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FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2002
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 1-8198
HOUSEHOLD INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 36-3121988
-------- ----------
(State of Incorporation) (I.R.S. Employer Identification No.)
2700 Sanders Road, Prospect Heights, Illinois 60070
------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(847) 564-5000
--------------
(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 [X] No [ ]
At July 31, 2002, there were 454,785,081 shares of the registrant's common stock
outstanding.
HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES
Table of Contents
PART I. Financial Information Page
----
Item 1. Financial Statements
Condensed Consolidated Statements of Income (Unaudited) -
Three and six months ended June 30, 2002 and 2001 (RESTATED) 2
Condensed Consolidated Balance Sheets (Unaudited) -
June 30, 2002 and December 31, 2001 (RESTATED) 3
Condensed Consolidated Statements of Cash Flows (Unaudited) -
Six months ended June 30, 2002 and 2001 (RESTATED) 4
Notes to Interim Condensed Consolidated Financial
Statements (Unaudited) 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 14
PART II. Other Information
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 6. Exhibits and Reports on Form 8-K 30
Signature 31
1
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Household International, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
- ---------------------------------------------------------------------------------------------------------------
Three months Six months
ended ended
June 30, June 30,
(In millions, except per share data) 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------
(RESTATED) (RESTATED)
Finance and other interest income $2,609.9 $2,434.4 $5,145.6 $4,849.6
Interest expense 980.9 1,048.4 1,919.7 2,155.2
- ---------------------------------------------------------------------------------------------------------------
Net interest margin 1,629.0 1,386.0 3,225.9 2,694.4
Provision for credit losses
on owned receivables 850.9 657.1 1,773.9 1,360.7
- ---------------------------------------------------------------------------------------------------------------
Net interest margin after
provision for credit losses 778.1 728.9 1,452.0 1,333.7
- ---------------------------------------------------------------------------------------------------------------
Securitization revenue 523.4 397.4 1,041.7 800.5
Insurance revenue 177.5 159.3 347.6 317.9
Investment income 44.0 37.8 90.2 79.6
Fee income 190.3 223.5 406.8 435.6
Other income 95.3 49.4 283.3 211.1
- ---------------------------------------------------------------------------------------------------------------
Total other revenues 1,030.5 867.4 2,169.6 1,844.7
- ---------------------------------------------------------------------------------------------------------------
Salaries and fringe benefits 453.0 387.2 898.3 764.8
Sales incentives 67.6 73.6 121.7 128.1
Occupancy and equipment expense 93.3 83.7 185.5 167.2
Other marketing expenses 133.5 121.8 273.9 250.5
Other servicing and administrative
expenses 204.1 173.0 435.8 368.7
Amortization of acquired intangibles
and goodwill 12.6 39.0 32.4 79.6
Policyholders' benefits 87.4 73.1 171.4 150.6
- ---------------------------------------------------------------------------------------------------------------
Total costs and expenses 1,051.5 951.4 2,119.0 1,909.5
- ---------------------------------------------------------------------------------------------------------------
Income before income taxes 757.1 644.9 1,502.6 1,268.9
Income taxes 249.7 221.6 504.2 440.1
- ---------------------------------------------------------------------------------------------------------------
Net income $ 507.4 $ 423.3 $ 998.4 $ 828.8
===============================================================================================================
EARNINGS PER COMMON SHARE
Net income $ 507.4 $ 423.3 $ 998.4 $ 828.8
Preferred dividends (15.5) (2.3) (24.0) (4.6)
- ---------------------------------------------------------------------------------------------------------------
Earnings available to common
shareholders $ 491.9 $ 421.0 $ 974.4 $ 824.2
- ---------------------------------------------------------------------------------------------------------------
Average common shares 456.3 463.0 456.6 464.5
Average common and common
equivalent shares 461.2 469.6 461.5 470.8
- ---------------------------------------------------------------------------------------------------------------
Basic earnings per common share $ 1.08 $ .91 $ 2.13 $ 1.77
Diluted earnings per common share 1.07 .90 2.11 1.75
- ---------------------------------------------------------------------------------------------------------------
DIVIDENDS DECLARED PER
COMMON SHARE $ .25 $ .22 $ .47 $ .41
- ---------------------------------------------------------------------------------------------------------------
See notes to interim condensed consolidated financial statements.
Household International, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
- --------------------------------------------------------------------------------------------------------
June 30, December 31,
(In millions, except share and per share data) 2002 2001
- --------------------------------------------------------------------------------------------------------
ASSETS (RESTATED)
Cash $ 346.6 $ 543.6
Investment securities 8,229.7 3,580.5
Receivables, net 82,133.0 79,263.5
Acquired intangibles, net 418.5 455.6
Goodwill 1,122.1 1,107.4
Properties and equipment, net 550.0 531.1
Real estate owned 456.7 398.9
Other assets 3,549.7 3,030.3
- --------------------------------------------------------------------------------------------------------
Total assets $96,806.3 $88,910.9
========================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Debt:
Deposits $ 5,611.8 $ 6,562.3
Commercial paper, bank and other borrowings 3,598.7 12,024.3
Senior and senior subordinated debt (with original
maturities over one year) 73,269.4 56,823.6
- --------------------------------------------------------------------------------------------------------
Total debt 82,479.9 75,410.2
Insurance policy and claim reserves 1,037.2 1,094.5
Other liabilities 2,809.8 3,132.5
- --------------------------------------------------------------------------------------------------------
Total liabilities 86,326.9 79,637.2
- --------------------------------------------------------------------------------------------------------
Company obligated mandatorily redeemable preferred
securities of subsidiary trusts* 975.0 975.0
Preferred stock 843.2 455.8
Common shareholders' equity:
Common stock, $1.00 par value, 750,000,000 shares authorized,
551,779,393 and 551,684,740 shares issued at June 30,
2002 and December 31, 2001, respectively 551.7 551.7
Additional paid-in capital 2,058.3 2,030.0
Retained earnings 9,597.3 8,837.5
Accumulated other comprehensive income (loss) (605.3) (732.4)
Less common stock in treasury, 95,154,527 and 94,560,437
shares at June 30, 2002 and December 31, 2001,
respectively, at cost (2,940.8) (2,843.9)
- --------------------------------------------------------------------------------------------------------
Total common shareholders' equity 8,661.2 7,842.9
- --------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $96,806.3 $88,910.9
========================================================================================================
* As described in note 8 to the condensed consolidated financial statements,
the sole assets of the trusts are Junior Subordinated Deferrable Interest
Notes issued by Household International, Inc. in November 2001, January
2001, June 2000, March 1998 and June 1995, bearing interest at 7.50, 8.25,
10.00, 7.25 and 8.25 percent, respectively, with principal balances of
$206.2, $206.2, $309.3, $206.2 and $77.3 million, respectively, and due
November 2031, January 2031, June 2030, December 2037 and June 2025,
respectively.
See notes to interim condensed consolidated financial statements.
Household International, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
- ---------------------------------------------------------------------------------------------------------------
Six months ended
June 30,
(In millions) 2002 2001
- ---------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY OPERATIONS (RESTATED)
Net income $ 998.4 $ 828.8
Adjustments to reconcile net income to cash
provided by operations:
Provision for credit losses on owned receivables 1,773.9 1,360.7
Insurance policy and claim reserves 86.8 142.6
Depreciation and amortization 116.5 165.9
Interest-only strip receivables, net change (58.8) (1.0)
Other assets, excluding FAS No. 133 (60.7) 20.6
Other liabilities, excluding FAS No. 133 737.5 (167.9)
Other, net 82.3 24.2
- ---------------------------------------------------------------------------------------------------------------
Cash provided by operations 3,675.9 2,373.9
- ---------------------------------------------------------------------------------------------------------------
INVESTMENTS IN OPERATIONS
Investment securities:
Purchased (2,817.3) (1,023.8)
Matured 621.8 212.5
Sold 232.0 403.8
Short-term investment securities, net change (2,585.3) 169.6
Receivables:
Originations, net (22,697.8) (19,906.6)
Purchases and related premiums (406.5) (349.4)
Sold 18,603.4 14,621.2
Properties and equipment purchased (84.4) (104.6)
Properties and equipment sold 3.0 3.1
- ---------------------------------------------------------------------------------------------------------------
Cash decrease from investments in operations (9,131.1) (5,974.2)
- ---------------------------------------------------------------------------------------------------------------
FINANCING AND CAPITAL TRANSACTIONS
Short-term debt and demand deposits, net change (7,709.4) 494.6
Time certificates, net change (951.8) (710.6)
Senior and senior subordinated debt issued 19,811.9 11,301.7
Senior and senior subordinated debt retired (5,747.4) (7,177.1)
Policyholders' benefits paid (214.0) (49.1)
Cash received from policyholders 35.4 27.6
Shareholders' dividends (238.5) (194.4)
Purchase of treasury stock (160.0) (539.0)
Issuance of common stock 86.4 48.6
Issuance of preferred stock 387.4 -
Issuance of company obligated mandatorily redeemable
preferred securities of subsidiary trusts - 200.0
- ---------------------------------------------------------------------------------------------------------------
Cash increase from financing and capital transactions 5,300.0 3,402.3
- ---------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash (41.8) 9.8
- ---------------------------------------------------------------------------------------------------------------
Decrease in cash (197.0) (188.2)
Cash at January 1 543.6 490.2
- ---------------------------------------------------------------------------------------------------------------
Cash at June 30 $ 346.6 $ 302.0
===============================================================================================================
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 1,891.8 $ 2,020.3
Income taxes paid 469.0 607.4
- ---------------------------------------------------------------------------------------------------------------
See notes to interim condensed consolidated financial statements.
Household International, Inc. and Subsidiaries
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Household International, Inc. ("Household") and its subsidiaries have been
prepared in accordance with accounting principles generally accepted in the
United States of America 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 adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Results for the three and
six months ended June 30, 2002 should not be considered indicative of the
results for any future quarters or the year ending December 31, 2002. Household
and its subsidiaries may also be referred to in this Form 10-Q as "we," "us" or
"our." These unaudited condensed consolidated financial statements should be
read in conjunction with the unaudited consolidated financial statements and
footnotes included in our restated Annual Report on Form 10-K for the year ended
December 31, 2001 which is included as Exhibit 99.4 to this Form 10-Q.
RESTATEMENT
Household International, Inc. has restated its consolidated financial statements
for the years ended December 31, 1999, 2000 and 2001 and the first quarter ended
March 31, 2002. We believe this Form 10-Q and the exhibits included herewith
include all adjustments relating to the restatement for all such prior periods.
The restatement relates to MasterCard/Visa co-branding and affinity credit card
relationships and a marketing agreement with a third party credit card marketing
company. All were part of our Credit Card Services segment. In consultation with
our prior auditors, Arthur Andersen, LLP, we treated payments made in connection
with these agreements that were entered into between 1992 and 1999 as prepaid
assets and amortized them in accordance with the underlying economics of the
agreements. Our current auditors, KPMG LLP, have advised us that, in their view,
these payments should have either been charged against earnings at the time they
were made or amortized over a shorter period of time. There is no significant
change as a result of these adjustments on the prior period net earnings trends
previously reported. The balance of retained earnings at December 31, 2001 has
been restated from amounts previously reported to reflect a retroactive charge
of $359.9 million, after tax, for these items. The principal executive officer
and principal financial officer of Household have certified that this quarterly
report fairly presents, in all material respects, the financial condition and
results of operations of Household for the period ended June 30, 2002. Our
independent auditors have reviewed the unaudited June 30, 2002 financial results
and have provided us with the letter required by Statement of Auditing Standards
No. 71. This letter is also attached to this Form 10-Q as Exhibit 99.5.
5
2. INVESTMENT SECURITIES
Investment securities consisted of the following available-for-sale investments:
- ------------------------------------------------------------------------------------------------------------------
June 30, December 31,
2002 2001
- ------------------------------------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
(In millions) Cost Value Cost Value
- ------------------------------------------------------------------------------------------------------------------
Corporate debt securities $ 2,034.1 $ 2,017.5 $ 2,089.5 $ 2,054.0
Money market funds 2,311.7 2,311.7 342.3 342.3
Certificates of deposit 201.8 206.8 246.1 259.8
U.S. government and federal agency debt securities 2,313.0 2,315.1 217.0 217.8
Marketable equity securities 31.6 25.1 24.4 21.2
Other 1,274.1 1,282.9 611.6 638.9
-------------------------------------------------------
Subtotal 8,166.3 8,159.1 3,530.9 3,534.0
Accrued investment income 70.6 70.6 46.5 46.5
-----------------------------------------------------------
Total available-for-sale investments $ 8,236.9 $ 8,229.7 $ 3,577.4 $3,580.5
===========================================================
3. RECEIVABLES
Receivables consisted of the following:
- --------------------------------------------------------------------------------------------------------
June 30, December 31,
(In millions) 2002 2001
- --------------------------------------------------------------------------------------------------------
Real estate secured $ 48,312.1 $ 43,856.8
Auto finance 2,362.6 2,368.9
MasterCard*/Visa* 6,880.7 8,141.2
Private label 10,827.1 11,663.9
Personal non-credit card 14,272.6 13,337.0
Commercial and other 482.8 506.9
- --------------------------------------------------------------------------------------------------------
Total owned receivables 83,137.9 79,874.7
Accrued finance charges 1,551.6 1,559.8
Credit loss reserve for owned receivables (2,983.3) (2,663.1)
Unearned credit insurance premiums and claims reserves (878.0) (895.8)
Interest-only strip receivables 1,012.2 968.2
Amounts due and deferred from receivable sales 292.6 419.7
- --------------------------------------------------------------------------------------------------------
Total owned receivables, net 82,133.0 79,263.5
Receivables serviced with limited recourse 22,322.7 20,948.0
- --------------------------------------------------------------------------------------------------------
Total managed receivables, net $ 104,455.7 $100,211.5
========================================================================================================
Interest-only strip receivables are reported net of our estimate of probable
losses under the recourse provisions for receivables serviced with limited
recourse. Our estimate of the recourse obligation totaled $1,385.6 million at
June 30, 2002 and $1,148.3 million at December 31, 2001. Interest-only strip
receivables also included fair value mark-to-market adjustments which increased
the balance by $334.1 million at June 30, 2002 and $348.6 million at December
31, 2001.
6
Receivables serviced with limited recourse consisted of the following:
- ----------------------------------------------------------------------------------------------------------------
June 30, December 31,
(In millions) 2002 2001
- ----------------------------------------------------------------------------------------------------------------
Real estate secured $ 575.4 $ 861.8
Auto finance 4,518.2 4,026.6
MasterCard/Visa 9,905.8 9,254.0
Private label 2,649.9 2,150.0
Personal non-credit card 4,673.4 4,655.6
- ----------------------------------------------------------------------------------------------------------------
Total receivables serviced with limited recourse $ 22,322.7 $ 20,948.0
================================================================================================================
The combination of owned receivables and receivables serviced with limited
recourse, which we consider our managed portfolio, consisted of the following:
- ----------------------------------------------------------------------------------------------------------------
June 30, December 31,
(In millions) 2002 2001
- ----------------------------------------------------------------------------------------------------------------
Real estate secured $ 48,887.5 $ 44,718.6
Auto finance 6,880.8 6,395.5
MasterCard/Visa 16,786.5 17,395.2
Private label 13,477.0 13,813.9
Personal non-credit card 18,946.0 17,992.6
Commercial and other 482.8 506.9
- ----------------------------------------------------------------------------------------------------------------
Total managed receivables $ 105,460.6 $ 100,822.7
================================================================================================================
* MasterCard is a registered trademark of MasterCard International, Incorporated
and Visa is a registered trademark of Visa USA, Inc.
4. CREDIT LOSS RESERVES
An analysis of credit loss reserves for the three and six months ended June 30
was as follows:
- ----------------------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
(In millions) 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------------------------------
Credit loss reserves for owned receivables:
Credit loss reserves at beginning of period $ 2,876.6 $ 2,282.4 $ 2,663.1 $ 2,111.9
Provision for credit losses 850.9 657.1 1,773.9 1,360.7
Charge-offs (830.6) (631.2) (1,609.2) (1,219.3)
Recoveries 65.0 58.0 124.9 114.6
Other, net 21.4 10.2 30.6 8.6
- ----------------------------------------------------------------------------------------------------------------------------------
Credit loss reserves for owned receivables
at June 30 2,983.3 2,376.5 2,983.3 2,376.5
- ----------------------------------------------------------------------------------------------------------------------------------
Credit loss reserves for receivables
serviced with limited recourse:
Credit loss reserves at beginning of period 1,269.9 1,057.8 1,148.3 1,082.3
Provision for credit losses 427.5 277.7 866.8 506.9
Charge-offs (353.1) (274.5) (689.0) (538.8)
Recoveries 26.0 18.6 49.1 34.8
Other, net 15.3 .4 10.4 (5.2)
- ----------------------------------------------------------------------------------------------------------------------------------
Credit loss reserves for receivables serviced with
limited recourse at June 30 1,385.6 1,080.0 1,385.6 1,080.0
- ----------------------------------------------------------------------------------------------------------------------------------
Total credit loss reserves for managed receivables
at June 30 $ 4,368.9 $ 3,456.5 $ 4,368.9 $ 3,456.5
==================================================================================================================================
We maintain credit loss reserves to cover probable losses of principal, interest
and fees, including late, overlimit and annual fees. Credit loss reserves are
based on a range of estimates and intended to be adequate but not excessive. We
statistically estimate losses for consumer receivables based on
7
delinquency and reage status and past loss experience. In addition, we provide
loss reserves on consumer receivables to reflect our assessment of portfolio
risk factors which may not be fully reflected in the statistical calculation
(which uses roll rates and migration analysis). These risk factors include
bankruptcy trends, recent growth, product mix, economic conditions and current
levels of charge-offs and delinquencies.
5. ACQUIRED INTANGIBLES AND GOODWILL (RESTATED)
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" ("FAS No. 142"). FAS
No. 142 changed the accounting for goodwill from an amortization method to an
impairment-only approach. Amortization of goodwill recorded in past business
combinations ceased upon adoption of the statement on January 1, 2002. We have
completed the transitional goodwill impairment test required by FAS No. 142 and
have concluded that none of our goodwill is impaired.
We do not hold any intangible assets which are not subject to amortization.
Amortized acquired intangibles consisted of the following:
- --------------------------------------------------------------------------------------------------------------------
June 30, December 31,
(In millions) 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Purchased credit card relationships $ 1,038.6 $ 1,038.6
Other intangibles 26.5 26.5
Accumulated amortization - purchased credit card relationships ( 639.9) (603.8)
Accumulated amortization - other intangibles (6.7) (5.7)
- --------------------------------------------------------------------------------------------------------------------
Acquired intangibles, net $418.5 $ 455.6
====================================================================================================================
Acquired intangible amortization expense totaled $12.6 million for the quarter
ended June 30, 2002, $24.2 million for the quarter ended June 30, 2001, $32.4
million for the six months ended June 30, 2002, $50.2 million for the six months
ended June 30, 2001 and $99.0 million for the twelve months ended December 31,
2001.
Estimated amortization expense associated with our acquired intangibles for each
of the following years is as follows:
- -----------------------------------------------------------------------------
(In millions)
Year ending December 31,
- -----------------------------------------------------------------------------
2002 $57.7
2003 50.3
2004 47.7
2005 43.3
2006 40.9
- -----------------------------------------------------------------------------
The following tables disclose the impact of goodwill amortization on net income
and earnings per share for the periods indicated.
- ---------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
(In millions) 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------------
Reported net income $507.4 $423.3 $998.4 $ 828.8
Add back: Goodwill amortization, net -- 11.6 -- 23.2
- ---------------------------------------------------------------------------------------------------------------------
Adjusted net income $507.4 $434.9 $998.4 $852.0
=====================================================================================================================
- ---------------------------------------------------------------------------------------------------------------------
Three months ended
June 30,
2002 2001
- ---------------------------------------------------------------------------------------------------------------------
Basic Diluted Basic Diluted
- ---------------------------------------------------------------------------------------------------------------------
8
- ---------------------------------------------------------------------------------------------------------------------
Reported earnings per share $ 1.08 $ 1.07 $.91 $.90
Add back: Goodwill amortization, net -- -- .03 .03
- ---------------------------------------------------------------------------------------------------------------------
Adjusted earnings per share $ 1.08 $ 1.07 $.94 $.93
=====================================================================================================================
- ---------------------------------------------------------------------------------------------------------------------
Six months ended
June 30,
2002 2001
- ---------------------------------------------------------------------------------------------------------------------
Basic Diluted Basic Diluted
- ---------------------------------------------------------------------------------------------------------------------
Reported earnings per share $ 2.13 $ 2.11 $ 1.77 $ 1.75
Add back: Goodwill amortization, net -- -- .05 .05
- ---------------------------------------------------------------------------------------------------------------------
Adjusted earnings per share $ 2.13 $ 2.11 $ 1.82 $ 1.80
=====================================================================================================================
There were no significant changes to our recorded amount of goodwill, either in
total or by segment, during the quarter or six months ended June 30, 2002.
6. INCOME TAXES (RESTATED)
Our effective tax rate was 33.6 percent for the six months ended June 30, 2002
and 34.7 percent for the first six months of 2001. The effective tax rate
differs from the statutory federal income tax rate primarily because of the
effects of state and local income taxes and tax credits.
9
7. EARNINGS PER COMMON SHARE (RESTATED)
Computations of earnings per common share for the three and six months ended
June 30 were as follows:
- ---------------------------------------------------------------------------------------------------------------------------------
Three months ended Three months ended
June 30, June 30,
(In millions, except per share data) 2002 2001
- --------------------------------------------------------------------------------------------------------------------------------
Diluted Basic Diluted Basic
-------------- ----------------------- -------------- -----------------------
Earnings:
Net income $ 507.4 $ 507.4 $ 423.3 $ 423.3
Preferred dividends (15.5) (15.5) (2.3) (2.3)
- ---------------------------------------------------------------------------------------------------------------------------------
Earnings available to common shareholders $ 491.9 $ 491.9 $ 421.0 $ 421.0
- ---------------------------------------------------------------------------------------------------------------------------------
Average shares outstanding:
Common 456.3 456.3 463.0 463.0
Common equivalents 4.9 - 6.6 -
- ---------------------------------------------------------------------------------------------------------------------------------
Average shares outstanding assuming dilution 461.2 456.3 469.6 463.0
- ---------------------------------------------------------------------------------------------------------------------------------
Earnings per common share, as restated $ 1.07 $ 1.08 $ .90 $ .91
=================================================================================================================================
Earnings per common share, as reported $ 1.08 $ 1.09 $ .93 $ .94
=================================================================================================================================
- ---------------------------------------------------------------------------------------------------------------------------------
Six months ended Six months ended
June 30, June 30,
(In millions, except per share data) 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Diluted Basic Diluted Basic
-------------- ----------------------- -------------- -----------------------
Earnings:
Net income $ 998.4 $ 998.4 $ 828.8 $ 828.8
Preferred dividends (24.0) (24.0) (4.6) (4.6)
- ---------------------------------------------------------------------------------------------------------------------------------
Earnings available to common shareholders $ 974.4 $ 974.4 $ 824.2 $ 824.2
- ---------------------------------------------------------------------------------------------------------------------------------
Average shares outstanding:
Common 456.6 456.6 464.5 464.5
Common equivalents 4.9 - 6.3 -
- ---------------------------------------------------------------------------------------------------------------------------------
Average shares outstanding assuming dilution 461.5 456.6 470.8 464.5
- ---------------------------------------------------------------------------------------------------------------------------------
Earnings per common share, as restated $ 2.11 $ 2.13 $ 1.75 $ 1.77
=================================================================================================================================
Earnings per common share, as reported $ 2.17 $ 2.19 $ 1.84 $ 1.86
=================================================================================================================================
8. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY
TRUSTS
We have formed special purpose trusts for the purpose of issuing trust preferred
securities. The sole assets of these trusts are Junior Subordinated Deferrable
Interest Notes ("Junior Subordinated Notes") issued by Household. The following
table summarizes our company obligated mandatorily redeemable preferred
securities of subsidiary trusts ("Preferred Securities") and the related Junior
Subordinated Notes:
- ---------------------------------------------------------------------------------------------------------------------
Household Household Household Household Household
(Dollar amounts are Capital Trust VII Capital Trust Capital Trust V Capital Trust Capital Trust I
in millions) ("HCT VII") VI ("HCT VI") ("HCT V") IV ("HCT IV") ("HCT I")
- ---------------------------------------------------------------------------------------------------------------------
Preferred Securities:
Interest rate 7.50% 8.25% 10.00% 7.25% 8.25%
Face value $200 $200 $300 $200 $75
Issue date November 2001 January 2001 June 2000 March 1998 June 1995
Junior Subordinated Notes:
Principal balance $206.2 $206.2 $309.3 $206.2 $77.3
Redeemable by issuer November 2006 January 2006 June 2005 March 2003 June 2001
Stated maturity November 2031 January 2031 June 2030 December 2037 June 2025
- ---------------------------------------------------------------------------------------------------------------------
The Preferred Securities must be redeemed when the Junior Subordinated Notes are
paid. The Junior Subordinated Notes have a stated maturity date, but are
redeemable by Household, in whole or in part,
10
beginning on the dates indicated above at which time the preferred securities
are callable at par ($25 per Preferred Security) plus accrued and unpaid
dividends. Dividends on the Preferred Securities are cumulative, payable
quarterly in arrears, and are deferrable at Household's option for up to five
years. Household cannot pay dividends on its preferred and common stocks during
such deferments. The Preferred Securities have a liquidation value of $25 per
preferred security. HCT I may elect to extend the maturity of its Preferred
Securities to June 2044. Dividends on the Preferred Securities have been
classified as interest expense in our statements of income.
HCT I, HCT IV, HCT V, HCT VI and HCT VII (collectively, "the Trusts") are wholly
owned subsidiaries of Household. Household's obligations with respect to the
Junior Subordinated Notes, when considered together with certain undertakings of
Household with respect to the Trusts, constitute full and unconditional
guarantees by Household of the Trust's obligations under the respective
Preferred Securities. The Preferred Securities are classified in our balance
sheet as company obligated mandatorily redeemable preferred securities of
subsidiary trusts (representing the minority interests in the trusts) at their
face and redemption amount of $975 million at both June 30, 2002 and December
31, 2001.
9. FORWARD PURCHASE AGREEMENTS
At June 30, 2002, we had agreements to purchase, on a forward basis,
approximately 6.1 million shares of our common stock with a weighted-average
forward price of $55.63 per share. The agreements expire at various dates
through June 2003. These agreements may be settled physically or on a net basis
either in shares of our common stock or in cash, depending on the terms of the
various agreements, at our option and consequently are accounted for as
permanent equity. During the current quarter, we received 966,000 shares at an
average cost of $62.11 per share as a result of settlements under these forward
contracts.
Under a net share settlement, if the price of our common stock falls below the
forward price, we would be required to deliver common shares to the counterparty
based upon the difference between the forward price and the then current stock
price. Conversely, if the price of our common stock rises above the forward
price, the counterparty would be required to deliver to us shares of our common
stock based on the price difference. Based upon the closing price of our common
stock of $49.70 per share at June 30, 2002, we would have been required to
deliver approximately 731,800 shares of our common stock to net share settle
these contracts at June 30, 2002. If our common stock price had been lower by $1
per share at June 30, 2002, we would have been required to deliver an additional
141,000 common shares to net share settle these contracts. If our common stock
price had been higher by $1 per share at June 30, 2002, we would have been
required to deliver a total of 596,400 shares of our common stock to net share
settle the contracts. These agreements, however, contain limits on the number of
shares to be delivered under a net share settlement, regardless of the price of
our common stock. At June 30, 2002, the maximum number of common shares we would
be required to deliver to net share settle the 6.1 million shares currently
outstanding was 31.5 million shares.
10. COMPREHENSIVE INCOME (RESTATED)
Comprehensive income was $297.7 million for the quarter ended June 30, 2002,
$444.8 million for the quarter ended June 30, 2001, $1,125.5 million for the six
months ended June 30, 2002, and $549.7 million for the six months ended June 30,
2001.
11
The components of accumulated other comprehensive income were as follows:
- --------------------------------------------------------------------------------------------------------------------
(In millions) June 30, December 31,
2002 2001
- --------------------------------------------------------------------------------------------------------------------
Unrealized losses on cash flow hedging instruments $ (567.9) $ (699.1)
Unrealized gains on investments and interest-only strip receivables 207.6 223.3
Foreign currency translation adjustments (245.0) (256.6)
- --------------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income (loss) $ (605.3) $ (732.4)
====================================================================================================================
11. NEW ACCOUNTING PRONOUNCEMENTS AND CHANGES IN ACCOUNTING POLICIES
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("FAS No. 144"). The adoption of FAS No. 144 did not have a significant
impact on our operations.
In the second quarter, we adopted the fair value method of accounting for our
stock option and employee stock purchase plans in 2002. Under the guidance of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation", ("FAS No. 123"), companies may either recognize stock-based
compensation expense associated with these plans currently in income or disclose
the pro forma impact of the expense. Pursuant to the requirements of FAS No.
123, options granted prior to January 1, 2002 continue to be accounted for under
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," under which expenses for stock options are generally not recognized.
The impact of adopting the expense recognition provisions of FAS No. 123 is not
expected to have a significant impact on our future results of operations.
12. SEGMENT REPORTING (RESTATED)
We have three reportable segments: Consumer, Credit Card Services and
International. Our Consumer segment consists of our consumer lending, mortgage
services, retail services and auto finance businesses. Our Credit Card Services
segment consists of our domestic MasterCard and Visa credit card business. Our
International segment consists of our foreign operations in the United Kingdom
and Canada. There has been no change in the basis of our segmentation or in the
measurement of segment profit as compared with the presentation in our Annual
Report on Form 10-K for the year ended December 31, 2001.
We allocate resources and provide information to management for decision making
on a managed basis. Therefore, an adjustment is required to reconcile the
managed financial information to our reported financial information in our
consolidated financial statements. This adjustment reclassifies net interest
margin, fee income and loss provision into securitization revenue.
12
Reportable Segments - Managed Basis
Adjustments/
Credit Card Inter- All Reconciling
(In millions) Consumer Services national Other Totals Items
- ------------------------------------------------------------------------------------------------------------------------------------
Three months ended June 30, 2002
Net interest margin $ 1,718.9 $ 423.0 $ 154.1 $ (15.4) $ 2,280.6 -
Fee income 84.3 256.5 13.1 1.4 355.3 -
Other revenues(1) 140.3 41.4 93.2 141.8 416.7 $ (53.1)(2)
Intersegment revenues 42.8 8.2 2.5 (.4) 53.1 (53.1)(2)
Provision for credit losses 841.5 346.8 88.8 .4 1,277.5 .9 (3)
Net income 363.5 65.9 56.1 56.3 541.8 (34.4)
Receivables 80,134.5 16,566.9 7,648.8 1,110.4 105,460.6 -
Assets 82,320.2 17,612.6 8,915.6 19,643.9 128,492.3 (9,363.3)(4)
Goodwill 857.6 248.7 1.0 14.8 1,122.1 -
- ------------------------------------------------------------------------------------------------------------------------------------
Three months ended June 30, 2001
Net interest margin $ 1,398.2 $ 344.2 $ 146.5 $ (11.4) $ 1,877.5 -
Fee income 88.3 275.0 19.2 1.5 384.0 -
Other revenues(1) 82.8 30.4 44.6 105.6 263.4 $ (66.8)(2)
Intersegment revenues 54.7 10.6 2.0 (.5) 66.8 (66.8)(2)
Provision for credit losses 524.2 331.3 63.6 15.3 934.4 .4 (3)
Net income 363.2 36.7 34.8 31.2 465.9 (42.6)
Receivables 67,182.8 15,806.6 7,875.6 673.5 91,538.5 -
Assets 69,696.4 16,876.4 9,124.1 14,113.1 109,810.0 (9,499.7)(4)
Goodwill 864.8 255.6 1.1 15.2 1,136.7 -
- ------------------------------------------------------------------------------------------------------------------------------------
Six months ended June 30, 2002
Net interest margin $ 3,377.1 $ 840.8 $ 307.5 $ 8.4 $ 4,533.8 -
Fee income 172.9 527.0 23.2 4.2 727.3 -
Other revenues(1) 305.7 108.3 136.3 380.1 930.4 $ (100.7)(2)
Intersegment revenues 78.6 18.2 4.8 (.9) 100.7 (100.7)(2)
Provision for credit losses 1,762.5 717.4 150.9 33.5 2,664.3 (23.6)(3)
Net income 670.7 143.3 81.9 151.5 1,047.4 (49.0)
- ------------------------------------------------------------------------------------------------------------------------------------
Six months ended June 30, 2001
Net interest margin $ 2,749.2 $ 691.9 $ 299.4 $ (48.3) $ 3,692.2 -
Fee income 183.9 527.2 34.1 2.8 748.0 -
Other revenues(1) 111.5 50.7 83.6 332.6 578.4 $ (123.3)(2)
Intersegment revenues 100.9 19.5 3.9 (1.0) 123.3 (123.3)(2)
Provision for credit losses 1,101.5 628.0 118.6 18.6 1,866.7 .9 (3)
Net income 641.6 69.9 81.2 114.8 907.5 (78.7)
- ------------------------------------------------------------------------------------------------------------------------------------
Managed Owned
Basis Basis
Consolidated Securitization Consolidated
Totals Adjustments Totals
- -----------------------------------------------------------------------------------------------
Three months ended June 30, 2002
Net interest margin $ 2,280.6 $ (651.6)(5) $ 1,629.0
Fee income 355.3 (165.0)(5) 190.3
Other revenues(1) 363.6 389.2 (5) 752.8
Intersegment revenues - - -
Provision for credit losses 1,278.4 (427.5)(5) 850.9
Net income 507.4 - 507.4
Receivables 105,460.6 (22,322.7)(6) 83,137.9
Assets 119,129.0 (22,322.7)(6) 96,806.3
Goodwill 1,122.1 - 1,122.1
- ------------------------------------------------------------------------------------------------
Three months ended June 30, 2001
Net interest margin $ 1,877.5 $ (491.5)(5) $ 1,386.0
Fee income 384.0 (160.5)(5) 223.5
Other revenues(1) 196.6 374.2 (5) 570.8
Intersegment revenues - - -
Provision for credit losses 934.8 (277.7)(5) 657.1
Net income 423.3 - 423.3
Receivables 91,538.5 (19,783.7)(6) 71,754.8
Assets 100,310.3 (19,783.7)(6) 80,526.6
Goodwill 1,136.7 - 1,136.7
- ------------------------------------------------------------------------------------------------
Six months ended June 30, 2002
Net interest margin $ 4,533.8 $(1,307.9)(5) $ 3,225.9
Fee income 727.3 (320.5)(5) 406.8
Other revenues(1) 829.7 761.7 (5) 1,591.4
Intersegment revenues - - -
Provision for credit losses 2,640.7 (866.8)(5) 1,773.9
Net income 998.4 - 998.4
- ------------------------------------------------------------------------------------------------
Six months ended June 30, 2001
Net interest margin $ 3,692.2 $ (997.8)(5) $ 2,694.4
Fee income 748.0 (312.4)(5) 435.6
Other revenues(1) 455.1 803.4 (5) 1,258.5
Intersegment revenues - - -
Provision for credit losses 1,867.6 (506.9)(5) 1,360.7
Net income 828.8 - 828.8
- ------------------------------------------------------------------------------------------------
(1) Net of policyholder benefits and excluding fees.
(2) Eliminates intersegment revenues.
(3) Eliminates bad debt recovery sales and reclassifies loss reserves between
operating segments.
(4) Eliminates investments in subsidiaries and intercompany borrowings.
(5) Reclassifies net interest margin, fee income and loss provisions relating
to securitized receivables to other revenues.
(6) Represents receivables serviced with limited recourse.
13
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Household International, Inc. and Subsidiaries
FINANCIAL HIGHLIGHTS (RESTATED)
- ---------------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
(Dollar amounts are in millions, except per share data) 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------
Net income $ 507.4 $ 423.3 $ 998.4 $ 828.8
Diluted earnings per common share 1.07 .90 2.11 1.75
Net interest margin and other revenues(1) 2,572.1 2,180.3 5,224.1 4,388.5
Owned Basis Ratios:
Return on average owned assets 2.18 % 2.14 % 2.18 % 2.11 %
Return on average common shareholders' equity 22.9 22.5 23.2 22.2
Net interest margin 7.62 7.74 7.72 7.63
Consumer net charge-off ratio, annualized 3.76 3.26 3.69 3.19
Reserves as a percentage of net charge-offs 97.4 103.7 100.5 107.6
Efficiency ratio(2) 37.5 40.3 37.3 40.1
Managed Basis Ratios:(3)
Return on average managed assets 1.78 % 1.72 % 1.77 % 1.70 %
Net interest margin 8.55 8.27 8.64 8.21
Consumer net charge-off ratio, annualized 4.26 3.71 4.17 3.63
Reserves as a percentage of net charge-offs 100.0 104.2 102.8 107.4
Efficiency ratio(2) 32.1 35.7 32.0 35.9
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
Owned Basis Managed Basis:(3)
------------------------- --------------------------
June 30, December 31, June 30, December 31,
(Dollar amounts are in millions) 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------
Total assets $96,806.3 $88,910.9 $119,129.0 $109,858.9
Receivables 83,137.9 79,874.7 105,460.6 100,822.7
Common and preferred equity as a percentage of assets 9.82 % 9.33 % 7.98 % 7.55 %
Common and preferred equity and trust preferred
securities as a percentage of assets(4) 10.83 10.43 8.80 8.44
Tangible equity to tangible managed assets(4)(5) n/a n/a 7.94 7.57
Two-month-and-over contractual delinquency ratio 4.61 4.53 4.53 4.46
Reserves as a percentage of receivables 3.59 3.33 4.14 3.78
Reserves as a percentage of performing loans 96.0 91.0 112.4 105.0
- ---------------------------------------------------------------------------------------------------------------------------
(1) Net of policyholder benefits.
(2) Ratio of operating expenses to net interest margin and other revenues less
policyholders' benefits.
(3) We monitor our operations and evaluate trends on both an owned basis as
shown in our financial statements and on a managed basis. Managed basis
reporting adjustments assume that securitized receivables have not been sold and
are still on our balance sheet. Managed basis information is intended to
supplement, and should not be considered a substitute for, owned basis reporting
and should be read in conjunction with reported owned basis results.
(4) The ratio of common and preferred equity and trust preferred securities as a
percentage of owned and managed assets and the ratio of tangible equity to
tangible managed assets are non-GAAP ratios that are used by rating agencies as
a measure to evaluate capital adequacy. These ratios may differ from similarly
named measures presented by other companies. Because of its long-term nature
and our ability to defer dividends, rating agencies consider trust preferred
securities as equity in calculating these ratios.
(5) Tangible shareholders' equity includes trust preferred securities, preferred
equity, and common shareholders' equity, excluding unrealized gains and losses
on investments and cash flow hedging instruments, less acquired intangibles and
goodwill. Tangible managed assets represents total managed assets less acquired
intangibles, goodwill and derivative assets.
14
RESTATEMENT
Household International, Inc. has restated its consolidated financial statements
for the years ended December 31, 1999, 2000 and 2001 and the first quarter ended
March 31, 2002. We believe this Form 10-Q and the exhibits included herewith
include all adjustments relating to the restatement for all such prior periods.
The restatement relates to MasterCard/Visa co-branding and affinity credit card
relationships and a marketing agreement with a third party credit card marketing
company. All were part of our Credit Card Services segment. In consultation with
our prior auditors, Arthur Andersen, LLP, we treated payments made in connection
with these agreements that were entered into between 1992 and 1999 as prepaid
assets and amortized them in accordance with the underlying economics of the
agreements. Our current auditors, KPMG LLP, have advised us that, in their view,
these payments should have either been charged against earnings at the time they
were made or amoritized over a shorter period of time. We believe this is a good
faith difference of opinion but we are following the advice of our current
auditors. There is no significant change as a result of these adjustments on the
prior period net earnings trends previously reported. The balance of retained
earnings at December 31, 2001 has been restated from amounts previously reported
to reflect a retroactive charge of $359.9 million, after tax, for these items.
The principal executive officer and principal financial officer of Household
have certified that this quarterly report fairly presents, in all material
respects, the financial condition and results of operations of Household for the
period ended June 30, 2002. Our independent auditors have reviewed the unaudited
June 30, 2002 financial results and have provided us with the letter required by
Statement of Auditing Standards No. 71. This letter is also attached to this
Form 10-Q as Exhibit 99.5.
This cumulative restatement relates to the following periods:
Restatements to Reported Income % Change from Prior Period Net Income
- -------------------------------------------------------------------------------------------------------------------------------
% Change
(Dollars in millions) Pre-Tax Tax Effect After- Tax to Reported As Reported As Restated
- -------------------------------------------------------------------------------------------------------------------------------
Q2 2002* $ (9.7) $ 3.6 $ (6.1) (1.2)% 17.0% 20.0%
Q1 2002 (31.6) 11.6 (20.0) (3.9) 18.3 21.0
-------------------------------------------------------------------------------------------------------
6 months 2002 (41.3) 15.2 (26.1) (2.5) 17.7 20.4
-------------------------------------------------------------------------------------------------------
2001 (120.2) 44.3 (75.9) (3.9) 13.1 13.3
2000 (110.9) 40.8 (70.1) (4.1) 14.4 14.2
1999 (91.8) 33.7 (58.1) (3.9) 28.5 28.3
1994-1998 (245.0) 89.2 (155.8) (3.8)
- -------------------------------------------------------------------------------------------------------------------------------
* Compared to that reported in our earnings release of July 17, 2002.
The impact of these amounts to reported diluted earnings per share was as
follows:
As Reported Restated
----------------------------------------
Q2 2002 $ 1.08 $1.07
Q1 2002 1.09 1.04
----------------------------------------
6 months 2002 2.17 2.11
----------------------------------------
2001 4.08 3.91
2000 3.55 3.40
1999 3.07 2.95
- ---------------------------------------------------------------------
BASIS OF REPORTING
This discussion should be read in conjunction with the unaudited condensed
consolidated financial statements, notes and tables included elsewhere in this
report and in the restated Household International, Inc. Annual Report on Form
10-K for the year ended December 31, 2001 (the "2001 Form 10-K") which contains
unaudited financial information for Household International, Inc. and is
included as an exhibit to this Form 10-Q. We expect that we will file with the
Securities and Exchange Commission an amended Form 10-K/A with audited financial
information on or about August 31, 2002. Management's
15
discussion and analysis may contain certain statements that may be
forward-looking in nature within the meaning of the Private Securities
Litigation Reform Act of 1995. Our results may differ materially from those
noted in the forward-looking statements. Forward-looking statements are
typically identified by words or phrases such as "believe", "expect",
"anticipate", "intend", "may", "will", "should", "would" and "could".
Forward-looking statements involve risks and uncertainties and are based on
current views and assumptions. The factors that may affect our actual results
are as follows:
. changes in laws and regulations, including attempts by local, state
and national regulatory agencies or legislative bodies to control
alleged "predatory" lending practices through broad initiatives aimed
at lenders operating in the nonprime or subprime consumer market;
. increased competition from well-capitalized companies or lenders with
access to government sponsored organizations for our consumer segment
which may impact the terms, rates, costs or profits historically
included in the loan products we offer or purchase;
. changes in accounting policies practices or standards, as they may be
adopted by regulatory agencies and the Financial Accounting Standards
Board;
. changes in overall economic conditions, including the interest rate
environment in which we operate, the capital markets in which we fund
our operations, the market values of consumer owned real estate
throughout the United States, recession, employment and currency
fluctuations;
. consumer perception of the availability of credit, including price
competition in the market segments we target and the ramifications or
ease of filing for personal bankruptcy;
. the effectiveness of models or programs to predict loan delinquency or
loss and initiatives to improve collections in all business areas;
. continued consumer acceptance of our distribution systems and demand
for our loan or insurance products;
. changes associated with, as well as the difficulty in integrating
systems, operational functions and cultures, as applicable, of any
organization or portfolio acquired by Household;
. a reduction of our short-term debt ratings by any of the nationally
recognized statistical rating organizations that rate these
instruments to a level that is below our current rating;
. the costs, effects and outcomes of regulatory reviews or litigation
relating to our nonprime loan receivables or the business practices of
any of our business units, including, but not limited to, additional
compliance requirements;
. the costs, effects and outcomes of any litigation matter that is
determined adversely to Household or its businesses;
. the ability to attract and retain qualified personnel to support the
underwriting, servicing, collection and sales functions of our
businesses;
. uncertainty with respect to the completion of the above referenced
reaudit of the consolidated financial information of Household within
the time period expected, including whether any further adjustments
may be required;
. acceptance of the market place of our debt and equity to fund our
businesses during the period prior to the issuance of the restated
audited financial information and thereafter; and
. the inability of Household to manage any or all of the foregoing risks
as well as anticipated.
We monitor our operations and evaluate trends on a managed basis which assumes
that securitized receivables have not been sold and are still on our balance
sheet. We manage our operations on a managed basis because the receivables that
we securitize are subjected to underwriting standards comparable to our owned
portfolio, are serviced by operating personnel without regard to ownership and
result in a similar credit loss exposure for us. In addition, we fund our
operations, review our operating results and make decisions about allocating
resources such as employees and capital on a managed basis. See Note 12,
"Segment Reporting," to the accompanying condensed consolidated financial
statements for additional information related to our results on a managed basis.
The following discussion of our financial condition and results of operations is
presented on an owned basis of reporting unless specifically noted. On an owned
basis of reporting, net interest margin,
16
provision for credit losses and fee income resulting from securitized
receivables are included as components of securitization revenue.
OPERATIONS SUMMARY AND TRENDS
.. Our net income for the second quarter of 2002 increased 20 percent to
$507.4 million, from $423.3 million a year ago. Net income for the first
six months of 2002 was $998.4 million, compared to $828.8 million in the
year-ago period. Diluted earnings per share was $1.07 in the second quarter
and $2.11 for the first six months of 2002, compared to $.90 and $1.75 in
the same periods in 2001. Our improved results were due to significant
receivable and revenue growth. Partially offsetting the revenue growth were
higher operating expenses as a result of portfolio growth and higher credit
loss provision due to the economic environment. We anticipate that our cost
of funds may increase during any period where we cannot fully access the
global capital markets due to our lack of audited financial statements.
Our credit loss provision was greater than charge-offs by $85.3 million in
the current quarter and $289.6 million for the first six months of 2002. In
addition, our year-to-date earnings included higher revenues from our tax
refund lending business which contributed $.19 to our first quarter
earnings per share, an increase of 27 percent over the $.15 contribution in
the first quarter of 2001.
.. In the first half of the year, we took a number of steps as part of our
liquidity management plans which reduced our reliance on short-term debt
and strengthened our position against market induced volatility. These
steps included establishing a $4.5 billion investment security liquidity
portfolio, issuing long-term debt which lengthened the term of our funding,
establishing $6 billion in incremental conduit capacity and issuing
securities backed by dedicated home equity loan receivables of $2.8
billion. We intend to maintain, and may grow, our investment security
liquidity portfolio to protect us from any liquidity concerns. This action
may adversely impact our net earnings due to the lower return generated by
these assets.
As we will not have audited financial statements until on or about August
31, 2002, our access to traditional funding sources through registered
public offerings will be limited until September. Pending the completion of
the audit, we will suspend the issuance of unsecured debt and equity
securities under our applicable shelf registrations. In any case, no
significant issuances had been planned until September, 2002. We believe we
have adequate sources of liquidity to continue to operate until audited
financial statements have been prepared.
.. The regulatory environment in which we operate has been very challenging.
As a result of the agitation of consumer activists, state regulators,
including attorney generals, have requested information with respect to the
policies, procedures and practices used by our consumer lending business in
the origination of loans. We are in regular contact with these governmental
agencies providing support for our business and responding to customer
complaints. We believe state authorities will continue to target the
nonprime and subprime credit market with new laws and regulations. We
believe compliance with these new laws may increase our expenses and may
reduce revenues. However, we do not expect that such compliance will have a
material adverse affect on our business operations.
17
.. On July 22, 2002, the four federal bank regulatory agencies issued draft
guidance for account management and loss allowance practices for credit
card lending. The agencies have indicated that they intend to issue final
guidance on August 16, 2002. As such, we do not yet know what the final
form of the guidance will be. Based on the current draft, however, we do
not expect the guidance to have a material adverse impact on our financial
statements or the way we manage our business.
.. The New York Stock Exchange has recently adopted new corporate governance
standards for all listed companies. Household currently meets and exceeds
those standards. In addition, in the second quarter, we have adopted the
fair value method of accounting for our stock options and employee stock
purchase plans in 2002. Based on our historical issuances of stock options,
we expect the impact of this change will not have a significant adverse
affect on our future financial results.
.. The United States Congress is expected to consider the passage of a new
bankruptcy bill. Although it should provide a more rationale approach to
the consumer bankruptcy practice, if the bill is passed, we expect an
increase in the number of personal bankruptcy filings during the period
immediately prior to the effective date of the law. This action may cause
our delinquency and charge-off ratios, foreclosures and related expenses to
increase until the full effects of the legislation can be achieved.
SEGMENT RESULTS - MANAGED BASIS
Our Consumer segment reported net income of $363.5 million for the second
quarter compared to $363.2 million in the year-ago quarter. Year-to-date, net
income increased to $670.7 million compared to $641.6 million for the first six
months of 2001. Net interest margin, fee income and other revenues increased
$374.2 million, to $1.9 billion in the quarter and $811.0 million, to $3.9
billion year-to-date. Strong receivable growth and higher securitization
activity, pursuant to our liquidity management plans, drove the increases. The
higher revenues were partially offset by substantially higher credit loss
provision and higher expenses. Our credit loss provision rose $317.3 million, to
$841.5 million in the quarter and $661.0 million, to $1.8 billion year-to-date
as a result of increased levels of receivables and the continued weak economy.
We increased managed loss reserves by recording loss provision greater than
charge-offs of $142.4 million in the quarter and $397.1 million year-to-date.
Higher salary and operating expenses were the result of additional employees and
operating costs to support the increased receivable levels, additional
collectors and investments in the growth of our businesses. Managed receivables
grew to $80.1 billion at June 30, 2002, from $77.0 billion at March 31, 2002 and
$67.2 billion at June 30, 2001. The managed receivable growth was driven by
growth in all products with the strongest growth in our real estate secured
receivables. Return on average managed assets ("ROMA") was 1.81 and 1.68 percent
in the second quarter and first six months of 2002 compared to 2.12 and 1.89
percent in the year-ago periods. The decline in the ratio reflects higher credit
loss provision.
Our Credit Card Services segment reported improved results over the prior-year
periods. Net income increased to $65.9 million for the second quarter compared
to $36.7 million in the year-ago quarter. Year-to-date, net income increased to
$143.3 million compared to $69.9 million for the first six months of 2001. The
increase was due primarily to higher net interest margin, which increased $78.8
million, to $423.0 million in the quarter and $148.9 million, to $840.7 million
year-to-date, as a result of higher receivable levels. Net interest margin as a
percent of average receivables increased in both the quarter and year-to-date as
a result of lower funding costs and pricing floors, which capped rate reductions
on certain variable rate credit card products. Fee income decreased during both
the quarter and year-to-date as improvements in early stage delinquency resulted
in lower late fees. Revenue growth was partially offset by higher credit loss
provision and higher operating expenses associated with the higher receivable
levels. We increased managed loss reserves by recording loss provision greater
than charge-offs of $16.3 million in the quarter and $80.8 million year-to-date.
Managed receivables were $16.6 billion at June 30, 2002, $16.2 billion at March
31, 2002 and $15.8 billion at June 30, 2001. The increase in receivables during
both the quarter and year reflects strong growth in our Household Bank branded
base portfolio and controlled growth in our subprime portfolio. Our Union
Privilege portfolio also reported year-over-year
18
growth. ROMA was 1.50 and 1.63 percent in the second quarter and first six
months of 2002 compared to .88 and .84 percent in the year-ago periods.
Our International segment also reported improved results over prior-year
periods. Net income increased to $56.1 million for the second quarter compared
to $34.8 million in the year-ago quarter. Year-to-date, net income was $81.9
million compared to $81.2 million for the first six months of 2001. Net interest
margin dollars increased modestly in both the quarter and year-to-date. Average
receivables were lower in both the quarter and year-to-date as a result of the
fourth quarter 2001 sale of the $1 billion Goldfish credit card portfolio.
However, higher yields and lower funding costs resulted in the higher net
interest margin dollars. Increased securitization activity contributed to the
increase in other revenues during both the quarter and year-to-date. Revenue
growth was partially offset by a higher credit loss provision and higher
operating expenses associated with our branch expansion efforts. We increased
managed loss reserves by recording loss provision greater than charge-offs of
$29.8 million in the quarter and $34.5 million year-to-date. Managed receivables
were $7.6 billion at June 30, 2002, $7.0 billion at March 31, 2002 and $7.9
billion at June 30, 2001. Receivable balances reflect positive foreign exchange
impacts of approximately $500 million during the quarter and $475 million
compared to prior year. Compared to the prior-year quarter, growth in real
estate secured and personal non-credit card receivables was more than offset by
reductions in our MasterCard and Visa portfolio resulting from the fourth
quarter 2001 Goldfish receivable sale. ROMA was 2.68 and 1.96 percent in the
second quarter and first six months of 2002 compared to 1.57 and 1.85 percent in
the year-ago periods. The increases were primarily attributable to
securitization transactions in the second quarter of 2002 and lower asset
levels.
BALANCE SHEET REVIEW
Increase (decrease) Increase (decrease)
from prior year from prior quarter
June 30, --------------------------------------------------
(All dollar amounts are stated in 2002 $ % $ %
millions)
- ------------------------------------------------------------------------------------------------------------------
Real estate secured $ 48,312.1 $ 9,711.4 25 % $ 2,683.2 6%
Auto finance 2,362.6 323.6 16 (240.3) (9)
MasterCard*/Visa* 6,880.7 (1,035.0) (13) (89.5) (1)
Private label 10,827.1 497.1 5 138.7 1
Personal non-credit card (1) 14,272.6 1,960.7 16 1,059.6 8
Commercial and other 482.8 (74.7) (13) (8.3) (2)
- ------------------------------------------------------------------------------------------------------------------
Total owned receivables $ 83,137.9 $ 11,383.1 16 % $ 3,543.4 4%
==================================================================================================================
(1) Personal non-credit card receivables are comprised of the following:
June 30, March 31, June 30,
(In millions) 2002 2002 2001
- -----------------------------------------------------------------------------------------------------------------
Domestic personal unsecured $ 6,710.3 $ 6,379.2 $ 6,364.4
Union Plus personal unsecured 1,193.7 1,065.0 894.3
Personal homeowner loans 4,393.2 4,055.0 3,690.9
Foreign unsecured 1,975.4 1,713.8 1,362.3
- -----------------------------------------------------------------------------------------------------------------
Total personal non-credit card $ 14,272.6 $ 13,213.0 $ 12,311.9
=================================================================================================================
* MasterCard is a registered trademark of MasterCard International, Incorporated
and Visa is a registered trademark of Visa USA, Inc.
Receivables growth was a key contributor to our improved results. To support
capital levels and maintain acceptable debt ratings, we expect to control
receivable growth with portfolio sales for the remainder of 2002. In this
manner, we do not anticipate our business operations will be adversely affected.
Compared to June 30, 2001, owned receivables increased $11.4 billion, or 16
percent, to $83.1 billion. Receivable growth was strongest in our real estate
secured portfolio, which increased 25 percent over the June 2001 level and was
balanced between our branch-based consumer lending business and our mortgage
services business. This growth was partially offset by the sale of approximately
$900 million in whole loans by our mortgage services business in March 2002
pursuant to our liquidity management plans. Our auto finance business increased
receivables $324 million, or 16 percent while maintaining consistent
underwriting criteria. A strong and
19
rational market, larger sales force, increased dealer penetration and strong
Internet originations contributed to the growth in auto finance receivables. In
our MasterCard and Visa portfolio, growth in our Union Privilege, subprime and
Household Bank branded base portfolios, was more than offset by the December
2001 sale of the $1 billion Goldfish portfolio in the United Kingdom and higher
securitization levels. Private label receivables increased 5 percent to $10.8
billion primarily as a result of organic growth from existing merchants and a
$725 million portfolio acquisition in the fourth quarter of 2001. Personal
non-credit card receivables increased 16 percent to $14.3 billion with the
strongest rate of growth in our prime-based Union Plus personal unsecured
portfolio. Our branches also generated strong personal non-credit card growth,
especially in our personal homeowner loan portfolio which grew at a rate almost
four times faster than that of our domestic personal unsecured portfolio.
Receivable growth was partially offset by securitization activity. During the
twelve months ended June 30, 2002, we securitized $7.6 billion of receivables
including $3.0 billion of auto finance receivables, $1.3 billion of MasterCard
and Visa receivables, $1.0 billion of private label receivables and $2.3 billion
of personal non-credit card receivables.
Compared to March 31, 2002, receivables grew $3.5 billion or an annualized 18
percent. Growth in real estate secured and personal non-credit card receivables
was the result of good consumer demand which generated strong volume in our
branch-based consumer lending and mortgage services businesses. In our auto
finance and MasterCard and Visa portfolios, receivable growth was more than
offset by higher securitization levels. During the second quarter, we
securitized $1.9 billion of receivables including $925.0 million of auto finance
receivables, $613.4 million of MasterCard and Visa receivables and $450.0
million of personal non-credit card receivables.
Owned consumer two-months-and-over contractual delinquency as a percent of owned
consumer receivables was 4.61 percent at June 30, 2002, compared with 4.77
percent at March 31, 2002 and 4.48 percent at June 30, 2001. The annualized
consumer owned charge-off ratio in the second quarter of 2002 was 3.76 percent,
compared with 3.61 percent in the prior quarter and 3.26 percent in the year-ago
quarter.
LIQUIDITY AND CAPITAL RESOURCES
Our ratio of tangible equity to tangible managed assets of 7.94 percent at June
30, 2002 was substantially higher than the 7.57 percent level at December 31,
2001. Compared to March 31, 2002, the ratio decreased 16 basis points. The March
ratio was impacted by the timing of a $400 million, 7.60 percent cumulative
preferred stock issuance. As a result of our restatement and its impact on our
capital position, we have committed to increase our capital levels to a target
of 8.50 percent by December 31, 2002. This level is higher than our current
stated target of 8.00 to 8.25 percent. Initiatives to achieve this target will
include suspension of our stock buy-back program, portfolio sales to control
growth and issuance of capital securities as necessary. We do not believe this
capital plan will materially impact our business operations or future prospects.
We purchased 966,000 shares of our common stock for a total of $60 million
during the quarter and 2.6 million shares for a total of $160 million during the
first six months of 2002. The amount of shares we repurchase is based on market
conditions, other investment opportunities for growth and capital targets.
We accessed the debt capital markets in accordance with our customary funding
plans with a goal to reduce dependence on the potentially volatile commercial
paper markets. Commercial paper, bank and other borrowings decreased $4.1
billion from March 31, 2002 and $8.4 billion from year-end 2001 to $3.6 billion
at June 30, 2002 as we took advantage of the current low interest rate
environment for long-term debt. We expect outstanding commercial paper to
increase in future quarters. Senior and senior subordinated debt (with original
maturities over one year) increased to $73.3 billion from $56.8 billion at
year-end.
20
Pending the completion of the audit, we will suspend the issuance of unsecured
debt and equity securities under our applicable shelf registrations. In any
case, no significant issuances had been planned until September, 2002. We
believe we have adequate sources of liquidity which are available to support the
temporary loss of this funding.
In the first half of the year, we took a number of steps to reduce our reliance
on short-term debt to strengthen our protection against market induced
volatility. These steps included the following:
.. At June 30, 2002, our investment security liquidity portfolio totaled $4.5
billion, a $3.5 billion increase over March 31, 2002.
.. We issued senior debt with original maturities greater than 5 years of $3.6
billion in the quarter and $6.8 billion year-to-date. These issuances
reduced our reliance on short-term debt in the currently volatile debt
markets. During the current quarter, we issued (euro)3 billion in Euro
bonds and $2.5 billion in U.S. dollar-denominated global debt. During the
first quarter of 2002, we issued (pound)500 million of 10-year debt to
investors in the U.K. and $2.5 billion in U.S. dollar-denominated global
debt.
.. We continued to actively access the securitization market as part of
liquidity management actions to limit reliance on short-term unsecured debt
in potentially volatile markets. The composition of receivables securitized
(excluding replenishments of certificateholder interests) was as follows:
Three months ended Six months ended
June 30, June 30,
(In millions) 2002 2001 2002 2001
-----------------------------------------------------------------------------------------------------------
Auto finance $ 925.0 $ 595.0 $ 1,350.0 $ 973.8
MasterCard/Visa 613.4 78.0 1,213.4 151.2
Private label -- -- 500.0 --
Personal non-credit card 450.0 698.6 1,352.7 1,148.6
-----------------------------------------------------------------------------------------------------------
Total $ 1,988.4 $ 1,371.6 $ 4,416.1 $ 2,273.6
===========================================================================================================
.. We established $6 billion in incremental conduit capacity (including $1
billion established in the second quarter) for our real estate secured
product. Consistent with previous transactions, draws on these facilities
are structured as secured financings for accounting purposes. At June 30,
2002, our undrawn conduit lines totaled $6.7 billion and included $5.5
billion of undrawn capacity on the real estate lines put in place in 2002.
.. We issued securities backed by dedicated home equity loan receivables of
$1.3 billion in the second quarter of 2002 and $2.8 billion year-to-date.
For accounting purposes, these transactions were structured as secured
financings. Therefore, the receivables and the related debt remain on our
balance sheet. As of June 30, 2002, closed-end real estate secured
receivables totaling $4.3 billion secured $3.8 billion of outstanding debt
related to these transactions. At December 31, 2001, closed-end real estate
secured receivables totaling $1.7 billion secured $1.5 billion of
outstanding debt related to these transactions.
.. We sold approximately $900 million in real estate secured loans that were
held by our mortgage services business during the first quarter of 2002.
Securitizations and secured financings of consumer receivables have been, and
will continue to be, a source of liquidity for us. In a securitization, a
designated pool of consumer receivables, typically MasterCard or Visa credit
card, private label credit card, personal non-credit card or auto finance, is
removed from the balance sheet and transferred to an unaffiliated trust that is
a qualifying special purpose entity ("QSPE") as defined by Statement of
Financial Accounting Standards No. 140 ("FAS No. 140") and therefore is not
consolidated. Under the terms of the securitizations, we receive annual
servicing fees on the outstanding balance of the securitized receivables and the
rights to future residual cash flows on
21
the sold receivables after the investors receive their contractual return. The
estimated present value of these rights to future residual cash flows are
recorded on our balance sheet at the time of sale as interest-only strip
receivables, net of our recourse obligation to investors for failure of debtors
to pay. Cash flows related to the interest-only strip receivables and servicing
the receivables are collected over the life of the underlying securitized
receivables.
In a secured financing, a designated pool of receivables, typically real estate
secured, are transferred to a wholly-owned special purpose subsidiary which
assigns the receivables to a trust which sells interests to investors. Repayment
of the debt issued by the trust is secured by the receivables transferred. The
transactions are structured as secured financings under FAS No. 140. Therefore,
the receivables and the underlying debt of the trust remain on our balance
sheet. Using this source of funding results in similar operating results and
cash flows as issuing debt through alternative funding sources.
Our securitized receivables totaled $22.3 billion at June 30, 2002, compared to
$20.9 billion at December 31, 2001. We believe the market for securities backed
by receivables is a reliable, efficient and cost-effective source of funds. At
June 30, 2002, securitizations represented 21 percent of the funding associated
with our managed portfolio compared to 23 percent a year earlier. We believe we
will be able to continue to access this market throughout 2002.
Regulatory Matters
Our banking subsidiaries are subject to the capital adequacy guidelines adopted
by the Office of Thrift Supervision ("OTS"), Office of the Comptroller of the
Currency ("OCC") and the Federal Deposit Insurance Corporation ("FDIC") and are
well capitalized. In the first quarter of 2002 we made capital contributions to
our banking subsidiaries of approximately $1.2 billion in response to the 2001
Guidance for Subprime Lending Programs issued by the OTS, OCC and FDIC. We
currently do not anticipate the need for significant additional capital
contributions to our banking subsidiaries. On July 1, 2002 we combined all of
our credit card banks into a single credit card banking subsidiary of Household
Finance Corporation. We believe the combination of the banks will streamline and
simplify our regulatory process as well as optimize capital and liquidity
management. As part of this combination, we confirmed our financial support for
our credit card bank and have designated approximately half of our $4.5 billion
liquidity investment security portfolio to enhance liquidity in this subsidiary.
State regulatory agencies, including the attorney generals of certain states,
have been focusing on the origination policies, procedures and practices of our
consumer lending business. We have responded to all customer complaints brought
to us by these authorities and believe those that may be valid have been
limited to isolated situations. We expect that these complaints, which are part
of an organized effort by certain consumer activists, will continue to be a
focus for regulatory authorities as long as there is an effort to induce
industry-wide changes for certain practices that are common in the nonprime
consumer lending industry. These practices include the imposition of prepayment
penalties and mandatory arbitration clauses. We intend to continue to support
these practices as they are a justifiable and reasonable business practice.
RESULTS OF OPERATIONS
Unless noted otherwise, the following discusses amounts reported in our owned
basis statements of income.
Net interest margin: Net interest margin on an owned basis was $1.6 billion for
the second quarter of 2002, up 18 percent from $1.4 billion for the prior-year
quarter. Net interest margin on an owned basis for the first six months of 2002
was $3.2 billion, up from $2.7 billion in the prior-year period. The increases
were primarily due to receivables growth and lower funding costs resulting from
easing in United States monetary policy in 2001.
22
Net interest margin as a percent of average owned interest-earning assets,
annualized, was 7.62 percent in the quarter and 7.72 percent in the first six
months of 2002, compared to 7.74 and 7.63 percent in the year ago periods. The
decrease in the quarter was due to an increase in the percentage of real estate
secured receivables in our portfolio as well as a larger liquidity-related
investment portfolio. Both real estate secured receivables and the
liquidity-related investment portfolio have lower margins than our other
products. These reductions were partially offset by lower funding costs.
Our net interest margin on a managed basis includes finance income earned on our
owned receivables as well as on our securitized receivables. This finance income
is offset by interest expense on the debt recorded on our balance sheet as well
as the contractual rate of return on the instruments issued to investors when
the receivables were securitized. Managed basis net interest margin increased
$400 million, to $2.3 billion in the second quarter of 2002, and $840 million,
to $4.5 billion year-to-date, primarily due to higher receivable levels and an
expanded margin.
Net interest margin as a percent of average managed interest-earning assets,
annualized, was 8.55 percent in the current quarter and 8.64 percent in the
first six months of 2002, compared to 8.27 and 8.21 percent in the year-ago
periods. The net interest margin on a managed basis is greater than on an owned
basis because the managed basis portfolio includes relatively more auto finance,
MasterCard and Visa and personal non-credit card loans, which have higher
yields. Lower funding costs were the primary driver of the increased margin.
Provision for credit losses The provision for credit losses for receivables for
the second quarter of 2002 totaled $850.9 million, compared to $657.1 million in
the prior-year quarter. The provision for the first six months of 2002 was $1.8
billion, compared to $1.4 billion in the year-ago period. The provision as a
percent of average owned receivables, annualized, was 4.15 percent in the second
quarter of 2002, compared to 3.71 percent in the second quarter of 2001. We
recorded owned loss provision greater than charge-offs of $85.3 million during
the second quarter and $289.6 million during the first six months of 2002.
Receivables growth, increases in personal bankruptcy filings and uncertainty as
to the timing and extent of an economic recovery contributed to a higher
provision. The provision for credit losses may vary from quarter to quarter,
depending on the product mix and credit quality of loans in our portfolio. See
Note 4, "Credit Loss Reserves" to the accompanying condensed consolidated
financial statements for further discussion of factors affecting the provision
for credit losses.
Other revenues Total other revenues were $1.0 and $2.2 billion for the second
quarter and first six months of 2002, compared to $867.4 million and $1.8
billion for the same periods in 2001 and included the following:
Three months ended Six months ended
June 30, June 30,
(In millions) 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------------------
(RESTATED) (RESTATED)
Securitization revenue $ 523.4 $ 397.4 $ 1,041.7 $ 800.5
Insurance revenue 177.5 159.3 347.6 317.9
Investment income 44.0 37.8 90.2 79.6
Fee income 190.3 223.5 406.8 435.6
Other income 95.3 49.4 283.3 211.1
- --------------------------------------------------------------------------------------------------------------------
Total other revenues $ 1,030.5 $ 867.4 $ 2,169.6 $1,844.7
====================================================================================================================
Securitization revenue is the result of the securitization of our receivables
and includes initial and replenishment gains on sale, net of our estimate of
probable credit losses under the recourse provisions, as well as servicing
revenue and excess spread. Securitization revenue was $523.4 million and $1.0
billion for the second quarter and first six months of 2002, compared to $397.4
and $800.5 million for the same periods in 2001. The increases were due to
higher average securitized receivables as well as increases in the level of
receivables securitized during both the quarter and year-to-date. Securitization
23
revenue will vary each period based on the level and mix of receivables
securitized in that particular period (which will impact the gross initial gains
and related estimated probable credit losses under the recourse provisions). It
is also affected by the overall level and mix of previously securitized
receivables (which will impact servicing revenue and excess spread). The
estimate for probable credit losses for securitized receivables is also impacted
by the level and mix of current period securitizations because, depending upon
loss estimates and severities, securitized receivables with longer lives may
result in higher over-the-life losses than receivables securitized with shorter
lives.
Securitization revenue included the following:
Three months ended Six months ended
June 30, June 30,
(In millions) 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------------------
(RESTATED) (RESTATED)
Net initial gains $ 73.8 $ 39.9 $ 148.2 $ 66.2
Net replenishment gains 127.0 102.6 251.2 197.6
Servicing revenue and excess spread 322.6 254.9 642.3 536.7
- --------------------------------------------------------------------------------------------------------------------
Total $ 523.4 $ 397.4 $ 1,041.7 $ 800.5
====================================================================================================================
The increase (decrease) in our interest-only strip receivables was $29.8 and
$58.8 million in the second quarter and first six months of 2002 compared to
$(2.5) and $1.0 million in the year-ago periods. These changes are net of the
related loss reserve and exclude the mark-to-market adjustment recorded in
accumulated other comprehensive income.
Insurance revenue was $177.5 and $347.6 million in the second quarter and first
six months of 2002 compared to $159.3 and $317.9 million in the year-ago
periods. The increases reflected increased sales on a larger receivable
portfolio.
Investment income, which includes interest income on investment securities in
the insurance business as well as realized gains and losses from the sale of
investment securities, was $44.0 and $90.2 million in the second quarter and
first six months of 2002 compared to $37.8 and $79.6 million in the year-ago
periods. The increases were primarily due to higher interest income, primarily
resulting from higher average investment balances, partially offset by lower
yields.
Fee income, which includes revenues from fee-based products such as credit
cards, was $190.3 and $406.8 million in the second quarter and first six months
of 2002, compared to $223.5 and $435.6 million in the year-ago periods.
Improvements in early stage delinquencies resulted in lower late fees in our
credit card businesses. The fourth quarter 2001 sale of the $1 billion Goldfish
credit card portfolio in the U.K. also contributed to the decreases.
See Note 12, "Segment Reporting," to the accompanying condensed consolidated
financial statements for additional information on fee income on a managed
basis.
Other income, which includes revenue from our tax refund lending business, was
$95.3 and $283.3 million in the second quarter and first six months of 2002
compared to $49.4 and $211.1 million in the prior-year periods. Higher revenues,
including higher collections, from our seasonal tax refund lending business as
well as increased revenues from our mortgage banking subsidiary drove the
increases in other income.
Expenses Total costs and expenses for the second quarter and first six months of
2002 were $1.1 and $2.1 billion compared to $951.4 million and $1.9 billion in
the comparable prior-year periods. The
24
increases were driven by higher compensation and other expenses
to support our growing portfolio. Our owned basis efficiency ratio was 37.5 and
37.3 percent in the second quarter and first six months of 2002 compared to 40.3
and 40.1 percent in the comparable prior-year periods.
Total costs and expenses included the following:
Three months ended Six months ended
June 30, June 30,
(In millions) 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------------------
(RESTATED) (RESTATED)
Salaries and fringe benefits $ 453.0 $ 387.2 $ 898.3 $ 764.8
Sales incentives 67.6 73.6 121.7 128.1
Occupancy and equipment expense 93.3 83.7 185.5 167.2
Other marketing expenses 133.5 121.8 273.9 250.5
Other servicing and administrative expenses 204.1 173.0 435.8 368.7
Amortization of acquired intangibles and goodwill 12.6 39.0 32.4 79.6
Policyholders' benefits 87.4 73.1 171.4 150.6
- --------------------------------------------------------------------------------------------------------------------
Total costs and expenses $ 1,051.5 $ 951.4 $ 2,119.0 $ 1,909.5
====================================================================================================================
Salaries and fringe benefits for the second quarter and first six months of 2002
were $453.0 and $898.3 million compared to $387.2 and $764.8 million in the
second quarter and first six months of 2001. The increases were primarily due to
additional staffing at all businesses to support growth including sales,
collections and service quality.
Sales incentives for the second quarter and first six months of 2002 were $67.6
and $121.7 million compared to $73.6 and $128.1 million in the comparable
prior-year periods. The decreases were due to the implementation of 2002
incentive plans in our branches which, generally, have higher volume
requirements than the prior-year plans.
Occupancy and equipment expense for the second quarter and first six months of
2002 was $93.3 and $185.5 million compared to $83.7 and $167.2 million in the
comparable prior-year periods. The increases were primarily the result of higher
repairs and maintenance costs.
Other marketing expenses for the second quarter and first six months of 2002
were $133.5 and $273.9 million compared to $121.8 and $250.5 million in the
comparable prior-year periods. The increases were primarily due to increased
credit card marketing initiatives, primarily in our domestic MasterCard and Visa
portfolios.
Other servicing and administrative expenses for the second quarter and first six
months of 2002 were $204.1 and $435.8 million compared to $173.0 and $368.7
million in the comparable prior-year periods. The increases were primarily due
to higher collection, REO, legal and consulting expenses.
Amortization of acquired intangibles and goodwill for the second quarter and
first six months of 2002 was $12.6 and $32.4 million compared to $39.0 and $79.6
million in the comparable prior-year periods. The decreases were primarily
attributable to the adoption of Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets", on January 1, 2002. Amortization of
goodwill recorded in past business combinations ceased upon adoption of the new
accounting statement.
25
Policyholders' benefits for the second quarter and first six months of 2002 were
$87.4 and $171.4 million compared to $73.1 and $150.6 million in the comparable
prior-year periods. The increases are consistent with the increase in insurance
revenues resulting from the increased policy sales.
CREDIT LOSS RESERVES
Our consumer credit management policies focus on product type and specific
portfolio risk factors. Our consumer credit portfolio is diversified by product
and geographic location. See Note 3, "Receivables" in the accompanying condensed
consolidated financial statements for receivables by product type and Note 4,
"Credit Loss Reserves," for our credit loss reserve methodology and an analysis
of changes in the credit loss reserves.
The following table sets forth owned basis credit loss reserves for the periods
indicated:
(All dollar amounts are stated in millions) June 30, March 31, June 30,
2002 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Owned credit loss reserves $ 2,983.3 $ 2,876.6 $ 2,376.5
Reserves as a percent of:
Receivables 3.59% 3.61% 3.31%
Net charge-offs (1) 97.4 100.1 103.7
Previous 12-months' net charge-offs 106.9 110.8 114.8
Nonperforming loans 96.0 92.7 91.0
====================================================================================================================
(1) Quarter-to-date, annualized
Reserves as a percentage of receivables at June 30, 2002 reflect continuing
uncertainty as to the ultimate impact the weak economy will have on charge-off
and delinquency levels. Compared to March 31, 2002, reserve levels also reflect
lower delinquency.
For securitized receivables, we also record a provision for estimated probable
losses that we expect to incur under the recourse provisions. The following
table sets forth managed credit loss reserves for the periods indicated:
June 30, March 31, June 30,
(All dollar amounts are stated in millions) 2002 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Managed credit loss reserves $ 4,368.9 $ 4,146.5 $ 3,456.5
Reserves as a percent of:
Receivables 4.14% 4.10% 3.78%
Net charge-offs (1) 100.0 100.5 104.2
Previous 12-months' net charge-offs 110.4 112.2 113.9
Nonperforming loans 112.4 108.3 109.9
====================================================================================================================
(1) Quarter-to-date, annualized
Managed basis reserve ratios are somewhat higher than comparable owned basis
ratios because our managed portfolio includes a lower percentage of real estate
secured receivables, which historically have had lower credit losses than our
other products.
CREDIT QUALITY
26
Delinquency - Owned Basis
Two-Months-and-Over Contractual Delinquency (as a percent of consumer
receivables):
June 30, March 31, June 30,
2002 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Real estate secured 2.78% 2.88% 2.59%
Auto finance 2.99 2.04 2.35
MasterCard/Visa 6.13 6.54 4.80
Private label 6.19 6.33 6.54
Personal non-credit card 9.12 9.60 8.79
- --------------------------------------------------------------------------------------------------------------------
Total Owned 4.61% 4.77% 4.48%
====================================================================================================================
Compared to the previous quarter, all products except auto finance reported
lower delinquencies which was well within our expectations. The biggest
improvement was in our MasterCard and Visa portfolio especially in the subprime
portfolio. The sequential increase in auto finance delinquency is consistent
with historical seasonal trends.
Compared to a year ago, the weakened economy negatively affected delinquency
rates for all products. These increases were partially offset in our real estate
secured and personal non-credit card portfolios and more than offset in our
private label portfolio by improved collections. The improved collections were a
direct result of increasing the size of our collection staff, especially in our
branch network.
Net Charge-offs of Consumer Receivables - Owned Basis
Net Charge-offs of Consumer Receivables (as a percent, annualized, of average
consumer receivables):
June 30, March 31, June 30,
2002 2002 2001
- -----------------------------------------------------------------------------------------------------------------------
Real estate secured .85% .65% .48%
Auto finance 4.80 5.63 3.26
MasterCard/Visa 9.94 9.73 8.33
Private label 5.86 6.25 5.25
Personal non-credit card 8.59 7.71 6.84
- -----------------------------------------------------------------------------------------------------------------------
Total Owned 3.76% 3.61% 3.26%
=======================================================================================================================
Real estate charge-offs and REO expense as a percent of average real
estate secured receivables 1.23% 1.05% .78%
=======================================================================================================================
The weak economy drove the increase in charge-off ratios over both the previous
and prior year quarters. These increases were consistent with our expectations.
Higher bankruptcy charge-offs, contributed to increases in the charge-off ratios
for our real estate secured, MasterCard and Visa and personal non-credit card
portfolios during the quarter. Charge-offs in our personal non-credit card
portfolio increased more than our other products because our typical personal
non-credit card customer is less resilient and, therefore, more exposed to the
recent economic downturn. Improvements in our auto finance and private label
portfolios during the quarter were primarily attributable to reductions in
bankruptcy charge-offs. The auto finance ratio also reflects positive seasonal
trends.
Compared to the prior-year quarter, our net charge-off ratio increased 50 basis
points, primarily due to the weak economy. These increases were partially offset
by improved collections in our real estate secured, private label and personal
non-credit card portfolios as a direct result of increasing the size of our
collection staff, especially in our branch network.
The increases in real estate charge-offs and REO expense as a percent of average
real estate secured receivables were the result of the seasoning of our
portfolios, higher loss severities, especially in second lien mortgages, and
higher bankruptcy filings.
27
OWNED NONPERFORMING ASSETS
(In millions) June 30, March 31, June 30,
2002 2002 2001
- -----------------------------------------------------------------------------------------------------------------------
Nonaccrual receivables $ 2,356.4 $ 2,261.0 $ 1,855.2
Accruing consumer receivables
90 or more days delinquent 750.6 839.3 743.6
Renegotiated commercial loans 1.4 1.3 12.3
- -----------------------------------------------------------------------------------------------------------------------
Total nonperforming receivables 3,108.4 3,101.6 2,611.1
Real estate owned 456.7 459.4 365.2
- -----------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 3,565.1 $ 3,561.0 $ 2,976.3
=======================================================================================================================
Credit loss reserves as a percent of 96.0% 92.7% 91.0%
nonperforming receivables
=======================================================================================================================
REAGE STATISTICS - MANAGED BASIS
Our credit policies for consumer loans permit the reset of the contractual
delinquency status of an account to current, subject to certain limits, if a
predetermined number of consecutive payments has been received and there is
evidence that the reason for the delinquency has been cured. Such reaging
policies vary by product and are designed to manage customer relationships and
ensure maximum collections. The tables below summarize reaging statistics in our
managed basis domestic portfolio as of June 30, 2002 and December 31, 2001.
Total Reaged by Reage Period - Domestic Portfolio June 30, December 31,
(Managed Basis) 2002 2001
- ---------------------------------------------------------------------------------------------------------------------
Never reaged 83.3% 83.1%
Reaged:
Reaged in the last 6 months 7.4 9.0
Reaged in the last 7-12 months 5.1 3.6
Previously reaged 4.2 4.3
- ---------------------------------------------------------------------------------------------------------------------
Total ever reaged 16.7 16.9
- ---------------------------------------------------------------------------------------------------------------------
Total 100.0% 100.0%
=====================================================================================================================
Total Reaged by Product - Domestic Portfolio June 30, December 31,
(Managed Basis) 2002 2001
- ---------------------------------------------------------------------------------------------------------------------
Real estate secured 19.1% 20.0%
Auto finance 15.9 15.0
MasterCard/Visa 3.4 3.2
Private label 10.5 11.1
Personal non-credit card 27.1 27.2
- ---------------------------------------------------------------------------------------------------------------------
Total 16.7% 16.9%
=====================================================================================================================
The percentage of our domestic, managed basis portfolio which has ever been
reaged at June 30, 2002 has declined slightly compared to December 31, 2001.
28
Item 4. Submission of Matters to a Vote of Security Holders
Our Annual Meeting of Stockholders was held on Tuesday, May 14, 2002, for the
purpose of (1) electing directors; (2) voting on a shareholder proposal relating
to a special executive compensation review; and (3) ratifying the appointment of
KPMG LLP as our public accountants. The voting results were as follows:
Each of the following persons received the number of votes set out after his or
her name and were elected directors to hold office for the ensuing year and
until their successors shall be elected and shall qualify:
FOR WITHHELD
W. F. Aldinger 404,175,073 4,281,846
R. J. Darnall 404,100,255 4,356,663
G. G. Dillon 394,433,513 14,023,405
A. Disney 404,144,851 4,312,067
J. Edwardson 402,307,350 6,149,568
J. D. Fishburn 396,204,192 12,252,726
C. F. Freidheim, Jr. 404,149,414 4,307,504
J. H. Gilliam, Jr. 404,141,110 4,315,809
L. E. Levy 400,555,121 7,901,797
G. A. Lorch 404,090,054 4,366,864
J. D. Nichols 404,078,248 4,378,670
J. B. Pitblado 402,302,758 6,154,160
L. M. Renda 402,273,817 6,183,101
S. J. Stewart 404,212,179 4,244,739
The stockholder proposal relating to a special executive compensation review was
defeated by the following vote:
For 109,655,384
Against 249,372,306
Abstain 6,996,059
Broker non-vote 42,433,170
The appointment of KPMG LLP as our public accountants for the year 2002 was
ratified by the following vote:
For 396,739,945
Against 9,931,063
Abstain 1,785,911
29
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
12 Statement of Computation of Ratio of Earnings to Fixed Charges and to
Combined Fixed Charges and Preferred Stock Dividends.
99.1 Debt and Preferred Stock Securities Ratings.
99.2 Certification of Chief Executive Officer.
99.3 Certification of Chief Financial Officer.
99.4 Restated Form 10-K of Household International, Inc. for the year ended
December 31, 2001, which contains unaudited consolidated financial
information and will amend and supplement the Form 10-K of Household
International, Inc. for the year ended December 31, 2001 that was
filed with the Securities and Exchange Commission on March 13, 2002.
99.5 Letter from KPMG LLP re: Statement of Auditing Standards Number 71.
(b) Report on Form 8-K
During the second quarter of 2002, we filed the following Current Reports
on Form 8-K:
. Report filed April 8, 2002 with respect to the 2001 financial and
statistical review ("factbook") containing certain financial detail
with respect to Household International, Inc. and certain of our
subsidiaries.
. Report filed April 9, 2002 with respect to presentations to investors
at our annual Financial Relations Conference.
. Report filed April 17, 2002 with respect to the press release
pertaining to our financial results for the quarter ended March 31,
2002.
30
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOUSEHOLD INTERNATIONAL, INC.
----------------------------
(Registrant)
Date: August 14, 2002 By: /s/ David A. Schoenholz
--------------- ---------------------------
David A. Schoenholz
President -
Chief Operating Officer (also as principal
financial officer)
and on behalf of
Household International, Inc.
31
Exhibit Index
12 Statement of Computation of Ratio of Earnings to Fixed Charges and to
Combined Fixed Charges and Preferred Stock Dividends.
99.1 Debt and Preferred Stock Securities Ratings.
99.2 Certification of Chief Executive Officer.
99.3 Certification of Chief Financial Officer.
99.4 Restated Form 10-K of Household International, Inc. for the year ended
December 31, 2001, which contains unaudited consolidated financial
information and will amend and supplement the Form 10-K of Household
International, Inc. for the year ended December 31, 2001 that was
filed with the Securities and Exchange Commission on March 13, 2002.
99.5 Letter from KPMG LLP re: Statement of Auditing Standards Number 71.
32