers until the associated receivable is sold.
The following table presents information about our TDR Loans at September 30, 2017 and December 31, 2016. As all of our TDR Loans are classified as held for sale as of September 30, 2017 and December 31, 2016 and carried at the lower of amortized cost or fair value, there are no credit loss reserves associated with TDR Loans.
 
 
 
(in millions)
Carrying value
$
136

 
$
1,691

Unpaid principal balance(1)
168

 
2,323

 
(1) 
At September 30, 2017 and December 31, 2016, the unpaid principal balance reflected above includes $6 million and $271 million, respectively, which have received a reduction in the unpaid principal balance as part of an account management action.
The following table provides additional information about the average balance and interest income recognized on TDR Loans.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
 
(in millions)
Average balance of TDR Loans
$
470

 
$
3,909

 
$
990

 
$
5,695

Interest income recognized on TDR Loans
2

 
80

 
35

 
330

Nonperforming Receivables The following table summarizes the status of receivables held for sale.
 
Accruing Receivables
 
Nonaccrual
Receivables(1)
 
Total
 
(in millions)
$
232

 
$
24

 
$
256

5,293

 
381

 
5,674

 
(1) 
Nonaccrual receivables are all receivables which are 90 or more days contractually delinquent as well as second lien receivables (regardless of delinquency status) where the first lien receivable that we own or service is 90 or more days contractually delinquent. Nonaccrual receivables do not include receivables which have made qualifying payments and have been re-aged such that the contractual delinquency status has been reset to current. If a re-aged receivable subsequently experiences payment default and becomes 90 or more days contractually delinquent, it will be reported as nonaccrual. Nonaccrual receivables do

13


HSBC Finance Corporation

not include receivables totaling $35 million and $252 million at September 30, 2017 and December 31, 2016, respectively, which are less than 90 days contractually delinquent and not accruing interest.
The following table provides additional information on nonaccrual receivables:
Nine Months Ended September 30,
2017
 
2016
 
(in millions)
Interest income that would have been recorded if the nonaccrual receivable had been current in accordance with contractual terms during the period
$
15

 
$
59

Interest income that was recorded on nonaccrual receivables during the period
2

 
18


4.
Credit Loss Reserves
 
As discussed in prior filings, during the third quarter of 2016, we transferred all of the remaining receivables held for investment to held for sale which are carried at the lower of amortized cost or fair value. As a result, we did not have any credit loss reserves as of September 30, 2017 or 2016 or during the three and nine months ended September 30, 2017. The table below summarizes the changes in credit loss reserves for real estate secured receivables held for investment during the three and nine months ended September 30, 2016.
 
Real Estate Secured
 
 
First Lien
 
Second Lien
 
Total
 
(in millions)
Three Months Ended September 30, 2016:
 
 
 
 
 
Credit loss reserve rollforward:
 
 
 
 
 
Credit loss reserve balances at beginning of period
$
102

 
$
152

 
$
254

Provision for credit losses(1)
75

 
497

 
572

Net charge-offs:
 
 
 
 
 
Charge-offs(1)(2)
(178
)
 
(649
)
 
(827
)
Recoveries
1

 

 
1

Total net charge-offs
(177
)
 
(649
)
 
(826
)
Credit loss reserve balance at end of period
$

 
$

 
$

 
 
 
 
 
 
Nine Months Ended September 30, 2016:
 
 
 
 
 
Credit loss reserve rollforward:
 
 
 
 
 
Credit loss reserve balance at beginning of period
$
137

 
$
174

 
$
311

Provision for credit losses(1)
107

 
514

 
621

Net charge-offs:
 
 
 
 
 
Charge-offs(1)(2)
(247
)
 
(691
)
 
(938
)
Recoveries
3

 
3

 
6

Total net charge-offs
(244
)
 
(688
)
 
(932
)
Credit loss reserve balance at end of period
$

 
$

 
$

 
(1) 
The provision for credit losses and charge-offs for real estate secured receivables during the three and nine months ended September 30, 2016 included $557 million and $576 million, respectively, related to the initial lower of amortized cost or fair value adjustment attributable to credit factors for receivables transferred to held for sale. See Note 2, "Receivables Held for Sale," for additional information.
(2) 
For collateral dependent receivables that were transferred to held for sale, existing credit loss reserves at the time of transfer were recognized as a charge-off. We transferred to held for sale certain real estate secured receivables during the three and nine months ended September 30, 2016 and, accordingly, we recognized the existing credit loss reserves on these receivables as additional charge-off totaling $244 million and $268 million, respectively.


14


HSBC Finance Corporation

5.
Fair Value Option
 
We have elected the fair value option ("FVO") for certain issuances of our fixed rate debt in order to align our accounting treatment with that of HSBC under International Financial Reporting Standards ("IFRSs"). Electing FVO accounting for the same issuances of fixed rate debt under U.S. GAAP and IFRSs allows us to simplify the accounting model applied to these fixed rate debt issuances. The following table summarizes fixed rate debt issuances accounted for under FVO:
 
 
 
(in millions)
Fixed rate debt accounted for under FVO reported in:
 
 
 
Long-term debt
$
253

 
$
1,317

Due to affiliates

 
485

Total fixed rate debt accounted for under FVO
$
253

 
$
1,802

 
 
 
 
Unpaid principal balance of fixed rate debt accounted for under FVO(1)
$
236

 
$
1,712

 
(1) 
Balance includes a foreign currency translation adjustment relating to our foreign denominated FVO debt which decreased the debt balance by $7 million at September 30, 2017 and decreased the debt balance by $310 million at December 31, 2016.
We determine the fair value of the fixed rate debt accounted for under FVO through the use of a third party pricing service. Such fair value represents the full market price (including our own credit spread and interest rate impacts) based on observable market data for the same or similar debt instruments. See Note 11, "Fair Value Measurements," for a description of the methods and significant assumptions used to estimate the fair value of our fixed rate debt accounted for under FVO.
The following table summarizes the components of the gain (loss) on debt designated at fair value and related derivatives reflected in the consolidated statement of income (loss) for the three and nine months ended September 30, 2017 and 2016:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
 
(in millions)
Mark-to-market on debt designated at fair value(1):
 
 
 
 
 
 
 
Interest rate component
$
8

 
$
24

 
$
34

 
$
42

Credit risk component(2)

 
(27
)
 

 
(8
)
Total mark-to-market on debt designated at fair value
8

 
(3
)
 
34

 
34

Mark-to-market on the related derivatives(1)(3)
(1
)
 
(16
)
 
(27
)
 
(40
)
Net realized gains on the related derivatives(1)
1

 
11

 
17

 
38

Gain (loss) on debt designated at fair value and related derivatives
$
8

 
$
(8
)
 
$
24

 
$
32

 
(1) 
The derivatives associated with debt designated at fair value are economic hedges but do not qualify for hedge accounting. See Note 6, "Derivative Financial Instruments," for additional discussion of these non-qualifying hedges.
(2) 
As discussed below and more fully in Note 13, "New Accounting Pronouncements," beginning January 1, 2017, the fair value movement on fair value option debt attributable to our own credit spread is recorded in common equity as a component of other comprehensive income (loss). For the three and nine months ended September 30, 2017, the fair value movement on fair value option debt attributable to our own credit spread was a loss of $5 million and loss of $13 million, respectively.
(3) 
Mark-to-market on debt designated at fair value and related derivatives excludes market value changes due to fluctuations in foreign currency exchange rates. Foreign currency translation gains (losses) recorded in derivative related income (expense) associated with debt designated at fair value was a loss of $4 million and a loss of $22 million for the three months ended September 30, 2017 and 2016, respectively, and a loss of $76 million and a loss of $68 million for the nine months ended September 30, 2017 and 2016, respectively. Offsetting gains (losses) recorded in derivative related income (expense) associated with the related derivatives was a gain of $4 million and a gain of $22 million for the three months ended September 30, 2017 and 2016, respectively, and a gain of $76 million and a gain of $68 million for the nine months ended September 30, 2017 and 2016, respectively.
Prior to January 1, 2017, changes in the fair value of fair value option debt and the value of the related derivatives, including changes in fair value related to interest rates, our own credit spread and other risks as well as any realized gains or losses on those derivatives, were reported in gain (loss) on debt designated at fair value and related derivatives in the consolidated statement of

15


HSBC Finance Corporation

income (loss). As discussed more fully in Note 13, "New Accounting Pronouncements," beginning January 1, 2017, the fair value movement on fair value debt attributable to our own credit spread is recorded in common equity as a component of other comprehensive income.
Differences arise between the movement in the fair value of the debt and the fair value of the related derivative due to the different credit characteristics and differences in the calculation of fair value for debt and derivatives. The size and direction of the accounting consequences of such changes can be volatile from period to period but do not alter the cash flows intended as part of our interest rate management strategy. On a cumulative basis, we have recorded fair value option adjustments which increased the value of our long-term debt and due to affiliates balances in total by $17 million and $90 million at September 30, 2017 and December 31, 2016, respectively.

6.
Derivative Financial Instruments
 
Our business activities involve analysis, evaluation, acceptance and management of some degree of risk or combination of risks. Accordingly, we have comprehensive risk management policies to address potential financial risks, which include credit risk, liquidity risk, market risk, and operational risks. Our risk management policy is designed to identify and analyze these risks, to set appropriate limits and controls, and to monitor the risks and limits continually by means of reliable and up-to-date administrative and information systems. Our risk management policies are primarily carried out in accordance with practice and limits set by the HSBC Group Management Board. The HSBC North America Asset Liability Committee ("HSBC North America ALCO") meets regularly to review risks and approve appropriate risk management strategies within the limits established by the HSBC Group Management Board. Additionally, the Risk Committee of our Board of Directors receives regular reports on our interest rate and liquidity risk positions in relation to the established limits. In accordance with the policies and strategies established by HSBC North America ALCO, in the normal course of business, we historically entered into various transactions involving derivative financial instruments. These derivative financial instruments primarily are used as economic hedges to manage risk.
Objectives for Holding Derivative Financial Instruments  Market risk (which includes interest rate and foreign currency exchange risks) is the possibility that a change in underlying market rate inputs will cause a financial instrument to decrease in value or become more costly to settle. The mix of receivables on our balance sheet and the corresponding market risk is changing as we manage the liquidation of our receivable portfolio. We maintain an overall risk management strategy that utilizes derivative financial instruments to mitigate our exposure to fluctuations caused by changes in currency exchange rates related to our debt liabilities. We manage our exposure to foreign currency exchange risk primarily through the use of cross currency interest rate swaps. Historically, we managed our exposure to interest rate risk through the use of interest rate swaps with the main objective of managing the interest rate volatility due to a mismatch in the duration of our assets and liabilities.
We have entered into currency swaps to convert both principal and interest payments on debt issued in one currency to the appropriate functional currency. 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 majority of our interest rate swaps were used to manage our exposure to changes in interest rates by converting floating rate debt to fixed rate or by converting fixed rate debt to floating rate.
To manage our exposure to changes in interest rates, we entered into currency swaps and historically interest rate swap agreements which have been designated as cash flow hedges under derivative accounting principles, or are treated as non-qualifying hedges. We currently utilize the long-haul method to assess effectiveness of all derivatives designated as hedges.
We do not manage credit risk or the changes in fair value due to the changes in credit risk by entering into derivative financial instruments such as credit derivatives or credit default swaps.
Credit Risk of Derivatives  By utilizing derivative financial instruments, we are exposed to counterparty credit risk. Counterparty credit risk is the risk that the counterparty to a transaction fails to perform according to the terms of the contract. We manage the counterparty credit (or repayment) risk in derivative instruments through established credit approvals, risk control limits, collateral, and ongoing monitoring procedures. We utilize HSBC affiliates as the provider of our derivatives. We have never suffered a loss due to counterparty credit failure.
At September 30, 2017 and December 31, 2016, we had derivative contracts for our continuing operations with a notional amount of $419 million and $1.8 billion, respectively, which are outstanding with HSBC Bank USA, National Association (together with its subsidiaries, "HSBC Bank USA"). Derivative financial 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. Derivative agreements require that payments be made to, or received from, the counterparty when the fair value of the agreement reaches a certain level. When the fair value of our agreements with the affiliate counterparty requires the posting of collateral, it is provided

16


HSBC Finance Corporation

in either the form of cash and recorded on the balance sheet, consistent with third party arrangements, or in the form of securities which are not recorded on our balance sheet. The fair value of our agreements with the affiliate counterparty required us to provide collateral to the affiliate of $35 million at September 30, 2017 and $317 million at December 31, 2016, all of which was provided in cash. These amounts are offset against the fair value amount recognized for derivative instruments that have been offset under the same master netting arrangement and recorded in our balance sheet as derivative financial assets or derivative related liabilities which are included as a component of other assets and other liabilities, respectively.
The following table presents the fair value of derivative contracts by major product type on a gross basis. Gross fair values exclude the effects of both counterparty netting and collateral, and therefore are not representative of our exposure. The table below also presents the amounts of counterparty netting and cash collateral that have been offset in the consolidated balance sheet.
 
 
 
Derivative Financial Assets
 
Derivative Financial Liabilities
 
Derivative Financial Assets
 
Derivative Financial Liabilities
 
(in millions)
Derivatives(1)
 
 
 
 
 
 
 
Derivatives accounted for as cash flow hedges associated with debt:
 
 
 
 
 
 
 
Currency swaps
$

 
$
(41
)
 
$

 
$
(58
)
Cash flow hedges

 
(41
)
 

 
(58
)
 
 
 
 
 
 
 
 
Non-qualifying hedge activities:
 
 
 
 
 
 
 
Derivatives associated with debt carried at fair value:
 
 
 
 
 
 
 
Cross currency interest rate swaps
17

 
(13
)
 
15

 
(286
)
Derivatives associated with debt carried at fair value
17

 
(13
)
 
15

 
(286
)
Total derivatives
17

 
(54
)
 
15

 
(344
)
Less: Gross amounts offset in the balance sheet(2)
(17
)
 
53

 
(15
)
 
332

Net amounts of derivative financial assets and liabilities presented in the balance sheet(3)
$

 
$
(1
)
 
$

 
$
(12
)
 
(1) 
All of our derivatives are bilateral over-the-counter derivatives.
(2) 
Represents the netting of derivative receivable and payable balances for the same counterparty under an enforceable netting agreement. Gross amounts offset in the balance sheet includes cash collateral paid of $35 million at September 30, 2017 and $317 million at December 31, 2016. At September 30, 2017 and December 31, 2016, we did not have any financial instrument collateral received/posted.
(3) 
At September 30, 2017 and December 31, 2016, we had not received any cash not subject to an enforceable master netting agreement.
Fair Value Hedges  At September 30, 2017 and December 31, 2016, we do not have any active fair value hedges. We recorded fair value adjustments to the carrying value of our debt for terminated fair value hedges which decreased the debt balance by $14 million at September 30, 2017 and $15 million at December 31, 2016.
Cash Flow Hedges Cash flow hedges include currency swaps to convert debt issued from one currency into U.S. dollar fixed rate debt and have historically also included interest rate swaps to convert our variable rate debt to fixed rate debt by fixing future interest rate resets of floating rate debt. Gains and losses on derivative instruments designated as cash flow hedges are reported in accumulated other comprehensive income (loss) and totaled losses of less than $1 million at both September 30, 2017 and December 31, 2016. We expect less than $1 million of currently unrealized net losses will be reclassified to earnings within one year. However, these reclassified unrealized losses will be offset by decreased interest expense associated with the variable cash flows of the hedged items and will result in no significant impact to our earnings.

17


HSBC Finance Corporation

The following table provides the gain or loss recorded on our cash flow hedging relationships.
 
Gain (Loss) Recognized in AOCI on Derivative (Effective Portion)
Location of Gain
(Loss) Reclassified
from AOCI into Income
(Effective Portion)
 
Gain (Loss) Reclassed From AOCI into Income (Effective Portion)
Location of Gain
(Loss) Recognized
in Income on the Derivative(Ineffective Portion)
 
Gain (Loss) Recognized In Income on Derivative (Ineffective Portion)
 
2017
 
2016
 
2017
 
2016
 
 
2017
 
2016
 
(in millions)
 
 
(in millions)
 
 
(in millions)
Three Months Ended September 30,
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
$

 
$

 
Interest expense
 
$

 
$

 
Derivative related income (expense)
 
$

 
$

Currency swaps

 

 
Interest expense
 

 

 
Derivative related income (expense)
 
1

 
3

Total
$

 
$

 
 
 
$

 
$

 
 
 
$
1

 
$
3

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
$

 
$
18

 
Interest expense
 
$

 
$

 
Derivative related income (expense)
 
$

 
$

Currency swaps

 
(1
)
 
Interest expense
 

 
(7
)
 
Derivative related income (expense)
 
4

 
8

Total
$

 
$
17

 
 
 
$

 
$
(7
)
 
 
 
$
4

 
$
8

Non-Qualifying Hedging Activities  As discussed in prior filings, during 2016 we terminated all of the interest rate swaps in our portfolio of non-qualifying hedges which we had previously used to minimize our exposure to changes in interest rates. Accordingly, there was no derivative related income (expense) for the three or nine months ended September 30, 2017 or for the three months ended September 30, 2016. Derivative related expense for interest rate contracts for the nine months ended September 30, 2016 was a loss of $117 million.
We have elected the fair value option for certain issuances of our fixed rate debt and have entered into currency swaps and historically interest rate swaps related to debt carried at fair value. The currency swaps and historically the interest rate swaps associated with this debt are non-qualifying hedges but are considered economic hedges and realized gains and losses are reported as gain (loss) on debt designated at fair value and related derivatives within other revenues. The derivatives related to fair value option debt are included in the notional amount of derivative contracts table below.
The following table provides the gain or loss recorded on the derivatives related to fair value option debt. See Note 5, "Fair Value Option," for further discussion.
 
Location of Gain (Loss)
Recognized in Income on Derivative
Amount of Gain (Loss) Recognized in Derivative Related Income (Expense)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
 
(in millions)
Cross currency interest rate contracts
Gain (loss) on debt designated at fair value and related derivatives
$

 
$
(5
)
 
$
(10
)
 
$
(2
)
Total
 
$

 
$
(5
)
 
$
(10
)
 
$
(2
)
Notional Amount of Derivative Contracts The following table provides the notional amounts of derivative contracts.
 
 
 
(in millions)
Derivatives designated as hedging instruments:
 
 
 
Currency swaps
$
203

 
$
203

Non-qualifying hedges:
 
 
 
Derivatives associated with debt carried at fair value:
 
 
 
Cross currency interest rate swaps
216

 
1,562

Total
$
419

 
$
1,765


18


HSBC Finance Corporation

7.
Accumulated Other Comprehensive Income (Loss)
 
Accumulated other comprehensive income (loss) ("AOCI") includes certain items that are reported directly within a separate component of equity. The following table presents changes in accumulated other comprehensive income (loss) balances.
 
2017
 
2016
 
(in millions)
Three Months Ended September 30,
 
 
 
Unrealized gains (losses) on fair value option debt attributable to our own credit spread:
 
 
 
Balance at beginning of period
$
(24
)
 
$

Other comprehensive loss for period:
 
 
 
Net loss arising during period, net of tax of $(2) million and $- million, respectively
(3
)
 

Reclassification adjustment for losses realized in net income, net of tax of $16 million and $- million, respectively(1)
26

 

Total other comprehensive loss for period
23

 

Balance at end of period
$
(1
)
 
$

Pension and postretirement benefit plan liability:
 
 
 
Balance at beginning and end of period
14

 
26

Total accumulated other comprehensive income (loss) at end of period
$
13

 
$
26

 
 
 
 
Nine Months Ended September 30,
 
 
 
Unrealized gains (losses) on fair value option debt attributable to our own credit spread:
 
 
 
Balance at beginning of period, as previously reported
$

 
$

Cumulative effect adjustment to initially apply new accounting guidance for fair value option debt attributable to our own credit spread, net of tax of $(11) million and $- million, respectively(2)
(19
)
 

Balance at beginning of period, adjusted
(19
)
 

Other comprehensive loss for period:
 
 
 
Net loss arising during period, net of tax of $(5) million and $- million, respectively
(8
)
 

Reclassification adjustment for losses realized in net income, net of tax of $16 million and $- million, respectively(1)
26

 

Total other comprehensive loss for period
18

 

Balance at end of period
(1
)
 

Unrealized gains (losses) on cash flow hedging instruments:
 
 
 
Balance at beginning of period

 
(15
)
Other comprehensive income for period:
 
 
 
Net gains arising during period, net of tax of $- million and $6 million, respectively

 
11

Reclassification adjustment for losses realized in net income, net of tax of $- million and $3 million, respectively(3)

 
4

Total other comprehensive income for period

 
15

Balance at end of period

 

Pension and postretirement benefit plan liability:
 
 
 
Balance at beginning of period
24

 
29

Other comprehensive income for period:
 
 
 
Reclassification adjustment for gains realized in net income, net of tax of $(6) million and $(1) million, respectively(4)
(10
)
 
(3
)
Total other comprehensive income for period
(10
)
 
(3
)
Balance at end of period
14

 
26

Total accumulated other comprehensive income (loss) at end of period
$
13

 
$
26


19


HSBC Finance Corporation

 
(1) 
For the three and nine months ended September 30, 2017, the amounts reclassified are included as a component of loss on extinguishment of debt in our consolidated statement of income (loss).
(2) 
For information on the adoption of new accounting guidance related to fair value option debt attributable to our own credit spread, see Note 13, "New Accounting Pronouncements."
(3) 
The amounts reclassified relate to currency swaps and are included as a component of interest expense in our consolidated statement of income (loss).
(4) 
The amounts reclassified are included as a component of salaries and employee benefits in our consolidated statement of income (loss).

8.
Pension and Other Postretirement Benefits
 
Defined Benefit Pension Plan The table below reflects the portion of pension expense and its related components of the HSBC North America Pension Plan which has been allocated to us and is recorded in our consolidated statement of income (loss). We have not been allocated any portion of the Plan's net pension liability.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
 
(in millions)
Interest cost on projected benefit obligation
$
12

 
$
12

 
$
36

 
$
36

Expected return on plan assets
(15
)
 
(15
)
 
(43
)
 
(43
)
Amortization of net actuarial loss
5

 
9

 
16

 
21

Administrative costs

 
1

 
2

 
3

Pension expense
$
2

 
$
7

 
$
11

 
$
17

In August 2017, the HSBC North America Board of Directors approved a limited-time option to former vested Plan employees who have not yet commenced payment of their annuity benefit to elect a) an immediate lump sum payment; b) an immediate annuity (reduced for early payment under the terms of the Plan); or c) to retain their existing benefit in an annuity to be paid under the original terms of the Plan. The election period for the program commenced in October. The program will result in a charge to pension expense at the time of payment which is expected to occur in the fourth quarter of 2017. The charge to pension expense will be based on the actual number of employees who elect to participate in an early distribution and, therefore, cannot be precisely determined until the election period ends.
Postretirement Plans Other Than Pensions Our employees also participate in plans which provide medical and life insurance benefits to retirees and eligible dependents. These plans cover substantially all employees who meet certain age and vested service requirements. We have instituted dollar limits on our payments under the plans to control the cost of future medical benefits.
The components of our net postretirement benefit cost are as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
 
(in millions)
Interest cost
$
1

 
$
1

 
$
3

 
$
3

Amortization of reduction in liability resulting from plan amendment
(1
)
 
(2
)
 
(4
)
 
(5
)
Gain from curtailment

 

 
(13
)
 

Amortization of net actuarial gain
(1
)
 

 
(1
)
 

Net periodic postretirement benefit cost
$
(1
)
 
$
(1
)
 
$
(15
)
 
$
(2
)
Substantially all of our postretirement benefit plans which provide medical insurance for post-65 retirees were amended in 2015 to provide a monthly payment for the retiree to purchase individual health care coverage in lieu of providing medical insurance on a self-insured basis. This amendment resulted in a reduction to our postretirement benefit obligation in 2015 of $46 million which is being amortized over the remaining service period of those affected. Due to the continued reduction in our staffing levels in the first nine months of 2017, a curtailment gain of $13 million (representing the acceleration of a portion of the remaining deferred gain) was recognized during the second quarter of 2017.

20


HSBC Finance Corporation


9.
Related Party Transactions
 
In the normal course of business, we conduct transactions with HSBC and its subsidiaries. HSBC policy requires that these transactions occur at prevailing market rates and terms and include funding arrangements, derivatives, servicing arrangements, information technology, centralized support services, item and statement processing services, banking and other miscellaneous services. The following tables and discussions below present the more significant related party balances and the income (expense) generated by related party transactions for continuing operations:
 
 
 
(in millions)
Assets:
 
 
 
Cash
$
26

 
$
128

Interest bearing deposits with banks

 
1,500

Securities purchased under agreements to resell(1)
4,040

 
2,392

Other assets
124

 
114

Total assets
$
4,190

 
$
4,134

Liabilities:
 
 
 
Due to affiliates(2)
$

 
$
3,300

Other liabilities
14

 
41

Total liabilities
$
14

 
$
3,341

 
(1) 
Securities under an agreement to resell are purchased from HSBC Securities (USA) Inc. and generally have terms of 120 days or less. The collateral underlying the securities purchased under agreements to resell, however, is with an unaffiliated third party. Interest income recognized on these securities is reflected as interest income from HSBC affiliate in the table below.
(2) 
Due to affiliates includes amounts owed to HSBC and its subsidiaries as a result of direct debt issuances and excludes preferred stock.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
 
(in millions)
Income/(Expense):
 
 
 
 
 
 
 
Interest income from HSBC affiliates
$
15

 
$
1

 
$
35

 
$
4

Interest expense paid to HSBC affiliates(1)
(12
)
 
(45
)
 
(53
)
 
(189
)
Net interest income (expense)
$
3

 
$
(44
)
 
$
(18
)
 
$
(185
)
Gain (loss) on FVO debt with affiliate
$
7

 
$
(13
)
 
$
9

 
$
(1
)
Servicing and other fees from HSBC affiliates

 
1

 
1

 
7

Support services from HSBC affiliates
(15
)
 
(40
)
 
(59
)
 
(120
)
Loss on extinguishment of debt held by HSBC affiliates
(85
)
 

 
(113
)
 

Stock based compensation income (expense) with HSBC(2)
(1
)
 
(1
)
 
(2
)
 
(1
)
 
(1) 
Includes interest expense paid to HSBC affiliates for debt held by HSBC affiliates as well as net interest paid to or received from HSBC affiliates on risk management hedges related to non-affiliated debt.
(2) 
Employees may participate in one or more stock compensation plans sponsored by HSBC. These expenses are included in salaries and employee benefits in our consolidated statement of income (loss). Certain employees are also eligible to participate in a defined benefit pension plan and other postretirement benefit plans sponsored by HSBC North America which are discussed in Note 8, "Pension and Other Postretirement Benefits."

21


HSBC Finance Corporation

Funding Arrangements with HSBC Affiliates:
All of our ongoing funding requirements have been integrated into the overall HSBC North America funding plans with any future funding requirements to be sourced primarily through HSBC USA Inc. ("HSBC USA") or HSBC North America. Due to affiliates consists of the following:
 
 
 
(in millions)
HSBC USA Inc.
$

 
$
2,500

HSBC Holdings plc (includes $- million and $485 million at September 30, 2017 and December 31, 2016 carried at fair value, respectively)

 
800

Due to affiliates
$

 
$
3,300

HSBC USA Inc. - We have a $5.0 billion, 364-day uncommitted unsecured revolving credit agreement with HSBC USA, which expired in October 2017 and was not renewed. In March 2017, we prepaid the entire outstanding balance on this credit agreement of $2.5 billion and incurred a loss on extinguishment of debt held by HSBC affiliates of $28 million.
HSBC Holdings plc - We have a public subordinated debt issue which matures in 2021. At December 31, 2016, HSBC held $800 million of this public subordinated debt issue. In September 2017, we repurchased all of the notes held by HSBC and recorded a loss on extinguishment of debt held by HSBC affiliates of $85 million.
We have a $1.0 billion, 364-day uncommitted revolving credit facility with HSBC North America, which expires in January 2018. At September 30, 2017 and December 31, 2016, there are no outstanding balances under this credit facility.
As previously discussed, we maintain an overall risk management strategy that utilizes interest rate and currency derivative financial instruments to mitigate our exposure to fluctuations caused by changes in interest rates and currency exchange rates related to third party debt liabilities. HSBC Bank USA is our counterparty in these derivative transactions. The notional amount of the derivative contracts outstanding with HSBC Bank USA totaled $419 million and $1.8 billion at September 30, 2017 and December 31, 2016, respectively. The fair value of our agreements with HSBC Bank USA required us to provide collateral to HSBC Bank USA of $35 million at September 30, 2017 and $317 million at December 31, 2016, all of which was provided in cash. See Note 6, "Derivative Financial Instruments," for additional information about our derivative portfolio.
In addition to the lending arrangements discussed above, our parent company holds 1,000 shares of Series C Preferred Stock. Dividends paid on the Series C Preferred Stock totaled $21 million and $64 million during the three and nine months ended September 30, 2017, respectively, compared with $21 million and $64 million during the three and nine months ended September 30, 2016, respectively.
At December 31, 2016, we had a deposit totaling $1,500 million with HSBC Bank USA at current market rates. We did not have any deposits with HSBC Bank USA at September 30, 2017. Interest income earned on deposits with HSBC Bank USA was included in interest income from HSBC affiliates in the table above and was insignificant during three and nine months ended September 30, 2017 and 2016.
Services Provided Between HSBC Affiliates:
Under multiple service level agreements, we provide services to and receive services from various HSBC affiliates. The following summarizes these activities:
HSBC Securities (USA) Inc. ("HSI") provides transaction assistance for our receivable sales program, including receivable valuation and other transaction related activities. We pay HSI a fee for these services for each sales transaction based on the unpaid principal balance of the receivables sold. Fees paid to HSI for these services totaled $2 million and $7 million during the three and nine months ended September 30, 2017, respectively, compared with $1 million and $5 million during year ago periods. The fees paid to HSI for these services are reported as a component of gain (loss) on sale of real estate secured receivables.
During the third quarter of 2017, HSI also provided transaction assistance, including deal structure and execution, in the purchase of $1.1 billion of our senior subordinated debt held by non-affiliates. We paid HSI a fee of $3 million for providing these services which is recorded as a component of loss on extinguishment of debt held by non-affiliates.

22


HSBC Finance Corporation

Servicing activities for real estate secured receivables across North America are performed both by us and HSBC Bank USA. As a result, we receive servicing fees from HSBC Bank USA for services performed on their behalf and pay servicing fees to HSBC Bank USA for services performed on our behalf. The fees we receive from HSBC Bank USA are reported in Servicing and other fees from HSBC affiliates. This includes fees received for servicing real estate secured receivables (with a carrying amount of $1 million and $559 million at September 30, 2017 and December 31, 2016, respectively) that we sold to HSBC Bank USA in 2003 and 2004. Fees we pay to HSBC Bank USA are reported in support services from HSBC affiliates.
We also provide various services to HSBC Bank USA, including processing activities and other operational and administrative support. Fees received for these services are included in servicing and other fees from HSBC affiliates.
HSBC North America's technology and certain centralized support services including human resources, corporate affairs, risk management, legal, compliance, tax, finance and other shared services are centralized within HSBC Technology & Services (USA) Inc. ("HTSU"). HTSU also provides certain item processing and statement processing activities for us. The fees we pay HTSU for the centralized support services and processing activities are included in support services from HSBC affiliates. We also receive fees from HTSU for providing certain administrative services to them as well as receiving rental revenue from HTSU for certain office space. The fees and rental revenue we receive from HTSU are included in servicing and other fees from HSBC affiliates.
We use HSBC Global Services Limited, an HSBC affiliate located outside of the United States, to provide various support services to our operations including among other areas, customer service, systems, collection and accounting functions. The expenses related to these services are included in support services from HSBC affiliates.
Banking services and other miscellaneous services are provided by other subsidiaries of HSBC, including HSBC Bank USA, which are included in support services from HSBC affiliates.
Transactions with HSBC Affiliates involving our Discontinued Operations:
In December 2016, we sold our Visa Class B Shares ("Class B Shares"). The Class B Shares are currently considered restricted and are transferable under limited circumstances until certain credit card litigation is settled. Any settlement will be indemnified by Visa members, including us. Simultaneously, our affiliate, HSBC USA also sold Class B Shares to the same purchaser. Under the terms of the sale agreement, HSBC USA entered into a derivative instrument with the purchaser to retain the litigation risk associated with all of the Class B Shares sold by both us and HSBC USA until the credit card litigation is settled. Immediately following the execution of the sale agreement, we entered into a derivative instrument with HSBC USA to retain the litigation risk associated with our portion of the Class B Shares sold to the purchaser.
At September 30, 2017 and December 31, 2016, the notional amount of this derivative contract totaled $68 million and $50 million, respectively. The fair value of this derivative is estimated using a discounted cash flow methodology and is dependent upon the final resolution of the credit card litigation. The fair value of the derivative related liability with HSBC USA Inc. was $6 million and $5 million at September 30, 2017 and December 31, 2016, respectively. Derivative related expense totaled $1 million and $2 million during the three and nine months ended September 30, 2017, respectively, and was recorded as a component of income (loss) from discontinued operations. See Note 3, "Discontinued Operations," in our 2016 Form 10-K for additional information about the sale of the Visa Class B Shares and this derivative instrument.

10.
Variable Interest Entities
 
We consolidate variable interest entities ("VIE") in which we hold a controlling financial interest as evidenced by the power to direct the activities of a VIE that most significantly impact its economic performance and the obligation to absorb losses of, or the right to receive benefits from, the VIE that could potentially be significant to the VIE and therefore are deemed to be the primary beneficiary. See Note 17, "Variable Interest Entities," in our 2016 Form 10-K for additional information regarding VIEs.
Consolidated VIEs  Historically, we have organized special purpose entities primarily to meet our funding needs through collateralized funding transactions. As part of these transactions, we transferred certain receivables to these trusts which in turn issued debt instruments collateralized by the transferred receivables. The entities used in these transactions are VIEs. As we are the servicer of the assets of these trusts and have retained the benefits and risks, we determined that we are the primary beneficiary of these trusts. Accordingly, we consolidate these entities and report the debt securities issued by them as secured financings in long-term debt. As a result, all receivables transferred in these secured financings remained and continue to remain on our balance sheet and the debt securities issued by them have remained and continue to be included in long-term debt. As all of our ongoing funding requirements have been integrated into the overall HSBC North America funding plans, we no longer use collateralized funding transactions to meet our funding needs.

23


HSBC Finance Corporation

The assets and liabilities of the consolidated secured financing VIEs consisted of the following at September 30, 2017 and December 31, 2016:
 
 
 
Consolidated
Assets
 
Consolidated
Liabilities
 
Consolidated
Assets
 
Consolidated
Liabilities
 
(in millions)
Real estate collateralized funding vehicles:
 
 
 
 
 
 
 
Receivables held for sale
$
195

 
$

 
$
750

 
$

Other liabilities

 
(3
)
 

 
(11
)
Long-term debt

 
76

 

 
404

Total
$
195

 
$
73

 
$
750

 
$
393

The assets of the consolidated VIEs serve as collateral for the obligations of the VIEs. The holders of the debt securities issued by these vehicles have no recourse to our general assets.
Unconsolidated VIEs We do not have any unconsolidated VIEs.

11.
Fair Value Measurements
 
Accounting principles related to fair value measurements provide a framework for measuring fair value and focus on an exit price that would be received to sell an asset or paid to transfer a liability in the principal market (or in the absence of the principal market, the most advantageous market) accessible in an orderly transaction between willing market participants (the "Fair Value Framework"). Where required by the applicable accounting standards, assets and liabilities are measured at fair value using the "highest and best use" valuation premise. Fair value measurement guidance clarifies that financial instruments do not have alternative use and, as such, the fair value of financial instruments should be determined using an "in-exchange" valuation premise.
Fair Value Adjustments  The best evidence of fair value is quoted market price in an actively traded market, where available. In the event listed price or market quotes are not available, valuation techniques that incorporate relevant transaction data and market parameters reflecting the attributes of the asset or liability under consideration are applied. Where applicable, fair value adjustments are made to ensure the financial instruments are appropriately recorded at fair value. The fair value adjustments reflect the risks associated with the products, contractual terms of the transactions, and the liquidity of the markets in which the transactions occur.
Credit Risk Adjustment The credit risk adjustment is an adjustment to a group of financial assets or financial liabilities to reflect the credit quality of the parties to the transaction in arriving at fair value. A credit valuation adjustment to a financial asset is required to reflect the default risk of the counterparty. Where applicable, we take into consideration the credit risk mitigating arrangements including collateral agreements and master netting arrangements in estimating the credit risk adjustments.
Valuation Control Framework  A control framework has been established which is designed to ensure that fair values are validated by a function independent of the risk-taker. To that end, the ultimate responsibility for the measurement of fair values rests with the HSBC U.S. Valuation Committee. The HSBC U.S. Valuation Committee establishes policies and procedures to ensure appropriate valuations. Fair values for long-term debt for which we have elected fair value option are measured by a third party valuation source (pricing service) by reference to external quotations on the identical or similar instruments. Once fair values have been obtained from the third party valuation source, an independent price validation process is performed and reviewed by the HSBC U.S. Valuation Committee. For price validation purposes, we obtain quotations from at least one other independent pricing source for each financial instrument, where possible. We consider the following factors in determining fair values:
Ÿ
similarities between the asset or the liability under consideration and the asset or liability for which quotation is received;
Ÿ
collaboration of pricing by reference to other independent market data such as market transactions and relevant benchmark indices;
Ÿ
whether the security is traded in an active or inactive market;
Ÿ
consistency among different pricing sources;
Ÿ
the valuation approach and the methodologies used by the independent pricing sources in determining fair value;
Ÿ
the elapsed time between the date to which the market data relates and the measurement date; and

24


HSBC Finance Corporation

Ÿ
the manner in which the fair value information is sourced.
Greater weight is given to quotations of instruments with recent market transactions, pricing quotes from dealers who stand ready to transact, quotations provided by market-makers who originally underwrote such instruments, and market consensus pricing based on inputs from a large number of participants. Any significant discrepancies among the external quotations are reviewed by management and adjustments to fair values are recorded where appropriate.
Fair values for derivatives are determined by management using valuation techniques, valuation models and inputs that are developed, reviewed, validated and approved by the Markets Independent Model Review Team of an HSBC affiliate. The models used apply appropriate control processes and procedures to ensure that the derived inputs are used to value only those instruments that share similar risk to the relevant benchmark indexes and therefore demonstrate a similar response to market factors.
We have various controls over our valuation process and procedures for receivables held for sale. As these fair values are generally determined using value estimates from third party and affiliate valuation specialists, the controls may include analytical reviews of quarterly value trends, corroboration of inputs by observable market data, direct discussion with potential investors and results of actual sales of such receivable, all of which are submitted to the HSBC U.S. Valuation Committee for review.
Fair Value of Financial Instruments  The fair value estimates, methods and assumptions set forth below for our financial instruments, including those financial instruments carried at cost, are made solely to comply with disclosures required by generally accepted accounting principles in the United States and should be read in conjunction with the financial statements and notes included in this Form 10-Q. The following table summarizes the carrying value and estimated fair value of our financial instruments at September 30, 2017 and December 31, 2016.
 
 
Carrying
Value
 
Estimated
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
(in millions)
Financial assets:
 
 
 
 
 
 
 
 
 
Cash
$
26

 
$
26

 
$
26

 
$

 
$

Securities purchased under agreements to resell
4,040

 
4,040

 

 
4,040

 

Real estate secured receivables held for sale
256

 
275

 

 

 
275

Due from affiliates
124

 
124

 

 
124

 

Financial liabilities:
 
 
 
 
 
 
 
 
 
Long-term debt carried at fair value
253

 
253

 

 
253

 

Long-term debt not carried at fair value
1,583

 
1,784

 

 
1,784

 

Derivative financial liabilities
1

 
1

 

 
1

 


 
 
Carrying
Value
 
Estimated
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
(in millions)
Financial assets:
 
 
 
 
 
 
 
 
 
Cash
$
128

 
$
128

 
$
128

 
$

 
$

Interest bearing deposits with banks
1,500

 
1,500

 
1,500

 

 

Securities purchased under agreements to resell
2,392

 
2,392

 

 
2,392

 

Real estate secured receivables held for sale
5,674

 
6,129

 

 

 
6,129

Due from affiliates
114

 
114

 

 
114

 

Financial liabilities:
 
 
 
 
 
 
 
 
 
Due to affiliates carried at fair value
485

 
485

 

 
485

 

Due to affiliates not carried at fair value
2,815

 
2,875

 

 
2,875

 

Long-term debt carried at fair value
1,317

 
1,317

 

 
1,317

 

Long-term debt not carried at fair value
3,023

 
3,359

 

 
3,359

 

Derivative financial liabilities
12

 
12

 

 
12

 


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HSBC Finance Corporation

Assets and Liabilities Recorded at Fair Value on a Recurring Basis  The following table presents information about our assets and liabilities measured at fair value on a recurring basis at September 30, 2017 and December 31, 2016, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Netting(1)
 
Total of Assets
(Liabilities)
Measured at
Fair Value
 
(in millions)
 
 
 
 
 
 
 
 
 
Derivative financial assets:
 
 
 
 
 
 
 
 
 
Currency swaps
$

 
$
17

 
$

 
$

 
$
17

Derivative netting

 

 

 
(17
)
 
(17
)
Total derivative financial assets

 
17

 

 
(17
)
 

Total assets
$

 
$
17

 
$

 
$
(17
)
 
$

Due to affiliates carried at fair value
$

 
$

 
$

 
$

 
$

Long-term debt carried at fair value

 
(253
)
 

 

 
(253
)
Derivative related liabilities:
 
 
 
 
 
 
 
 
 
Currency swaps

 
(54
)
 

 

 
(54
)
Derivative netting

 

 

 
53

 
53

Total derivative related liabilities

 
(54
)
 

 
53

 
(1
)
Total liabilities
$

 
$
(307
)
 
$

 
$
53

 
$
(254
)
 
 
 
 
 
 
 
 
 
Derivative financial assets:
 
 
 
 
 
 
 
 
 
Currency swaps
$

 
$
15

 
$

 
$

 
$
15

Derivative netting

 

 

 
(15
)
 
(15
)
Total derivative financial assets

 
15

 

 
(15
)
 

Total assets
$

 
$
15

 
$

 
$
(15
)
 
$

Due to affiliates carried at fair value
$

 
$
(485
)
 
$

 
$

 
$
(485
)
Long-term debt carried at fair value

 
(1,317
)
 

 

 
(1,317
)
Derivative related liabilities:
 
 
 
 
 
 
 
 
 
Currency swaps

 
(344
)
 

 

 
(344
)
Derivative netting

 

 

 
332

 
332

Total derivative related liabilities

 
(344
)
 

 
332

 
(12
)
Total liabilities
$

 
$
(2,146
)
 
$

 
$
332

 
$
(1,814
)
 
(1) 
Represents counterparty and swap collateral netting which allow the offsetting of amounts relating to certain contracts when certain conditions are met.
Significant Transfers Between Level 1 and Level 2 There were no transfers between Level 1 and Level 2 for assets and liabilities recorded at fair value on a recurring basis during the three and nine months ended September 30, 2017 and 2016.
Information on Level 3 Assets and Liabilities There were no assets or liabilities recorded at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three and nine months ended September 30, 2017 and 2016. Transfers between leveling categories are assessed, determined and recognized at the end of each reporting period.

26


HSBC Finance Corporation

Assets and Liabilities Recorded at Fair Value on a Non-recurring Basis The following table presents information about our assets and liabilities measured at fair value on a non-recurring basis at September 30, 2017 and 2016, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value. Certain of the fair values in the table below were not obtained as of September 30, 2017 or 2016 but during the periods then ended. See Note 2, "Summary of Significant Accounting Policies and New Accounting Pronouncements," in our 2016 Form 10-K as well as the summary of our valuation techniques below for discussion of our policy in measuring fair value.
 
Non-Recurring Fair Value Measurements
 
Total Gains
(Losses) for the
Three Months Ended
September 30, 2017
 
Total Gains
(Losses) for the
Nine Months Ended
September 30, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(in millions)
Receivables held for sale
$

 
$

 
$
256

 
$
256

 
$
(16
)
 
$
155

Real estate owned(1)

 
10

 

 
10

 
(2
)
 
(6
)
Total assets at fair value on a non-recurring basis
$

 
$
10

 
$
256

 
$
266

 
$
(18
)
 
$
149

 
Non-Recurring Fair Value Measurements
September 30, 2016
 
Total Gains
(Losses) for the
Three Months Ended
September 30, 2016
 
Total Gains
(Losses) for the
Nine Months Ended
September 30, 2016
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(in millions)
Receivables held for sale
$

 
$
757

 
$
9,391

 
$
10,148

 
$
(565
)
 
$
(695
)
Receivables held for investment carried at the lower of amortized cost or fair value of the collateral less cost to sell(2)

 

 

 

 
(19
)
 
(50
)
Real estate owned(1)

 
55

 

 
55

 
(4
)
 
(14
)
Total assets at fair value on a non-recurring basis
$

 
$
812

 
$
9,391

 
$
10,203

 
$
(588
)
 
$
(759
)
 
(1) 
Real estate owned is required to be reported on the balance sheet net of transactions costs. The real estate owned amounts in the table above reflect the fair value of the underlying asset unadjusted for transaction costs.
(2) 
Total gains (losses) for the three and nine months ended September 30, 2016 include amounts recorded on receivables that were subsequently transferred to held for sale.
Significant Transfers Between Level 1 and Level 2 There were no transfers between Level 1 and Level 2 for assets and liabilities recorded at fair value on a non-recurring basis during the three and nine months ended September 30, 2017 and 2016.
Significant Transfers Between Level 2 and Level 3 We transferred real estate secured receivables held for sale from Level 3 to Level 2 prior to the sale of these receivables totaling $1,048 million and $5,267 million during the three and nine months ended September 30, 2017, respectively, compared with $757 million and $5,683 million during the three and nine months ended September 30, 2016, respectively. Receivables held for sale are reclassified from Level 3 to Level 2 upon acceptance of a final offer from a third party to purchase a distinct pool of receivables for a specified purchase price on a specific date.

27


HSBC Finance Corporation

The following table presents quantitative information about non-recurring fair value measurements of assets and liabilities classified as Level 3 in the fair value hierarchy at September 30, 2017 and December 31, 2016:
 
Fair Value
 
 
 
 
 
Range of Inputs
Financial Instrument Type
 
 
Valuation Technique
 
Significant Unobservable Inputs
 
 
 
(in millions)
 
 
 
 
 
 
 
 
 
 
 
 
Receivables held for sale
$
256

 
$
5,674

 
Third party appraisal valuation based on
 
Collateral loss severity rates(1)
 
0
%
-
100%
 
0
%
-
100%
 
 
 
 
 
estimated loss severities, including collateral values, cash flows and
 
Expenses incurred through collateral disposition
 
5
%
-
10%
 
5
%
-
10%
 
 
 
 
 
market discount rate
 
Market discount rate
 
4
%
-
14%
 
4
%
-
14%
 
(1) 
At September 30, 2017 and December 31, 2016, the weighted average collateral loss severity rate was 45 percent and 51 percent, respectively, taking into consideration both expected net cash flows as well as current collateral values.
Valuation Techniques  The following summarizes the valuation methodologies used for assets and liabilities recorded at fair value on both a recurring and non-recurring basis and for estimating fair value for financial instruments not recorded at fair value but for which fair value disclosures are required.
Cash:  Carrying amount approximates fair value due to the liquid nature of cash.
Interest bearing deposits with banks and securities purchased under agreements to resell:  The fair value of interest bearing deposits with banks and securities purchased under agreements to resell approximates carrying amount due to the short-term maturity of the agreements.
Receivables held for sale:  The estimated fair value of our receivables held for sale is determined by developing an approximate range of value from a mix of various sources appropriate for the respective pools of assets aggregated either by similar risk characteristics or by pools of receivables being marketed. These sources include recently observed over-the-counter transactions where available and fair value estimates obtained from an HSBC affiliate and a third party valuation specialist for distinct pools of receivables. These fair value estimates are based on discounted cash flow models using assumptions we believe are consistent with those that would be used by market participants in valuing such receivables and trading inputs from other market participants which includes observed primary and secondary trades. In certain cases, the estimated fair value for a pool of receivables being marketed may be based on bids received from third parties interested in purchasing the pool of receivables.
Valuation inputs include estimates of future interest rates, prepayment speeds, default and loss curves, estimated collateral values (including expenses to be incurred to maintain the collateral) and market discount rates reflecting management's estimate of the rate of return that would be required by investors in the current market given the specific characteristics and inherent credit risk. Some of these inputs are influenced by collateral value changes and unemployment rates. We perform analytical reviews of fair value changes on a quarterly basis and periodically validate our valuation methodologies and assumptions based on the results of actual sales of such receivables. We also may hold discussions on value directly with potential investors. Since some receivables pools may have features which are unique, the fair value measurement processes use significant unobservable inputs which are specific to the performance characteristics of the various receivable portfolios.
Real estate owned:  Fair value is determined based on third party valuations obtained at the time we take title to the property and, if less than the carrying amount of the receivable, the carrying amount of the receivable is adjusted to the fair value less estimated cost to sell. The carrying amount of the property is further reduced, if necessary, at least every 45 days to reflect observable local market data, including local area sales data.
Due from affiliates:  Carrying amount approximated fair value because the interest rates on these receivables adjusted with changing market interest rates.
Long-term debt and Due to affiliates:  Fair value is primarily determined by a third party valuation source. The pricing services source fair value from quoted market prices and, if not available, expected cash flows are discounted using the appropriate interest rate for the applicable duration of the instrument adjusted for our own credit spread. Our own credit spreads applied to these instruments are derived from the spreads recognized in the secondary market for similar debt as of the measurement date. Where available, relevant trade data is also considered as part of our validation process.

28


HSBC Finance Corporation

Derivative financial assets and liabilities:  Derivative values are defined as the amount we would receive or pay to extinguish the contract using a market participant at the reporting date. The values are determined by management using a pricing system maintained by HSBC Bank USA. In determining these values, HSBC Bank USA uses quoted market prices, when available. For non-exchange traded contracts, such as interest rate swaps, fair value is determined using discounted cash flow modeling techniques. Valuation models calculate the present value of expected future cash flows based on models that utilize independently-sourced market parameters, including interest rate yield curves, option volatilities, and currency rates. Valuations may be adjusted in order to ensure that those values represent appropriate estimates of fair value. These adjustments are generally required to reflect factors such as market liquidity and counterparty credit risk that can affect prices in arms-length transactions with unrelated third parties. Finally, other transaction specific factors such as the variety of valuation models available, the range of unobservable model inputs and other model assumptions can affect estimates of fair value. Imprecision in estimating these factors can impact the amount of revenue or loss recorded for a particular position.
Counterparty credit risk is considered in determining the fair value of a financial asset. The Fair Value Framework specifies that the fair value of a liability should reflect the entity's non-performance risk and accordingly, the effect of our own credit spread has been factored into the determination of the fair value of our financial liabilities, including derivative instruments. In estimating the credit risk adjustment to the derivative assets and liabilities, we take into account the impact of netting and/or collateral arrangements that are designed to mitigate counterparty credit risk.

12. Litigation and Regulatory Matters
 
The following supplements, and should be read together with, the disclosure in Note 20, "Litigation and Regulatory Matters," in our 2016 Form 10-K and in Note 12, "Litigation and Regulatory Matters," in our Form 10-Q for the three month period ended March 31, 2017 (the "2017 First Quarter Form 10-Q") and our Form 10-Q for the six month period ended June 30, 2017 (the "2017 Second Quarter Form 10-Q"). Only matters with significant updates and new matters since our disclosure in our 2016 Form 10-K, 2017, First Quarter Form 10-Q and 2017 Second Quarter Form 10-Q are reported herein.
In addition to the matters described below and in our 2016 Form 10-K, 2017 First Quarter Form 10-Q and 2017 Second Quarter Form 10-Q, in the ordinary course of business, we are routinely named as defendants in, or as parties to, various legal actions and proceedings relating to activities of our current and/or former operations. These legal actions and proceedings may include claims for substantial or indeterminate compensatory or punitive damages, or for injunctive relief. In the ordinary course of business, we also are subject to governmental and regulatory examinations, information-gathering requests, investigations and proceedings (both formal and informal), certain of which may result in adverse judgments, settlements, fines, penalties, injunctions or other relief. In connection with formal and informal inquiries by these regulators, we receive numerous requests, subpoenas and orders seeking documents, testimony and other information in connection with various aspects of our regulated activities.
Due to the inherent unpredictability of legal matters, including litigation, governmental and regulatory matters, particularly where the damages sought are substantial or indeterminate or when the proceedings or investigations are in the early stages, we cannot determine with any degree of certainty the timing or ultimate resolution of such matters or the eventual loss, fines, penalties or business impact, if any, that may result. We establish reserves for litigation, governmental and regulatory matters when those matters present loss contingencies that are both probable and can be reasonably estimated. Once established, reserves are adjusted from time to time, as appropriate, in light of additional information. The actual costs of resolving litigation and regulatory matters, however, may be substantially higher than the amounts reserved for those matters.
For the legal matters disclosed below, including litigation, governmental and regulatory matters, as well as for the legal matters discussed in Note 20, "Litigation and Regulatory Matters," in our 2016 Form 10-K and in Note 12, "Litigation and Regulatory Matters," in our 2017 First Quarter Form 10-Q and 2017 Second Quarter Form 10-Q as to which a loss in excess of accrued liability is reasonably possible in future periods and for which there is sufficient currently available information on the basis of which we believe we can make a reliable estimate, we believe a reasonable estimate could be as much as $400 million for HSBC Finance Corporation. The legal matters underlying this estimate of possible loss will change from time to time and actual results may differ significantly from this current estimate.
Given the substantial or indeterminate amounts sought in certain of these matters, and the inherent unpredictability of such matters, an adverse outcome in certain of these matters could have a material adverse effect on our consolidated financial statements in any particular quarterly or annual period.
Litigation - Continuing Operations
County of Cook. v. HSBC North America Holdings Inc., et al. Defendants filed a motion to dismiss the amended complaint in August 2017. The motion is fully briefed and the HSBC defendants await a decision.

29


HSBC Finance Corporation

Mortgage Securitization Activity
Deutsche Bank, as Trustee of MSAC 2007-HE6 v. Decision One and HSBC Finance Corp In September 2017, we received court approval of the settlement reached in this matter in 2016.
As noted previously, discussions are ongoing with the U.S. Department of Justice regarding liability under the Financial Industry Reform, Recovery, and Enforcement Act in connection with certain residential mortgage-backed securities securitizations from 2005 to 2007.

13.
New Accounting Pronouncements
 
The following new accounting pronouncements were adopted effective January 1, 2017:
Financial Instruments - Classification and Measurement of Financial Liabilities Measured Under the Fair Value Option In January 2016, the Financial Accounting Standards Board ("FASB") issued an Accounting Standard Update ("ASU") which, for financial liabilities measured under the fair value option, requires recognizing the change in fair value attributable to our own credit spread in other comprehensive income (loss). We elected to early adopt this guidance, which required a cumulative effect adjustment to the consolidated balance sheet, resulting in a reclassification from retained earnings to accumulated other comprehensive income (loss) of an after tax loss of $19 million as of January 1, 2017. The adoption of this guidance did not require financial statements for periods prior to 2017 to be restated.
Compensation - Stock Compensation In March 2016, the FASB issued an ASU that requires all excess tax benefits and tax deficiencies for share-based payment awards to be recorded within income tax expense (benefit) in the consolidated statement of income (loss) rather than directly to additional paid-in capital and for excess tax benefits to be classified as an operating activity in the consolidated statement of cash flows. The adoption of the guidance related to excess tax benefits for share-based payment awards resulted in a cumulative effect adjustment of $4 million which decreased the accumulated deficit as of January 1, 2017.
The following are accounting pronouncements which will be adopted in future periods:
Financial Instruments - Classification and Measurement (Excluding Financial Liabilities Measured Under the Fair Value Option) In January 2016, the FASB issued an ASU which changes aspects of its guidance on classification and measurement of financial instruments. The ASU requires equity investments (except those accounted for under the equity method or those that result in consolidation) to be measured at fair value with changes in fair value recognized in net income. Under a practicability exception, entities may measure equity investments that do not have readily determinable fair values at cost adjusted for changes in observable prices minus impairment. Under this exception, a qualitative assessment for impairment will be required and, if impairment exists, the carrying amount of the investments must be adjusted to their fair value and an impairment loss recognized in net income. Additionally, the ASU requires new disclosure related to equity investments and modifies certain disclosure requirements related to the fair value of financial instruments. The ASU is effective for all annual and interim periods beginning January 1, 2018 and the guidance should be applied by recording a cumulative effect adjustment to the balance sheet or, as it relates to equity investments without readily determinable fair values, prospectively. The adoption of this guidance will not have a material impact on our financial position or results of operations.
Leases In February 2016, the FASB issued an ASU which requires a lessee to recognize a lease liability and a right-of-use asset on its balance sheet for all leases, including operating leases, with a term greater than 12 months. Lease classification will determine whether a lease is reported as a financing transaction in the income statement and statement of cash flows. The ASU does not substantially change lessor accounting, but it does make certain changes related to leases for which collectability of the lease payments is uncertain or there are significant variable payments. Additionally, the ASU makes several other targeted amendments including a) revising the definition of lease payments to include fixed payments by the lessee to cover lessor costs related to ownership of the underlying asset such as for property taxes or insurance; b) narrowing the definition of initial direct costs which an entity is permitted to capitalize to include only those incremental costs of a lease that would not have been incurred if the lease had not been obtained; c) requiring seller-lessees in a sale-leaseback transaction to recognize the entire gain from the sale of the underlying asset at the time of sale rather than over the leaseback term; and d) expanding disclosures to provide quantitative and qualitative information about lease transactions. The ASU is effective for all annual and interim periods beginning January 1, 2019 and is required to be applied retrospectively to the earliest period presented at the date of initial application, with early adoption permitted. During the third quarter of 2017, we completed our review of our existing lease and service contracts which may contain embedded leases and determined that as of the effective date of this ASU, we will not have any unrecorded future rent payments and, therefore, we will also not have any associated right of use assets. Accordingly, we do not expect this ASU will have a material impact on our financial statements.
Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments In August 2016, the FASB issued an ASU that clarifies how certain cash receipts and cash payments should be classified in the statement of cash flows. Under the ASU, cash proceeds from the settlement of bank-owned life insurance policies should be classified as cash inflows from investing activities. The ASU is effective for all annual and interim periods beginning January 1, 2018 and is required to be applied retrospectively to all periods presented. While the adoption of this guidance will result in a change in the classification of cash proceeds from the settlement of bank-owned life insurance policies in the statement of cash flows,

30


HSBC Finance Corporation

the balances to which this new guidance will apply are immaterial. Accordingly, the new guidance is not expected to have any impact on our financial position and results of operations.
Compensation - Retirement Benefits  In March 2017, the FASB issued an ASU that requires only the service cost component of net periodic pension and postretirement benefit costs to be reported in salaries and employee benefits in the statement of income (loss) while the other components of net periodic pension and postretirement benefit costs are required to be reported separately from the service cost component. The ASU is effective for all annual and interim periods beginning January 1, 2018 and is required to be applied retrospectively. The adoption of this guidance will not have an impact on our financial statement presentation.
There have been no additional accounting pronouncements issued that are expected to have or could have a material impact on our financial position or results of operations.

31


HSBC Finance Corporation

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
 
 
Forward-Looking Statements
 
Certain matters discussed throughout this Form 10-Q are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make or approve certain statements in future filings with the United States Securities and Exchange Commission, in press releases, or oral or written presentations by representatives of HSBC Finance Corporation that are not statements of historical fact and may also constitute forward-looking statements. Words such as "may", "will", "should", "would", "could", "appears", "believe", "intends", "expects", "estimates", "targeted", "plans", "anticipates", "goal", and similar expressions are intended to identify forward-looking statements but should not be considered as the only means through which these statements may be made. These matters or statements will relate to our future financial condition, economic forecast, results of operations, plans, objectives, performance or business developments and will involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from that which was expressed or implied by such forward-looking statements.
All forward-looking statements are, by their nature, subject to risks and uncertainties, many of which are beyond our control. Our actual future results may differ materially from those set forth in our forward-looking statements. While there is no assurance that any list of risks and uncertainties or risk factors is complete, below are certain factors which could cause actual results to differ materially from those in the forward-looking statements:
uncertain market and economic conditions and changes in interest rates;
changes in laws and regulatory requirements;
disruption in our operations from the external environment arising from events such as natural disasters, terrorist attacks, or essential utility outages;
a failure in or a breach of our operation or security systems or infrastructure, or those of third party servicers or vendors, including as a result of cyberattacks;
the ability to successfully manage our risks;
damage to our reputation;
the ability to retain key employees;
losses suffered due to the negligence or misconduct of our employees or the negligence or misconduct on the part of employees of third parties;
a failure in our internal controls;
our ability to meet our funding requirements;
adverse changes to our or our affiliates' credit ratings;
heightened regulatory and government enforcement scrutiny of financial institutions;
our ability to complete the wind down of our real estate secured receivable portfolio in a timely manner;
adverse changes in factors which impact the fair value of receivables held for sale, such as home prices, default rates, estimated costs to obtain properties and investors' required returns;
additional costs and expenses due to representations and warranties made in connection with receivable sale transactions that may require us to repurchase the loans and/or indemnify private investors for losses due to breaches of these representations and warranties;
the possibility of incorrect assumptions or estimates in our financial statements, including reserves related to litigation, deferred tax assets and the fair value of certain assets and liabilities;
the possibility of incorrect interpretations, application of or changes in tax laws to which we are subject;
additional financial contribution requirements to the HSBC North America Holdings Inc. ("HSBC North America") pension plan; and

32


HSBC Finance Corporation

the other risk factors and uncertainties described under Item 1A, "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2016 (the "2016 Form 10-K").
Forward-looking statements are based on our current views and assumptions and speak only as of the date they are made. We undertake no obligation to update any forward-looking statement to reflect subsequent circumstances or events. You should, however, consider any additional disclosures of a forward-looking nature that arise after the date hereof as may be discussed in any of our subsequent Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q or Current Reports on Form 8-K.

Executive Overview
 
Organization and Basis of Reporting  HSBC Finance Corporation and its subsidiaries are wholly owned subsidiaries of HSBC North America, which is an indirect, wholly owned subsidiary of HSBC Holdings plc ("HSBC" and, together with its subsidiaries, "HSBC Group"). HSBC Finance Corporation and its subsidiaries may also be referred to in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") as "we", "us" or "our."
The following discussion of our financial condition and results of operations excludes the results of our discontinued operations unless otherwise noted. See Note 3, "Discontinued Operations," in our 2016 Form 10-K for further discussion of these operations.
Economic Environment Despite the continued improvement of the U.S. economy, economic uncertainty remains and recent geopolitical events and the implications of those events further add to this uncertainty. The sustainability of the U.S. economic recovery will be determined by numerous variables including consumer sentiment, energy prices, credit market volatility, employment levels and housing market conditions, which will impact corporate earnings and the capital markets. These conditions in combination with global economic conditions, fiscal and monetary policy, geopolitical concerns and the regulatory and government scrutiny of financial institutions will continue to impact our results in 2017 and beyond.
2017 Events As discussed in prior filings, our entire receivable portfolio is classified as held for sale and we continue to execute our receivable sales program. During the three and nine months ended September 30, 2017, we sold real estate secured receivables with an unpaid principal balance of $1,244 million (aggregate carrying value of $1,048 million) and $6,228 million (aggregate carrying value of $5,267 million), respectively, at the time of sale to third party investors. Aggregate cash consideration received totaled $1,196 million and $6,059 million during the three and nine months ended September 30, 2017, respectively. We realized a gain of $139 million and gain of $754 million, net of transaction costs, during the three and nine months ended September 30, 2017, respectively.
At September 30, 2017, the aggregate carrying value of real estate secured receivables held for sale totaled $256 million. While we currently expect that these remaining receivables will be sold before December 31, 2017, the ultimate timing and impact to earnings depends on many factors, including future market conditions. We also continue to evaluate various options corresponding to our remaining other assets and liabilities. The ultimate resolution and timing is dependent on several factors and, therefore, remains uncertain.
In order to effectively utilize the cash generated from our receivable sales program and reduce excess funding as our receivable balances decline, in September 2017, we purchased $1.1 billion of our senior subordinated debt held by non-affiliates and recorded a loss on extinguishment of debt held by non-affiliates of $174 million during the third quarter of 2017. Additionally, in September 2017, we also repurchased all of the senior subordinated debt held by HSBC and recorded a loss on extinguishment of debt held by HSBC affiliates of $85 million during the third quarter of 2017.
In September 2017, we announced a meeting for the holders (the "Bondholders") of our Japanese Yen bonds (the "Bonds"). The meeting, which is scheduled for November 1, 2017, is to seek approval to change the maturity date of the Bonds from February 16, 2021 to an earlier date and to change the current redemption amount to the principal amount of the Bonds plus a premium of 9.156 percent (the "Proposal"). As of September 30, 2017, the Bonds have a carrying value of $141 million. If the Proposal is approved by the Bondholders, we will file a petition for approval with the Japanese court. Assuming that the Proposal is approved by the Bondholders and the Japanese court, we intend to redeem the Bonds shortly thereafter.
In June 2017, we received an interest payment from the Internal Revenue Service ("IRS") of $37 million related to the resolution of an IRS appeals matter involving the netting of under-payments and over-payments for tax years 1995 through 2009. The interest payment was recorded in the second quarter of 2017 as a component of interest income.
In March 2017, we prepaid a credit agreement with an HSBC affiliate of $2.5 billion and incurred a loss on extinguishment of debt held by HSBC affiliates of $28 million.

33


HSBC Finance Corporation

Performance, Developments and Trends The following table sets forth selected financial highlights of HSBC Finance Corporation for the three and nine months ended September 30, 2017 and 2016.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(dollars are in millions)
Income (loss) from continuing operations
$
(134
)
 
$
(406
)
 
$
301

 
$
(606
)
Return on average assets, annualized
(6.0
)%
 
(10.6
)%
 
3.7
%
 
(4.2
)%
Return on average common equity, annualized
(12.7
)
 
(37.5
)
 
6.6

 
(19.4
)
Net interest margin, annualized(1)
(1.37
)
 
3.43

 
.16

 
3.49

Efficiency ratio(1)(2)
(59.1
)
 
137.8

 
30.6

 
145.2

 
(1) 
See "Results of Operations" for a detailed discussion of trends in our net interest margin.
(2) 
Ratio of total costs and expenses from continuing operations to net interest income (expense) and other revenues from continuing operations.
We reported a net loss of $131 million and net income of $306 million during the three and nine months ended September 30, 2017, respectively, compared with a net loss of $404 million and $612 million during the three and nine months ended September 30, 2016, respectively.
Loss from continuing operations was $134 million during the three months ended September 30, 2017and income from continuing operations was $301 million during the nine months ended September 30, 2017, respectively, compared with a loss from continuing operations of $406 million and $606 million during the three and nine months ended September 30, 2016, respectively. We reported a loss from continuing operations before income tax of $218 million and income from continuing operations before income tax of $475 million during the three and nine months ended September 30, 2017, respectively, compared with a loss from continuing operations before income tax of $609 million and $928 million during the three and nine months ended September 30, 2016, respectively. The improvement in income from continuing operations before income tax during the three and nine months ended September 30, 2017 was driven by a lower provision for credit losses, lower operating expenses and, for the nine months ended September 30, 2017, higher other revenues, partially offset by a continuing decline in net interest income (expense) as the decrease in interest income due to receivable sales has outpaced the decrease in interest expense. During the three months ended September 30, 2017, the improvement was partially offset by lower other revenues.
Our reported results in all periods were impacted by certain items management believes to be significant, which distort comparability between periods. Significant items are excluded to arrive at adjusted performance because management would ordinarily identify and consider them separately to better understand underlying business trends. The following table summarizes the impact of these significant items for all periods presented:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
 
(in millions)
Income (loss) from continuing operations before income tax, as reported
$
(218
)
 
$
(609
)
 
$
475

 
$
(928
)
Fair value movement on fair value option debt attributable to our own credit spread(1)

 
27

 

 
8

Impact of non-qualifying hedge portfolio

 

 

 
117

Interest income related to the resolution of an IRS appeal matter

 

 
(37
)
 

File review costs associated with the receivable sales program
2

 
17

 
18

 
55

Loss on extinguishment of debt(2)
259

 

 
287

 

Severance costs

 
21

 

 
21

Provision for securities litigation liability

 

 

 
575

Adjusted performance from continuing operations before income tax(3)
$
43

 
$
(544
)
 
$
743

 
$
(152
)
 
(1) 
As discussed more fully in Note 13, "New Accounting Pronouncements," in the accompanying consolidated financial statements, beginning January 1, 2017, the fair value movement on fair value option debt attributable to our own credit spread is recorded in common equity as a component of other comprehensive income.

34


HSBC Finance Corporation

(2) 
Includes loss on extinguishment of debt recorded for both non-affiliates and HSBC affiliates.
(3) 
Represents a non-U.S. GAAP financial measure.
Excluding the impact of the items presented in the table above, adjusted performance from continuing operations before income tax improved by $587 million and $895 million during the three and nine months ended September 30, 2017, respectively, compared with the year-ago periods. The improvement in both periods was significantly impacted by a large provision for credit losses in the year-ago periods as a result of the decision in September 2016 to transfer to held for sale all of the receivables remaining in our held for investment portfolio. In the current year periods, no provision for credit losses was recorded as all receivables are classified as held for sale. The improvement in both periods also reflects higher other revenues and, to a lesser extent, lower operating expenses, partially offset by a continuing decline in net interest income (expense) as discussed above. Higher other revenues was driven by higher gains on receivable sales during the current year periods as well as, for the year-to-date period, reversals of lower of amortized cost or fair value adjustments recorded in prior periods.
See "Results of Operations" for a more detailed discussion of our operating trends. In addition, see "Balance Sheet Review" for further discussion on our receivables held for sale, deferred income taxes, net and other asset trends. See "Liquidity and Capital Resources" for further discussion on funding and capital, including short-term investments, due to affiliates and long-term debt. See "Credit Quality" for additional discussion on our credit trends.

Balance Sheet Review
  
Unless noted otherwise, the following discusses changes in amounts reported in our consolidated balance sheet for continuing operations. See "Liquidity and Capital Resources" for discussion regarding changes in short-term investments, due to affiliates and long-term debt.
Receivables Held for Sale The following table summarizes receivables held for sale at September 30, 2017 and decreases since June 30, 2017 and December 31, 2016:
 
 
 
Decrease from
 
 
 
 
 
 
$
 
%
 
$
 
%
 
(dollars are in millions)
First lien real estate secured receivable
$
235

 
$
(1,067
)
 
(82.0
)%
 
$
(4,464
)
 
(95.0
)%
Second lien real estate secured receivable
21

 
(23
)
 
(52.3
)
 
(954
)
 
(97.8
)
Total receivables held for sale
$
256

 
$
(1,090
)
 
(81.0
)%
 
$
(5,418
)
 
(95.5
)%
The decrease in receivables held for sale since June 30, 2017 and December 31, 2016 reflects the impact of receivable sales during the three and nine months ended September 30, 2017 with a carrying value of $1,048 million and $5,267 million, respectively. The decrease also reflects the impact of continued liquidation in the portfolio.
See Note 2, "Receivables Held for Sale," in the accompanying consolidated financial statements for additional discussion of receivables held for sale, including a rollforward of the receivables held for sale balance for the three and nine months ended September 30, 2017 and 2016.
Deferred Income Taxes, Net Deferred income taxes, net, totaled $1,863 million at September 30, 2017 compared with $2,897 million at December 31, 2016. Deferred income taxes, net, decreased due to utilization of our deferred net operating loss carryforwards by the consolidated HSBC North America tax group (the "HNAH Tax Group") during the nine months ended September 30, 2017 as well as the impact of the receivable sales during the first nine months of 2017 which resulted in a reclassification between the deferred tax asset and current taxes receivable. The carrying value of our deferred tax asset is determined, in part, by the enacted U.S. corporate income tax rate. A reduction in the enacted corporate income tax rate would result in a decrease in the carrying value of our deferred tax assets and a reduction in our net income in the period enacted.
Other Assets Other assets totaled $983 million at September 30, 2017 compared with $427 million at December 31, 2016 which primarily consists of current taxes receivable totaling $832 million at September 30, 2017 compared with $269 million at December 31, 2016. The increase in current taxes receivable reflects utilization of our deferred net operating loss carryforwards by the HNAH Tax Group during the first nine months of 2017 as well as the reclassification of deferred tax assets to current tax receivable resulting from the receivable sales during the first nine months of 2017. The increase in current taxes receivable was

35


HSBC Finance Corporation

partially offset by settlements during the first nine months of 2017 in accordance with the tax allocation agreement with the HNAH Tax Group.

Results of Operations
 
As we continue to make progress in our strategy to sell substantially all of our receivable portfolio in 2017, the decrease in interest income for receivables has outpaced the decrease in interest expense and will continue to do so in future periods. Decreases in operating expenses may not necessarily decline in line with the sale of our receivable portfolio as a result of certain fixed costs. Accordingly, net income (loss) for the nine months ended September 30, 2017 or any prior periods should not be considered indicative of the results for any future periods.
Unless noted otherwise, the following discusses amounts from continuing operations as reported in our consolidated statement of income (loss).
Net Interest Income (Expense)  The following table summarizes net interest income (expense) and net interest margin for the three and nine months ended September 30, 2017 and 2016.

2017
 
%(1)
 
2016
 
%(1)
 
(dollars are in millions)
Three Months Ended September 30,
 
 
 
 
 
 
 
Interest income
$
33

 
1.89
 %
 
$
217

 
6.82
%
Interest expense
57

 
3.26

 
108

 
3.39

Net interest income (expense)
$
(24
)
 
(1.37
)%
 
$
109

 
3.43
%
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
 
Interest income
$
226

 
3.61
 %
 
$
845

 
6.84
%
Interest expense
216

 
3.45

 
414

 
3.35

Net interest income
$
10

 
.16
 %
 
$
431

 
3.49
%
 
(1) 
% Columns: comparison to average interest-earning assets.
The following table summarizes the significant trends affecting the comparability of net interest income (expense) and net interest margin:
 
Three Months Ended
 
Nine Months Ended
 
(dollars are in millions)
Net interest income (expense)/net interest margin from prior year period
$
109

 
3.43
 %
 
$
431

 
3.49
%
Impact to net interest income (expense) resulting from:
 
 
 
 
 
 
 
Lower asset levels
(98
)
 
 
 
(414
)
 
 
Receivable yields
(1
)
 
 
 
3

 
 
Asset mix
(99
)
 
 
 
(274
)
 
 
Interest income related to the resolution of an IRS appeals matter

 
 
 
37

 
 
Investment income (rate and volume)
14

 
 
 
31

 
 
Cost of funds (rate and volume)
52

 
 
 
199

 
 
Other
(1
)
 
 
 
(3
)
 
 
Net interest income (expense)/net interest margin for current year period
$
(24
)
 
(1.37
)%
 
$
10

 
.16
%
Lower asset levels were driven by receivable sales and continued liquidation of the receivable portfolio.
Receivable yields were essentially flat during the three and nine months ended September 30, 2017.
Asset mix reflects the impact of lower overall yields on total average interest earning assets driven by a significant shift in mix of total average interest earning assets to a higher percentage of short-term investments as a result of receivable sales. Short-term investments have significantly lower yields than our receivable portfolio. Upon the completion of our receivable sales program, short-term investments will be the primary driver of interest income.

36


HSBC Finance Corporation

Interest income related to the resolution of an IRS appeals matter In June 2017, we received an interest payment from the IRS of $37 million related to the resolution of an IRS appeals matter involving the netting of under-payments and over-payments for tax years 1995 through 2009.
Investment income increased as a result of higher average investment balances as a result of the proceeds received from receivable sales and higher yields on investments.
Cost of funds (rate and volume) The lower cost of funds in both current periods reflects lower average borrowings, partially offset by the impact of higher average rates due to the maturing of certain lower rate long-term borrowings and rate increases on certain variable rate debt since September 2016.
Net interest margin was (1.37) percent and .16 percent for the three and nine months ended September 30, 2017, respectively, compared with 3.43 percent and 3.49 percent for the three and nine months ended September 30, 2016, respectively. Excluding the impact of the interest payment received from the IRS in June 2017 as discussed above, net interest margin would have been negative during both the three and nine months ended September 30, 2017. The negative net interest margin reflects the impact of lower overall yields on total average interest earning assets driven by a significant shift in mix of total average interest earning assets to a higher percentage of short-term investments and the impact of higher average rates on borrowings during the three and nine months ended September 30, 2017 as discussed above.
The varying maturities and repricing frequencies of both our assets and liabilities expose us to interest rate risk. When the various risks inherent in both the asset and the debt do not meet our desired risk profile, we historically used derivative financial instruments to manage these risks to acceptable interest rate risk levels. See "Risk Management" for additional information regarding interest rate risk and derivative financial instruments.
Provision for Credit Losses  As previously discussed, at September 30, 2017 and December 31, 2016 all of our receivables are classified as held for sale and no longer have any associated credit loss reserves. Accordingly, no provision for credit losses was recorded during the three or nine months ended September 30, 2017.
During the three and nine months ended September 30, 2016, the provision for credit losses totaled $572 million and $621 million, respectively, primarily reflecting the impact of the decision in September 2016 to transfer to held for sale all of the receivables remaining in our held for investment portfolio as the lower of amortized cost or fair value adjustment related to credit factors for these receivables was recorded as a component of the provision for credit losses.

37


HSBC Finance Corporation

Other Revenues  The following table summarizes the components of other revenues:
 
 
 
 
 
Increase (Decrease)

2017
 
2016
 
Amount
 
%
 
(dollars are in millions)
Three Months Ended September 30,
 
 
 
 
 
 
 
Derivative related income (expense)
$
1

 
$
3

 
$
(2
)
 
(66.7
)%
Gain (loss) on debt designated at fair value and related derivatives
8

 
(8
)
 
16

 
*
Servicing and other fees from HSBC affiliates

 
1

 
(1
)
 
(100.0
)
Lower of amortized cost or fair value adjustment on receivables held for sale
(16
)
 
(8
)
 
(8
)
 
(100.0
)
Gain (loss) on sale of real estate secured receivables
139

 
(5
)
 
144

 
*
Loss on extinguishment of debt held by:
 
 
 
 
 
 
 
Non-affiliates
(174
)
 

 
(174
)
 
*
HSBC affiliates
(85
)
 

 
(85
)
 
*
Other income
14

 
6

 
8

 
*
Total other revenues
$
(113
)
 
$
(11
)
 
$
(102
)
 
*
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
 
Derivative related income (expense)
$
4

 
$
(109
)
 
$
113

 
*
Gain (loss) on debt designated at fair value and related derivatives
24

 
32

 
(8
)
 
(25.0
)
Servicing and other fees from HSBC affiliates
1

 
7

 
(6
)
 
(85.7
)
Lower of amortized cost or fair value adjustment on receivables held for sale
155

 
(119
)
 
274

 
*
Gain (loss) on sale of real estate secured receivables
754

 
418

 
336

 
80.4

Loss on extinguishment of debt held by:
 
 
 
 
 
 
 
Non-affiliates
(174
)
 

 
(174
)
 
*
HSBC affiliates
(113
)
 

 
(113
)
 
*
Other income
23

 
19

 
4

 
21.1

Total other revenues
$
674

 
$
248

 
$
426

 
*
 
*
Not meaningful
Derivative related income (expense) for the three and nine months ended September 30, 2017 and 2016 reflects ineffectiveness primarily related to our cross currency cash flow hedges which are qualifying hedges and are approaching maturity. As discussed in prior filings, in May 2016 we terminated a portfolio of interest rate swaps which had been used to minimize our exposure to changes in interest rates. Prior to the termination of this portfolio of interest rate swaps, derivative related income (expense) during the nine months ended September 30, 2016 also included realized and unrealized gains and losses on this portfolio of interest rate swaps as they did not qualify as effective hedges under hedge accounting principles. Net income volatility has been reduced as a result of the elimination of our non-qualifying hedge portfolio.

38


HSBC Finance Corporation

The following table summarizes derivative related income (expense) for the three and nine months ended September 30, 2017 and 2016:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,

2017
 
2016
 
2017
 
2016
 
(in millions)
Net realized losses
$

 
$

 
$

 
$
(26
)
Mark-to-market on derivatives in our non-qualifying hedge portfolio

 

 

 
(91
)
Hedge accounting ineffectiveness
1

 
3

 
4

 
8

Total derivative related income (expense)
$
1

 
$
3

 
$
4

 
$
(109
)
Gain (loss) on debt designated at fair value and related derivatives reflects fair value changes on our fixed rate debt accounted for under fair value option as well as the fair value changes and realized gains (losses) on the related derivatives associated with debt designated at fair value. Beginning January 1, 2017, the fair value movement on fair value option liabilities attributable to our own credit spreads is recorded in other comprehensive income (loss). Excluding the impact of this item, which resulted in a loss of $27 million and $8 million during the three and nine months ended September 30, 2016, respectively, the gain on debt designated at fair value and related derivatives was lower during the three and nine months ended September 30, 2017 as compared with the year-ago periods. See Note 5, "Fair Value Option," in the accompanying consolidated financial statements for additional information, including a break out of the components of the gain on debt designated at fair value and related derivatives.
Net income volatility resulting from fair value movements on fair value option debt impacts the comparability of our reported results between periods. The gain on debt designated at fair value and related derivatives for the nine months ended September 30, 2017 should not be considered indicative of the results for any future periods.
Servicing and other fees from HSBC affiliates includes rental revenue from HSBC Technology & Services (USA) Inc. ("HTSU") for certain office and administrative costs and revenue received under service level agreements under which we service real estate secured receivables. As a result of facility closings subsequent to September 30, 2016 and lower administrative costs with affiliates due to the continuing reduced scope of our business operations as well as the significant decrease in the levels of receivables we service for affiliates as previously discussed, servicing and other fees received from affiliates decreased during the three and nine months ended September 30, 2017.
Lower of amortized cost or fair value adjustment on receivables held for sale during the three and nine months ended September 30, 2017 and 2016 is summarized in the following table:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,

2017
 
2016
 
2017
 
2016
 
(in millions)
Income (expense)
 
 
 
 
 
 
 
Initial lower of amortized cost or fair value adjustment recorded on receivables transferred to held for sale during the period
$

 
$
(5
)
 
$

 
$
(11
)
Lower of amortized cost or fair value adjustment subsequent to the initial transfer to held for sale
(16
)
 
(3
)
 
155

 
(108
)
Lower of amortized cost or fair value adjustment
$
(16
)
 
$
(8
)
 
$
155

 
$
(119
)
During the three months ended September 30, 2017, we recorded an additional lower of amortized cost or fair value adjustment of $16 million, of which $10 million related to a change in fair value resulting from a change in the estimated pricing on a specific pool of receivables and $6 million related to settlements. Settlements reflect either receivable charge-off or payoff (including short sales) or transfer of receivables to real estate owned ("REO".) During the nine months ended September 30, 2017, we reversed $155 million of the lower of amortized cost or fair value adjustment recorded in prior periods, of which $153 million reflects reversals attributable to fair value changes resulting from aggregating all receivables held for sale into pools based on the marketing strategy for the remainder of 2017 as well as improvements in the fair value of these receivables during the first nine months of 2017. The lower of amortized cost or fair value adjustment for the nine months ended September 30, 2017 also includes reversals attributable to the impact of settlements totaling $2 million.
During the three and nine months ended September 30, 2016, we recorded an additional lower of amortized cost or fair value adjustment on receivables held for sale totaling $3 million and $108 million, respectively. Of this amount, $15 million and $145

39


HSBC Finance Corporation

million during the three and nine months ended September 30, 2016, respectively, reflects additional adjustments attributable to fair value changes as a result of establishing separate pools for receivables being marketed and $12 million and $37 million, respectively, of reversals related to settlements as described above.
We did not record an initial lower of amortized cost or fair value adjustment during the three or nine months ended September 30, 2017 as no new receivables were transferred to held for sale during the first nine months of 2017 as a result of classifying our entire portfolio of receivables as held for sale in September 2016. During the three and nine months ended September 30, 2016, we recorded an initial lower of amortized cost or fair value adjustment on receivables transferred to held for sale totaling $562 million and $587 million, respectively, of which $5 million and $11 million, respectively, was attributable to non-credit factors and recorded as a component of other revenues in the consolidated statement of income (loss). The remainder of the total initial lower of amortized cost or fair value adjustment for the three and nine months ended September 30, 2016 of $557 million and $576 million, respectively, was attributed to credit factors and recorded as a component of the provision for credit losses.
See Note 2, "Receivables Held for Sale," in the accompanying consolidated financial statements for additional discussion.
Gain (loss) on sale of real estate secured receivables The following table summarizes receivables sold during the three and nine months ended September 30, 2017 and 2016.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,

2017
 
2016
 
2017
 
2016
 
(in millions)
Unpaid principal balance at the time of sale
$
1,244

 
$
930

 
$
6,228

 
$
5,652

 
 
 
 
 
 
 
 
Aggregate cash consideration received
$
1,196

 
$
715

 
$
6,059

 
$
5,382

Aggregate carrying value at the time of sale
1,048

 
714

 
5,267

 
4,933

Transaction costs
9

 
6

 
38

 
31

Gain (loss) on sale of real estate secured receivables
$
139

 
$
(5
)
 
$
754

 
$
418

Loss on extinguishment of debt held by non-affiliates for the three and nine months ended September 30, 2017 reflects the impact of the purchase of $1.1 billion of our senior subordinated debt held by non-affiliates in September 2017.
Loss on extinguishment of debt held by HSBC affiliates for the three and nine months ended September 30, 2017 reflects the impact of the repurchase of the senior subordinated debt held by HSBC in September 2017. The loss on extinguishment of debt held by HSBC affiliates for the nine months ended September 2017 also includes a loss on extinguishment of debt held by HSBC affiliates of $28 million recorded during the first quarter of 2017 as a result of prepaying a $2.5 billion credit agreement with HSBC USA Inc. ("HSBC USA") in March 2017.
Other income increased during the three and nine months ended September 30, 2017 as a result of larger releases during the current year periods in the reserve for repurchase liabilities related to receivable sale transactions which occurred in prior periods. Changes in the reserve for repurchase liabilities related to receivable sale transactions which occurred in the current year periods are included as a component of gain (loss) on sale of real estate secured receivables.

40


HSBC Finance Corporation

Our reserve for potential repurchase liability represents our best estimate of the loss that has been incurred resulting from various representations and warranties in the contractual provisions of our receivable sales. Because the level of receivable repurchase losses are dependent upon strategies for bringing claims or pursuing legal action for losses incurred, the level of the liability for receivables repurchase losses requires significant judgment. As such, there is uncertainty inherent in these estimates making it reasonably possible that they could change. The following table summarizes the changes in our reserve for potential repurchase liability related to our receivable sales:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,

2017
 
2016
 
2017
 
2016
 
(in millions)
Balance at beginning of period
$
62

 
$
43

 
$
53

 
$
36

Increase (decrease) in liability recorded through earnings(1)
(5
)
 
2

 
8

 
9

Realized losses
(3
)
 

 
(7
)
 

Balance at end of period
$
54

 
$
45

 
$
54

 
$
45

 
(1) 
The portion of the increase in the reserve for repurchase liabilities arising at the time of a receivable sale transaction are included as a component of gain (loss) on sale of real estate secured receivables and are not reflected in other income.
Operating Expenses  The following table summarizes the components of operating expenses.
 
 
 
 
 
Increase (Decrease)

2017
 
2016
 
Amount
 
%
 
(dollars are in millions)
Three Months Ended September 30,
 
 
 
 
 
 
 
Salaries and employee benefits
$
43

 
$
56

 
$
(13
)
 
(23.2
)%
Occupancy and equipment expenses, net
2

 
3

 
(1
)
 
(33.3
)
Real estate owned expenses

 
1

 
(1
)
 
(100.0
)
Support services from HSBC affiliates
15

 
40

 
(25
)
 
(62.5
)
Other expenses
21

 
35

 
(14
)
 
(40.0
)
Total operating expenses
$
81

 
$
135

 
$
(54
)
 
(40.0
)%
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
 
Salaries and employee benefits
$
79

 
$
128

 
$
(49
)
 
(38.3
)%
Occupancy and equipment expenses, net
9

 
13

 
(4
)
 
(30.8
)
Real estate owned expenses
1

 
6

 
(5
)
 
(83.3
)
Support services from HSBC affiliates
59

 
120

 
(61
)
 
(50.8
)
Provision for securities litigation liability

 
575

 
(575
)
 
(100.0
)
Other expenses
61

 
144

 
(83
)
 
(57.6
)
Total operating expenses
$
209

 
$
986

 
$
(777
)
 
(78.8
)%
Salaries and employee benefits decreased during the three and nine months ended September 30, 2017 due to the impact of the continuing reduced scope of our business operations and the impact of entity-wide initiatives to reduce costs. The decrease during the year-to-date period also reflects a gain on curtailment of $13 million related to our postretirement plans. See Note 8, "Pension and Other Postretirement Benefits," in the accompanying consolidated financial statements for additional information. The decrease was partially offset by an out of period adjustment recorded in the third quarter of 2017 associated with certain employee medical benefits which increased Salaries and employee benefits expense by approximately $22 million.
Occupancy and equipment expenses, net were decreased during the three and nine months ended September 30, 2017 due to lower rental expense and lower repair and utility costs reflecting the impact of the continuing reduced scope of our business operations.
Real estate owned expenses decreased during the three and nine months ended September 30, 2017 driven by fewer average numbers of REO properties held during the year.

41


HSBC Finance Corporation

Support services from HSBC affiliates decreased during the three and nine months ended September 30, 2017 due to lower technology and centralized support services provided by HTSU reflecting the reduced scope of our business operations. To a lesser extent, the decrease in support services from affiliates during the three and nine months ended September 30, 2017 also reflects lower fees for the servicing of receivables by HSBC affiliates as a result of receivable sales subsequent to September 30, 2016.
Provision for securities litigation liability As discussed more fully in Note 20, "Litigation and Regulatory Matters," in our 2016 Form 10-K, in June 2016, we agreed to pay $1,575 million to settle all claims of the outstanding securities litigation. As a result, we recorded a provision for securities litigation liability of $575 million during the second quarter of 2016.
Other expenses decreased during the three and nine months ended September 30, 2017 reflecting lower file review costs related to our receivable sales program, lower third party collection costs and, in the year-to-date period, lower litigation costs. For the nine months ended September 30, 2017, the decrease also reflects a reduction of an accrual related to mortgage servicing matters. The decrease in both periods also reflects the continuing reduction in the scope of our business operations and the impact of entity-wide initiatives to reduce costs.
Income taxes The following table provides an analysis of the difference between effective rates based on the total income tax provision attributable to pretax income and the statutory U.S. Federal income tax rate:
 
2017
 
2016
 
(dollars are in millions)
Three Months Ended September 30,
 
 
 
 
 
 
 
Tax expense (benefit) at the U.S. Federal statutory income tax rate
$
(76
)
 
(35.0
)%
 
$
(213
)
 
(35.0
)%
Increase (decrease) in rate resulting from:
 
 
 
 
 
 
 
State and local taxes, net of Federal benefit
1

 
.5

 
(8
)
 
(1.3
)
Adjustment with respect to tax for prior periods(1)

 

 
8

 
1.3

Change in valuation allowance(2)

 

 
17

 
2.8

Uncertain tax positions(3)
(2
)
 
(.9
)
 
(10
)
 
(1.6
)
Other non-deductible/non-taxable items
(3
)
 
(1.4
)
 
(3
)
 
(.5
)
Other
(4
)
 
(1.7
)
 
6

 
1.0

Total income tax expense (benefit)
$
(84
)
 
(38.5
)%
 
$
(203
)
 
(33.3
)%
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
 
Tax expense (benefit) at the U.S. Federal statutory income tax rate
$
166

 
35.0
 %
 
$
(325
)
 
(35.0
)%
Increase (decrease) in rate resulting from:
 
 
 
 
 
 
 
State and local taxes, net of Federal benefit
21

 
4.4

 
(16
)
 
(1.7
)
Adjustment with respect to tax for prior periods(1)

 

 
30

 
3.2

Change in valuation allowance(2)

 

 
17

 
1.8

Uncertain tax positions(3)
(4
)
 
(.7
)
 
(22
)
 
(2.4
)
Other non-deductible/non-taxable items
(8
)
 
(1.7
)
 
(6
)
 
(.6
)
Other
(1
)
 
(.4
)
 

 

Total income tax expense (benefit)
$
174

 
36.6
 %
 
$
(322
)
 
(34.7
)%
 
(1) 
For the three and nine months ended September 30, 2016, the amounts include a $8 million and $15 million adjustment, respectively, related to the Federal audit of the 2013 tax year. The amount for the nine months ended September 30, 2016, was also impacted by a reversal of approximately $15 million associated with an out of period adjustment to our deferred tax asset balance.
(2) 
For the three and nine months ended September 30, 2016, the amounts reflect an increase in valuation allowance reserves on certain state net operating loss carryforwards.
(3) 
For the three and nine months ended September 30, 2016, the amounts primarily relate to the resolution of an uncertain item during the third quarter of 2016 primarily related to the Federal Audit of the 2013 tax year. Additionally, the nine months ended September 30, 2016, also reflects the conclusion of certain State audits.


42


HSBC Finance Corporation

Credit Quality
 
Credit Loss Reserves As discussed in prior filings, subsequent to the third quarter of 2016 all of our receivables are classified as held for sale and no longer have any associated credit loss reserves as they are carried at the lower of amortized cost or fair value.
Delinquency  Our policies and practices for the collection of receivables, including our customer account management policies and practices, permit us to modify the terms of receivables, either temporarily or permanently (a "modification"), and/or to reset the contractual delinquency status of an account that is contractually delinquent to current (a "re-age"), based on indicators or criteria which, in our judgment, evidence continued payment probability. Such policies and practices are designed to manage customer relationships, improve collection opportunities and avoid foreclosure or repossession as determined to be appropriate. If a re-aged account subsequently experiences payment defaults, it will again become contractually delinquent and be included in our delinquency ratios.
The table below summarizes dollars of two-months-and-over contractual delinquency and two-months-and-over contractual delinquency as a percent of receivables ("delinquency ratio") for our portfolio of real estate secured receivables, all of which are classified as held for sale at September 30, 2017, June 30, 2017 and December 31, 2016.
 
 
 
 
(dollars are in millions)
Dollars of contractual delinquency(1)
$
31

 
$
285

 
$
457

Delinquency ratio
12.10
%
 
21.18
%
 
8.05
%
 
(1) 
The receivables held for sale balances reflect the lower of amortized cost or fair value for the receivable.
Dollars of contractual delinquency for real estate secured receivables held for sale at September 30, 2017 decreased as compared with June 30, 2017 and December 31, 2016 as a result of the sale of substantially all of our receivables during the first nine months of 2017.
The delinquency ratio for real estate secured receivables held for sale was 12.10 percent at September 30, 2017 compared with 21.18 percent at June 30, 2017 and 8.05 percent at December 31, 2016. The fluctuations in the delinquency ratio during the three and nine months ended September 30, 2017 reflect the impact of differences in the credit quality mix of the various receivable sales transactions that have occurred during the first nine months of 2017.
See "Customer Account Management Policies and Practices" regarding the delinquency treatment of re-aged and modified accounts.
Net Charge-offs  As discussed in prior filings, beginning in September 2016 all of our receivables are classified as held for sale and we no longer record charge-offs on these receivables as they are carried at the lower of amortized cost or fair value. Accordingly, there are no net charge-off dollars to report for the quarterly periods ended September 30, 2017 and June 30, 2017. For the quarterly period ended September 30, 2016, net charge-off dollars totaled $826 million and the net charge-off ratio (net charge-offs for the quarter, annualized, as a percentage of average receivables for the quarter) was 46.43 percent.
Nonperforming Assets  Nonperforming assets consisted of the following for the periods presented:
 
 
 
 
(in millions)
Nonaccrual receivables held for sale(1)
$
24

 
$
247

 
$
381

Real estate owned
10

 
19

 
31

Total nonperforming assets
$
34

 
$
266

 
$
412

 
(1) 
The receivables held for sale balances reflect the lower of amortized cost or fair value for the receivable. Nonaccrual receivables reflect all receivables which are 90 or more days contractually delinquent as well as second lien receivables (regardless of delinquency status) where the first lien receivable that we own or service is 90 or more days contractually delinquent. Nonaccrual receivables do not include receivables totaling $35 million, $183 million and $252 million at September 30, 2017, June 30, 2017 and December 31, 2016, respectively, which are less than 90 days contractually delinquent and not accruing interest. In addition, nonaccrual receivables do not include receivables which have made qualifying payments and have been re-aged and the contractual delinquency status reset to current as such activity, in our judgment, evidences continued payment probability. If a re-aged receivable subsequently experiences payment default and becomes 90 or more days contractually delinquent, it will be reported as nonaccrual.

43


HSBC Finance Corporation

Nonaccrual receivables held for sale decreased at September 30, 2017 compared with June 30, 2017 and December 31, 2016 as a result of the sale of substantially all of our receivables during the first nine months of 2017.
Customer Account Management Policies and Practices  Our policies and practices focus on ethical and effective collection and customer account management efforts for each receivable. Our customer account management policies and practices permit us to take action with respect to delinquent or troubled accounts based on criteria which, in our judgment, evidence continued payment probability, as well as a continuing desire for borrowers to stay in their homes. The policies and practices are designed to manage customer relationships, improve collection opportunities and avoid foreclosure as determined to be appropriate. From time to time we re-evaluate these policies and procedures and make changes as deemed appropriate. Our account management programs include certain eligibility criteria, including time since last account management action, minimum qualifying payment required and a maximum number of account management actions during a five year period.
As of September 30, 2017, we utilized the following account management actions:
Modification – Management action that results in a change to the terms and conditions of the receivable without changing the delinquency status of the receivable. Modifications include changes to the terms of the receivable and have historically included, but were not limited to, a change in interest rate, extension of the amortization period, reduction in payment amount and partial forgiveness or deferment of principal. Beginning May 1, 2017, we revised our modification program to only include changes in interest rates.
Collection Re-age – Management action that results in the resetting of the contractual delinquency status of an account to current but does not involve any changes to the original terms and conditions of the receivable. If an account which has been re-aged subsequently experiences a payment default, it will again become contractually delinquent. We use collection re-aging as an account and customer management tool in an effort to increase the cash flow from our account relationships, and accordingly, the application of this tool is subject to complexities, variations and changes from time to time.
Modification Re-age – Management action that results in a change to the terms and conditions of the receivable, either temporarily or permanently, and also resets the contractual delinquency status of an account to current as discussed above. If an account which has been re-aged subsequently experiences a payment default, it will again become contractually delinquent.
As previously discussed, as of September 30, 2017 we have sold substantially all of our receivables held for sale and expect that the remaining receivables will be sold before December 31, 2017. Beginning on October 1, 2017, we ceased offering modifications and modification re-ages. We will continue to offer collection re-ages to borrowers until the associated receivables are sold. As a result of these factors, the reporting of outstanding balances associated with our account management actions and the performance of these accounts is no longer meaningful. Therefore, beginning in the third quarter of 2017, we no longer report this activity. See "Credit Quality" in MD&A in our 2016 Form 10-K and in our Form 10-Q for the six month period ended June 30, 2017 for historical information regarding our account management programs.
Concentration 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 having similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions.
Our receivable portfolio is comprised of loans to non-prime consumers. Such customers are individuals who have limited credit histories, modest incomes, high debt-to-income ratios or have experienced credit problems evidenced by occasional delinquencies, prior charge-offs, bankruptcy or other credit related actions. The majority of our secured receivables have high loan-to-value ratios.

44


HSBC Finance Corporation

Because our lending activities were primarily to individual consumers, we do not have receivables from any industry group that equal or exceed 10 percent of total receivables at September 30, 2017. The following table reflects the percentage of receivables by state which individually account for 5 percent or greater of our portfolio.
 
Percent of Total Real Estate
Secured Receivables
New York
14.1
%
Florida
8.2

Virginia
7.8

Pennsylvania
6.0

California
5.6

Maryland
5.5


Liquidity and Capital Resources
 
HSBC Related Funding  We work with our affiliates under the oversight of HSBC North America to maximize funding opportunities and efficiencies in HSBC's operations in the United States. All of our ongoing funding requirements have been integrated into the overall HSBC North America funding plans with any future funding requirements to be sourced primarily through HSBC USA or HSBC North America.
Due to affiliates totaled $3,300 million at December 31, 2016. In March 2017, we prepaid $2.5 billion of the due to affiliates balance and incurred a loss on extinguishment of debt held by HSBC affiliates of $28 million. In September 2017, we repurchased the senior subordinated debt held by HSBC and recorded a loss on extinguishment of debt held by HSBC affiliates of $85 million during the third quarter of 2017. As a result of these transactions, at September 30, 2017 we no longer have any debt outstanding with affiliates.
Interest rates on funding from HSBC subsidiaries was market-based and comparable to those available from unaffiliated parties.
See Note 9, "Related Party Transactions," in the accompanying consolidated financial statements for further discussion about our funding arrangements with HSBC affiliates, including derivatives.
Short-Term Investments  Securities purchased under agreements to resell ("Resale Agreements") totaled $4,040 million and $2,392 million at September 30, 2017 and December 31, 2016, respectively, all of which were purchased from HSBC Securities (USA) Inc. The collateral subject to the Resale Agreements consists of investment-grade securities, primarily U.S. Treasuries or U.S. government backed securities. Interest bearing deposits with banks totaled $1,500 million at December 31, 2016 and were with HSBC Bank USA, National Association (together with its subsidiaries, "HSBC Bank USA"). We did not have any interest bearing deposits at September 30, 2017. Short-term investments increased as compared with December 31, 2016 reflecting cash received from receivable sales, partially offset by debt repayments.
Long-Term Debt (excluding amounts due to affiliates) decreased to $1,836 million at September 30, 2017 from $4,340 million at December 31, 2016. There were no issuances of long-term debt during the nine months ended September 30, 2017 and 2016. Repayments of long-term debt totaled $2,584 million and $5,074 million during the nine months ended September 30, 2017 and 2016, respectively.
In September 2017, we repurchased $1.1 billion of our senior subordinated debt held by non-affiliates and recorded a loss on extinguishment of debt held by non-affiliates of $174 million during the third quarter of 2017.
As previously discussed, we have called a meeting of the Bondholders of our Japanese Yen Bonds. The meeting, which is scheduled for November 1, 2017, is to seek approval to change to the terms of the Bonds which would allow us to redeem the Bonds prior to the current redemption date of February 16, 2021 and to change the redemption amount to include a premium of 9.156 percent. The Proposal will also require approval of the Japanese court.

45


HSBC Finance Corporation

Maturities of long-term debt at September 30, 2017, including secured financings based on the anticipated clean-up date for the collateralized funding transactions, are as follows:
  
(in millions)
2017
$
103

2018
185

2019
168

2020

2021
1,238

Thereafter
142

Total
$
1,836

Secured financings previously issued under public trusts of $76 million at September 30, 2017 are secured by $195 million of closed-end real estate secured receivables which are classified as receivables held for sale at September 30, 2017. Secured financings previously issued under public trusts of $404 million at December 31, 2016 were secured by $750 million of closed-end real estate secured receivables which are classified as receivables held for sale at December 31, 2016.
In order to eliminate future foreign exchange risk, currency swaps were used at the time of issuance of all foreign-denominated notes to fix the notes in U.S. dollars.
We have used derivatives for managing interest rate and currency risk but we do not otherwise enter into off-balance sheet transactions.
Common Equity  During the nine months ended September 30, 2017 and 2016, we did not receive any capital contributions.
Equity ratio  Common and preferred equity to total assets totaled 70.84 percent at September 30, 2017 compared with 39.14 percent at December 31, 2016.
HSBC North America continues to review the composition of its capital structure following the adoption by the U.S. banking regulators of the final rules implementing the Basel III regulatory capital and liquidity reforms from the Basel Committee on Banking Supervision, which were effective as of January 1, 2014. Upon receipt of regulatory approval, we have replaced instruments whose treatment was less favorable under the new rules with Basel III compliant instruments. Any required funding has been integrated into the overall HSBC North America funding plans with any future funding requirements to be sourced through HSBC USA, HSBC North America, or through direct support from HSBC or its affiliates.
HSBC North America participates in the Federal Reserve Board's ("FRB") Comprehensive Capital Analysis and Review ("CCAR") program and submitted its latest CCAR capital plan and annual company-run stress test results in April 2017. In June 2017, the FRB informed HSBC North America that it did not object to HSBC North America's capital plan or the planned capital distributions included in its 2017 CCAR submission. Stress testing results are based solely on hypothetical adverse scenarios and should not be viewed or interpreted as forecasts of expected outcomes or capital adequacy or of the actual financial condition of HSBC North America. Capital planning and stress testing for HSBC North America may impact our future capital and liquidity.
2017 Funding Strategy  The following table summarizes our current range of estimates for funding needs and sources for 2017:
 
Actual Jan. 1 through
 
Estimated October 1 through December 31, 2017
(Minimum-Maximum)(1)
 
Estimated Full Year 2017 (Minimum-Maximum)
 
(in billions)
Funding needs:
 
 
 
 
 
 
 
 
 
Long-term debt retired
$
3

 
$

-
$

 
$
3

-
$
3

Affiliate debt retired
3

 

-

 
3

-
3

Total funding needs
$
6

 
$

-
$

 
$
6

-
$
6

Funding sources:
 
 
 
 
 
 
 
 
 
Receivable sales
$
6

 
$

-
$

 
$
6

-
$
6

Total funding sources
$
6

 
$

-
$

 
$
6

-
$
6

 
(1) 
Estimated funding needs and funding sources for October 1, 2017 through December 31, 2017 are less than $1 billion.

46


HSBC Finance Corporation

Our cash requirements during the nine months ended September 30, 2017 were primarily met from proceeds of sales of real estate secured receivables. For the remainder of 2017, we expect that proceeds from sales of real estate secured receivables and other balance sheet attrition will generate the liquidity necessary to meet our maturing debt obligations.

Fair Value
 
Control Over Valuation Process and Procedures  We have established a control framework which is designed to ensure that fair values are either determined or validated by a function independent of the risk-taker. See Note 11, "Fair Value Measurements," in the accompanying consolidated financial statements for further details on our valuation control framework.
Fair Value Hierarchy  Accounting principles related to fair value measurements establish a fair value hierarchy structure that prioritizes the inputs to valuation techniques used to determine the fair value of an asset or liability (the "Fair Value Framework"). The Fair Value Framework distinguishes between inputs that are based on observed market data and unobservable inputs that reflect market participants' assumptions. It emphasizes the use of valuation methodologies that maximize market inputs. For financial instruments carried at fair value, the best evidence of fair value is a quoted price in an actively traded market (Level 1). Where the market for a financial instrument is not active, valuation techniques are used. The majority of valuation techniques use market inputs that are either observable or indirectly derived from and corroborated by observable market data for substantially the full term of the financial instrument (Level 2). Because Level 1 and Level 2 instruments are determined by observable inputs, less judgment is applied in determining their fair values. In the absence of observable market inputs, the financial instrument is valued based on valuation techniques that feature one or more significant unobservable inputs (Level 3). The determination of the level of fair value hierarchy within which the fair value measurement of an asset or a liability is classified often requires judgment.
Level 1 inputs are unadjusted quoted prices in active markets that the reporting entity has the ability to access for the identical assets or liabilities. A financial instrument is classified as a Level 1 measurement if it is listed on an exchange or is an instrument actively traded in the over-the-counter market where transactions occur with sufficient frequency and volume.
Level 2 inputs are inputs that are observable either directly or indirectly but do not qualify as Level 1 inputs. We generally classify derivative contracts as well as our own debt issuance for which we have elected fair value option as Level 2 measurements. These valuations are typically obtained from a third party valuation source which, in the case of derivatives, includes valuations provided by HSBC Bank USA.
Level 3 inputs are unobservable inputs for the asset or liability and include situations where there is little, if any, market activity for the asset or liability. Level 3 inputs incorporate market participants' assumptions about risk and the risk premium required by market participants in order to bear that risk. We develop Level 3 inputs based on the best information available in the circumstances. At September 30, 2017 and December 31, 2016, our Level 3 assets recorded at fair value on a non-recurring basis totaled $256 million (3 percent of total assets) and $5,674 million (41 percent of total assets), respectively. At September 30, 2017 and December 31, 2016, we had no Level 3 assets recorded at fair value on a recurring basis. The decrease in Level 3 assets recorded at fair value on a non-recurring basis has declined since December 31, 2016 as a result of the sale of substantially all of our receivables held for sale during the nine months ended September 30, 2017.
Classification within the fair value hierarchy is based on whether the lowest level input that is significant to the fair value measurement is observable. As such, the classification within the fair value hierarchy is dynamic and can be transferred to other hierarchy levels in each reporting period.
See Note 11, "Fair Value Measurements," in the accompanying consolidated financial statements for further details including our valuation techniques as well as the classification hierarchy associated with assets and liabilities measured at fair value. Additionally, see Note 11, "Fair Value Measurements," in the accompanying consolidated financial statements for information about transfers between Level 1 and Level 2 measurements and transfers between Level 2 and Level 3 measurements during the three and nine months ended September 30, 2017 and 2016.

Risk Management
 
Overview  Managing risk effectively is fundamental to the delivery of our strategic priorities. To do so, we employ a risk management framework at all levels and across all risk types. This framework fosters the continuous monitoring of the risk environment and an integrated evaluation of risks and their interactions. It also ensures that we have a robust and consistent approach to risk management across all of our activities. While we are subject to a number of legal and regulatory actions and investigations, our risk management framework has been designed to provide robust controls and ongoing monitoring of our principal risks. We strive

47


HSBC Finance Corporation

to continuously improve our risk management processes through ongoing employee training and development.
In the course of our regular risk management activities, we use simulation models to help quantify the risk we are taking. The output from some of these models is included in this section of our filing. By their nature, models are based on various assumptions and relationships. We believe that the assumptions used in these models are reasonable, but events may unfold differently than what is assumed in the models. In actual stressed market conditions, these assumptions and relationships may no longer hold, causing actual experience to differ significantly from the results predicted in the model. Consequently, model results may be considered reasonable estimates, with the understanding that actual results may differ significantly from model projections.
See "Risk Management" in MD&A in our 2016 Form 10-K for a more complete discussion of the principal risks associated with our operations and the objectives of our risk management system as well as our risk management policies and procedures. There have been no material changes to our approach to credit risk management, market risk management, reputational risk management, strategic risk management, model risk management or pension risk management since December 31, 2016.
Liquidity Risk Management  The primary driver of our liquidity going forward will be sales of real estate secured receivables and other balance sheet attrition. However, as we continue to execute our receivables sales program, cash flows subsequent to 2017 may not provide sufficient cash to fully cover all of our financial obligations in future periods. We currently do not expect third party debt to be a source of funding for us in the future given the run-off nature of our business. Any required incremental funding has been integrated into the overall HSBC North America funding plan and we expect it to be sourced through HSBC USA, HSBC North America, or will be obtained through direct support from HSBC or its affiliates. HSBC has indicated it remains fully committed and has the capacity to continue to provide such support.
HSBC North America maintains a liquidity management and contingency funding plan, which identifies certain potential early indicators of liquidity problems, and actions that can be taken both initially and in the event of a liquidity crisis, to minimize the long-term impact on its businesses. The liquidity contingency funding plan is reviewed annually and approved by the Risk Committee of the Board of Directors. We recognize a liquidity crisis can either be specific to us, relating to our ability to meet our obligations in a timely manner, or market-wide, caused by a macro risk event in the broader financial system. A range of indicators is monitored to attain an early warning of any liquidity issues. These include widening of key spreads or indices used to track market volatility, widening of our own credit spreads and higher borrowing costs. In the event of a cash flow crisis, our objective is to fund cash requirements without HSBC affiliate access to the wholesale unsecured funding market for at least 90 days. Contingency funding needs will be satisfied primarily through liquidation of short-term investments, sale of receivables or secured borrowing using the mortgage portfolio as collateral. We maintain a liquid asset buffer consisting of cash and short-term liquid assets.
We project cash flow requirements and determine the level of liquid assets and available funding sources to have at our disposal, with consideration given to anticipated balance sheet run-off, including liquidation of receivables held for sale, contingent liabilities and the ability of HSBC USA to access wholesale funding markets.
The Basel Committee based Liquidity Coverage Ratio ("LCR") is designed to be a short-term liquidity measure to ensure banks have sufficient High Quality Liquid Assets ("HQLA") to cover net stressed cash outflows over the next 30 days. A LCR ratio of 100 percent or higher reflects an unencumbered HQLA balance that is equal to or exceeds liquidity needs for a 30 calendar day liquidity stress scenario. HQLA consists of cash or assets that can be converted into cash at little or no loss of value in private markets. HSBC North America has adjusted its liquidity profile to support compliance with these rules. HSBC North America may need to make further changes to its liquidity profile to support compliance with any future final rules. HSBC Finance Corporation may need to adjust its liquidity profile to support HSBC North America's compliance with these rules, but it is not anticipated to significantly impact our operations.
As indicated by the major rating agencies, our credit ratings are directly dependent upon the continued support of HSBC. A credit rating downgrade would increase future borrowing costs only for new debt obligations, if any. As discussed above, we do not currently expect to need to raise funds from the issuance of third party debt going forward, but instead any required funding has been integrated into HSBC North America's funding plans and we expect it to be sourced through HSBC USA, HSBC North America or through direct support from HSBC or its affiliates. HSBC has historically provided significant capital in support of our operations and has indicated that they remain fully committed and have the capacity to continue that support.
The following table summarizes our credit ratings at both September 30, 2017 and December 31, 2016:
 
Standard &
Poor's
Corporation
 
Moody's
Investors
Service
 
Fitch, Inc.
Senior debt
A
 
Baa1
 
A+
Senior subordinated debt
A-
 
Baa2
 
A

48


HSBC Finance Corporation

Rating agencies continue to evaluate economic and geopolitical trends, regulatory developments, future profitability, risk management practices and litigation matters, all of which could lead to adverse ratings actions.
Although we closely monitor and strive to manage factors influencing our credit ratings, there is no assurance that our credit ratings will not be changed in the future. As of September 30, 2017, there were no pending actions from these rating agencies in terms of changes to the ratings presented in the table above for HSBC Finance Corporation.
Other conditions that could negatively affect our liquidity include unforeseen capital requirements, a strengthening of the U.S. dollar which would require us to post additional collateral for our cross currency swaps and an inability to obtain expected funding from HSBC and its subsidiaries.
See "Liquidity and Capital Resources" for further discussion of our liquidity position.
There have been no material changes to our approach to liquidity risk management since December 31, 2016.
Interest Rate Risk Management  Interest rate risk is the potential reduction of net interest income due to mismatched pricing between assets and liabilities as well as losses in value due to rate movements. Due to the sale of substantially all of our receivables, interest expense now outpaces interest income. As a result, we are reporting net interest expense on our consolidated statement of income (loss) as opposed to net interest income and will continue to do so in future periods.
In response to these changing dynamics, we have made changes to the way in which we manage interest rate risk. Currently, interest rate risk is monitored and managed by HSBC North America. HSBC North America has established certain limits and benchmarks that serve as guidelines in determining the appropriate levels of interest rate risk for each of its subsidiaries. The limit that HSBC North America has established for us is the Present Value of a Basis Point ("PVBP"), which reflects the change in value of the balance sheet for a one basis point movement in all interest rates without considering correlation factors or assumptions. At September 30, 2017, our absolute PVBP position was $1.3 million compared with our limit of $3.0 million. Any necessary interest rate risk management actions would be taken directly by HSBC North America and reflected on their balance sheet.
In addition to interest rate risk implications, the receivable sales program also has liquidity risk implications as cash flows subsequent to 2017 may not provide sufficient cash to fully cover all of our financial obligations in future periods. We are currently evaluating various options corresponding to the remaining other assets and liabilities from both an interest rate risk and liquidity risk perspective. The ultimate resolution and timing is dependent on several factors.
Operational Risk Management During the second quarter of 2017, we implemented a new Operational Risk Management Framework ("ORMF") and operational risk database. The new ORMF was designed to simplify and improve our approach to managing operational risks. It promotes more focused efforts on material risks and ensures clarity and accountability of related roles and responsibilities.
Under the new ORMF, risk and control assessments provide an end to end view of operational risk. Material risks are assigned an inherent risk assessment based on the likelihood and the direct (financial costs) and indirect impacts to the business. An assessment of the effectiveness of key controls that mitigate these risks is made and a residual risk assessment is determined. An operational risk database is used to record risk and control assessments and track related issues and mitigation action plans. The risk assessments, which are refreshed based on relevant triggers, provide an up-to-date view of the operational risk profile.
There have been no other material changes to our approach to operational risk management since December 31, 2016.
Compliance Risk Management During the second quarter of 2017, there was a reorganization of certain risk activities as we continued to implement the most effective global standards to combat financial crime and strengthen our financial crime detection and compliance capabilities. As part of this reorganization, the activities related to financial crime and fraud risk management previously performed by the Security and Fraud Risk Management function, are now performed by the Financial Crime Risk function. Additionally, during the second quarter of 2017, the Compliance Committee of the Board of Directors was demised and the Compliance and Conduct Committee of the Board of Directors (the "CCC") was established. The CCC oversees the remediation of the compliance risk management program. There have been no other material changes to our approach to compliance risk management since December 31, 2016.
Security Risk Management As discussed above, during the second quarter of 2017, activities related to financial crime and fraud risk management activities are no longer performed by the Security and Fraud Risk Management function, but are now performed by the Financial Crime Risk function. Additionally, the Security and Fraud Risk Management function was renamed "Security Risk Management" to reflect this reorganization. During the third quarter of 2017, Security Risk Management was expanded to include Insider Risk which focuses holistically around managing, monitoring and controlling the risks related to all insiders, including employees, contractors and third parties. There have been no other material changes to our approach to security risk management since December 31, 2016.

Item 3.    Quantitative and Qualitative Disclosures About Market Risk.
 
 
Information required by this Item is included in the following sections of Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations: "Liquidity and Capital Resources" and "Risk Management."

Item 4. Controls and Procedures.
 
Evaluation of Disclosure Controls and Procedures We maintain a system of internal and disclosure controls and procedures designed to ensure that information required to be disclosed by HSBC Finance Corporation in the reports we file or submit under the Securities Exchange Act of 1934, as amended, (the "Exchange Act"), is recorded, processed, summarized and reported on a timely basis. Our Board of Directors, operating through its Audit Committee, which is composed entirely of independent non-executive directors, provides oversight to our financial reporting process.
We conducted an evaluation, with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report so as to alert them in a timely fashion to material information required to be disclosed in reports we file under the Exchange Act.
Changes in Internal Control Over Financial Reporting There has been no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II

Item 1. Legal Proceedings.
 
See Note 12, "Litigation and Regulatory Matters," in the accompanying consolidated financial statements for our legal proceedings disclosure, which is incorporated herein by reference.

Item 5. Other Information.
 
Disclosures pursuant to Section 13(r) of the Securities Exchange Act Section 13(r) of the Securities Exchange Act requires each issuer registered with the SEC to disclose in its annual or quarterly reports whether it or any of its affiliates have knowingly engaged in specified activities or transactions with persons or entities targeted by U.S. sanctions programs relating to Iran, terrorism, or the proliferation of weapons of mass destruction, even if those activities are not prohibited by U.S. law and are conducted outside the U.S. by non-U.S. affiliates in compliance with local laws and regulations.
To comply with this requirement, HSBC has requested relevant information from its affiliates globally. During the period covered by this Form 10-Q, HSBC Finance Corporation did not engage in any activities or transactions requiring disclosure pursuant to Section 13(r). The following activities conducted by our affiliates are disclosed in response to Section 13(r):
Loans in repayment Between 2001 and 2005, the Project and Export Finance division of the HSBC Group arranged or participated in a portfolio of loans to Iranian energy companies and banks. All of these loans were guaranteed by European and Asian export credit agencies and have varied maturity dates with final maturity in 2018. For those loans that remain outstanding, the HSBC Group continues to seek repayment in accordance with its obligations to the supporting export credit agencies. Details of these loans follow.
At September 30, 2017, the HSBC Group had five loans outstanding to an Iranian petrochemical company. These loans are supported by the official export credit agencies of the following countries: the United Kingdom, South Korea, and Japan. The HSBC Group
continues to seek repayments from the Iranian company under the outstanding loans in accordance with their original maturity profiles.
There was no measurable gross revenue or net profit to the HSBC Group during the third quarter of 2017 relating to the loans in repayment. While the HSBC Group intends to continue to seek repayment under the existing loans, all of which were entered into before the petrochemical sector of Iran became a target of U.S. sanctions, it does not currently intend to extend any new loans.
Additionally, the HSBC Group processed one payment related to the aforementioned loans for the benefit of the Japanese export credit agency. There was no measurable gross revenue or net profit to the HSBC Group during the third quarter of 2017 relating to that payment.
Legacy contractual obligations related to guarantees Between 1996 and 2007, the HSBC Group provided guarantees to a number of its non-Iranian customers in Europe and the Middle East for various business activities in Iran. In a number of cases, the HSBC Group issued counter indemnities in support of guarantees issued by Iranian banks as the Iranian beneficiaries of the guarantees required that they be backed directly by Iranian banks. The Iranian banks to which the HSBC Group provided counter indemnities included Bank Tejarat, Bank Melli, and the Bank of Industry and Mine.
There was no measurable gross revenue in the third quarter of 2017 under those guarantees and counter indemnities. The HSBC Group does not allocate direct costs to fees and commissions and, therefore, has not disclosed a separate net profit measure. The HSBC Group is seeking to cancel all relevant guarantees and counter indemnities and does not currently intend to provide any new guarantees or counter indemnities involving Iran. None were canceled in the third quarter of 2017 and approximately 19 remain outstanding.
Other relationships with Iranian banks Activity related to U.S.-sanctioned Iranian banks not covered elsewhere in this disclosure includes the following:
Ÿ
The HSBC Group maintains several accounts in the United Kingdom for an Iranian-owned, U.K.-regulated financial institution. These accounts are generally no longer restricted under U.K. law, though HSBC maintains restrictions on the accounts as a matter of policy. The HSBC Group is seeking to exit these accounts and has begun transferring the funds to the client's accounts at other financial institutions. Estimated gross revenue in the third quarter of 2017 on these accounts, which includes fees and/or commissions, was approximately $27,180.
Ÿ
The HSBC Group acts as the trustee and administrator for a pension scheme involving six employees of a U.S.-sanctioned Iranian bank in Hong Kong. Under the rules of this scheme, the HSBC Group accepts contributions from the Iranian bank each month and allocates the funds into the pension accounts of the Iranian bank’s employees. The HSBC Group runs and operates this pension scheme in accordance with Hong Kong laws and regulations. Estimated gross revenue, which includes fees and/or commissions, generated by this pension scheme during the third quarter of 2017 was approximately $990.
For the Iranian bank related-activity discussed above, the HSBC Group does not allocate direct costs to fees and commissions and, therefore, has not disclosed a separate net profit measure.
The HSBC Group has been holding a safe custody box for the Central Bank of Iran. For a number of years, the box has not been accessed by the Central Bank of Iran and no fees have been charged to the Central Bank of Iran.
The HSBC Group currently intends to continue to wind down the activity discussed in this section, to the extent legally permissible, and not enter into any new such activity.
Other Activity The HSBC Group has an insurance company customer in the United Arab Emirates that made two payments for the reimbursement of medical treatment to a hospital located in the United Arab Emirates and owned by the Government of Iran. HSBC processed the payments to the hospital made by its customer. There was no measurable gross revenue or net profit to the HSBC Group during the third quarter of 2017 relating to these two payments.
The HSBC Group has a travel agent customer in Europe that made four payments to an airline owned by the Government of Iran for the purchase of airline tickets on behalf of a customer. There was no measurable gross revenue or net profit to the HSBC Group during the third quarter of 2017 relating to these payments.
Frozen accounts and transactions The HSBC Group maintains several accounts that are frozen as a result of relevant sanctions programs and safekeeping boxes and other similar custodial relationships, for which no activity, except as licensed or otherwise authorized, took place during the third quarter of 2017.There was no measurable gross revenue or net profit to the HSBC Group during the third quarter of 2017 relating to these frozen accounts.


49


HSBC Finance Corporation


Item 6. Exhibits and Financial Statement Schedules.
 
3(i)
 
3(ii)
 
12
 
31
 
32
 
101.INS
 
XBRL Instance Document(1)
101.SCH
 
XBRL Taxonomy Extension Schema Document(1)
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document(1)
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document(1)
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document(1)
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document(1)
 
*
Schedules and exhibits are omitted pursuant to Item 601(b)(2) of Regulation S-K. HSBC Finance Corporation agrees to furnish supplementally a copy of any omitted schedules or exhibits to the Securities and Exchange Commission upon request.
(1) 
Pursuant to Rule 405 of Regulation S-T, includes the following financial information included in our Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2017, formatted in eXtensible Business Reporting Language ("XBRL") interactive data files: (i) the Consolidated Statement of Income (Loss) for the three and nine months ended September 30, 2017 and 2016, (ii) the Consolidated Statement of Comprehensive Income (Loss) for the three and nine months ended September 30, 2017 and 2016, (iii) the Consolidated Balance Sheet as of September 30, 2017 and December 31, 2016, (iv) the Consolidated Statement of Changes in Equity for the nine months ended September 30, 2017 and 2016, (iv) the Consolidated Statement of Cash Flows for the nine months ended September 30, 2017 and 2016, and (v) the Notes to Consolidated Financial Statements.


50


HSBC Finance Corporation

Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, HSBC Finance Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: October 30, 2017
HSBC FINANCE CORPORATION
 
 
 
By:
 
 
 
 
 
Executive Vice President
 
 
 


51

Dates Referenced Herein   and   Documents Incorporated by Reference

This ‘10-Q’ Filing    Date    Other Filings
2/16/21
1/1/19
1/1/18
12/31/17
11/1/17
Filed on:10/30/17IRANNOTICE
10/27/17
10/1/17
For Period end:9/30/17
6/30/1710-Q
5/1/17
4/20/17
3/31/1710-Q
1/1/17
12/31/1610-K
9/30/1610-Q
1/1/16
1/1/14
12/15/048-K
 List all Filings 


4 Previous Filings that this Filing References

  As Of               Filer                 Filing    For·On·As Docs:Size             Issuer                      Filing Agent

 4/24/17  HSBC Finance Corp                 8-K:5,9     4/24/17    2:90K
11/30/10  HSBC Finance Corp                 8-K:3,5,9  11/30/10    2:68K
12/19/05  HSBC Finance Corp                 8-K:5,9    12/15/05    2:18K
 6/22/05  HSBC Finance Corp                 8-K:8,9     6/15/05    4:376K                                   Toppan Merrill/FA
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