HSBC FINANCE CORP – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Executive Overview

    Organization and Basis of Reporting HSBC Finance Corporation and subsidiaries is an indirect wholly owned subsidiary of HSBC North America Holdings Inc. ("HSBC North America") which is a wholly owned subsidiary of HSBC Holdings plc ("HSBC"). HSBC Finance Corporation may also be referred to in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") as "we", "us", or "our".  We currently provide MasterCard(1), Visa(1), American Express(1) and Discover(1) credit cards as well as private label cards to customers in the United States. A portion of new credit card and all new private label receivable originations are sold on a daily basis to HSBC Bank USA, National Association ("HSBC Bank USA"). We also offer specialty insurance products in the United States and Canada. Historically, we also provided several other types of loan products in the United States including real estate secured, personal non-credit card and auto finance loans as well as tax refund anticipation loans and related products all of which we no longer originate. Upon completion of the proposed sale of our Card and Retail Services business as discussed below, substantially all of our remaining operations will be in run-off.  We generate cash to fund our businesses primarily by collecting receivable balances, selling certain credit card and all private label receivables to HSBC Bank USA on a daily basis, borrowing from HSBC affiliates and customers of HSBC, and issuing commercial paper, retail notes and long-term debt. We also receive capital contributions as necessary from HSBC which serve as an additional source of funding. We use the cash generated by these funding sources to fund our operations, service our debt obligations, originate new credit card and private label receivables and pay dividends to our preferred stockholders. During 2011, the shelf registration statement under which we have historically issued long-term debt expired and we chose not to renew it. We currently do not expect third-party long-term debt to be a source of funding for us in the future given the run-off nature of our business subsequent to the sale of our Card and Retail Services business as discussed more fully below.  The following discussion of our financial condition and results of operations excludes the results of our discontinued operations unless otherwise noted. See Note 3, "Discontinued Operations" in the accompanying consolidated financial statements for further discussion of these operations.  Current Environment Weak employment growth and sluggish consumer spending throughout much of 2011 have led to concerns about the prospects for the U.S. economy's growth going forward. However, conditions began to show signs of improvement during the fourth quarter as employment growth began to accelerate, in part due to seasonal hiring, and consumer spending increased. These factors, along with other positive data from the manufacturing sector in the fourth quarter suggest that the economic recovery is gaining momentum once again after nearly stalling out earlier in the year. Serious threats to economic growth remain however, including continued pressure and uncertainty in the housing market and elevated unemployment levels. Federal Reserve policymakers currently anticipate that economic conditions are likely to warrant exceptionally low levels for the Federal funds rate at least through late 2014. The financial markets became somewhat volatile once again in the second half of 2011, with stock market averages moving up and down sharply across the globe as heightened risk aversion gripped the markets. While marketplace liquidity continues to be available, the European sovereign debt crisis triggered by Greece and other countries as well as increased concerns regarding government spending, including the Federal budget deficit and the fear of a return to economic recession continued to impact the financial markets including interest rates and spreads. During 2011, we continued to see home prices decline in many markets as housing prices remain under pressure due to elevated foreclosure levels. Although the pace of new foreclosures has fallen from its peak, in part due to industry-wide compliance issues, further declines in home prices may be necessary before substantial progress in reducing the inventory of homes occurs.    

(1) MasterCard is a registered trademark of MasterCard International

Incorporated (d/b/a MasterCard Worldwide); Visa is a registered trademark of

Visa, Inc.; American Express is a registered trademark of American Express

     Company and Discover is a registered trademark of Discover Financial      Services.                                            27 

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  Table of Contents                                                          HSBC Finance Corporation        While the economy continued to add jobs in 2011, the pace of new job creation continues to be slower than needed to meaningfully reduce unemployment. As a result, there continues to be uncertainty as to how pronounced the economic recovery will be and whether it can be sustained. Although consumer spending picked up during the fourth quarter, it was sluggish for most of 2011 as high food and gas prices and a weak labor market continued to influence consumer spending. In addition, while consumer confidence has improved in recent months after being below its 12-month average at September 30, 2011, it continues to be low based on historical standards. U.S. unemployment rates, which have been a major factor in the deterioration of credit quality in the U.S., remained high at 8.5 percent in December 2011. Also, a significant number of U.S. residents are no longer looking for work and, therefore, are not reflected in the U.S. unemployment rates. Unemployment rates in 17 states are at or above the U.S. national average. High unemployment rates have generally been most pronounced in the markets which had previously experienced the highest appreciation in home values. Unemployment has continued to have an impact on the provision for credit losses in our loan portfolio and in loan portfolios across the industry.  

Mortgage lending industry trends continued to be affected by the following in 2011:

     >   Overall levels of delinquencies remain elevated;    

> While we ceased originating mortgage loans in early 2009, mortgage loan

       originations from 2006 through 2008 continue to perform worse than        originations from prior periods;    

> Significant delays in foreclosure proceedings as a result of the broad

horizontal review of industry foreclosure practices by the Federal Reserve

Board ("Federal Reserve") and the Office of the Comptroller of the Currency

("OCC"), culminating in the issuance of consent orders to many servicers;

       >   Real estate markets in a large portion of the United States continue to be

affected by stagnation or declines in property values experienced over the

       last few years;        >   Levels of foreclosed properties and properties in the process of being

foreclosed remain elevated which has contributed to a continued general

       decline in home prices during 2011;    

> Lower secondary market demand for subprime loans resulting in reduced

       liquidity for subprime mortgages; and    

> Tighter lending standards by mortgage lenders which impacts the ability of

borrowers to refinance existing mortgage loans.

   Concerns about the future of the U.S. economy, including the pace and magnitude of recovery from the recent economic recession which has been slow to date, consumer confidence, volatility in energy prices, credit market volatility, including the ability to permanently resolve the European sovereign debt crisis, and trends in corporate earnings will continue to influence the U.S. economic recovery and the capital markets. In particular, continued improvement in unemployment rates, a sustained recovery of the housing markets and stabilization in energy prices remain critical components of a broader U.S. economic recovery. Further weakening in these components as well as in consumer confidence may result in additional deterioration in consumer payment patterns and credit quality and increase the possibility of a return to recession. Weak consumer fundamentals including declines in wage income, wealth and a difficult job market continue to depress consumer confidence. Additionally, there is uncertainty as to the future course of monetary policy and uncertainty as to the impact on the economy and consumer confidence as the actions previously taken by the government to restore faith in the capital markets and stimulate consumer spending end. These conditions in combination with the impact of recent regulatory changes, including the mortgage reform and continued implementation of the "Dodd-Frank Wall Street Reform and Consumer Protection Act" ("Dodd-Frank") as discussed below, will continue to impact our results through 2012 and beyond, the degree of which is largely dependent upon the pace and extent of the economic recovery.  Due to the significant slow-down in foreclosure processing, and in some instances, cessation of all foreclosure processing by numerous loan servicers, there has been a reduction in the number of properties being marketed following foreclosure which may increase demand for properties currently on the market resulting in a stabilization of home prices but could also result in a larger number of vacant properties in communities creating downward pressure on general property values. As a result, the short term impact of the foreclosure processing delay is highly uncertain. However, the longer term impact is even more uncertain as servicers begin to increase                                           28

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  Table of Contents                                                          HSBC Finance Corporation        foreclosure activities and market properties in large numbers which is likely to create a significant over-supply of housing inventory. This could lead to a significant increase in overall loss severity which would impact our provision for credit losses in future periods.  In addition, certain courts and state legislatures are implementing new rules or statutes relating to foreclosures. Scrutiny of foreclosure documentation has increased in some courts. Also, in some areas, courts are requiring additional verification of information filed prior to the foreclosure proceeding. The combination of these factors when coupled with other mortgage lenders who also temporarily suspended foreclosure activities and are beginning to resume their foreclosure activities has led to a significant backlog of foreclosures in the marketplace which will take time to resolve. If these trends continue, there could be additional delays in the processing of foreclosures, which could have an adverse impact upon housing prices which is likely to result in higher loss severities while foreclosures are delayed.  In addition to the heightened foreclosure scrutiny discussed above, we have also noticed increased scrutiny in consumer bankruptcy proceedings, particularly with respect to proving ownership of the promissory note. On December 1, 2011, a new bankruptcy rule became effective which requires much more documentation to be filed with proofs of claim filed in connection with debt secured by residential mortgages. The new rule also imposes new notice requirements around routine payment changes, such as escrow. We have met the requirements of this new law but expect this will result in an immaterial increase in compliance related expense in 2012.  Growing government indebtedness and a large budget deficit have resulted in a downgrade in the U.S. sovereign debt rating by one major credit rating agency and two major credit rating agencies having U.S. sovereign debt on a negative watch. There is an underlying risk that lower growth, fiscal challenges and a general lack of political consensus will result in continued scrutiny of the U.S. credit standing over the longer term. While the potential effects of the U.S. downgrade are broad and impossible to accurately predict, they could over time include a widening of sovereign and corporate credit spreads, devaluation of the U.S. dollar and a general market move away from riskier assets.  2011 Regulatory Developments As previously reported, HSBC Finance Corporation and our indirect parent, HSBC North America Holdings Inc. ("HSBC North America"), have entered into a consent cease and desist order with the Federal Reserve (the "Federal Reserve Servicing Consent Order") and our affiliate, HSBC Bank USA, entered into a similar consent order with the Office of the Comptroller of the Currency (the "OCC") (together with the Federal Reserve Servicing Consent Order, the "Servicing Consent Orders") following completion of a broad horizontal review of industry foreclosure practices. The Federal Reserve Servicing Consent Order requires us to take prescribed actions to address the deficiencies noted in the joint examination and described in the consent order. We are committed to full compliance with the terms of the Servicing Consent Orders, as described in our Form 10-Q for the quarter ended March 31, 2011. We continue to work with the Federal Reserve and the OCC to align our processes with the requirements of the Servicing Consent Orders and are implementing operational changes as required.  The Servicing Consent Orders require an independent review of foreclosures pending or completed between January 2009 and December 2010 (the "Foreclosure Review Period") to determine if any borrower was financially injured as a result of an error in the foreclosure process. Consistent with the industry, and as required by the Servicing Consent Orders, an independent consultant has been retained to conduct that review, and remediation, including restitution, may be required if a borrower is found to have been financially injured as a result of servicer errors. In conjunction with the foreclosure review, a communication and outreach plan has been developed and implemented to contact borrowers with foreclosures pending or completed during the Foreclosure Review Period. We are conducting the outreach efforts in collaboration with other mortgage loan servicers and independent consultants in order to present a uniform, coherent and user-friendly complaint process. Written communications have been sent to borrowers who were subject to foreclosure proceedings during the Foreclosure Review Period notifying them of the foreclosure complaint review process and providing them with forms that can be used to request a review of their foreclosure proceeding. The outreach plan includes a staggered mailing to borrowers, which began on November 1, and industry media advertising, which began in January 2012. We expect the costs associated with the Servicing Consent Orders, including the foreclosure review, customer outreach plan and complaint process and any resulting remediation, will result in significant increases to our operating expenses in future periods.                                           29

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  Table of Contents                                                          HSBC Finance Corporation        The Servicing Consent Orders do not preclude additional enforcement actions against HSBC Finance Corporation or our affiliates by bank regulatory, governmental or law enforcement agencies, such as the Department of Justice or State Attorneys General, which could include the imposition of civil money penalties and other sanctions relating to the activities that are the subject of the Servicing Consent Orders. The Federal Reserve has indicated in a press release that it believes monetary penalties are appropriate for the enforcement actions and that it plans to announce such penalties. We may also see an increase in private litigation concerning foreclosure and other mortgage servicing practices.  On February 9, 2012, the U.S. Department of Justice, the U.S. Department of Housing and Urban Development and State Attorneys General of 49 states announced a settlement with the five largest U.S. mortgage services with respect to foreclosure and other mortgage servicing practices. HSBC North America, HSBC Finance Corporation and HSBC Bank USA have had preliminary discussions with U.S. bank regulators and other governmental agencies regarding a potential resolution, although the timing of any settlement is not presently known. Based on discussions to date, an accrual of $195 million was determined based on the total projected impact at HSBC North America associated with a proposed settlement of this matter. We have recorded an accrual of $157 million in the fourth quarter of 2011 which reflects the portion of the HSBC North America liability that we currently believe is allocable to HSBC Finance Corporation. As this matter progresses and more information becomes available, we will continue to evaluate our portion of the HSBC North America liability which may result in a change to our current estimate. Any such settlement, however, may not completely preclude other enforcement actions by state or federal agencies, regulators or law enforcement agencies relating to foreclosure and other mortgage servicing practices, including, but not limited to, matters relating to the securitization of mortgages for investors, including the imposition of civil money penalties, criminal fines or other sanctions. In addition, such a settlement would not preclude private litigation concerning these practices.  We remain committed to assisting customers who are experiencing financial difficulties, and we will continue to review our policies and processes to make modification and other account management alternatives for the benefit of our customers more easily accessible to those in need of assistance. Foreclosure proceedings are only instituted when other reasonable alternatives have been exhausted and where the borrower is seriously delinquent. We also offer assistance, including financial, to those wishing to leave a property without having to go through the foreclosure process.  Financial Regulatory Reform On July 21, 2010, the "Dodd-Frank Wall Street Reform and Consumer Protection Act" was signed into law and is a sweeping overhaul of the financial regulatory system. The legislation will have a significant impact on the operations of many financial institutions in the U.S., including us and our affiliates. As the legislation calls for extensive regulations to be promulgated to interpret and implement the legislation, it is not possible to precisely determine the impact to operations and financial results at this time. For a more complete description of the law and implications to our business, see the "Regulation - Financial Regulatory Reform" section under the "Regulation and Competition" section in Item 1. Business.  

2011 Events

• In August 2011, HSBC, through its wholly-owned subsidiaries HSBC Finance

Corporation, HSBC USA Inc. and other wholly owned affiliates, agreed to

sell its Card and Retail Services business to Capital One Financial

Corporation ("Capital One") for a premium of 8.75 percent of receivables.

The sale will include real estate and other assets and certain liabilities

which will be sold at book value or in the case of real estate, appraised

value at the date of closing. Based on balances at December 31, 2011, the

        total consideration would be approximately $12.7 billion, including a         premium of $3.1 billion regardless of whether all our merchant         relationships consent to transfer to Capital One. The consideration may be         paid in cash or a combination of cash and common stock to a maximum of         $750 million of common stock (to be priced at $39.23 per share) at the         option of Capital One. Under the terms of the agreement, facilities in

Chesapeake, Virginia; Las Vegas, Nevada; Mettawa, Illinois; Hanover,

Maryland; Salinas, California; Sioux Falls, South Dakota and Tigard, Oregon

will be sold or transferred to Capital One although we may enter into

site-sharing arrangements for certain of these locations for a period of

time. We will also transfer a data center located in Volo, Illinois. The

        majority of the employees in our Card and Retail                                            30 

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   Table of Contents                                                          HSBC Finance Corporation             Services business will transfer to Capital One. As such, we anticipate      severance costs or other restructuring charges as a result of this

transaction will not be significant. Based on balances at December 31, 2011,

as a result of this transaction we anticipate recording a gain of

approximately $1.9 billion (after-tax) net of transaction costs which are

not expected to exceed $70 million. However, the final amount recognized

will be dependent upon the balances at the time of closing which is expected

to occur in the second quarter of 2012. As a result of this transaction, our

Card and Retail Services business, which was previously included in the Card

and Retail Services segment, is now reported as discontinued operations. See

Note 3, "Discontinued Operations," in the accompanying consolidated

financial statements for further discussion.

   We do not anticipate that the proposed sale of our Card and Retail Services business will have a material impact on the recognition of our deferred tax assets. We are part of a consolidated group for filing federal and state income taxes. This consolidated group includes other U.S. affiliates which are profitable. Projected taxable profits arising from the proposed disposal are incorporated into the ongoing analysis of recoverability of our deferred tax assets and considered with all other relevant factors, including on-going tax planning strategies. While the profit on disposal will have a positive effect in providing support for the recognition of deferred tax assets, currently the recognition of deferred tax assets relies more heavily on future taxable profits generated as a result of tax planning strategies implemented in relation to capital support from HSBC and these strategies remain unaffected by the proposed sale.        •   Due to the impact of the marketplace conditions described above on the

performance of our receivable portfolios, we have incurred significant

losses in 2011, 2010 and 2009. If our forecasts hold true, we expect to

continue to generate losses from continuing operations for the foreseeable

future. We believe that the pending sale of our Card and Retail Services

business in the second quarter of 2012, as well as other aspects of our

2012 funding strategy, including balance sheet attrition, cash generated

from operations and other actions, will be sufficient to meet our funding

requirements and maintain capital at levels we believe are prudent for the

foreseeable future. However long-term, we will continue to remain dependent

on capital infusions from HSBC and funding from HSBC and its affiliates as

necessary to fully meet our longer-term funding requirements and maintain

capital at levels we believe are prudent. HSBC has indicated it is fully

committed and has the capacity to continue to provide such support. In 2011

and 2010, HSBC Investments (North America) Inc. ("HINO") made capital

contributions to us totaling $690 million and $200 million, respectively.

        •   In our real estate secured receivable portfolio, dollars of

two-months-and-over contractual delinquency decreased slightly as compared

to December 31, 2010 as a significant increase in late stage delinquency

reflecting the continuing impact of our temporary suspension of foreclosure

activities was more than offset by a decrease in dollars of contractual

delinquency on accounts less than 180 days contractually delinquent due to

lower receivable levels and improving economic conditions. Credit quality

in our personal non-credit card receivable portfolio improved during 2011

as dollars of two-months-and-over contractual delinquency decreased

significantly as compared to December 31, 2010 reflecting the impact of

lower receivable levels and improved credit quality. Dollars of net

charge-offs for real estate secured and personal non-credit card

receivables decreased during 2011 as a result of lower average receivable

levels as well as the impact from lower average dollars of delinquency as

compared to the prior year and lower levels of personal bankruptcy filings.

See "Credit Quality" in this MD&A for additional discussion.

   We anticipate delinquency and charge-off will continue to remain under pressure during 2012. While the U.S. economic environment continues to slowly improve, there remains uncertainty as to pace and magnitude of recovery from the recent economic recession which could impact our results.    

• During the third quarter of 2011 we adopted a new Accounting Standards

Update which provided additional guidance to determine whether a

restructuring of a receivable meets the criteria to be considered a

troubled debt restructuring ("TDR Loan"). Under this new guidance, we have

determined that substantially all receivables modified as a result of a

financial difficulty, regardless of whether the modification was permanent

or temporary, including all modifications with trial periods, should be

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  Table of Contents                                                          HSBC Finance Corporation       

reported as TDR Loans. Additionally, we have determined that all re-ages,

except first time early stage delinquency re-ages where the customer has not

been granted a prior modification or re-age since the first quarter of 2007,

should be considered TDR Loans. As required, the new guidance was applied

retrospectively to restructurings occurring on or after January 1, 2011 and

resulted in the reporting of an additional $4.1 billion of real estate

secured receivables and an additional $717 million of personal non-credit

card receivables as TDR Loans for the first time at September 30, 2011 with

credit loss reserves of $1.3 billion associated with these receivables. An

incremental loan loss provision for these receivables of approximately

$925 million was recorded during the third quarter of 2011 upon adoption. At

December 31, 2011, $1.0 billion of first time early stage delinquency

accounts which had been re-aged since January 1, 2011, were not reported as

TDR Loans. See Note 6, "Receivables," in the accompanying consolidated

financial statements for further discussion. TDR Loans are reserved for

based on the present value of expected future cash flows discounted at the

      loans' original effective interest rate.         •   During the third quarter of 2011, as part of an ongoing review of our

Insurance business, we decided to cease issuing new term life insurance in

the United States effective January 2012. As the review of the Insurance

business continues, other Insurance lines may be impacted. Regardless of

        future actions, HSBC will continue to provide insurance products to its         customers.   Business Focus The real estate secured and personal non-credit card receivable portfolios of our Consumer Lending and Mortgage Services businesses, which totaled $47.9 billion at December 31, 2011, are currently running off. The timeframe in which these portfolios will liquidate is dependent upon the rate at which receivables pay off or charge-off prior to their maturity, which fluctuates for a variety of reasons such as interest rates, availability of refinancing, home values and individual borrowers' credit profile, all of which are outside of our control. In light of the current economic conditions and mortgage industry trends described above, as well as an increase in late stage delinquency for real estate secured receivables during 2011, our loan prepayment rates have slowed when compared to historical experience even though interest rates remain low. Additionally, our loan modification programs, which are primarily designed to improve cash collections and avoid foreclosure as determined to be appropriate, are contributing to these slower loan prepayment rates.  While difficult to project both loan prepayment rates and default rates, based on current experience we expect the real estate secured receivable portfolios of our run-off Consumer Lending and Mortgage Services businesses to decline to between 40 percent and 50 percent of the December 31, 2011 receivable levels over the next four to five years. Attrition will not be linear during this period. While in the near term charge-off related receivable run-off will likely continue to remain elevated due to the economic environment, run-off is beginning to slow as charge-offs decline and the remaining real estate secured receivables stay on the balance sheet longer due to the impact of modifications and/or the lack of re-financing alternatives.  We continue to evaluate our operations as we seek to optimize our risk profile and cost efficiencies as well as our liquidity, capital and funding requirements. This could result in further strategic actions that may include changes to our legal structure, asset levels, or cost structure in support of HSBC's strategic priorities. We also continue to focus on cost optimization efforts to ensure realization of cost efficiencies. Cost reduction initiatives achieved to date include workforce reductions which have resulted in a reduction in total legal entity full-time equivalent employees of 14 percent since December 31, 2010. Workforce reductions are also occurring in certain shared services functions, other than compliance, which we expect will result in reductions to future allocated costs from these functions. This review will continue in 2012 and, as a result, we may incur restructuring charges in future periods, the amount of which will depend on any actions that are ultimately implemented.  

Performance, Developments and Trends We reported a net loss of $1.4 billion during 2011 compared to a net loss of $1.9 billion and $7.5 billion during 2010 and 2009, respectively.

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  Table of Contents                                                          HSBC Finance Corporation        As discussed above, in August 2011, we announced that we had entered into an agreement to sell our Card and Retail Services business and as a result, our Card and Retail Services business results are reported as discontinued operations for all periods presented. See Note 3, "Discontinued Operations," in the accompanying consolidated financial statements for further discussion. Loss from continuing operations was $2.3 billion during 2011 compared to losses from continuing operations of $2.5 billion and $5.9 billion during 2010 and 2009, respectively. We reported a loss from continuing operations before taxes of $3.7 billion during 2011 compared to losses from continuing operations before tax of $3.9 billion and $8.8 billion during 2010 and 2009, respectively. Our results in these periods were significantly impacted by the change in the fair value of debt and related derivatives for which we have elected fair value option and in 2011 the adoption of new accounting guidance related to TDR Loans as discussed above. The following table summarizes the impact of these items on our income (loss) from continuing operations before income tax for all periods presented:    Year Ended December 31,                                 2011            2010            2009                                                                    (in millions) Loss from continuing operations before income tax, as reported                                      $ (3,734 )      $ (3,903 )      $ (8,784 ) (Gain) loss in value of fair value option debt and related derivatives                                 (1,164 )          (741 )         2,125 Incremental provision for credit losses recorded as a result of adopting new accounting guidance on TDR Loans in the third quarter of 2011                  925               -               - Goodwill and other intangible asset impairment charges                                                      -               -             274  Loss from continuing operations before income tax, excluding above items(1)                         $ (3,973 )      $ (4,644 )      $ (6,385 )        (1)  Represents a non-U.S. GAAP financial measure.   Excluding the collective impact of the items in the above table, our loss from continuing operations before tax during 2011 improved $671 million compared to 2010 reflecting a lower provision for credit losses, partially offset by lower net interest income, lower other revenues, driven by lower derivative related income, and higher operating expenses. The lower derivative related income reflects the impact of decreasing interest rates on the fair value of derivatives in our non-qualifying economic hedge portfolio. The impact of interest rates on our non-qualifying economic hedge portfolio resulted in losses of $1.1 billion during 2011 as compared to losses of $188 million during 2010. While these positions act as economic hedges by lowering our overall interest rate risk through more closely matching both the structure and duration of our liabilities to the structure and duration of our assets, they do not qualify as effective hedges under generally accepted accounting principles.  Net interest income decreased during 2011 reflecting lower average receivables as a result of receivable liquidation and lower overall receivable yields driven by a shift in receivable mix to higher levels of lower yielding first lien real estate secured receivables as higher yielding second lien real estate secured receivables and personal non-credit card receivables have run-off at a faster pace than first lien real estate secured receivables. Lower overall receivable yields were partially offset by lower levels of nonaccrual receivables. These decreases were partially offset by an increase in our estimate of interest receivable relating to income tax receivables which totaled $117 million during 2011 due to a pending resolution of an issue with the Internal Revenue Service Appeals' Office compared to tax-related interest income of $6 million during 2010, which is recorded as a component of finance and other interest income as well as lower interest expense due to lower average borrowings and lower average rates.  Net interest margin was 2.90 percent in 2011 and 2.62 percent in 2010. Net interest margin was positively impacted, particularly in 2011, by the estimated interest receivable relating to income tax receivables as discussed above. Excluding the impact of this item in both periods, net interest margin remained higher during 2011 reflecting a lower cost of funds as a percentage of interest earning assets, partially offset by lower overall receivable yield as discussed above. See "Results of Operations" in this MD&A for additional discussion regarding net interest income and net interest margin.  Other revenues in both 2011 and 2010 were impacted by changes in the value of debt designated at fair value and related derivatives. Excluding the gain on debt designated at fair value and related derivatives from both periods,                                           33

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  Table of Contents                                                          HSBC Finance Corporation        other revenues declined significantly during 2011 primarily due to lower derivative related income as discussed above as well as lower insurance revenue, partially offset by higher investment income. Lower insurance revenue reflects a decrease in the number of credit insurance policies in force since March 31, 2009 primarily due to the run-off of our Consumer Lending portfolio. Investment income increased due to higher gains on sales of securities, partially offset by lower average balances and lower yields on money market funds. See "Results of Operations" for a more detailed discussion of other revenues.  As discussed above, our provision for credit losses during 2011 included approximately $766 million for real estate secured receivables and approximately $159 million for personal non-credit card receivables recorded in the third quarter of 2011 related to the adoption of new accounting guidance related to TDR Loans. This new accounting guidance has and will continue to impact our provision for credit losses in periods post-adoption, including the fourth quarter of 2011, as loans which otherwise would not have qualified for such reporting in the past will now meet the criteria under the new accounting guidance in future periods to be reported and reserved for as TDR Loans. Therefore, the provision for credit losses is not comparable to prior reporting periods. See Note 6, "Receivables," in the accompanying consolidated financial statements for further discussion of this new guidance and the related impacts. Excluding the impact of the adoption of the new Accounting Standards Update during the third quarter of 2011, our overall provision for credit losses decreased significantly during 2011 as discussed below.    

• The provision for credit losses for real estate secured loans in our

Consumer Lending and Mortgage Services business decreased $260 million and

$436 million, respectively, during 2011. The decrease reflects lower         balances outstanding as the portfolios continue to liquidate and lower

charge-off levels. These decreases were partially offset by higher expected

losses on TDR Loans. Also contributing to the decrease was lower levels of

two-months-and-over contractual delinquency on accounts less than 180 days

contractually delinquent, which in our total reported contractual

delinquency for real estate secured receivables was largely offset by an

increase in late stage delinquency, reflecting the continuing impact from

        foreclosure delays as discussed above.         •   The provision for credit losses for our personal non-credit card

receivables decreased $1.2 billion during 2011 reflecting lower receivable,

delinquency and charge-off levels as well as improved credit quality.

See "Results of Operations" for a more detailed discussion of our provision for credit losses.

  During 2011, we increased our credit loss reserves as the provision for credit losses was $440 million higher than net charge-offs. Excluding the impact of adopting new accounting guidance on TDR Loans as previously discussed, the provision for credit losses was $485 million lower than net charge-offs reflecting lower receivable levels, lower overall delinquency levels and improvements in economic conditions. See "Credit Quality" for further discussion of credit loss reserves.  Credit loss reserve levels for real estate secured receivables at our Mortgage Services and Consumer Lending businesses can be further analyzed as follows:                                                              Real Estate Secured Receivables                                                   Consumer Lending              Mortgage Services Year Ended December 31,                          2011           2010           2011           2010                                                                    (in millions)

Credit loss reserves at beginning of period $ 2,409$ 3,047

  $  1,781       $  2,385 Provision for credit losses(1)                    2,675          2,339          1,309          1,575 Charge-offs                                      (1,975 )       (3,038 )       (1,380 )       (2,230 ) Recoveries                                           55             61             40             51 

Credit loss reserves at end of period $ 3,164$ 2,409

$  1,750$  1,781

(1) During 2011, the provision for credit losses for our Consumer Lending real

estate secured receivables included $596 million related to the adoption of

new accounting guidance for TDR Loans. During 2011, provision for credit

losses for our Mortgage Services real estate secured receivables included

$170 million related to the adoption of new accounting guidance for TDR      Loans.                                            34 

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  Table of Contents                                                          HSBC Finance Corporation        A significant portion of our receivable portfolio is considered to be TDR Loans which are reserved for based on the present value of expected future cash flows discounted at the loans' original effective interest rate which generally results in a higher reserve requirement for these loans. Additionally, a significant portion of real estate secured receivables in our portfolio is carried at the lower of amortized cost or fair value less cost to sell. The following table summarizes these receivables in comparison to our entire receivable portfolio:    At December 31,                                                   2011            2010                                                                      (in millions) Total receivable portfolio                                      $ 47,936        $ 56,486  Real estate secured receivables carried at fair value less cost to sell                                                    $  5,937        $  5,095 TDR Loans: Real estate secured(1)                                            11,717           7,875 Personal non-credit card                                           1,341             704  TDR Loans                                                         13,058           8,579 

Receivables carried at either fair value less cost to sell or reserved for using a discounted cash flow methodology $ 18,995

$ 13,674

Real estate secured receivables carried at either fair value less cost to sell or reserved for using a discounted cash flow methodology as a percentage of real estate secured receivables

                                                41.33 %  

26.29 %

Receivables carried at either fair value less cost to sell or reserved for using a discounted cash flow methodology as a percentage of total receivables

                                  39.63 %         24.21 %        (1)  Excludes TDR Loans which are recorded at fair value less cost to sell and      included separately in the table.   Total operating expenses for continuing operations increased $73 million, or 5 percent, during 2011 driven by an expense accrual related to mortgage servicing matters of $157 million, an increase in legal reserves of $150 million reflecting increased exposure estimates on litigation and a $58 million increase in compliance related costs associated principally with our foreclosure remediation efforts, partially offset by lower salary and employee benefits and lower real estate owned ("REO") expenses. See "Results of Operations" for a more detailed discussion of operating expenses.  Our effective income tax rate for continuing operations was (38.1) percent in 2011 and (34.8) percent in 2010. The effective tax rate for 2011 was impacted by a release of valuation allowance previously established on foreign tax credits. HSBC North America implemented an additional tax planning strategy which is expected to generate sufficient taxable foreign source income to allow us to recognize and utilize foreign tax credits currently on our balance sheet before they expire. The effective tax rate for 2011 was also impacted by the non-deductible portion of the accrual related to mortgage servicing matters, an increase in the valuation allowance on state deferred taxes, an increase in uncertain tax positions and state taxes, including states where we file combined unitary state tax returns with other HSBC affiliates. See Note 14, "Income Taxes," in the accompanying consolidated financial statements for further discussion.  2010 as compared to 2009 Our 2010 and 2009 results were significantly impacted by the change in the fair value of debt and related derivatives for which we have elected fair value option. Excluding the collective impact of this item in both periods, our results improved to a loss of $4.6 billion in 2010 as compared to a loss of $6.4 billion in 2009 driven by significantly lower provision for credit losses and lower operating expenses, partially offset by lower net interest income and lower other revenues including lower derivative related income. The lower derivative related income in 2010 reflects the impact of decreasing interest rates on the mark-to-market on derivatives in our non-qualifying economic hedge portfolio which resulted in losses of $188 million during 2010 as compared to a gain of $487 million during 2009.  Net interest income decreased during 2010 primarily due to lower average receivables as a result of receivable liquidation, partially offset by higher overall receivable yields and lower interest expense. During 2010, we experienced higher yields for both real estate secured and personal non-credit card receivables as a result of                                           35

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  Table of Contents                                                          HSBC Finance Corporation        lower levels of nonperforming receivables, including reduced levels of nonperforming modified real estate secured receivables, due to charge-off and declines in new modification volumes. Higher yields in our real estate secured receivable portfolio were partially offset by the impact of an increase in the expected lives of receivables in payment incentive programs since December 2009. As receivable yields vary between receivable products, overall receivable yields were negatively impacted by a shift in receivable mix to higher levels of lower yielding first lien real estate secured receivables as higher yielding second lien real estate secured and personal non-credit card receivables ran-off at a faster pace than first lien real estate secured receivables. The decrease in net interest income during 2010 was partially offset by higher net interest income on our non-insurance investment portfolio reflecting higher levels of investments held and slightly higher yields. These decreases in interest income were partially offset by lower interest expense due to lower average borrowings and lower average rates.  Net interest margin was 2.62 percent in 2010 and 2.33 percent in 2009. Net interest margin in 2010 increased due to lower cost of funds as a percentage of average interest-earning assets as well as higher overall yields on our receivable portfolio. See "Results of Operations" in this MD&A for additional discussion regarding net interest income and net interest margin.  Other revenues during 2010 were impacted by changes in the value of debt designated at fair value and related derivatives. Excluding the gain (loss) on debt designated at fair value and related derivatives, other revenues decreased during 2010 primarily driven by significantly lower derivative-related income as discussed above, lower servicing and other fees from HSBC affiliates and lower insurance revenues. Lower servicing and other fees from HSBC affiliates reflects lower levels of receivables being serviced. Lower insurance revenue reflects a decrease in the number of credit insurance policies in force since March 31, 2009 primarily due to the run-off of our Consumer Lending portfolio. See "Results of Operations" for a more detailed discussion of other revenues.  

Our provision for credit losses decreased significantly during 2010 as discussed below.

• The provision for credit losses for the real estate secured receivable

portfolios in our Consumer Lending and Mortgage Services business decreased

$658 million and $342 million, respectively, during 2010. The decrease

reflects lower receivable levels as the portfolios continued to liquidate,

        lower delinquency levels, improved loss severities and improvements in         economic conditions since 2009. The decrease also reflects lower loss         estimates on TDR Loans, partially offset by the impact of continued high

unemployment levels, lower receivable prepayments, higher loss estimates on

        recently modified loans and for real estate secured receivables in our         Consumer Lending business, portfolio seasoning. Improvements in loss

severities reflect an increase in the number of properties for which we

accepted a deed to the property in lieu of payment (also referred to as

"deed-in-lieu") which result in lower losses compared to loans which are

subject to a formal foreclosure process for which average loss severities

        in 2010 have remained relatively flat to 2009 levels.         •   The provision for credit losses for our personal non-credit card

receivables decreased $1.6 billion reflecting lower receivable levels,

        lower delinquency levels and improvements in economic conditions since         2009, partially offset by higher reserve requirements on TDR Loans.  

See "Results of Operations" for a more detailed discussion of our provision for credit losses.

  In 2010, we decreased our credit loss reserves as the provision for credit losses was $1.8 billion less than net charge-offs. Lower credit loss reserve levels reflect lower receivable levels, improved economic and credit conditions since 2009 including lower delinquency levels and overall improvements in loss severities on real estate secured receivables as discussed above.  

Total operating expenses during 2009 were significantly impacted by the following items which impact comparability between periods:

• Restructuring charges totaling $151 million primarily recorded during 2009,

related to the decision to discontinue all new customer account

originations for our Consumer Lending business and to close the Consumer

Lending branch offices. See Note 4, "Strategic Initiatives," in the

accompanying consolidated financial statements for additional information

        related to this decision;                                            36 

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  Table of Contents                                                          HSBC Finance Corporation       

• Goodwill impairment charges of $260 million during 2009 related to our

Insurance Services businesses. Additionally, during 2009 impairment charges

of $14 million during the first quarter of 2009 relating to technology,

customer lists and loan related relationships resulting from the

discontinuation of originations for our Consumer Lending business.

   Excluding these items in 2009, total operating expenses decreased $315 million, or 18 percent during 2010 primarily due to lower salary expense reflecting reduced headcount reflecting the further reduced scope of our business operations since March 2009 and continued entity-wide initiatives to reduce costs as well as lower occupancy and equipment expenses and lower support services from HSBC affiliates. These decreases were partially offset by higher real estate owned ("REO") expenses and higher legal costs. See "Results of Operations" for a more detailed discussion of operating expenses.  Our effective income tax rate for continuing operations was (34.8) percent in 2010 and (32.6) percent in 2009. The effective tax rate for continuing operations in 2010 was primarily impacted by state taxes, including states where we file combined unitary state tax returns with other HSBC affiliates and amortization of purchase accounting adjustments on leveraged leases that matured in December 2010.  Performance Ratios Our efficiency ratio from continuing operations was 66.80 percent in 2011 compared to 47.51 percent in 2010 and 178.50 percent in 2009. Our efficiency ratio from continuing operations during all periods was impacted by the change in the fair value of debt and related derivatives for which we have elected fair value option accounting. Additionally, the efficiency ratio in 2009 was also impacted by goodwill and intangible asset impairment charges and the Consumer Lending closure costs, as discussed above. Excluding these items from the periods presented, our efficiency ratio deteriorated significantly in 2011 reflecting lower other revenues driven by lower derivative related income and lower net interest income driven by portfolio liquidation while operating expenses increased as discussed above. Excluding these items from the periods presented, our efficiency ratio deteriorated during 2010 reflecting significantly lower net interest income and other revenues driven by receivable portfolio liquidation and lower derivative-related income which outpaced the decrease in operating expenses.  Our return on average common shareholder's equity ("ROE") was (38.83) percent in 2011 compared to (36.93) percent in 2010 and (54.29) percent in 2009. Our return on average assets ("ROA") was (3.77) percent in 2011 compared to (3.37) percent in 2010 and (6.73) percent in 2009. ROE and ROA in all periods were significantly impacted by the change in the fair value of debt for which we have elected fair value option accounting. During 2011, ROA and ROE were also impacted by the adoption of new accounting guidance related to TDR Loans as previously discussed. During 2009, ROA and ROE were impacted by goodwill and intangible asset impairment charges and the Consumer Lending closure costs as discussed above. Excluding these items, ROE during 2011 improved 249 basis points reflecting a lower loss from continuing operations driven by lower provision for credit losses. Excluding these items, ROA during 2011 was essentially flat as the rate of improvement in loss from continuing operations as discussed above was at the same pace as the decrease in average assets. Excluding these same items discussed above, ROE deteriorated 531 basis points in 2010 and ROA improved 75 basis points in 2010. The deterioration in ROE during 2010 was driven by lower average shareholders' equity which outpaced the change in our loss from continuing operations. The improvement in ROA in 2010 was driven by the change in our loss from continuing operations which outpaced the decrease in average assets.  Receivables Receivables decreased to $47.9 billion at December 31, 2011, a 15 percent decrease from December 31, 2010, as a result of the continued liquidation of our real estate secured and personal non-credit card receivable portfolios which will continue going forward. As it relates to our real estate secured receivable portfolio, liquidation rates continue to be impacted by low loan prepayments as few refinancing opportunities for our customers exist and the previously discussed trends impacting the mortgage lending industry. See "Receivables Review" for a more detailed discussion of the decreases in receivable balances.  

Credit Quality Dollars of two-month-and-over contractual delinquency for continuing operations decreased for both real estate secured and personal non-credit card receivables as compared to December 31, 2010. In our real

                                       37

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  Table of Contents                                                          HSBC Finance Corporation        estate secured receivable portfolio, dollars of two-months-and-over contractual delinquency decreased modestly as compared to December 31, 2010 as a significant increase in late stage delinquency driven by our earlier decision to temporarily suspend foreclosure activities was offset by a decrease in dollars of contractual delinquency on accounts less than 180 days contractually delinquent due to lower receivable levels and the impact of improvements in economic conditions. Dollars of delinquency decreased in our personal non-credit card portfolio reflecting the impact of lower receivable levels and improved credit quality. Dollars of two-months-and-over contractual delinquency as a percentage of receivables and receivables held for sale ("delinquency ratio") increased as compared to December 31, 2010 as the decrease in receivable levels outpaced the decrease in dollars of delinquency during the year driven by the continuing impact of our temporary suspension of foreclosure activities. See "Credit Quality-Delinquency" for a more detailed discussion of our delinquency ratio.  Overall dollars of net charge-offs decreased significantly during 2011 as all receivable portfolios were positively impacted by the lower average dollars of delinquency as compared to the prior year and, for personal non-credit card receivables, lower levels of personal bankruptcy filings. These decreases were partially offset for all receivable portfolios by the impact of continued high unemployment levels. Net charge-off of consumer receivables as a percentage of average consumer receivables (the "net charge-off ratio") for full year 2011 decreased as compared to full year 2010 reflecting lower dollars of net charge-offs as discussed above which outpaced the decrease in average receivables. See "Credit Quality-Net Charge-offs of Consumer Receivables" for a more detailed discussion of our net charge-off ratio.  Performance of our Discontinued Card and Retail Services Business The financial information set forth below summarizes selected financial highlights of our discontinued Card and Retail Services business for the years ended December 31, 2011, 2010 and 2009.    Year Ended December 31,                                   2011          2010           2009                                                               (dollars are in millions) Finance and other interest income                        $ 1,948       $ 2,214       $  2,748 Interest expense                                              94           117            217  Net interest income                                        1,854         2,097          2,531 Provision for credit losses(1)                               424           

834 1,746

Net interest income after provision for credit losses 1,430 1,263

            785 Fee income and enhancement services revenue                  690           572          1,109 Gain on bulk sale of receivables to HSBC Bank USA              -             -             50 Gain on receivable sales with affiliates                     567           540            468 Servicing and other fees from HSBC affiliates                599           629            637 Other income                                                  19            14           (344 )  Total other revenues                                       1,875         1,755          1,920 Salaries and employee benefits                               282           336            457 Other marketing expenses                                     272           308            166 Other servicing and administrative expenses                  450           422            617 Support services from affiliates                             846           817            608 Amortization of intangibles                                   91           138            138 Goodwill impairment charges                                    -             -          2,034  Total operating expenses                                   1,941         2,021          4,020  Income from discontinued operations before income tax    $ 1,364       $   997       $ (1,315 )  Net interest margin                                        20.15 %       20.10 %        19.17 % Efficiency ratio                                           52.05         52.47          90.32                                            38 

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   Table of Contents                                                          HSBC Finance Corporation                       As of December 31,               2011               2010                                             (dollars are in millions)              Credit card receivables(2)   $       9,001       $    9,897      

(1) For periods following the transfer of the receivables to held for sale, the

receivables are included as part of the disposal group held for sale to

Capital One which is carried at the lower of amortized cost or fair value

and we no longer record provisions for credit losses, including charge-offs,

     for these receivables.     (2)  At December 31, 2011, credit card receivables are included as part of the

disposal group held for sale to Capital One which is carried at the lower of

amortized cost or fair value, as they are held for sale to Capital One as

discussed above. At December 31, 2010, credit card receivables were carried

at amortized cost and as such are not directly comparable to the current

period balances.

   In our credit card business, although on an active account basis purchase volumes were higher than the prior year, we saw continued declines in our credit card receivable balances due to increased receivable run-off in the segments of our credit card receivable portfolio for which we no longer originate new accounts partially offset by increases in receivables associated with new account activity. Credit quality remains improved compared to the prior year as delinquency and charge-off levels have declined as the impact of continued high unemployment rates has not been as severe as originally expected due in part to improved customer payment behavior which has resulted in continued improvements in delinquency levels. While implementation of changes required by the Credit Card Accountability Responsibility and Disclosure Act of 2009 ("CARD Act") continued to result in reductions to revenue, the impact has been mitigated by improved credit quality for our credit card business during 2011 as compared to the prior year. As discussed more fully above, in August 2011 we announced that we had entered into an agreement to sell our credit card business to Capital One.  2011 as compared to 2010 Income from our discontinued Card and Retail Services business improved during 2011 as compared to 2010 primarily due to lower provision for credit losses, lower operating expenses and higher other revenues, partially offset by lower net interest income.  Lower net interest income in 2011 reflects the impact of lower average receivables as discussed more fully below and a slightly lower yield on credit card receivables, partially offset by lower interest expense. The lower yields on our credit card receivables reflect the impacts of the CARD Act including periodic re-evaluations of rate increase and restrictions on repricing of delinquent accounts, partially offset by improved credit quality as compared to the prior year. Net interest margin for our Card and Retail Services business increased slightly in 2011 as a result of a lower cost of funds as a percentage of average interest earning assets, partially offset by lower receivable yields as discussed above.  The provision for credit losses for our credit card receivable portfolio decreased during 2011. Provision for credit losses in 2011 was impacted by our announcement in August 2011 to sell our credit card operations to Capital One as discussed above. As these receivables are now included as part of the disposal group held for sale, which is carried at the lower of amortized cost or fair value, we no longer record provisions for credit losses on these receivables following the transfer to held for sale during the third quarter of 2011. The decrease also reflects lower receivable levels as a result of receivable run-off. Additionally, the decrease reflects improvement in the underlying credit quality of the portfolio including improvements in early stage delinquency roll rates and lower delinquency and charge-off levels as customer payment rates have continued to be strong during 2011.  Other revenues for our discontinued Card and Retail Services business increased during 2011 reflecting lower fee charge-offs driven by improved credit quality, improved roll rates and lower fees billed. Additionally, overlimit fees, which significantly decreased since the implementation of certain provisions of the CARD Act which required customers to opt-in for such overlimit fees, began to increase during the second quarter of 2011 and continued through the remainder of 2011 as more customers have opted-in.  Operating expenses decreased during 2011 due to lower third party collection costs as credit card loan balances have decreased and credit quality has improved, lower salaries and employee benefits due to the impact of entity-wide initiatives to reduce costs, lower marketing expenses and lower intangible amortization as amortization ceased following the transfer to held for sale. These decreases were partially offset by an impairment of certain previously capitalized software development costs of $40 million and higher legal expense.                                           39 

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  Table of Contents                                                          HSBC Finance Corporation        2010 as compared to 2009 Income from our discontinued Card and Retail Services business in 2009 was significantly impacted by goodwill impairment charges of $2.0 billion as discussed more fully below. Excluding the goodwill impairment charges from 2009 results, income from our discontinued Card and Retail Services business remained higher during 2010 as compared to 2009 driven by lower provision for credit losses, partially offset by lower other revenues, lower net interest income and higher operating expenses.  Lower net interest income in 2010 reflects the impact of lower average receivables as a result of receivable liquidation, risk mitigation efforts and an increased focus and ability by consumers to reduce outstanding credit card debt, partially offset by higher receivable yields and lower interest expense. The higher credit card receivable yields reflect the impact of improved credit quality during 2010, partially offset by the implementation of certain provision of the Card Act, including restrictions impacting repricing of delinquent accounts and periodic re-evaluation of rate increases. Net interest margin for our Card and Retail Services business increased in 2010 as a result of the higher yields as discussed above.  The provision for credit losses for our credit card receivable portfolio decreased during 2010 due to lower receivable levels as a result of actions taken beginning in the fourth quarter of 2007 to manage risk as well as an increased focus and ability by consumers to reduce outstanding credit card debt. The decrease also reflects improvement in the underlying credit quality of the portfolio including continuing improvements in early stage delinquency roll rates and lower delinquency levels as customer payment rates were strong throughout 2010. The impact on credit card receivable losses from the economic environment, including high unemployment levels, was not as severe as originally expected due in part to improved customer payment behavior.  Other revenues for our discontinued Card and Retail Services business decreased during 2010 reflecting lower fee income and lower enhancement services revenues, partially offset by higher gains on receivable sales to HSBC affiliates and lower of amortized cost or fair value adjustments on receivables held for sale in the prior year. Fee income decreased in 2010 due to lower late and overlimit fees due to lower volumes and lower delinquency levels, changes in customer behavior and impacts from changes required by the Card Act. The Card Act resulted in significant decreases in late fees due to limits on fees that can be assessed and overlimit fees as customers must now opt-in for such overlimit fees as well as restrictions on fees charged to process on-line and telephone payments. Enhancement services revenues decreased in 2010 as a result of lower new origination volumes and lower receivable levels. Higher gains on receivable sales to HSBC affiliates reflects higher overall premiums partially offset by lower overall origination volumes. Gain on receivable sales to HSBC affiliates in 2009 also included a gain on the bulk sale of the General Motors and Union Privilege receivable portfolios to HSBC Bank USA which resulted in a gain of $50 million. There was no similar transaction in 2010. The decrease in lower of amortized cost or fair value adjustments on receivables held for sale in 2010 reflects lower levels of receivables held for sale during 2010 as the majority of the credit card receivables held for sale were sold to HSBC Bank USA in January 2009 as previously discussed.  Operating expenses in 2009 were significantly impacted by a goodwill impairment charge of $2.0 billion as a result of the continuing deterioration of economic conditions. This goodwill impairment charge reflects the remainder of the goodwill allocated to our Card and Retail Services business. Excluding the impact of this goodwill impairment charge in 2009, operating expenses in 2010 increased due to higher support services from affiliates and higher marketing expenses, partially offset by lower salaries and employee benefits and lower servicing and administrative expenses due to entity-wide initiatives to reduce costs. The increase in support services from affiliates during 2010 reflects an increase in services provided to us by HSBC affiliates located outside of the United States which provides operational support, including among other areas, customer service, systems, collection and accounting functions. Marketing expenses increased during 2010 as we increased direct marketing mailings and new customer account originations for portions of our non-prime credit card receivable portfolio based on recent performance trends in the portfolios as well as increased compliance mailings in the second quarter of 2010 related to the implementation of the Card Act. Lower salaries and employee benefits reflect the increase in services provided by HSBC affiliates located outside of the United States as discussed above as well as other entity-wide initiatives to reduce costs.                                           40 

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  Table of Contents                                                          HSBC Finance Corporation        Receivables Credit card receivables totaled $9.0 billion at December 31, 2011 compared to $9.9 billion at December 31, 2010. At December 31, 2011, credit card receivables are included as part of the disposal group held for sale to Capital One which is carried at the lower of amortized cost or fair value. At December 31, 2010, credit card receivables were carried at amortized cost and as such, are not directly comparable to the current period balances. When viewed on a comparable basis, credit card receivables remained lower as compared to December 31, 2010 reflecting continued receivable run-off largely in the segments of our credit card receivable portfolio for which we no longer originate new accounts, partially offset by increases in receivables associated with new account activity.  Funding and Capital During 2011, HINO made two capital contributions to us totaling $690 million to support ongoing operations and to maintain capital above the minimum levels we believe are necessary to support our operations. As we continue to liquidate our Consumer Lending and Mortgage Services receivable portfolios, HSBC's continued support will be required to properly manage our business operations and maintain appropriate levels of capital. HSBC has historically provided significant capital in support of our operations and has indicated that it is fully committed and has the capacity and willingness to continue that support.  During 2011, we retired $13.4 billion of term debt as it matured or was redeemed. The maturing and redeemed debt cash requirements were met through planned balance sheet attrition, cash generated from operations, asset sales, capital contributions from HSBC, and issuance of cost effective retail debt. The balance sheet and credit dynamics described above continue to have an impact on our liquidity and risk management processes. Continued success in reducing the size of our Consumer Lending and Mortgage Services receivable portfolios coupled with the planned sale of our Card and Retail Services business during the second quarter of 2012 as discussed above will be the primary driver of our liquidity during 2012. However, lower cash flow as a result of declining receivable balances will not provide sufficient cash to fully repay maturing debt over the next four to five years. We anticipate any required incremental funding will be integrated into the overall HSBC North America funding plans or through direct HSBC support. HSBC has indicated it remains fully committed and has the capacity to continue to provide such support.  In the current market environment, market pricing continues to value the cash flows associated with our Consumer Lending and Mortgage Services receivable portfolios at amounts which are lower than what we believe will ultimately be realized. Therefore, we have determined that we have the positive intent and ability to hold these receivables for the foreseeable future and, as such, have classified our Consumer Lending and Mortgage Services receivable portfolios as held for investment purposes. However, should market pricing improve in the future or if HSBC North America calls upon us to execute certain strategies in order to address capital considerations, it could result in the reclassification of a portion of these portfolios into receivables held for sale.  The tangible common equity to tangible assets ratio was 7.12 percent and 7.31 percent at December 31, 2011 and 2010, respectively. This ratio represents a non-U.S. GAAP financial ratio that is used by HSBC Finance Corporation management, certain rating agencies and our credit providing banks to evaluate capital adequacy and may be different from similarly named measures presented by other companies. See "Basis of Reporting" and "Reconciliations to U.S. GAAP Financial Measures" for additional discussion and quantitative reconciliation to the equivalent U.S. GAAP basis financial measure.  As discussed in previous filings, HSBC North America is required to implement Basel II provisions in accordance with current regulatory timelines. While we will not report separately under the new rules, the composition of our balance sheet will impact the overall HSBC North America regulatory capital requirement. Adoption of Basel II requires the approval of U.S. regulators and encompasses enhancements to a number of risk policies, processes and systems to align HSBC North America with the Basel II final rule requirements. It is uncertain when HSBC North America will receive approval to adopt Basel II from the Federal Reserve Board, its primary regulator. HSBC North America has integrated Basel II metrics into its management reporting and decision making processes. As a result of Dodd-Frank, a banking organization that has formally implemented Basel II must calculate its capital requirements under Basel I and Basel II, compare the two results, and then use the lower of such ratios for purposes of determining compliance with its minimum Tier 1 capital and total risk-based capital requirements.                                           41 

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  Table of Contents                                                          HSBC Finance Corporation        Future Prospects While the sale of our Card and Retail Services business in 2012 will be the primary source of funding for our operations during 2012, in the longer term we will continue to be dependent on balance sheet attrition, capital contributions from our parent and affiliate funding to meet our funding requirements. In the event we were unable to complete the sale of our Card and Retail Services business to Capital One in the second quarter of 2012 or the closing of the transaction was delayed, our 2012 funding would rely more heavily on additional secured funding, other asset sales and affiliate support.  Numerous factors, both internal and external, may impact funding strategy. These factors may include our affiliate's debt ratings, overall economic conditions, overall capital markets volatility, the counterparty credit limits of investors to the HSBC Group and the effectiveness of our management of credit risks inherent in our customer base.  Our results are also impacted by general economic conditions, including unemployment, housing market conditions, property valuations, interest rates and legislative and regulatory changes, all of which are beyond our control. Because our Consumer Lending and Mortgage Services businesses have historically lent to customers who have limited credit histories, modest incomes and high debt-to-income ratios or who have experienced prior credit problems, overall our customers are more susceptible to economic slowdowns than other consumers. When unemployment increases or changes in the rate of home value appreciation or depreciation occur, a higher percentage of our customers default on their loans and our charge-offs increase. Changes in interest rates generally affect both the rates that we charge to our customers on variable rate loans and the rates that we must pay on our borrowings. In 2011, the interest rates that we paid on our short-term debt decreased. During 2011, we experienced lower overall yields on our receivable portfolio primarily due to a shift in receivable mix to higher levels of lower yielding first lien real estate secured receivables as higher yielding second lien real estate secured and personal non-credit card receivables have run-off at a faster pace than first lien real estate secured receivables. See "Results of Operations" in this MD&A for additional discussion on receivable yields. The primary risks to our performance in 2012 are largely dependent upon macro-economic conditions which include a weak housing market, high unemployment rates, the pace and extent of the economic recovery, the performance of modified loans, consumer spending and consumer confidence, all of which could impact loan volume, delinquencies, charge-offs, net interest income and ultimately our results of operations.  

Basis of Reporting

    Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). Unless noted, the discussion of our financial condition and results of operations included in MD&A are presented on a continuing operations basis of reporting. Certain reclassifications have been made to prior year amounts to conform to the current year presentation.  

In addition to the U.S. GAAP financial results reported in our consolidated financial statements, MD&A includes reference to the following information which is presented on a non-U.S. GAAP basis:

  Equity Ratios Tangible common equity to tangible assets is a non-U.S. GAAP financial measure that is used by HSBC Finance Corporation management, certain rating agencies and our credit providing banks to evaluate capital adequacy. This ratio excludes from equity the impact of unrealized gains (losses) on cash flow hedging instruments, postretirement benefit plan adjustments, unrealized gains (losses) on investments, intangible assets as well as subsequent changes in fair value recognized in earnings associated with debt for which we elected the fair value option and the related derivatives. This ratio may differ from similarly named measures presented by other companies. The most directly comparable U.S. GAAP financial measure is the common and preferred equity to total assets ratio. For a quantitative reconciliation of these non-U.S. GAAP financial measures to our common and preferred equity to total assets ratio, see "Reconciliations to U.S. GAAP Financial Measures."                                           42

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  Table of Contents                                                          HSBC Finance Corporation        International Financial Reporting Standards Because HSBC reports results in accordance with International Financial Reporting Standards ("IFRSs") and IFRSs results are used in measuring and rewarding performance of employees, our management also separately monitors net income under IFRSs (a non-U.S. GAAP financial measure). All purchase accounting fair value adjustments relating to our acquisition by HSBC have been "pushed down" to HSBC Finance Corporation for both U.S. GAAP and IFRSs. The following table reconciles our net loss on a U.S. GAAP basis to net loss on an IFRSs basis:    Year Ended December 31,                                  2011           2010           2009                                                                     (in millions) Net loss - U.S. GAAP basis                             $ (1,408 )     $ (1,916 )     $  (7,450 ) Adjustments, net of tax: Derivatives and hedge accounting (including fair value adjustments)                                           (8 )          (16 )             2 Intangible assets                                            21             35              43 Loan origination cost deferrals                               4             17              76 Loan impairment                                             (36 )          (95 )           199 Loans previously held for sale                              (18 )          (51 )           (98 ) Credit card receivables transferred to held for sale and included in discontinued operations for U.S. GAAP                                                  (194 )            -               - Interest recognition                                          1              2              (1 ) Other-than-temporary impairments on available-for-sale securities                                 -              3               2 Securities                                                   10             17             (63 ) Present value of long term insurance contracts              (53 )            7              54 Pension and other postretirement benefit costs               35             55              32 Litigation accrual                                           56              -               - Extinguishment of debt                                        -             22               -

Loss on sale of auto finance receivables and other related assets

                                                -            (47 )             - Goodwill and other intangible asset impairment charges                                                       -              -            (615 ) Other                                                       (34 )           22             (67 )  Net loss - IFRSs basis                                   (1,624 )       (1,945 )        (7,886 ) Tax benefit - IFRSs basis                                 1,080          1,085           2,443  Loss before tax - IFRSs basis                          $ (2,704 )     $ 

(3,030 ) $ (10,329 )

A summary of the significant differences between U.S. GAAP and IFRSs as they impact our results are presented below:

  Derivatives and hedge accounting (including fair value adjustments) - The historical use of the "shortcut" and "long haul" hedge accounting methods for U.S. GAAP resulted in different cumulative adjustments to the hedged item for both fair value and cash flow hedges. These differences are recognized in earnings over the remaining term of the hedged items. All of the hedged relationships which previously qualified under the shortcut method provisions of derivative accounting principles have been redesignated and are now either hedges under the long-haul method of hedge accounting or included in the fair value option election.  Intangible assets - Intangible assets under IFRSs are significantly lower than those under U.S. GAAP as the intangibles created as a result of our acquisition by HSBC were reflected in goodwill for IFRSs. As a result, amortization of intangible assets is lower under IFRSs.  Loan origination costs deferrals - Under IFRSs, loan origination cost deferrals are more stringent and generally result in lower costs being deferred than permitted under U.S. GAAP. In addition, all deferred loan origination fees, costs and loan premiums must be recognized based on the expected life of the receivables under IFRSs as                                           43 

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  Table of Contents                                                          HSBC Finance Corporation        part of the effective interest calculation while under U.S. GAAP they may be recognized on either a contractual or expected life basis. As a result, in years with lower levels of receivable originations, net income is lower under U.S. GAAP as the higher costs deferred in prior periods are amortized into income without the benefit of similar levels of cost deferrals for current period originations.  Loan impairment - IFRSs requires a discounted cash flow methodology for estimating impairment on pools of homogeneous customer loans which requires the discounting of cash flows including recovery estimates at the original effective interest rate of the pool of customer loans. The amount of impairment relating to the discounting of future cash flows unwinds with the passage of time, and is recognized in interest income. Also under IFRSs, if the recognition of a write-down to fair value on secured loans decreases because collateral values have improved and the improvement can be related objectively to an event occurring after recognition of the write-down, such write-down can be reversed, which is not permitted under U.S. GAAP. Additionally under IFRSs, future recoveries on charged-off loans or loans written down to fair value less cost to obtain title and sell the collateral are accrued for on a discounted basis and a recovery asset is recorded. Subsequent recoveries are recorded to earnings under U.S. GAAP, but are adjusted against the recovery asset under IFRSs. Under IFRSs, interest on impaired loans is recorded at the effective interest rate on the customer loan balance net of impairment allowances, and therefore reflects the collectibility of the loans.  As previously discussed, in the third quarter of 2011 we adopted new guidance under U.S. GAAP for determining whether a restructuring of a receivable meets the criteria to be considered a TDR Loan. Credit loss reserves on TDR Loans are established based on the present value of expected future cash flows discounted at the loans' original effective interest rate.  Under IFRSs, impairment on the residential mortgage loans where we have granted the borrower a concession as a result of financial difficulty is measured based on the cash flows attributable to the credit loss events which occurred before the reporting date. HSBC's accounting policy under IFRSs is to remove such loans from the category of impaired loans after a defined period of re-performance, although such loans remain segregated from loans that were not impaired in the past for the purposes of collective impairment assessment to reflect their credit risk. Under U.S. GAAP, when a loan is impaired the impairment is measured based on all expected cash flows over the remaining expected life of the loan. Such loans generally remain impaired for the remainder of their lives under U.S. GAAP.  Loans previously held for sale- IFRSs requires loans designated as held for sale at the time of origination to be treated as trading assets and recorded at their fair value. Under U.S. GAAP, loans designated as held for sale are reflected as loans and recorded at the lower of amortized cost or fair value. Under U.S. GAAP, the income and expenses related to receivables held for sale are reported similarly to loans held for investment. Under IFRSs, the income and expenses related to receivables held for sale are reported in other operating income.  Certain receivables that were previously classified as held for sale under U.S. GAAP were transferred to held for investment during 2009 as at that time we intended to hold these receivables for the foreseeable future. Under U.S. GAAP, these receivables were subject to lower of amortized cost or fair value ("LOCOM") adjustments while classified as held for sale and were transferred to held for investment at LOCOM. Since these receivables were not classified as held for sale under IFRSs during 2008, these receivables were always reported within loans and the measurement criteria did not change. As a result, loan impairment charges were recorded under IFRSs which were essentially included as a component of the lower of amortized cost or fair value adjustments under U.S. GAAP.  Credit card receivables transferred to held for sale and included in discontinued operations for U.S. GAAP For receivables transferred to held for sale subsequent to origination, IFRSs requires these receivables to be reported separately on the balance sheet but does not change the recognition and measurement criteria. Accordingly for IFRSs purposes, such loans continue to be accounted for in accordance with IAS 39, "Financial Instruments: Recognition and Measurement" ("IAS 39"), with any gain or loss recorded at the time of sale. U.S. GAAP requires loans that meet the held for sale classification requirements be transferred to a held for sale category at the lower of amortized cost or fair value.  Interest recognition - The calculation of effective interest rates under IAS 39 requires an estimate of changes in estimated contractual cash flows, including fees and points paid or recovered between parties to the contract that                                           44

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  Table of Contents                                                          HSBC Finance Corporation        are an integral part of the effective interest rate be included. U.S. GAAP generally prohibits recognition of interest income to the extent the net investment in the loan would increase to an amount greater than the amount at which the borrower could settle the obligation. Also under U.S. GAAP, prepayment penalties are generally recognized as received. During 2011, for IFRSs there was approximately $185 million of cumulative effective interest rate adjustments recognized to correct prior period errors.  Other-than-temporary impairment on available-for-sale securities - Under U.S. GAAP, the credit loss component of an other-than-temporary impairment of a debt security is recognized in earnings while the remaining portion of the impairment loss is recognized in other comprehensive income provided a company concludes it neither intends to sell the security nor concludes that it is more-likely-than-not that it will have to sell the security prior to recovery. Under IFRSs, there is no bifurcation of other-than-temporary impairment and the entire decline in fair value is recognized in earnings.  Securities - Under IFRSs, securities include HSBC shares held for stock plans at fair value. These shares are recorded at fair value through other comprehensive income and subsequently recognized in profit and loss as the shares vest. If it is determined these shares have become impaired, the fair value loss is recognized in profit and loss and any fair value loss recorded in other comprehensive income is reversed. There is no similar requirement under U.S. GAAP.  During the second quarter of 2009, under IFRSs we recorded income for the value of additional shares attributed to HSBC shares held for stock plans as a result of HSBC's rights offering earlier in 2009. During 2011 and 2010, under IFRSs we recorded additional gains as these shares vest. The additional shares are not recorded under U.S. GAAP.  Present value of long-term insurance contracts - Under IFRSs, the present value of an in-force ("PVIF") long-term insurance contract is determined by discounting future cash flows expected to emerge from business currently in force using appropriate assumptions plus a margin in assessing factors such as future mortality, lapse rates and levels of expenses, and a discount rate that reflects the risk free rate plus a margin for operational risk. Movements in the PVIF of long-term insurance contracts are included in other operating income. Under U.S. GAAP, revenue is recognized over the life insurance policy term.  During the second quarter of 2009, we refined the income recognition methodology in respect to long-term insurance contracts. This resulted in the recognition of a revenue item on an IFRSs basis of $66 million ($43 million after-tax). Approximately $43 million ($28 million after-tax) would have been recorded prior to January 1, 2009 if the refinement in respect of income recognition had been applied at that date.  During 2011, we updated the assumptions used to calculate the PVIF asset. This resulted in a net decrease of $53 million in the PVIF asset on an IFRS basis. The decrease in the asset was recognized in other income. The decrease is primarily due to the increased mortality and policy expenses related to life insurance contracts and increased longevity in the annuity book.  Pension and other postretirement benefit costs - Net income under U.S. GAAP is lower than under IFRSs as a result of the amortization of the amount by which actuarial losses exceeded the higher of 10 percent of the projected benefit obligation or fair value of plan assets (the "corridor.") During the fourth quarter of 2011, under IFRSs we recorded a curtailment gain of $52 million related to our decision to sell our Card and Retail Services business, as previously discussed. Under U.S. GAAP, the curtailment gain will be recorded at the time of the transaction. Additionally, in the fourth quarter of 2011 an amendment was made to the benefit formula associated with services provided by certain employees in past periods. Under IFRSs, the financial impact of this amendment of $31 million was immediately recognized in earnings. Under U.S. GAAP, the financial impact was recorded in accumulated other comprehensive income and will be amortized to net periodic pension cost over the remaining life expectancy of the participants.  Furthermore, in 2010 changes to future accruals for legacy participants under the HSBC North America Pension Plan were accounted for as a plan curtailment under IFRSs, which resulted in immediate income recognition. Under U.S. GAAP, these changes were considered to be a negative plan amendment which resulted in no immediate income recognition. During the first quarter of 2009, the curtailment gain related to postretirement benefits and also resulted in lower net income under U.S. GAAP than IFRSs.                                           45

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  Table of Contents                                                          HSBC Finance Corporation        Litigation accrual - A litigation accrual was recorded at year end for U.S. GAAP related to a potential settlement of a legal matter where the loss criteria have been met and an accrual can be estimated. Under IFRSs, apart from the likelihood of a potential settlement, it was determined that a present obligation did not exist at December 31, 2011 and therefore a liability was not recognized. In addition, under limited circumstances, the amount of litigation provision may be different between U.S. GAAP and IFRSs when the criteria have been met to recognize an accrual.  Extinguishment of debt - During the fourth quarter of 2010, we exchanged $1.8 billion in senior debt for $1.9 billion in new fixed rate subordinated debt. Under IFRSs, the population of debt exchanged which qualified for extinguishment treatment was larger than under U.S. GAAP which resulted in a gain on extinguishment of debt under IFRSs compared to a small loss under U.S. GAAP.  Loss on sale of auto finance receivables and other related assets - The differences in the loss on sale of the auto finance receivables between IFRSs and U.S. GAAP primarily reflects the differences in loan impairment provisioning between IFRSs and U.S. GAAP as discussed above. These differences resulted in a higher loss under IFRSs, as future recoveries are accrued for on a discounted basis.  Goodwill and other intangible asset impairment charges - Goodwill levels established as a result of our acquisition by HSBC were higher under IFRSs than U.S. GAAP as the HSBC purchase accounting adjustments reflected higher levels of intangibles under U.S. GAAP. Consequently, the amount of goodwill allocated to our Card and Retail Services and Insurance Services businesses and written off during 2009 was greater under IFRSs. Additionally, the intangible assets allocated to our Consumer Lending business and written off during the first quarter of 2009 were higher under U.S. GAAP. There are also differences in the valuation of assets and liabilities under IFRSs and U.S. GAAP resulting from the Metris acquisition in December 2005.  

Other - There are other differences between IFRSs and U.S. GAAP including purchase accounting, other miscellaneous items and, in 2011, mortgage servicing related matters.

  Quantitative Reconciliations of Non-U.S. GAAP Financial Measures to U.S. GAAP Financial Measures For quantitative reconciliations of non-U.S. GAAP financial measures presented herein to the equivalent GAAP basis financial measures, see "Reconciliations to U.S. GAAP Financial Measures."  

Critical Accounting Policies and Estimates

    Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. We believe our policies are appropriate and fairly present the financial position of HSBC Finance Corporation.  The significant accounting policies used in the preparation of our financial statements are more fully described in Note 2, "Summary of Significant Accounting Policies and New Accounting Pronouncements," to the accompanying consolidated financial statements. Certain critical accounting policies, which affect the reported amounts of assets, liabilities, revenues and expenses, are complex and involve significant judgment by our management, including the use of estimates and assumptions. As a result, changes in estimates, assumptions or operational policies could significantly affect our financial position or our results of operations. We base and establish our accounting estimates on historical experience, observable market data, inputs derived from or corroborated by observable market data by correlation or other means, and on various other assumptions including those based on unobservable inputs that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying amounts of assets and liabilities. In addition, to the extent we use certain modeling techniques to assist us in measuring the fair value of a particular asset or liability, we strive to use such techniques which are consistent with those used by other market participants. Actual results may differ from these estimates due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change. The impact of estimates and assumptions on the financial condition or operating performance may be material.  

We believe that of the significant accounting policies used in the preparation of our consolidated financial statements, the items discussed below involve critical accounting estimates and a high degree of judgment and

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  Table of Contents                                                          HSBC Finance Corporation        complexity. Our management has discussed these critical accounting policies with the Audit and Risk Committee of our Board of Directors, including certain underlying estimates and assumptions, and the Audit and Risk Committee has reviewed our disclosure relating to these accounting policies and practices in this MD&A.  Credit Loss Reserves Because we lend money to others, we are exposed to the risk that borrowers may not repay amounts owed to us when they become contractually due. Consequently, we maintain credit loss reserves at a level that we consider adequate, but not excessive, to cover our estimate of probable incurred losses of principal, interest and fees, including late, over-limit and annual fees, in the existing portfolio. Loss reserves are set at each business unit in consultation with the Finance and Risk Departments. Loss reserve estimates are reviewed periodically and adjustments are reflected through the provision for credit losses in the period when they become known. We believe the accounting estimate relating to the reserve for credit losses is a "critical accounting estimate" for the following reasons:      •   Changes in the provision can materially affect our financial results;         •   Estimates related to the reserve for credit losses require us to project

future delinquency and charge-off trends which are uncertain and require a

         high degree of judgment; and         •   The reserve for credit losses is influenced by factors outside of our

control such as customer payment patterns, economic conditions such as

national and local trends in housing markets, interest rates, unemployment

rates, bankruptcy trends and changes in laws and regulations.

   Because our loss reserve estimates involve judgment and are influenced by factors outside of our control, there is uncertainty inherent in these estimates, making it reasonably possible such estimates could change. Our estimate of probable net credit losses is inherently uncertain because it is highly sensitive to changes in economic conditions, which influence growth, portfolio seasoning, bankruptcy trends, trends in housing markets, the ability of customers to refinance their adjustable rate mortgages, the performance of modified loans, unemployment levels, delinquency rates and the flow of loans through the various stages of delinquency, the realizable value of any collateral and actual loss exposure. Changes in such estimates could significantly impact our credit loss reserves and our provision for credit losses. For example, a 10 percent change in our projection of probable net credit losses on receivables would have resulted in a change of approximately $595 million in our credit loss reserves for receivables at December 31, 2011. The reserve for credit losses is a critical accounting estimate for our Consumer segment.  We estimate probable losses for certain consumer receivables which do not qualify as a troubled debt restructuring using a roll rate migration analysis that estimates the likelihood that a loan will progress through the various stages of delinquency, or buckets, and ultimately charge-off based upon recent historical performance experience of other loans in our portfolio. This analysis considers delinquency status, loss experience and severity and takes into account whether loans have filed for bankruptcy, have been re-aged, or are subject to forbearance, an external debt management plan, hardship, modification, extension or deferment. Our credit loss reserves also take into consideration the expected loss severity based on the underlying collateral, if any, for the loan in the event of default based on recent trends. Delinquency status may be affected by customer account management policies and practices, such as the re-age of accounts, forbearance agreements, extended payment plans, modification arrangements, external debt management programs and deferments. When customer account management policies, or changes thereto, shift loans from a "higher" delinquency bucket to a "lower" delinquency bucket, this will be reflected in our roll rates statistics. To the extent that re-aged or modified accounts have a greater propensity to roll to higher delinquency buckets, this will be captured in the roll rates. Since the loss reserve is computed based on the composite of all these calculations, this increase in roll rate will be applied to receivables in all respective delinquency buckets, that will increase the overall reserve level. In addition, loss reserves on consumer receivables are maintained to reflect our judgment of portfolio risk factors which may not be fully reflected in the statistical roll rate calculation or when historical trends are not reflective of current inherent losses in the loan portfolio. Portfolio risk factors considered in establishing loss reserves on consumer receivables include product mix, unemployment rates, bankruptcy trends, the credit performance of modified loans, geographic concentrations, loan product features such as adjustable rate loans, economic                                           47

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  Table of Contents                                                          HSBC Finance Corporation        conditions such as national and local trends in housing markets and interest rates, portfolio seasoning, account management policies and practices, current levels of charge-offs and delinquencies, changes in laws and regulations and other factors which can affect consumer payment patterns on outstanding receivables, such as natural disasters. Another portfolio risk factor we consider is the credit performance of certain second lien loans following more delinquent first lien loans which we own or service. Once we determine that such a second lien loan is likely to progress to charge-off, the loss severity assumed in establishing our credit loss reserves is close to 100 percent. Approximately 3 percent of our second lien mortgages where the first lien mortgage is held or serviced by us and has a delinquency status of 90 days or more delinquent were less than 90 days delinquent and not considered to be a troubled debt restructure or already recorded at fair value less cost to sell.  While our credit loss reserves are available to absorb losses in the entire portfolio, we specifically consider the credit quality and other risk factors for each of our products. We recognize the different inherent loss characteristics in each of our products and for certain products their vintages, as well as customer account management policies and practices and risk management/collection practices. Charge-off policies are also considered when establishing loss reserve requirements. We also consider key ratios such as reserves as a percentage of nonperforming loans, reserves as a percentage of net charge-offs and reserves as a percentage of two-months-and-over contractual delinquency in developing our loss reserve estimate. In addition to the above procedures for the establishment of our credit loss reserves, our Risk and Finance Departments independently assess and approve the adequacy of our loss reserve levels.  Reserves against loans modified in troubled debt restructurings are determined primarily by an analysis of discounted expected cash flows and may be based on independent valuations of the underlying loan collateral, where appropriate.  

For more information about our charge-off and customer account management policies and practices, see "Credit Quality - Delinquency and Charge-off Policies and Practices," and "Credit Quality - Customer Account Management Policies and Practices," in this MD&A and Note 7, "Changes in Charge-off Policies During 2009," in the accompanying consolidated financial statements.

  Goodwill and Intangible Assets Goodwill and intangible assets with indefinite lives are not subject to amortization. Intangible assets with finite lives are amortized over their estimated useful lives. Intangible assets and goodwill recorded on our balance sheet are reviewed annually on July 1 for impairment using discounted cash flows, but impairment may also be reviewed at other interim dates if circumstances indicate that the carrying amount may not be recoverable. We consider significant and long-term changes in industry and economic conditions to be examples of primary indicators of potential impairment due to their impact on expected future cash flows. In addition, shorter-term changes may impact the discount rate applied to such cash flows based on changes in investor requirements or market uncertainties.  The impairment testing of our intangibles has historically been a critical accounting estimate due to the level of intangible assets recorded and the significant judgment required in the use of discounted cash flow models to determine fair value. For certain prior periods presented, the impairment testing of our goodwill has been a critical accounting estimate due to the level of goodwill recorded and the significant judgment required in the use of discounted cash flow models to determine fair value. Discounted cash flow models include such variables as revenue growth rates, expense trends, interest rates and terminal values. Based on an evaluation of key data and market factors, management's judgment is required to select the specific variables to be incorporated into the models. Additionally, the estimated fair value can be significantly impacted by the risk adjusted cost of capital used to discount future cash flows. The risk adjusted cost of capital is generally derived from an appropriate capital asset pricing model, which itself depends on a number of financial and economic variables which are established on the basis of that used by market participants, which involves management judgment. Because our fair value estimate involves judgment and is influenced by factors outside our control, it is reasonably possible such estimates could change. When management's judgment is that the anticipated cash flows have decreased and/or the risk adjusted cost of capital has increased, the effect will be a lower estimate of fair value. If the fair value is determined to be lower than the carrying amount, an impairment charge may be recorded and net income will be negatively impacted.                                           48 

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  Table of Contents                                                          HSBC Finance Corporation        Impairment testing of goodwill requires that the fair value of each reporting unit be compared to its carrying amount, including goodwill. A reporting unit is defined as an operating segment or any distinct, separately identifiable component of an operating segment for which complete, discrete financial information is available that management regularly reviews. For purposes of the annual goodwill impairment test and any interim test which may be required, we assign our goodwill to our reporting units. As a result of the continuing deterioration of economic conditions throughout 2008 and into 2009 as well as the adverse impact to our Insurance Services business which resulted from the closure of all of our Consumer Lending branches, we wrote off all of our remaining goodwill balance during 2009.  Impairment testing of intangible assets requires that the fair value of the asset be compared to its carrying amount. At July 1, 2011, the estimated fair value of each intangible asset exceeded its carrying amount and, as such, none of our intangible assets were impaired. As a result of the pending sale of our Card and Retail Services business to Capital One as discussed above, all of our remaining intangible assets are reported in discontinued operations.  Valuation of Financial Instruments A control framework has been established which is designed to ensure that fair values are either determined or validated by a function independent of the risk-taker. To that end, the ultimate responsibility for the determination of fair values rests with the HSBC Finance Valuation Committee. The HSBC Finance Valuation Committee establishes policies and procedures to ensure appropriate valuations.  Where available, we use quoted market prices to determine fair value. If quoted market prices are not available, fair value is determined using internally developed valuation models based on inputs that are either directly observable or derived from and corroborated by market data. Where neither quoted market prices nor observable market parameters are available, fair value is determined using valuation models that feature one or more significant unobservable inputs based on management's expectation that market participants would use in determining the fair value of the asset or liability. However, these unobservable inputs must incorporate market participants' assumptions about risks in the asset or liability and the risk premium required by market participants in order to bear the risks. The determination of appropriate unobservable inputs requires exercise of management judgment. A significant majority of our assets and liabilities that are reported at fair value are measured based on quoted market prices and observable market-based or independently-sourced inputs.  We review and update our fair value hierarchy classifications quarterly. Changes from one quarter to the next related to the observability of inputs to a fair value measurement may result in a reclassification between hierarchy levels. While we believe our valuation methods are appropriate, the use of different methodologies or assumptions to determine the fair value of certain financial assets and liabilities could result in a different estimate of fair value at the reporting date.  

Significant assets and liabilities recorded at fair value include the following:

  Derivative financial assets and liabilities - We regularly use derivative instruments as part of our risk management strategy to protect the value of certain assets and liabilities and future cash flows against adverse interest rate and foreign exchange rate movements. All derivatives are recognized on the balance sheet at fair value. Related collateral that has been received or paid is netted against fair value for financial reporting purposes where a master netting arrangement with the counterparty exists that provides for the net settlement of all contracts through a single payment in a single currency in the event of default or termination on any one contract. We believe the valuation of derivative instruments is a critical accounting estimate because certain instruments are valued using discounted cash flow modeling techniques in lieu of observable market value quotes for identical or similar assets or liabilities in active and inactive markets. These modeling techniques require the use of estimates regarding the amount and timing of future cash flows and utilize independently-sourced market parameters, including interest rate yield curves, option volatilities, and currency rates, where available. Where market data is not available, fair value may be affected by the choice of valuation model and the underlying assumptions about the timing of cash flows and credit spreads. These estimates are susceptible to significant changes in future periods as market conditions evolve.                                           49 

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  Table of Contents                                                          HSBC Finance Corporation        We may adjust certain fair value estimates determined using valuation models to ensure that those estimates appropriately represent fair value. These adjustments, which are applied consistently over time, are generally required to reflect factors such as market liquidity and counterparty credit risk. Assessing the appropriate level of liquidity adjustment requires management judgment and is often affected by the product type, transaction-specific terms and the level of liquidity for the product in the market. In assessing the credit risk relating to derivative assets and liabilities, we take into account the impact of risk mitigants including, but not limited to, master netting and collateral arrangements. We also consider the effect of our own non-performance credit risk on fair values. Imprecision in estimating these factors can impact the amount of revenue or loss recorded for a particular position.  We utilize HSBC Bank USA to determine the fair value of substantially all of our derivatives using these modeling techniques. Significant changes in the fair value can result in equity and earnings volatility as follows:    

• Changes in the fair value of a derivative that has been designated and

           qualifies as a fair value hedge, along with the changes in the fair            value of the hedged asset or liability (including losses or gains on            firm commitments), are recorded in current period earnings.    

• Changes in the fair value of a derivative that has been designated and

            qualifies as a cash flow hedge are recorded in other 

comprehensive

            income, net of tax, to the extent of its effectiveness, until 

earnings

            are impacted by the variability of cash flows from the hedged 

item. Any

            ineffectiveness is recognized in current period earnings.            •   Changes in the fair value of a derivative that has not been designated            as an effective hedge are reported in current period earnings.   A derivative designated as an effective hedge will be tested for effectiveness in all circumstances under the long haul method. For these transactions, we formally assess, both at the inception of the hedge and on a quarterly basis, whether the derivative used in a hedging transaction has been and is expected to continue to be highly effective in offsetting changes in fair values or cash flows of the hedged item. This assessment is conducted using statistical regression analysis.  If it is determined as a result of this assessment that a derivative is not expected to be a highly effective hedge or that it has ceased to be a highly effective hedge, we discontinue hedge accounting as of the beginning of the quarter in which such determination was made. We also believe the assessment of the effectiveness of the derivatives used in hedging transactions is a critical accounting estimate due to the use of statistical regression analysis in making this determination. Similar to discounted cash flow modeling techniques, statistical regression analysis also requires the use of estimates regarding the amount and timing of future cash flows, which are susceptible to significant change in future periods based on changes in market rates. Statistical regression analysis also involves the use of additional assumptions including the determination of the period over which the analysis should occur as well as selecting a convention for the treatment of credit spreads in the analysis. The statistical regression analysis for our derivative instruments is performed primarily by HSBC Bank USA.  The outcome of the statistical regression analysis serves as the foundation for determining whether or not the derivative is highly effective as a hedging instrument. This can result in earnings volatility as the mark-to-market on derivatives which do not qualify as effective hedges and the ineffectiveness associated with qualifying hedges are recorded in current period earnings. For example, a 10 percent adverse change in the value of our derivatives which do not qualify as effective hedges would have reduced revenue by approximately $209 million at December 31, 2011.  For more information about our policies regarding the use of derivative instruments, see Note 2, "Summary of Significant Accounting Policies and New Accounting Pronouncements," and Note 13, "Derivative Financial Instruments," to the accompanying consolidated financial statements.  

Long-term debt carried at fair value - We have elected the fair value option for certain issuances of our fixed rate debt in order to align our accounting treatment with that of HSBC under IFRSs. We believe the

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  Table of Contents                                                          HSBC Finance Corporation        valuation of this debt is a critical accounting estimate because valuation estimates obtained from third parties involve inputs other than quoted prices to value both the interest rate component and the credit component of the debt. In many cases, management can obtain quoted prices for identical or similar liabilities but the markets are not active, the prices are not current, or such price quotations vary substantially either over time or among market makers. Changes in such estimates, and in particular the credit component of the valuation, can be volatile from period to period and may impact the total mark-to-market on debt designated at fair value recorded in our consolidated statement of income (loss). For example, a 10 percent change in the value of our debt designated at fair value could have resulted in a change to our reported mark-to-market of approximately $1.4 billion at December 31, 2011.  Debt securities - Debt securities, which include mortgage-backed securities and other asset-backed securities, are measured at fair value based on a third party valuation source using quoted market prices and if not available, based on observable quotes for similar securities or other valuation techniques (e.g., matrix pricing). Otherwise, for non-callable corporate securities, a credit spread scale is created for each issuer and these spreads are then added to the equivalent maturity U.S. Treasury yield to determine current pricing. The fair value measurements for mortgage-backed securities and other asset-backed securities are primarily obtained from independent pricing sources taking into account differences in the characteristics and the performance of the underlying collateral, such as prepayments and defaults. A determination will be made as to whether adjustments to the observable inputs are necessary as a result of investigations and inquiries about the reasonableness of the inputs used and the methodologies employed by the independent pricing sources.  Receivables held for sale - Receivables held for sale are carried at the lower of amortized cost or fair value. Accordingly, fair value for such receivables must be estimated to determine any required write down to fair value when the amortized cost of the receivables exceeds their current fair value. Where available, quoted market prices are used to estimate the fair value of these receivables. Where market quotes are not available, fair value is estimated using observable market prices of similar instruments with similar characteristics.  Where quoted market prices and observable market parameters are not available, the fair value of receivables held for sale is based on contractual cash flows adjusted for management's estimates of prepayments, defaults, and recoveries, discounted at management's estimate of the rate of return that would be required by investors in the current market given the specific characteristics and inherent credit risk of the receivables. Management attempts to corroborate its estimates of prepayments, defaults, and recoveries using observable data by correlation or other means. Reduced liquidity in credit markets has resulted in a decrease in the availability of observable market data, which has in turn resulted in an increased level of management judgment required to estimate fair value for receivables held for sale. In certain cases, an independent third party is utilized to substantiate management's estimate of fair value.  Deferred Tax Assets We recognize deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for tax credits and state net operating losses. Our deferred tax assets, net of valuation allowances, totaled $3.3 billion and $2.8 billion as of December 31, 2011 and 2010, respectively. We evaluate our deferred tax assets for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including our historical financial performance, projections of future taxable income, future reversals of existing taxable temporary differences and any carryback available. We are required to establish a valuation allowance for deferred tax assets and record a charge to earnings or shareholders' equity if we determine, based on available evidence at the time the determination is made, that it is more-likely-than-not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, we estimate future taxable income based on management approved business plans, future capital requirements and ongoing tax planning strategies, including capital support from HSBC necessary as part of such plans and strategies. This process involves significant management judgment about assumptions that are subject to change from period to period. Because the recognition of deferred tax assets requires management to make                                           51

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  Table of Contents                                                          HSBC Finance Corporation        significant judgments about future earnings, the periods in which items will impact taxable income and the application of inherently complex tax laws, we have included the assessment of deferred tax assets and the need for any related valuation allowance as a critical accounting estimate.  Since recent market conditions have created significant downward pressure on our near-term pretax book income, our analysis of the realizability of deferred tax assets significantly discounts any future taxable income expected from continuing operations and relies to a greater extent on continued liquidity and capital support from our parent, HSBC, including tax planning strategies implemented in relation to such support. We are included in HSBC North America's consolidated Federal income tax return and in various combined state tax returns. As we have entered into tax allocation agreements with HSBC North America and its subsidiary entities included in the consolidated return which govern the current amount of taxes to be paid or received by the various entities, we look at HSBC North America and its affiliates, together with the tax planning strategies identified, in reaching conclusions on recoverability. Absent capital support from HSBC and implementation of the related tax planning strategies, we would be required to record a valuation allowance against our deferred tax assets.  The use of different estimates can result in changes in the amounts of deferred tax items recognized, which can result in equity and earnings volatility because such changes are reported in current period earnings. Furthermore, if future events differ from our current forecasts, valuation allowances may need to be established or adjusted, which could have a material adverse effect on our results of operations, financial condition and capital position. We will continue to update our assumptions and forecasts of future taxable income and assess the need and adequacy of any valuation allowance.  We estimate and provide for potential liabilities that may arise out of tax audits to the extent that uncertain tax positions fail to meet the recognition standard under generally accepted accounting principles. Additional detail on our assumptions with respect to the judgments made in evaluating the realizability of our deferred tax assets and on the components of our deferred tax assets and deferred tax liabilities as of December 31, 2011 and 2010 can be found in Note 14, "Income Taxes," in the accompanying consolidated financial statements.  Contingent Liabilities Both we and certain of our subsidiaries are parties to various legal proceedings resulting from ordinary business activities relating to our current and/or former operations. Certain of these activities are or purport to be class actions seeking damages in significant amounts. These actions include assertions concerning violations of laws and/or unfair treatment of consumers.  We estimate and provide for potential losses that may arise out of litigation and regulatory proceedings to the extent that such losses are probable and can be reasonably estimated. Significant judgment is required in making these estimates and our final liabilities may ultimately be materially different. Our total estimated liability in respect of litigation and regulatory proceedings is determined on a case-by-case basis and represents an estimate of probable losses after considering, among other factors, the progress of each case or proceeding, our experience and the experience of others in similar cases or proceedings, and the opinions and views of legal counsel.  Litigation exposure represents a key area of judgment and is subject to uncertainty and certain factors outside of our control. Due to the uncertainties in litigation and other factors, we cannot be certain that we will ultimately prevail in each instance. Such uncertainties impact our ability to determine whether it is probable that a liability exists and whether the amount can be reasonably estimated. Also, as the ultimate resolution of these proceedings is influenced by factors that are outside of our control, it is reasonably possible our estimated liability under these proceedings may change. We will continue to update our accruals for these legal proceedings as facts and circumstances change. See Note 23, "Commitments and Contingent Liabilities" in the accompanying consolidated financial statements.                                           52

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  Table of Contents                                                          HSBC Finance Corporation        Receivables Review   

The table below summarizes receivables at December 31, 2011 and increases (decreases) over prior periods:

                                                                          Increases (Decreases) From                                                                December 31,                  December 31,                                                                    2010                          2009                                        December 31,                                            2011              $              %               $              %                                                               (dollars are in millions) Receivables: Real estate secured(1)(2)             $       42,713      $ (6,623 )       (13.4 )%     $ (16,822 )       (28.3 )% Personal non-credit card                       5,196        (1,921 )       (27.0 )         (5,290 )       (50.4 ) Commercial and other                              27            (6 )       (18.2 )            (23 )       (46.0 )  Total receivables                     $       47,936      $ (8,550 )       (15.1 )%     $ (22,135 )       (31.6 )%        (1)  Real estate secured receivables are comprised of the following:                                                                               Increases (Decreases) From                                                                   December 31,                  December 31,                                                                       2010                          2009                                           December 31,                                               2011              $              %               $              %                                                                  (dollars are in millions) Mortgage Services                        $       13,482      $ (2,500 )       (15.6 )%     $  (6,459 )       (32.4 )% Consumer Lending                                 29,227        (4,120 )       (12.4 )        (10,359 )       (26.2 ) All Other                                             4            (3 )       (42.9 )             (4 )       (50.0 ) 

Total real estate secured receivables $ 42,713 $ (6,623 )

  (13.4 )%     $ (16,822 )       (28.3 )%     

(2) At December 31, 2011, 2010 and 2009, real estate secured receivables

includes $5.9 billion, $5.1 billion and $3.4 billion, respectively, of

receivables that have been written down to their fair value less cost to

sell in accordance with our existing charge-off policy.

Real estate secured receivables The following table summarizes various real estate secured receivables information (excluding receivables held for sale) for our Mortgage Services and Consumer Lending businesses:

                                          December 31, 2011           December 31, 2010           December 31, 2009                                    Mortgage      Consumer      Mortgage      Consumer      Mortgage      Consumer                                    Services       Lending      Services       Lending      Services       Lending                                                                     (in millions) Fixed rate(1)                      $   8,792     $  27,945     $  10,014     $  31,827     $  11,962     $  37,717 Adjustable rate(1)                     4,690         1,282         5,968         1,520         7,979         1,869  Total                              $  13,482     $  29,227     $  15,982     $  33,347     $  19,941     $  39,586  First lien                         $  11,802     $  26,436     $  13,821     $  30,042     $  16,979     $  35,014 Second lien                            1,680         2,791         2,161         3,305         2,962         4,572  Total                              $  13,482     $  29,227     $  15,982     $  33,347     $  19,941     $  39,586  Adjustable rate(1)                 $   3,942     $   1,282     $   4,898     $   1,520     $   6,471     $   1,869 Interest only(1)                         748             -         1,070             -         1,508             -  Total adjustable rate(1)           $   4,690     $   1,282     $   5,968     $   1,520     $   7,979     $   1,869  Total stated income                $   2,157     $       -     $   2,703     $       -     $   3,677     $       -        (1)  Receivable classification between fixed rate, adjustable rate, and      interest-only receivables is based on the classification at the time of      receivable origination and does not reflect any changes in the 

classification that may have occurred as a result of any loan modifications.

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  Table of Contents                                                          HSBC Finance Corporation        The decrease in real estate secured receivable balances since December 31, 2010 and 2009 reflects the continuing liquidation of these portfolios which will continue going forward. The liquidation rates in our real estate secured receivable portfolios also continue to be impacted by low loan prepayments as few refinancing opportunities for our customers exist and by the trends impacting the mortgage lending industry as discussed above.  As previously discussed, real estate markets in a large portion of the United States have been affected by stagnation or declines in property values. As such, the loan-to-value ("LTV") ratios for our real estate secured receivable portfolios have generally deteriorated since origination. Receivables which have an LTV greater than 100 percent have historically had a greater likelihood of becoming delinquent, resulting in higher loss severities which could adversely impact our provision for credit losses. Refreshed loan-to-value ratios for our real estate secured receivable portfolios are presented in the table below as of December 31, 2010 and 2011.                                               Refreshed LTVs(1)(2) at December 31, 2011                               Refreshed LTVs(1)(2) at December 31, 2010                                    Consumer  Lending(3)                  Mortgage Services                 Consumer  Lending(3)                  Mortgage Services                                  First            Second              First             Second           First            Second              First             Second                                  Lien              Lien               Lien               Lien            Lien              Lien               Lien               Lien LTV < 80%                            39 %               17 %               35 %                7 %           39 %               18 %               34 %                8 % 80% £ LTV < 90%                      16                 10                 17                  9             18                 13                 18                 11 90% £ LTV < 100%                     16                 17                 18                 16             17                 20                 21                 19 LTV ³ 100%(4)                        29                 56                 30                 68             26                 49                 27                 62 Average LTV for portfolio            88                104                 90                114             87                100                 89                109      

(1) Refreshed LTVs for first liens are calculated using the receivable balance

     as of the reporting date (including any charge-offs recorded to reduce      receivables to their fair value less cost to sell in accordance with our      existing charge-off policies). Refreshed LTVs for second liens are

calculated using the receivable balance as of the reporting date (including

any charge-offs recorded to reduce receivables to their fair value less cost

to sell in accordance with our existing charge-off policies) plus the senior

lien amount at origination. For purposes of this disclosure, current

estimated property values are derived from the property's appraised value at

the time of receivable origination updated by the change in the Federal

Housing Finance Agency's (formerly known as the Office of Federal Housing

Enterprise Oversight) house pricing index ("HPI") at either a Core Based

Statistical Area ("CBSA") or state level. The estimated value of the homes

could vary from actual fair values due to changes in condition of the

underlying property, variations in housing price changes within metropolitan

statistical areas and other factors. As a result, actual property values

associated with loans which end in foreclosure may be significantly lower

     than the estimated values used for purposes of this disclosure.     (2)  For purposes of this disclosure, current estimated property values are      calculated using the most current HPI's available and applied on an

individual loan basis, which results in an approximately three month delay

in the production of reportable statistics for the current period.

Therefore, the December 31, 2011 and 2010 information in the table above

reflects current estimated property values using HPIs as of September 30,

2011 and 2010, respectively. Given the recent declines in property values in

certain markets, the refreshed LTVs of our portfolio may, in fact, be higher

     than reflected in the table.    

(3) Excludes the purchased receivable portfolios of our Consumer Lending

business which totaled $1.1 billion and $1.2 billion at December 31, 2011

     and 2010, respectively.    

(4) The following reflects the average Refreshed LTVs for loans with an LTV

      ratio greater than or equal to 100 percent:                                                 Refreshed LTVs at  December 31, 2011                                Refreshed LTVs at  December 31, 2010                                     Consumer  Lending                 Mortgage Services                 Consumer  Lending                 Mortgage Services                                  First            Second            First            Second          First            Second            First            Second                                   Lien             Lien             Lien              Lien            Lien             Lien             Lien              Lien Average LTV for LTV³100%             120 %            124 %             119 %            126 %           117 %            120 %             118 %            123 %   Personal non-credit card receivables Personal non-credit card receivables are comprised of the following:                                                                           Increases (Decreases) From                                                                December 31,                  December 31,                                                                    2010                          2009                                        December 31,                                            2011              $              %              $              %                                                               (dollars are in millions) Personal non-credit card               $       3,762      $ (1,533 )       (29.0 )%     $ (4,334 )       (53.5 )% Personal homeowner loans ("PHLs")              1,434          (388 )       

(21.3 ) (956 ) (40.0 )

  Total personal non-credit card receivables                            $       5,196      $ (1,921 )       (27.0 )%     $ (5,290 )       (50.4 )%                                             54 

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  Table of Contents                                                          HSBC Finance Corporation        The decrease in personal non-credit card receivables since December 31, 2010 and 2009 reflect the continuing liquidation of this portfolio which will continue going forward.  PHLs typically have terms of 120 to 240 months and are subordinate lien, home equity loans with high (100 percent or more) combined loan-to-value ratios which we underwrote, priced and service like unsecured loans. The average PHL principal balance in our portfolio at December 31, 2011 is approximately $17,000. Because recovery upon foreclosure is unlikely after satisfying senior liens and paying the expenses of foreclosure, we do not consider the collateral as a source for repayment in the establishment of credit loss reserves.  

Real Estate Owned

    We obtain real estate by taking possession of the collateral pledged as security for real estate secured receivables. Prior to taking possession of the pledged collateral, receivable carrying amounts in excess of fair value less cost to sell are generally charged-off at or before the time foreclosure is completed or settlement is reached with the borrower but, in any event, generally no later than the end of the month in which the account becomes six months contractually delinquent. If foreclosure is not pursued (which frequently occurs on loans in the second lien position) and there is no reasonable expectation for recovery (insurance claim, title claim, pre-discharge bankrupt account), the account is generally charged-off no later than the end of the month in which the account becomes six months contractually delinquent. Values are determined based upon broker price opinions or appraisals which are updated every 180 days.  

During the quarterly period between updates, real estate price trends are reviewed on a geographic basis and additional downward adjustments are recorded as necessary.

  Collateral acquired in satisfaction of a loan is initially recognized at the lower of amortized cost or its fair value, less estimated costs to sell and reported as real estate owned ("REO"). Fair values of foreclosed properties at the time of acquisition are initially determined based upon broker price opinions. Subsequent to acquisition, a more detailed property valuation is performed, reflecting information obtained from a walk-through of the property in the form of a listing agent broker price opinion as well as an independent broker price opinion or appraisal. A valuation is determined from this information within 90 days and any additional write-downs required are recorded through charge-off at that time. This value, which includes the impact on fair value from the conditions inside the property, becomes the "Initial REO Carrying Amount."  In determining the appropriate amounts to charge-off when a property is acquired in exchange for a loan, we do not consider losses on sales of foreclosed properties resulting from deterioration in value during the period the collateral is held because these losses result from future loss events which cannot be considered in determining the fair value of the collateral at the acquisition date in accordance with generally accepted accounting principles. Once a property is classified as real estate owned, we do not consider the losses on past sales of foreclosed properties when determining the fair value of any collateral during the period it is held in REO. Rather, a valuation allowance is created to recognize any subsequent declines in fair value less cost to sell as they become known after the Initial REO Carrying Amount is determined with a corresponding amount reflected in operating expense. Property values are periodically reviewed for impairment until the property is sold and any impairment identified is immediately recognized through the valuation allowance. Recoveries in value are also recognized against the valuation allowance but not in excess of cumulative losses previously recognized subsequent to the date of repossession. Adjustments to the valuation allowance, costs of holding REO and any gain or loss on disposition are credited or charged to operating expense.                                           55 

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  Table of Contents                                                          HSBC Finance Corporation        The following table provides quarterly information regarding our REO properties:                                                                              Quarter Ended                                     Full Year        Dec. 31,        Sept. 30,        June 30,       Mar. 31,        Full Year                                       2011             2011            2011             2011           2011            2010 Number of REO properties at end of period                                3,446           3,446            4,250           6,854         10,016           10,749 Number of properties added to REO inventory in the period             10,957           1,676            1,378           2,495          5,408           20,112 Average loss on sale of REO properties(1)                              8.2 %          10.2 %            8.9 %           7.0 %          7.9 %            4.8 % Average total loss on foreclosed properties(2)                             55.5 %          57.6 %           56.4 %          54.9 %         54.6 %           51.1 % Average time to sell REO properties (in days)                       185             206              196             169            167              161      

(1) Property acquired through foreclosure is initially recognized at the lower

of amortized cost or its fair value less estimated costs to sell ("Initial

REO Carrying Amount"). The average loss on sale of REO properties is

calculated as cash proceeds less the Initial REO Carrying Amount divided by

the unpaid loan principal balance prior to write-down (excluding any accrued

finance income) plus certain other ancillary disbursements that, by law, are

reimbursable from the cash proceeds (e.g., real estate tax advances) and

     were incurred prior to our taking title to the property. This ratio      represents the portion of our total loss on foreclosed properties that      occurred after we took title to the property.    

(2) The average total loss on foreclosed properties sold each quarter includes

both the loss on sale of the REO property as discussed above and the

cumulative write-downs recognized on the loans up to the time we took title

to the property. This calculation of the average total loss on foreclosed

properties uses the unpaid loan principal balance prior to write-down

(excluding any accrued finance income) plus certain other ancillary

disbursements that, by law, are reimbursable from the cash proceeds (e.g.,

real estate tax advances) and were incurred prior to our taking title to the

property.

   Our methodology for determining the fair values of the underlying collateral as described above is continuously validated by comparing our net investment in the loan subsequent to charging the loan down to fair value less cost to sell, or our net investment in the property upon completing the foreclosure process, to the updated broker's price opinion and once the collateral has been obtained, any adjustments that have been made to lower the expected selling price, which may be lower than the broker's price opinion. Adjustments in our expectation of the ultimate proceeds that will be collected are recognized as they occur based on market information at that time and consultation with our listing agents for the properties.  As previously reported, beginning in late 2010 we suspended all new foreclosure proceedings and in early 2011 suspended foreclosures in process where judgment had not yet been entered while we enhanced foreclosure documentation and processes for foreclosures and re-filed affidavits where necessary. During 2011, we added 10,957 properties to REO inventory which primarily reflects loans for which we had either accepted the deed to the property in lieu of payment or for which we had received a foreclosure judgment prior to the suspension of foreclosures. We expect the number of REO properties added to inventory during 2012 will be impacted by our continuing refinements to our foreclosure processes as well as the extended foreclosure timelines in all states as discussed below.  The number of REO properties at December 31, 2011 decreased as compared to December 31, 2010 driven by the temporary suspension of foreclosures as previously discussed above as well as sales of REO properties during the year. We have resumed processing the majority of suspended foreclosure activities in 48 states where judgment had not yet been entered and anticipate resuming suspended foreclosure activities in all remaining states in the first quarter of 2012. While we have not yet begun initiating new foreclosure activities in any states, we anticipate initiating new foreclosure activities in certain states during the first quarter of 2012. However, it will be a number of months before we resume all foreclosure activities in all states as we need to ensure we are satisfied that applicable enhanced processes have been implemented and it will take time to work through the backlog of loans that have not been referred to foreclosure in each state.  In addition, certain courts and state legislatures are implementing new rules or statutes relating to foreclosures. Scrutiny of foreclosure documentation has increased. Also, in some areas, courts are requiring additional verification of information filed prior to the foreclosure proceeding. The combination of these factors when coupled with other mortgage lenders who also temporarily suspended foreclosure activities and have now                                           56

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  Table of Contents                                                          HSBC Finance Corporation        resumed their foreclosure activities has led to a significant backlog of foreclosures in the marketplace which will take time to resolve. If these trends continue, there could be additional delays in the processing of foreclosures, which could have an adverse impact upon housing prices which is likely to result in higher loss severities while foreclosures are delayed.  The average loss on sale of REO properties and the average total loss on foreclosed properties for full year 2011 increased as compared to full year 2010 due to continuing declines in home prices during 2011 as well as a greater mix of REO properties being sold which we have held for longer periods of time due in part to the age and condition of the property which is also reflected in a low sales price. Typically the longer the holding period, the greater the loss we recognize at the time of sale. The increase also reflects continued declines in home prices during the year due, in part, to the continued elevated levels of foreclosed properties.  During the second half of 2011, we began to see an increase in the average number of days to sell REO properties. As a result of the decrease in new REO properties being added to inventory, there is a greater mix of REO properties being sold which we have held for longer periods of time as discussed above.  Results of Operations   

Unless noted otherwise, the following discusses amounts from continuing operations as reported in our consolidated statement of income.

  Net Interest Income In the following table which summarizes net interest income, interest expense includes $94 million, $263 million and $519 million for the years ended December 31, 2011, 2010 and 2009, respectively, that has been allocated to our discontinued operations in accordance with our existing internal transfer pricing policies as external interest expense is unaffected by the transfer of businesses to discontinued operations.    Year Ended December 31,                       2011        %(1)        2010        %(1)        2009        %(1)                                                                  (dollars are in millions) Finance and other interest income            $ 4,124       7.11 %    $ 5,000       7.18 %    $ 6,139       7.11 % Interest expense                               2,442       4.21        3,174       4.56        4,132       4.78  Net interest income                          $ 1,682       2.90 %    $ 1,826       2.62 %    $ 2,007       2.33 %       

(1) % Columns: comparison to average interest-earning assets.

   Net interest income decreased during 2011 reflecting lower average receivables as a result of receivable liquidation and lower overall receivable yield driven by a shift in receivable mix to higher levels of lower yielding first lien real estate secured receivables as higher yielding second lien real estate secured and personal non-credit card receivables have run-off at a faster pace than first lien real estate secured receivables. These decreases were partially offset by an increase in our estimate of interest receivable relating to income tax receivables which totaled $117 million during 2011 due to a pending resolution of an issue with the Internal Revenue Service Appeals' Office compared to tax-related interest income of $6 million during 2010 which is recorded as a component of finance and other interest income. The decrease in net interest income was partially offset by lower interest expense due to lower average borrowings and lower average rates.  While we experienced a lower overall receivable yield in our receivable portfolio during 2011 which was impacted by the changes in receivable mix discussed above, receivable yields vary between receivable products. Yields in our real estate secured receivable portfolio were essentially flat during 2011 as the positive impact of lower levels of nonaccrual receivables during the year were offset by increased participation in payment incentive programs during 2011 as well as an adjustment of approximately $60 million in 2011, principally related to prior years, relating to the process used to determine the amount of deferred income under these programs. Yields in our personal non-credit card receivable portfolio increased during 2011 reflecting the impact of lower levels of nonaccrual receivables.  

Net interest income decreased during 2010 primarily due to lower average receivables as a result of receivable liquidation, partially offset by higher overall receivable yields and lower interest expense. During 2010, we experienced higher yields for all receivable products as a result of lower levels of nonperforming receivables,

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  Table of Contents                                                          HSBC Finance Corporation        including reduced levels of nonperforming modified real estate secured receivables, due to charge-off and declines in new modification volumes. Higher yields in our real estate secured receivable portfolio were partially offset by the impact of an increase in the expected lives of receivables in payment incentive programs. As receivable yields vary between receivable products, overall receivable yields were negatively impacted by a shift in receivable mix to higher levels of lower yielding first lien real estate secured receivables as higher yielding second lien real estate secured and personal non-credit card receivables have run-off at a faster pace than first lien real estate secured receivables. The decrease in net interest income during 2010 was partially offset by higher net interest income on our non-insurance investment portfolio reflecting higher levels of investments held and slightly higher yields. These decreases were partially offset by lower interest expense due to lower average borrowings and lower average rates.  Net interest margin was 2.90 percent in 2011, 2.62 percent in 2010 and 2.33 percent in 2009. Net interest margin in 2011 and 2010 was positively impacted, particularly in 2011, by the estimated interest receivable relating to income tax receivables as discussed above. Excluding the impact of this item in those periods, net interest margin remained higher in 2011 reflecting a lower cost of funds as a percentage of interest-earning assets, partially offset by a lower overall receivable yield driven by a shift in receivable mix to lower yielding first lien real estate secured receivables as discussed above.  

Significant trends affecting the comparability of net interest income and net interest margin for the years:

                                                                2011                       2010 Net interest income/net interest margin from prior year                                          $ 1,826         2.62 %  

$ 2,007 2.33 %

  Impact to net interest income resulting from: Lower receivable levels                                (828 )                    (1,073 ) Receivable yields: Receivable pricing                                     (117 )                        53 Impact of nonperforming assets                          124                 

146

 Volume and rate impact of modified loans                 62                 

65

 Receivable mix                                         (218 )                      (321 ) Interest receivable related to income tax receivables                                             111                 

6

 Non-insurance investment income (rate and volume)                                                   2                 

3

 Cost of funds (rate and volume)                         732                 

958

 Other                                                   (12 )               

(18 )

  Net interest income/net interest margin for current year                                        $ 1,682         2.90 %     $  1,826         2.62 %    The varying maturities and repricing frequencies of both our assets and liabilities expose us to interest rate risk. When the various risks inherent in both the asset and the debt do not meet our desired risk profile, we use derivative financial instruments to manage these risks to acceptable interest rate risk levels. See "Risk Management" for additional information regarding interest rate risk and derivative financial instruments.  Provision for Credit Losses The provision for credit losses associated with our various loan portfolios is summarized below. The provision for credit losses may vary from year to year depending on a variety of factors including product mix and the credit quality of the loans in our portfolio including historical delinquency roll rates, portfolio seasoning, customer account management policies and practices, risk management/collection policies and practices related to our loan products, economic conditions such as national and local trends in housing markets and interest rates and changes in laws and regulations.                                           58 

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  Table of Contents                                                          HSBC Finance Corporation       

The following table summarizes provision for credit losses by business:

                 Year Ended December 31,         2011        2010        2009                                                       (in millions)               Provision for credit losses:               Mortgage Services              $ 1,309     $ 1,575     $ 1,917               Consumer Lending:               Real estate secured              2,675       2,339       2,997               Personal non-credit card           434       1,432       2,990                Total Consumer Lending           3,109       3,771       5,987                                               $ 4,418     $ 5,346     $ 7,904    As discussed above, our provision for credit losses during 2011 included approximately $766 million for real estate secured receivables and approximately $159 million for personal non-credit card receivables recorded in the third quarter of 2011 related to the adoption of new accounting guidance related to TDR Loans. This new accounting guidance has and will continue to impact our provision for credit losses in periods post-adoption, including the fourth quarter of 2011, as loans which otherwise would not have qualified for TDR reporting in the past will now meet the criteria under the new accounting guidance in future periods to be reported and reserved for as TDR Loans. Therefore, the provision for credit losses is not comparable to prior reporting periods. See Note 6, "Receivables," in the accompanying consolidated financial statements for further discussion of this new guidance and related impacts. Excluding the impact of the adoption of the new Accounting Standards Update during the third quarter of 2011, our overall provision for credit losses decreased significantly in 2011 for all components as discussed below.    

• The provision for credit losses for real estate secured loans in our

Consumer Lending and Mortgage Services business decreased $260 million and

$436 million, respectively, during 2011. The decrease reflects lower         balances outstanding as the portfolios continue to liquidate and lower

charge-off levels. These decreases were partially offset by higher expected

losses on TDR. Also contributing to the decrease was lower levels of

two-months-and-over contractual delinquency on accounts less than 180 days

contractually delinquent, which in our total reported contractual

delinquency for real estate secured receivables was largely offset by an

increase in late stage delinquency, reflecting the continuing impact from

        foreclosure delays as discussed above.         •   The provision for credit losses for our personal non-credit card

receivables decreased $1.2 billion during 2011 reflecting lower receivable,

delinquency and charge-off levels as well as improved credit quality.

   Net charge-off dollars totaled $4.0 billion during 2011 compared to $7.1 billion during 2010. The decrease was driven by lower average delinquency levels throughout 2011 as compared to 2010 as a result of lower average receivable levels and improvements in economic conditions. See "Credit Quality" for further discussion of our net charge-offs.  In 2011, we increased our credit loss reserves as the provision for credit losses was $440 million higher than net charge-offs. Excluding the impact of adopting new accounting guidance on TDR Loans as previously discussed, the provision for credit losses was $485 million lower than net charge-offs reflecting lower receivable levels, lower overall delinquency levels and improvements in economic conditions. The provision as a percent of average receivables was 8.53 percent in 2011 and 8.49 percent in 2010. Excluding the impact of adopting new accounting guidance on TDR Loans as previously discussed, the provision as a percentage of average receivables would have decreased 174 basis points in 2011 as compared to 2010. See "Credit Quality" for further discussion of credit loss reserves.  We anticipate delinquency and charge-off levels will remain under pressure during 2012 as the U.S. economic environment continues to impact our business and foreclosure delays, resulting in part from our earlier decision to temporarily suspend foreclosure activities, continue to impact our delinquency levels. The magnitude of these trends will largely be dependent on the nature and extent of the economic recovery, including unemployment rates and a recovery in the housing markets.                                           59 

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  Table of Contents                                                          HSBC Finance Corporation       

Our provision for credit losses decreased significantly during 2010 as discussed below.

• The provision for credit losses for the real estate secured receivable

portfolios in our Consumer Lending and Mortgage Services business decreased

$658 million and $342 million, respectively, during 2010. The decrease

reflects lower receivable levels as the portfolios continue to liquidate,

        lower delinquency levels, improved loss severities and improvements in         economic conditions since 2009. The decrease also reflects lower loss         estimates on TDR Loans, partially offset by the impact of continued high

unemployment levels, lower receivable prepayments, higher loss estimates on

        recently modified loans and for real estate secured receivables in our         Consumer Lending business, portfolio seasoning. Improvements in loss

severities reflect an increase in the number of properties for which we

accepted a deed-in-lieu which result in lower losses compared to loans

which are subject to a formal foreclosure process for which average loss

        severities in 2010 have remained relatively flat to 2009 levels.         •   The provision for credit losses for our personal non-credit card

receivables decreased $1.6 billion reflecting lower receivable levels,

        lower delinquency levels and improvements in economic conditions since         2009, partially offset by higher reserve requirements on TDR Loans.   Net charge-off dollars totaled $7.1 billion during 2010 compared to $10.4 billion in 2009 driven by lower delinquency levels as a result of lower average receivable levels and improvements in the U.S. economic conditions since year end 2009. See "Credit Quality" for further discussion of our net charge-offs.  In 2010, we decreased our credit loss reserves as the provision for credit losses was $1.8 billion less than net charge-offs. Lower credit loss reserve levels reflect lower receivable levels, improved economic and credit conditions since 2009 including lower delinquency levels and overall improvements in loss severities as discussed above. The provision as a percent of average receivables was 8.49 percent in 2010 and 9.80 percent in 2009.  See "Critical Accounting Policies," "Credit Quality" and "Analysis of Credit Loss Reserves Activity" for additional information regarding our loss reserves. See Note 8, "Credit Loss Reserves" in the accompanying consolidated financial statements for additional analysis of loss reserves.  

Other Revenues The following table summarizes other revenues:

   Year Ended December 31,                                   2011          2010          2009                                                                    (in millions) Insurance revenue                                       $    246       $  274       $    334 Investment income                                            127           99            108 Net other-than-temporary impairment losses                     -            -            (25 ) Derivative related income (expense)                       (1,146 )       (379 )          300 Gain (loss) on debt designated at fair value and related derivatives                                        1,164          741         (2,125 ) Servicing and other fees from HSBC affiliates                 21           36            111 Other income                                                  27           41             89  Total other revenues (expense)                          $    439       $  

812 $ (1,208 )

    Insurance revenue decreased in 2011 and 2010 as a result of a decrease in the number of credit insurance policies in force since March 31, 2009 primarily due to the run-off of our Consumer Lending portfolio. During the third quarter of 2011, we announced our decision to cease issuing new term life insurance in the United States effective January 2012 which will result in lower insurance revenue in future periods.  Investment income includes interest income on available-for-sale securities in our insurance investment portfolio as well as realized gains and losses from the sale of all investment securities. Investment income increased during 2011 due to higher gains on sales of securities, partially offset by lower average balances and lower yields on money market funds. In 2010, investment income decreased due to lower gains on sales of securities and lower yields on money market funds as well as lower average investment balances.  Net other-than temporary impairment losses ("OTTI") During 2011 and 2010, OTTI totaled than $1 million. For further information regarding other-than-temporary impairment losses, see Note 5, "Securities," in the accompanying consolidated financial statements.                                           60 

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  Table of Contents                                                          HSBC Finance Corporation        Derivative related income (expense) includes realized and unrealized gains and losses on derivatives which do not qualify as effective hedges under hedge accounting principles as well as the ineffectiveness on derivatives which are qualifying hedges. Designation of swaps as effective hedges reduces the volatility that would otherwise result from mark-to-market accounting. All derivatives are economic hedges of the underlying debt instruments regardless of the accounting treatment. Derivative related income (expense) is summarized in the table below:    Year Ended December 31,                                      2011          2010         2009                                                                      (in millions) Net realized gains (losses)                                $    (77 )     $ (206 )     $ (290 ) Mark-to-market on derivatives which do not qualify as effective hedges                                             (1,104 )       (188 )        487 Ineffectiveness                                                  35           15          103  Total                                                      $ (1,146 )     $ (379 )     $  300    Derivative related income (expense) decreased significantly during 2011. As previously discussed, our Consumer Lending and Mortgage Services real estate secured receivables are remaining on the balance sheet longer due to lower prepayment rates. At December 31, 2011, we had $10.4 billion of interest rate swaps outstanding for the purpose of offsetting the increase in the duration of these receivables and the corresponding increase in interest rate risk as measured by the present value of a basis point ("PVBP"). While these positions acted as economic hedges by lowering our overall interest rate risk by more closely matching both the structure and duration of our liabilities to the structure and duration of our assets, they did not qualify as effective hedges under hedge accounting principles. As a result, these positions are carried at fair value and are marked-to-market through income while the item being hedged is not carried at fair value and, therefore, no offsetting fair value adjustment is recorded. Of these non-qualifying hedges, $6.9 billion were longer-dated pay fixed/receive variable interest rate swaps with an average life of 12.6 years and $3.5 billion were shorter-dated receive fixed/pay variable interest rate swaps with an average life of 3.2 years. Market value movements for the longer-dated pay fixed/receive variable interest rate swaps may be volatile during periods in which long term interest rates fluctuate, but they effectively lock in fixed interest rates for a set period of time which results in funding that is better aligned with longer term assets. Market value movements on the shorter-dated receive fixed/pay variable interest rate swaps may offset a portion of this volatility.  Falling long-term interest rates during 2011 had a negative impact on the mark-to-market on this portfolio of swaps. Over time, we may elect to further reduce our exposure to rising interest rates through the execution of additional pay fixed/receive variable interest rate swaps. Net realized losses were lower during 2011 as a result of lower losses on terminations of non-qualifying hedges during the year. Ineffectiveness income and expense during 2011 was driven by changes in the market value of our cash flow and fair value hedges due to decreases in U.S and foreign interest rates.  Derivative related income decreased during 2010. At December 31, 2010, we had $11.3 billion of interest rate swaps outstanding for the purpose of offsetting the increase in the duration of real estate secured receivables and the corresponding increase in interest rate risk as measured by PVBP as discussed above. Of these non-qualifying hedges, $6.3 billion were longer-dated pay fixed/receive variable interest rate swaps, which represented an increase of $1.1 billion during 2010, and $5.0 billion were shorter-dated receive fixed/pay variable interest rate swaps. Falling long-term interest rates during 2010 had a significant negative impact on the mark-to-market on this portfolio of swaps. Net realized losses were lower during 2010 as a result of lower losses on terminations of non-qualifying hedges due to changes in rates during 2010 as well as changes in the timing of the non-qualifying hedge terminations. During 2010, ineffectiveness was largely due to the impact of falling U.S. long term rates on our cross currency cash flow hedges, partially offset by falling long-term foreign interest rates, while during 2009, long term U.S. rates and long-term foreign interest rates increased.  Net income volatility, whether based on changes in interest rates for swaps which do not qualify for hedge accounting or ineffectiveness recorded on our qualifying hedges under the long haul method of accounting, impacts the comparability of our reported results between periods. Accordingly, derivative related income (expense) for the year ended December 31, 2011 or any prior periods should not be considered indicative of the results for any future periods.                                           61 

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  Table of Contents                                                          HSBC Finance Corporation        Gain (loss) on debt designated at fair value and related derivatives reflects fair value changes on our fixed rate debt accounted for under FVO as well as the fair value changes and realized gains (losses) on the related derivatives associated with debt designated at fair value. The gain on debt designated at fair value and related derivatives during 2011 and 2010 reflects falling U.S. interest rates and a widening of credit spreads. See Note 12, "Fair Value Option," in the accompanying consolidated financial statements for additional information, including a break out of the components of the gain (loss) on debt designated at fair value and related derivatives.  Servicing and other fees from HSBC affiliates represents revenue received under service level agreements under which we service real estate secured receivables as well as revenue from HSBC Technology & Services (USA) Inc. ("HTSU") for certain office space rental and administrative costs. Servicing and other fees from HSBC affiliates decreased during 2011 primarily due to lower rental revenue due to lower office and administrative costs as a result of entity-wide initiatives to cut costs and lower levels of real estate secured receivables being serviced for HSBC Bank USA as the portfolio continues to liquidate. The decrease in 2010 reflects lower levels of receivables being serviced for HSBC Bank USA as well as the transfer to HTSU of certain services we previously provided to other HSBC affiliates.  

Other income decreased during 2011 and 2010. The following table summarizes significant components of other income for the years presented:

   Year Ended December 31,                                          2011       2010       2009                                                                         (in millions)

Gains on miscellaneous asset sales, including real estate investments

                                                      $   6      $  22      $  38 Gain on sale of Low Income Housing Tax Credit Investment Funds to HSBC Bank USA                                               -          -         20 Other, net                                                          21         19         31                                                                   $  27      $  41      $  89    The decrease in other income during 2011 and 2010 reflects lower gains on sales of miscellaneous commercial assets. Additionally, other income in 2009 included a $20 million gain on the sale of Low Income Housing Tax Credit Investment Funds to HSBC Bank USA.  

Operating Expenses The following table summarizes operating expenses:

    Year Ended December 31,                                   2011        2010        2009                                                                    (in millions)  Salaries and employee benefits                           $   187     $   

261 $ 663

  Occupancy and equipment expenses, net                         52          

56 116

  Real estate owned expenses                                   206         

274 199

  Other servicing and administrative expenses                  620         

440 432

  Support services from HSBC affiliates                        311         

275 317

  Policyholders' benefits                                      155         

152 197

  Goodwill and other intangible asset impairment charges         -           -         274   Operating expenses                                       $ 1,531     $ 1,458     $ 2,198    Salaries and employee benefits were lower during 2011 and 2010 as a result of the reduced scope of our business operations, including for 2010 the decision in February 2009 to close all of the Consumer Lending branch offices, the impact of entity-wide initiatives to reduce costs and in 2010, the centralization of additional shared services in North America, including, among other things, legal, compliance, tax and finance although this decrease was offset by an increase in support services from HSBC affiliates. The decrease in 2011 and 2010 also reflects the impact of the transfer of certain employees to a subsidiary of HSBC Bank USA during the third quarter of 2010 although this decrease was also offset by an increase in support services from HSBC affiliates. Salaries and employee benefits during 2009 included severance costs of $73 million, primarily related to our decision in February 2009 to discontinue new account originations for all products in our Consumer Lending business and close all branch offices. See Note 4, "Strategic Initiatives," in the accompanying consolidated financial statements for a complete description of the decisions made in each year.                                           62

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  Table of Contents                                                          HSBC Finance Corporation        Occupancy and equipment expenses, net decreased during 2011 as a result of the reduction of the scope of our business operations. Occupancy and equipment expenses, net in 2010, were reduced by $14 million as a result of a reduction in the lease liability associated with an office of our Mortgage Services business which has now been fully subleased. Additionally, occupancy and equipment expenses, net during 2009 included $53 million, related to our decision to close the Consumer Lending branch offices. Excluding these items from the appropriate periods, occupancy and equipment expenses, net increased slightly during 2010 due to changes in the manner in which rent expense is allocated to HSBC affiliates.  Real estate owned expenses decreased during 2011 primarily due to lower holding costs for REO properties due to a decrease in the number of REO properties held during the year resulting from a significant decrease in the number of new REO properties added to inventory during the year due to the temporary suspension of foreclosure activities as well as higher volumes of REO sales. REO expense also decreased during 2011 due to lower losses on sales of REO properties as a greater mix of REO properties being sold are properties we have held for longer periods of time which resulted in a portion of the cumulative loss being recognized as REO expense in 2010. During 2010, REO expenses increased as a result of higher average number of REO properties held during 2010, higher overall expenses on REO properties held and higher losses on REO properties as home prices began to decline during the second half of 2010. During periods in which home prices deteriorate, the reduction in value between the date we take title to the property and when the property is ultimately sold results in higher valuation allowances during the holding period and potentially higher losses at the time the property is sold.  Other servicing and administrative expenses increased during 2011 driven by higher legal reserves reflecting increased exposure estimates on litigation of $150 million and an expense accrual related to mortgage servicing matters of $157 million compared to approximately $90 million in 2010 relating to certain litigation matters. The increase in 2011 also reflects higher fees for consulting services and other expenses related to compliance matters. These increases were partially offset by the continuing reduction in the scope of our business operations and the impact of entity wide initiatives to reduce costs, including lower third party collection costs as our receivable portfolios continue to run-off. Other servicing and administrative expenses during 2009 included $29 million of fixed asset and other miscellaneous asset write-downs related to the decision to close the Consumer Lending branch offices. Excluding this from 2009, other servicing and administrative expenses remained higher during 2010 reflecting higher legal costs and higher third party collection costs, partially offset by reductions in the scope of our business operations and the impact of entity wide initiatives to reduce costs.  Support services from HSBC affiliates increased during 2011 reflecting higher technology operational support costs provided by HTSU, driven by the transfer in July 2010 of certain employees to a subsidiary of HSBC Bank USA as discussed above and a higher allocation of compliance and utility expenses. These increases were partially offset by lower expenses for services provided by an affiliate outside the U.S. due to a decrease in offshore personnel headcount as compared to the prior year driven by cost containment measures and overall organizational restructuring. Support services from HSBC affiliates decreased during 2010 driven by lower expenses for services provided by an affiliate outside the U.S. due to decreases in offshore personnel headcount driven by facility closures which occurred through out 2009 and overall organizational restructuring as well as fewer information technology projects from HTSU during 2010. The decrease in 2010 was partially offset by additional shared services allocated to us by HTSU, including legal, compliance, tax and finance, beginning in January 2010 as well as impact of the transfer of certain employees to a subsidiary of HSBC Bank USA in July 2010 as discussed above.  Policyholders' benefits increased during 2011 due to higher claims on term life insurance policies, partially offset by lower claims on credit insurance policies as there are fewer such policies in force primarily due to the run-off of our Consumer Lending business. Policyholders' benefits decreased during 2010 due to lower claims on credit insurance policies as there were fewer such policies in force primarily due to the run-off of our Consumer Lending portfolio.  Goodwill and other intangible asset impairment charges During 2009, we recorded goodwill impairment charges of $260 million related to our Insurance Services business, which represented all of our remaining goodwill. Additionally, during 2009, we recorded impairment charges of $14 million relating to technology, customer lists and loan related relationships resulting from the discontinuation of originations for our Consumer Lending business. There were no intangible asset impairment charges during 2011 and 2010.                                           63

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  Table of Contents                                                          HSBC Finance Corporation        Efficiency Ratio Our efficiency ratio from continuing operations was 66.80 percent in 2011 compared to 47.51 percent in 2010 and 178.50 percent in 2009. Our efficiency ratio from continuing operations during all periods was impacted by the change in the fair value of debt and related derivatives for which we have elected fair value option accounting. Additionally, the efficiency ratio in 2009 was also impacted by goodwill and intangible asset impairment charges and the Consumer Lending closure costs, as discussed above. Excluding these items from the periods presented, our efficiency ratio deteriorated significantly in 2011 reflecting lower other revenues driven by lower derivative related income and lower net interest income driven by portfolio liquidation while operating expenses increased as discussed above. Excluding these items from the periods presented, our efficiency ratio deteriorated during 2010 reflecting significantly lower net interest income and other revenues driven by receivable portfolio liquidation and lower derivative-related income which outpaced the decrease in operating expenses.  Income taxes Our effective tax rates for continuing operations were as follows:                     Year Ended December 31,   Effective Tax Rate                  2011                                    (38.1 )%                  2010                                    (34.8 )                  2009                                    (32.6 )   The effective tax rate for 2011 was impacted by a release of valuation allowance previously established on foreign tax credits. HSBC North America implemented an additional tax planning strategy which is expected to generate sufficient taxable foreign source income to allow us to recognize and utilize foreign tax credits currently on our balance sheet before they expire. The effective tax rate for 2011 was also impacted by the non-deductible portion of the accrual related to mortgage servicing matters, an increase in the valuation allowance or state deferred taxes, an increase in uncertain tax positions and state taxes, including states where we file combined unitary state tax returns with other HSBC affiliates. The effective tax rate for continuing operations in 2010 was primarily impacted by state taxes as discussed above and amortization of purchase accounting adjustments on leveraged leases that matured in December 2010. See Note 14, "Income Taxes," in the accompanying consolidated financial statements for further discussion.  

Segment Results - IFRS Basis

    Through June 30, 2011, we reported the results of our operations in two reportable segments: Card and Retail Services and Consumer. These segments were managed separately and were characterized by different middle-market consumer lending products, originations processes, and locations. As a result of the previously announced sale of our Card and Retail Services business in August 2011, these operations are reported as discontinued operations. Because our segment results are reported on a continuing operations basis, we have one remaining reportable segment: Consumer.  Our Consumer segment consists of our run-off Consumer Lending and Mortgage Services businesses. The Consumer segment provided real estate secured and personal non-credit card loans with both revolving and closed-end terms and with fixed or variable interest rates. Loans were originated through branch locations and direct mail. Products were also offered and customers serviced through the Internet. Prior to the first quarter of 2007, we acquired loans from correspondent lenders and prior to September 2007 we also originated loans sourced through mortgage brokers. While these businesses are all operating in run-off mode, they have not been reported as discontinued operations because we continue to generate cash flow from the ongoing collections of the receivables, including interest and fees.  The All Other caption includes our Insurance and Commercial businesses. Each of these businesses falls below the quantitative threshold tests under segment reporting accounting principles for determining reportable segments. The "All Other" caption also includes our corporate and treasury activities, which includes the impact of FVO debt. Certain fair value adjustments related to purchase accounting resulting from our acquisition by HSBC and related amortization have been allocated to corporate, which is included in the "All Other" caption within our segment disclosure. Goodwill which was established as a result of our acquisition by HSBC was not                                           64

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  Table of Contents                                                          HSBC Finance Corporation        allocated to or included in the reported results of our reportable segments as the acquisition by HSBC was outside of the ongoing operational activities of our reportable segments, consistent with management's view of our reportable segment results. During 2009, the remainder of this goodwill was impaired. Goodwill relating to acquisitions subsequent to our acquisition by HSBC were included in the reported respective operating segment results as those acquisitions specifically related to the business, consistent with management's view of the segment results.  We report results to our parent, HSBC, in accordance with its reporting basis, International Financial Reporting Standards ("IFRSs"). Our segment results are presented on an IFRSs legal entity basis ("IFRS Basis") (a non-U.S. GAAP financial measure) as operating results are monitored and reviewed and trends are evaluated on an IFRS Basis. However, we continue to monitor capital adequacy, establish dividend policy and report to regulatory agencies on a U.S. GAAP basis. Except for moving our Card and Retail Services business to discontinued operations as discussed above, there have been no other changes in measurement or composition of our segment reporting as compared with the presentation in our consolidated financial statements for the fiscal year ended December 31, 2010 included in our Current Report on Form 8-K filed with the SEC on May 27, 2011.  

Consumer Segment The following table summarizes the IFRS Basis results for our Consumer segment for the years ended December 31, 2011, 2010 and 2009.

           Year Ended December 31,                  2011          2010          2009                                                    (dollars are in millions)        Net interest income                    $  2,448      $  2,316      $  2,545        Other operating income                      (48 )         (30 )      

71

         Total operating income                    2,400         2,286        

2,616

        Loan impairment charges                   4,907         5,686         7,927                                                  (2,507 )      (3,400 )      (5,311 )        Operating expenses                        1,021           883         1,279         Loss before tax                        $ (3,528 )    $ (4,283 )    $ (6,590 )         Net interest margin                        4.71 %        3.67 %        3.16 %        Efficiency ratio                          42.54         38.63         48.89

Return (after-tax) on average assets (4.48 ) (4.38 )

(5.51 )

Balances at end of period:

       Customer loans                         $ 48,021      $ 56,650      $ 70,202        Assets                                   46,807        57,460        71,298   2011 loss before tax compared to 2010 Our Consumer segment reported a lower loss before income taxes due to lower loan impairment charges and higher net interest income, partially offset by higher operating expenses and lower other operating income.  During 2011, HSBC adopted a revised disclosure convention for impaired loans and advances. This revised disclosure convention impacted the classification of loans and advances in HSBC's geographical regions with material levels of forbearance activity for which our portfolio was included. The revision introduces a more stringent approach to classification of renegotiated loans as impaired. Management believes that the revised approach better reflects the nature of risks and inherent credit quality in our loan portfolio. The approach also reflects developments in industry disclosure best practice, including guidance provided by the Financial Services Authority, the regulator of all financial services in the United Kingdom, as well as a refinement of loan segmentation. As a result of this review, we reported impaired loans of $19.3 billion at December 31, 2011 which was $12.2 billion higher than what otherwise would have been reported. In the third quarter of 2011, we refined our loan classification methodology to provide greater differentiation of loans based on their credit risk characteristics. This review was performed as a result of the Company's adoption of Clarifications to Accounting for Troubled Debt Restructures by Creditors and because an increasing percentage of the portfolio has been subject to forbearance in recent periods, with the closure of the portfolio to new business. It was determined that the segmentation of the portfolio should be improved to better reflect the credit characteristics of                                           65 

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  Table of Contents                                                          HSBC Finance Corporation        forbearance cases. This re-segmentation also included a review of certain processes for recognizing and measuring impairment allowances under IFRSs, including changes to the provisioning methodology for loans subject to forbearance to measure the cash flows attributable to the credit loss events which occurred before the reporting date and improved assumptions about default and severity rates for the purposes of measuring impairment allowances. The increase to our population of impaired loans and the refinements to our provisioning methodologies resulted in a net incremental loan impairment charge of approximately $150 million at the time of implementation during the third quarter of 2011.  Historically, severity estimates were determined based on the average total losses incurred at the time the loans were transferred to Real Estate Owned ("REO"). Due to the significant reduction in loans transferred to REO during 2011, as a result of foreclosure delays and concentrations in the mix of loans transferring to REO in certain states that are no longer representative of our portfolio of loans requiring credit loss reserves, we determined that the best estimate of severity should be based on a 12-month average of broker price opinions received. As part of this review, we also increased the granularity of certain segments used to establish impairment provisions to include specific characteristics of the portfolios such as year of origination, location of the property and underlying economic factors affecting the location in which the property is located. Segmenting the portfolio based on these risk characteristics provides greater risk differentiation based on the underlying trends in our portfolio. We believe these enhancements to the credit loss reserve estimation process were responsive to the changing environment and will result in credit loss reserves that will be more responsive to the changing portfolio characteristics in the future as the loan portfolio continues to run-off.  

Excluding the impact of the net incremental loan impairment charges of approximately $150 million during the third quarter of 2011 as discussed above, our loan impairment charges remained lower during 2011 as discussed below.

• Loan impairment charges for the real estate secured loans portfolios in our

Consumer Lending and Mortgage Services business decreased during 2011. The

decrease reflects lower balances outstanding as the portfolios continue to

liquidate as well as lower charge-off levels. These decreases were

partially offset by higher estimated costs to obtain the underlying

property securing the loan and the impact of discounting estimated future

amounts to be received on real estate loans which have been written down to

fair value less cost to obtain and sell the collateral on real estate

        secured loans which resulted in higher reserve requirements due to the         delay in the timing of estimated cash flows to be received driven by

foreclosure delays. Additionally, loan impairment charges were negatively

        impacted by lower estimated cash flows from impaired loans due to an         increase in estimated severity and other changes in assumptions. Also

contributing to the decrease was lower levels of two-months-and-over

contractual delinquency on accounts less than 180 days contractually

delinquent, which in our total reported contractual delinquency for real

estate secured receivables was largely offset by an increase in late stage

delinquency, reflecting the continuing impact from foreclosure delays as

        discussed above.    

• Loan impairment charges for personal non-credit card loans decreased during

2011 reflecting lower loan, delinquency and charge-off levels due to

improved credit quality and lower reserve requirements on impaired loans.

   During 2011, loan impairment charges were $760 million greater than net charge-offs reflecting the higher reserve requirements on impaired loans as discussed above and higher reserve requirements relating to the discounting of future cash flows related to foreclosure delays. During 2011, we increased credit loss reserves to $5.9 billion of which approximately $150 million reflects the impact of the review of our methodology in the third quarter of 2011 as discussed above. Excluding these items, credit loss reserves were still higher as compared to December 31, 2010 reflecting higher loss estimates related to deterioration in credit quality for real estate secured loans reflecting, in part, the impact of continuing high unemployment levels, higher estimated                                           66

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  Table of Contents                                                          HSBC Finance Corporation        costs to obtain the underlying property securing the loan and higher reserve requirements due to the discounting of future cash flows related to foreclosure delays, partially offset by lower loan levels and lower overall dollars of delinquency as compared to December 31, 2010.  Net interest income increased during 2011 primarily due to higher yields for real estate secured and personal non-credit card loans and lower interest expense, partially offset by lower average loan levels as a result of loan liquidation. The higher yields in our real estate secured and personal non-credit card loan portfolios reflect the impact of lower levels of nonperforming loans as well as higher amortization associated with the discounting of the estimated future cash flows associated with real estate secured loans due to the passage of time, partially offset by increased participation in payment incentive programs during 2011 as well as the impacts of correcting prior period effective interest rate estimates in the current year of approximately $185 million. As yields vary between loan products, overall loan yields were negatively impacted by a shift in mix to higher levels of lower yielding first lien real estate secured loans as higher yielding second lien real estate secured and personal non-credit card loans have run-off at a faster pace than first lien real estate secured loans. Lower interest expense during 2011 reflects lower average borrowings. Additionally, lower interest expense also reflects changes in our internal funding strategies to better match the lives of our loan portfolio with our external funding which has resulted in lower average rates. Net interest margin increased in 2011 reflecting the higher loan yields as discussed above as well as a lower cost of funds as a percentage of average interest earning assets.  Other operating income decreased as a result of an adjustment to expected cash flows of a loan portfolio purchased in 2006, partially offset by lower losses on REO properties. Lower losses on REO properties reflects a greater mix of REO properties being sold which we have held for longer periods of time which results in a portion of the loss being recorded in prior years.  Operating expenses increased 16 percent during 2011 due to an expense accrual of $197 million relating to mortgage servicing matters, higher legal fees, higher fees for consulting services and other expenses relating to compliance matters and higher pension costs, partially offset by lower salary and benefits, lower third party collection costs as our receivable portfolios continue to run-off and lower holding costs on REO properties. The expense accrual relating to mortgage serving matters of $197 million reflects the portion of the $257 million accrued at HSBC North America that we currently believe is allocable to HSBC Finance Corporation. As this matter progresses and more information becomes available, we will continue to evaluate our portion of the HSBC North America liability which may result in a change to our current estimate. Lower holding costs on REO properties reflects a significant decrease in the number of new REO properties due to the temporary suspension of foreclosure activities previously discussed. Pension expense in 2011 includes $13 million related to a plan amendment in December 2011 for services provided by certain employees in prior years compared to a one-time curtailment gain of $18 million in 2010 for changes made to employees' future benefits. Additionally, operating expenses during 2010 were impacted by the reduction in a lease liability of $15 million associated with an office of our Mortgage Services business which became fully subleased during the second quarter of 2010.  

The efficiency ratio deteriorated during 2011 due to higher operating expenses and lower other operating revenues, partially offset by higher net interest income as discussed above.

ROA deteriorated during 2011 primarily due to the impact of higher operating expenses as discussed above as well as the impact of lower average assets.

  2010 loss before tax compared to 2009 Our Consumer segment reported a lower loss before tax during 2010 due to lower loan impairment charges and lower operating expenses, partially offset by lower net interest income and lower other operating income.  

Loan impairment charges decreased significantly during 2010 as discussed below.

• Loan impairment charges for the real estate secured loan portfolios in our

Consumer Lending and Mortgage Services business decreased during 2010. The

decrease reflects lower loan levels as the portfolios continue to

liquidate, lower delinquency levels, improved loss severities and

improvements in economic conditions since 2009. The decrease also reflects

        lower loss estimates on TDR Loans, partially offset by the impact of         continued high unemployment levels, lower loan prepayments, higher loss                                            67 

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  Table of Contents                                                          HSBC Finance Corporation       

     estimates on recently modified loans and for real estate secured loans in 

our Consumer Lending business, portfolio seasoning. Improvements in loss

severities reflect an increase in the number of properties for which we

accepted a deed-in-lieu and an increase in the number of short sales, both

     of which result in lower losses compared to loans which are subject to a      formal foreclosure process for which average loss severities in 2010      remained relatively flat to 2009 levels.    

• Loan impairment charges for our personal non-credit card loan portfolio

reflects lower loan levels, lower delinquency levels and improvements in

economic conditions since 2009, partially offset by higher reserve

requirements on TDR Loans.

   During 2010, credit loss reserves decreased to $5.5 billion as loan impairment charges were $1.6 billion lower than net charge-offs reflecting lower loan levels and lower delinquency levels as discussed above as well as lower reserve requirements on real estate secured TDR Loans, partially offset by higher reserve requirements on personal non-credit card TDR Loans.  Net interest income decreased in 2010 due to lower average loans as a result of liquidation, risk mitigation efforts, partially offset by lower interest expense and higher overall loan yields. During 2010, we experienced higher overall yields for all products as a result of lower levels of nonperforming receivables and reduced levels of nonperforming modified loans due to charge-off and declines in new modification volumes. Higher yields in our real estate secured loan portfolio were partially offset by a shift in loan mix to higher levels of lower yielding first lien real estate secured loans as higher yielding second lien real estate secured and personal non-credit card loans have run-off at a faster pace than first lien real estate secured loans. Net interest margin increased in 2010 as compared to 2009 reflecting the higher loan yields as discussed above.  Other operating income decreased during 2010 due to lower credit insurance commissions and higher losses on REO properties reflecting an increase in the number of REO properties sold and declines in home prices during the second half of 2010.  Operating expenses decreased during 2010 due to the reductions in the scope of our business operations as well as other cost containment measures and lower pension expense driven by a curtailment gain, partially offset by higher collection costs and higher REO expense as a result of a higher average number of REO properties held during the year and higher overall expenses on the REO properties held. Operating expenses during 2009 included $133 million of costs related to the decision to discontinue new originations for all products in our Consumer Lending business and closure of the Consumer Lending branch offices. In addition, we were required to perform an interim intangible asset impairment test for our remaining Consumer Lending intangible asset which resulted in an impairment charge of $5 million during 2009. See Note 4, "Strategic Initiatives," in the accompanying consolidated financial statements for additional information regarding this decision.  The efficiency ratio during 2009 was impacted by the $133 million in restructuring and impairment charges discussed above. Excluding the impact of the restructuring charges from the prior year, the efficiency ratio improved 499 basis points during 2010 as the decrease in operating expenses outpaced the decrease in net interest income due to lower loan levels and lower yields.  

ROA improved during 2010 primarily due to a lower net loss as discussed above and the impact of lower average assets.

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  Table of Contents                                                          HSBC Finance Corporation        Customer loans Customer loans for our Consumer segment can be analyzed as follows:                                                                           Increases (Decreases) From                                       December 31,          December 31, 2010              December 31, 2009                                           2011               $              %               $              %                                                              (dollars are in millions) Real estate secured(1)               $       42,701      $  (6,611 )       (13.4 )%     $ (16,795 )       (28.2 )% Personal non-credit card                      5,320         (2,018 )       (27.5 )         (5,386 )       (50.3 )  Total customer loans                 $       48,021      $  (8,629 )       (15.2 )%     $ (22,181 )       (31.6 )%        (1)  Real estate secured receivables are comprised of the following:                                                                            Increases (Decreases) From                                       December 31,          December 31, 2010              December 31, 2009                                           2011               $              %               $              %                                                              (dollars are in millions) Mortgage Services                    $       13,518      $  (2,522 )       (15.7 )%     $  (6,478 )       (32.4 )% Consumer Lending                             29,183         (4,089 )       (12.3 )        (10,317 )       (26.1 )  Total real estate secured            $       42,701      $  (6,611 )       (13.4 )%     $ (16,795 )       (28.2 )%    Customer loans decreased to $48.0 billion at December 31, 2011 as compared to $56.7 billion at December 31, 2010 and $70.2 billion at December 31, 2009 reflecting the continued liquidation of these portfolios which will continue to decline going forward. The liquidation rates in our real estate secured loan portfolio continues to be impacted by low loan prepayments as few refinancing opportunities for our customers exist and the trends impacting the mortgage lending industry as previously discussed.  

See "Receivables Review" for a more detail discussion of the decreases in our receivable portfolios.

  Reconciliation of Segment Results As previously discussed, segment results are reported on an IFRS Basis. See Note 20, "Business Segments," in the accompanying consolidated financial statements for a discussion of the differences between IFRSs and U.S. GAAP. For segment reporting purposes, intersegment transactions have not been eliminated. We generally account for transactions between segments as if they were with third parties. Also see Note 20, "Business Segments," in the accompanying consolidated financial statements for a reconciliation of our IFRS Basis segment results to U.S. GAAP consolidated totals.  

Credit Quality

    Credit Loss Reserves We maintain credit loss reserves to cover probable incurred losses of principal, interest and fees and, as it relates to loans which have been identified as troubled debt restructures, credit loss reserves are maintained based on the present value of expected future cash flows discounted at the loans' original effective interest rates. Credit loss reserves are based on a range of estimates and are intended to be adequate but not excessive. We estimate probable losses for consumer receivables which do not qualify as troubled debt restructurings using a roll rate migration analysis that estimates the likelihood that a loan will progress through the various stages of delinquency, or buckets, and ultimately charge-off based upon recent historical performance experience of other loans in our portfolio. This analysis considers delinquency status, loss experience and severity and takes into account whether loans have filed for bankruptcy, have been re-aged, or are subject to forbearance, an external debt management plan, hardship, modification, extension or deferment. Our credit loss reserves take into consideration the expected loss severity based on the underlying collateral, if any, for the loan in the event of default based on recent trends. Delinquency status may be affected by customer account management policies and practices, such as the re-age of accounts, forbearance agreements, extended payment plans, modification arrangements, external debt management programs and deferments. When customer account management policies or changes thereto, shift loans from a "higher" delinquency bucket to a "lower" delinquency bucket, this will be reflected in our roll rate statistics. To the extent that re-aged or modified                                           69

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  Table of Contents                                                          HSBC Finance Corporation        accounts have a greater propensity to roll to higher delinquency buckets, this will be captured in the roll rates. Since the loss reserve is computed based on the composite of all of these calculations, this increase in roll rate will be applied to receivables in all respective delinquency buckets, which will increase the overall reserve level. In addition, loss reserves on consumer receivables are maintained to reflect our judgment of portfolio risk factors that may not be fully reflected in the statistical roll rate calculation or when historical trends are not reflective of current inherent losses in the portfolio. Portfolio risk factors considered in establishing loss reserves on consumer receivables include product mix, unemployment rates, bankruptcy trends, the credit performance of modified loans, geographic concentrations, loan product features such as adjustable rate loans, the credit performance of certain second lien loans following more delinquent first lien loans which we own or service, economic conditions, such as national and local trends in housing markets and interest rates, portfolio seasoning, account management policies and practices, current levels of charge-offs and delinquencies, changes in laws and regulations and other factors which can affect consumer payment patterns on outstanding receivables, such as natural disasters.  While our credit loss reserves are available to absorb losses in the entire portfolio, we specifically consider the credit quality and other risk factors for each of our products. We recognize the different inherent loss characteristics in each of our products as well as customer account management policies and practices and risk management/collection practices. We also consider key ratios, including reserves to nonperforming loans, reserves as a percentage of net charge-offs and reserves as a percentage of two-months-and-over contractual delinquency. Loss reserve estimates are reviewed periodically and adjustments are reported in earnings when they become known. As these estimates are influenced by factors outside of our control such as consumer payment patterns and economic conditions, there is uncertainty inherent in these estimates, making it reasonably possible that they could change.  In establishing reserve levels, given the general decline in U.S. home prices that has occurred since 2007, we anticipate that losses in our real estate secured receivable portfolios will continue to be incurred with greater frequency and severity than experienced prior to 2007. There is currently little secondary market liquidity for subprime mortgages. As a result of these conditions, lenders have significantly tightened underwriting standards, substantially limiting the availability of alternative and subprime mortgages. As fewer financing options currently exist in the marketplace for home buyers, properties in certain markets are remaining on the market for longer periods of time which contributes to home price depreciation. For many of our customers, the ability to refinance and access equity in their homes is no longer an option as home prices remain stagnant in many markets and have depreciated in others. These housing market trends were exacerbated by the recent economic downturn, including high levels of unemployment, and these industry trends continue to impact our portfolio. It is generally believed that a sustained recovery of the housing market, as well as unemployment conditions, is not expected in the near-term. We have considered these factors in establishing our credit loss reserve levels, as appropriate.  Real estate secured receivable carrying amounts in excess of fair value less cost to sell are generally charged-off no later than the end of the month in which the account becomes six months contractually delinquent. Values are determined based upon broker price opinions or appraisals which are updated every 180 days. Typically, receivables written down to fair value less cost to sell did not require credit loss reserves. As part of our on-going review of our process for estimating fair value less cost to sell for receivables, we began to see a pattern in 2011 for lower estimates of value after the more detailed property valuations are performed which include information obtained from a walk-through of the property after we have obtained title. As a result, we established credit loss reserves for receivables written down to fair value less cost to sell to reflect an estimate of the likely additional loss following an interior appraisal of the property. However, this change had a marginal impact on our overall reserve levels because the majority of this was the result of reclassifying one component of loss reserves to another.                                           70

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  Table of Contents                                                          HSBC Finance Corporation        During the third quarter of 2011, we reviewed our existing models for determining credit loss reserves. As part of this process, we considered recent environmental activity including the impact of the foreclosure delays, unique characteristics of our run-off portfolio and changes in how loans are ultimately running-off. As a result, we made the following enhancements to our credit loss reserve estimation process during the third quarter of 2011:    

• Historically, severity estimates were determined based on the average total

losses incurred at the time the loans were transferred to Real Estate Owned

("REO"). Due to the significant reduction in loans transferred to REO

during 2011, as a result of foreclosure delays and concentrations in the

mix of loans transferred to REO in certain states that are no longer

representative of our portfolio of loans requiring credit loss reserves, we

determined that the best estimate of severity should be based on a 12-month

         average of broker price opinions received.         •   As part of this review, we also increased the granularity of certain

segments used to establish impairment provisions to include specific

characteristics of the portfolios such as year of origination, location of

the property and underlying economic factors affecting the location in

which the property is located. Segmenting the portfolio based on these risk

characteristics provides greater risk differentiation based on the

underlying trends in our portfolio. We believe these enhancements to the

credit loss reserve estimation process were responsive to the changing

        environment and will result in credit loss reserves that will be more         responsive to the changing portfolio characteristics in the future as the         loan portfolio continues to run-off.  

The following table sets forth credit loss reserves for our continuing operations for the periods indicated:

   At December 31,                             2011          2010         2009(5)         2008          2007                                                               (dollars are in millions) Credit loss reserves(1)                    $ 5,952       $ 5,512       $  7,275       $ 9,781       $ 7,492 Reserves as a percentage of: Receivables(2)(3)(4)                         12.42 %        9.76 %        10.38 %       11.19 %        7.29 % Net charge-offs(4)                           149.6          77.5           69.9         149.4         203.5 Two-months-and-over contractual delinquency(2)(3)                             69.3          61.6           67.2          74.2          83.5 Nonperforming receivables(2)(3)(4)            86.6          80.0           91.0          96.5         109.1      

(1) At December 31, 2011 and 2010, credit loss reserves include $425 million and

$95 million, respectively, related to receivables which have been written

down to the lower of amortized cost or fair value less cost to sell

primarily reflecting an estimate of additional loss following an interior

     appraisal of the property as previously discussed. We typically did not      carry credit loss reserves for receivables which had been written down to

the lower of amortized cost or fair value less cost to sell at December 31,

     2009 or prior.    

(2) In December 2009, we implemented changes to our charge-off policies for real

estate secured and personal non-credit card receivables due to changes in

customer behavior ("December 2009 Charge-off Policy Changes"). As a result,

beginning in December 2009, real estate secured receivables are written down

to net realizable value less cost to sell generally no later than the end of

the month in which the account becomes 180 days contractually delinquent.

For personal non-credit card receivables, beginning in December 2009,

charge-off occurs generally no later than the end of the month in which the

account becomes 180 days contractually delinquent. See Note 7, "Changes in

Charge-off Policies During 2009," in the accompanying consolidated financial

statements for additional discussion. The reserve ratios for 2011, 2010 and

2009 have been significantly impacted by changes in the level of real estate

secured receivables which have been written down to the lower of amortized

cost or fair value less cost to sell. The following table shows these ratios

      excluding the receivables written down to fair value less cost to sell and      any associated credit loss reserves.          At December 31,                                2011         2010         2009      Reserves as a percentage of:      Receivables                                     13.16 %      10.54 %      10.92 %      Two-months-and-over contractual delinquency     147.5        114.0         96.4      Nonperforming loans                             251.9        192.3        170.4    

(3) While reserves associated with accrued finance charges are reported within

our total credit loss reserve balances noted above, accrued finance charges

for real estate secured receivables and certain personal non-credit card

receivables are not reported within receivables, nonperforming receivables

     and two-months-and-over contractual delinquency.                                            71 

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  Table of Contents                                                          HSBC Finance Corporation       

(4) Ratio excludes receivables, charge-off and nonperforming receivables

associated with receivable portfolios which are considered held for sale as

these receivables are carried at the lower of amortized cost or fair value

with no corresponding credit loss reserves. Reserves as a percentage of net

charge-off includes any charge-off recorded on receivables prior to the

     transfer to receivables held for sale.    

(5) As discussed above, in December 2009, we implemented changes to our

charge-off policies for real estate secured and personal non-credit card

receivables due to changes in customer behavior. See Note 7, "Changes in

Charge-off Policies During 2009," in the accompanying consolidated financial

statements for additional discussion. Had these charge-offs not been

      accelerated, credit loss reserves and the related ratios would have been as      follows:                                                           As             Excluding     December 31, 2009                              Reported        Policy Change     Credit loss reserves                          $    7,275      $        10,747

Reserves as a percentage of:

    Receivables                                        10.38 %             

14.61 %

    Net charge-offs                                     69.9               

154.9

    Two-months-and-over contractual delinquency         67.2               

 75.2     Nonperforming loans                                 91.0                 93.7   Credit loss reserves at December 31, 2011 increased as we recorded provision for credit losses greater than net charge-offs of $440 million during 2011. As previously discussed, during the third quarter of 2011 we recorded an incremental in credit loss reserves of approximately $766 million and $159 million for real estate secured receivables and personal non-credit card receivables, respectively, related to the adoption of new accounting guidance related to the identification and reporting of TDR Loans as TDR Loans are typically reserved for based on the present value of expected future cash flows discounted at the loans' original effective interest rate which generally results in higher reserve requirements. The new accounting guidance has and will continue to impact our credit loss reserves in periods post-adoption, including the fourth quarter of 2011, as loans which otherwise would not have qualified for TDR reporting in the past will now meet the criteria under the new guidance in future periods to be reported and reserved for as TDR Loans. Therefore, credit loss reserves are not comparable to prior reporting periods. See Note 6, "Receivables," in the accompanying consolidated financial statements for further discussion of this new guidance and related impacts. Excluding the impact of the adoption of the new Accounting Standards Update during the third quarter of 2011, overall credit loss reserves were lower at December 31, 2011 as compared to the prior year as discussed below.    

• Credit loss reserves for real estate secured receivables were modestly

lower driven by lower receivable levels, partially offset by the impact of

lower receivable prepayments and continued high unemployment levels.

Additionally, credit loss reserves were negatively impacted by higher

reserve requirements for TDR Loans reflecting the impact of lower estimated

cash flows from TDR Loans due to an increase in estimated severity and

other changes in assumptions including the length of time these receivables

will remain on our balance sheet as a result of the temporary suspension of

foreclosure activities previously discussed. Also contributing to the

decrease was lower levels of two-months-and-over contractual delinquency on

accounts less than 180 days contractually delinquent, which in our total

reported contractual delinquency for real estate secured receivables was

        largely offset by an increase in late stage delinquency, reflecting the         continuing impact from foreclosure delays as previously discussed.    

• Credit loss reserve levels in our personal non-credit card portfolio

decreased due to lower receivable levels and improved credit quality. These

decreases were partially offset by the impact of continued high

unemployment levels.

   At December 31, 2011, 74 percent of our credit loss reserves are associated with TDR Loans which are reserved for using a discounted cash flow analysis which, in addition to considering all expected future cash flows, also takes into consideration the time value of money and the difference between the current interest rate and the original effective interest rate on the loan. This methodology generally results in a higher reserve requirement for TDR Loans than the remainder of our receivable portfolio for which credit loss reserves are established using a roll rate migration analysis that only considers credit losses. This methodology is highly sensitive to changes in volumes of TDR Loans as well as changes in estimates of the timing and amount of cash flows for TDR Loans.                                           72 

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  Table of Contents                                                          HSBC Finance Corporation        As a result, credit loss reserves and provisions for credit losses for TDR Loans for the year ended December 31, 2011 should not be considered indicative of the results for any future periods. Generally as TDR Loan levels increase overall credit loss reserves also increase.  At December 31, 2011, approximately $5.9 billion, or 14 percent of our real estate secured receivable portfolio has been written down to fair value less cost to sell. In addition, approximately $11.7 billion of real estate secured receivables which have not been written down to fair value less cost to sell are considered TDR Loans and $1.3 billion of personal non-credit card receivables are considered TDR Loans, which are reserved for using a discounted cash flow analysis that generally results in a higher reserve requirement. As a result, at December 31, 2011, 41 percent of our real estate secured receivable portfolio and 40 percent of our total receivable portfolio have either been written down to fair value less cost to sell or are reserved for using a discounted cash flow analysis.  Credit loss reserves at December 31, 2010 decreased as we recorded provision for credit losses less than net charge-offs of $1.8 billion during 2010. Credit loss reserves were lower for all products as discussed below.    

• The decrease in credit loss reserve levels in our real estate secured

receivable portfolio reflects lower receivable levels as the portfolio

continues to liquidate and as compared to December 31, 2009, improvements

        in total loss severities largely as a result of an increase in the number         of properties for which we accepted a deed-in-lieu and an increase in the

number of short sales, both of which result in lower losses compared to

loans which are subject to a formal foreclosure process for which average

loss severities in 2010 have remained relatively flat to 2009 levels. The

decrease also reflects the impact of an increase of $1.7 billion during

2010 of real estate secured receivables which have been written down to net

realizable value less cost to sell and, therefore, generally do not have

credit loss reserves associated with them. Real estate secured receivables

which have been written down to net realizable value less cost to sell are

generally in the process of foreclosure and will remain in our delinquency

        totals until we obtain title to the property. Credit loss reserves also         reflect lower delinquency levels as the delinquent balances migrate to

charge-off and are replaced by lower levels of newly delinquent loans as

the portfolio seasons, partially offset by higher loss estimates on

recently modified loans. Additionally, reserve requirements for real estate

secured TDR Loans decreased as compared to December 31, 2009 due to lower

new TDR Loan volumes and lower expected loss rates as a larger percentage

        of our real estate TDR Loans are performing due to an increase in         charge-off of non-performing real estate secured TDR Loans.    

• Credit loss reserve levels in our personal non-credit card portfolio

        decreased as a result of lower receivable levels including lower         delinquency levels, partially offset by slightly higher reserve         requirements on personal non-credit card TDR Loans due to increases in

expected loss rates, partially offset by lower new TDR Loan volumes.

   Credit loss reserves decreased significantly in 2009, largely as a result of the December 2009 Charge-off Policy Changes which reduced loss reserve levels by $3.5 billion. Excluding the impact of this policy change, reserve levels would have increased to $10.7 billion in 2009, driven by higher loss estimates for Consumer Lending real estate secured receivables driven by higher delinquency levels and the impact of higher real estate secured troubled debt restructurings and higher reserve requirements associated with these receivables at both Consumer Lending and Mortgage Services. Excluding the impact of the December 2009 Charge-off Policy Changes, with the exception of our Consumer Lending real estate secured receivable portfolio, credit loss reserves were lower for all products as compared to December 31, 2008 reflecting lower dollars of delinquency and lower receivable levels. These decreases were partially offset by higher credit loss reserves in our Consumer Lending real estate secured receivable portfolio during 2009 due to the continued deterioration in the U.S. economy and housing markets, significantly higher unemployment rates, portfolio seasoning, higher loss severities and delays in processing foreclosures for real estate secured receivables as a result of backlogs in foreclosure proceedings and actions by local governments and certain states that have lengthened the foreclosure process.  Credit loss reserve levels in 2009 also reflect higher loss estimates related to TDR Loans. We use certain assumptions and estimates to compile our TDR balances and future cash flow estimates. In the fourth quarter of                                           73

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  Table of Contents                                                          HSBC Finance Corporation        2009, we received updated performance data on loan modifications which included activity associated with the recent increases in volume since late 2008 through mid-2009. Based on this data, we completed an update of the assumptions reflected in the cash flow models used to estimate credit losses associated with TDR Loans, including payment speeds and default rates. The update of these assumptions resulted in an increase to the provision for credit losses and an increase in the component of credit loss reserves specifically related to TDR of approximately $400 million net of reclassifications from other components of credit loss reserves.  Credit loss reserves at December 31, 2008 increased significantly as compared to December 31, 2007 as we recorded loss provision in excess of net charge-offs of $2.5 billion (excluding additional provision recorded as part of the lower of amortized cost or fair value adjustment recorded on receivables transferred to held for sale). The increase was primarily as a result of higher delinquency and credit loss estimates in all of our receivable portfolios, the continued deterioration of the U.S. economy and housing markets during 2008, significantly higher unemployment rates, portfolio seasoning, higher personal bankruptcy filings; and delays in foreclosure activity as discussed above. Increases in credit loss reserves levels at December 31, 2008 were partially offset by the reclassification of $252 million in credit loss reserves associated with the transfer of receivables to held for sale as well as the impact of lower overall receivables.  Credit loss reserves at December 31, 2007 increased as compared to December 31, 2006 as we recorded loss provision in excess of net charge-offs of $3.4 billion. The increase was primarily a result of the higher delinquency and loss estimates in all of our receivable portfolios. In addition, the higher credit loss reserve levels reflected higher dollars of delinquency driven by portfolio seasoning and increased levels of personal bankruptcy filings as compared to the exceptionally low levels experienced in 2006 following enactment of new bankruptcy legislation in the United States in October 2005, partially offset by lower overall receivables.  Reserve ratios Following is a discussion of changes in the reserve ratios we consider in establishing reserve levels. The reserve ratios for the year ended December 31, 2009 were significantly impacted by the December 2009 Charge-off Policy changes described above as well as in Note 7, "Changes in Charge-off Policies During 2009," in the accompanying consolidated financial statements. When noted, the discussion of the change between years excludes the impact of the adoption of these new charge-off policies on the ratios at December 31, 2009.  Reserves as a percentage of receivables were higher at December 31, 2011 as compared to December 31, 2010 due to higher reserve levels on TDR Loans driven by the impact of adopting new accounting guidance related to TDR Loans during the third quarter of 2011, partially offset by the impact of lower levels of two-months-and-over contractual delinquency on accounts less than 180 days contractually delinquent. This increase was also partially offset by a shift in mix in our receivable portfolio to higher levels of first lien real estate secured receivables which generally carry lower reserve requirements than second lien real estate secured and personal non-credit card receivables. This ratio in 2011 was also impacted by increases in the level of real estate secured receivables which have been written down to net realizable value less cost to sell. These written down receivables increased by $842 million as compared to December 31, 2010. Reserves as a percentage of receivables were lower at December 31, 2010 as compared to December 31, 2009 driven by significantly lower dollars of delinquency for all products as discussed more fully below which resulted in decreases in our credit loss reserves outpacing the decreases in receivable levels. This ratio in 2010 was also impacted by increases in the level of real estate secured receivables which have been written down to net realizable value less cost to sell. These written down receivables increased by $1.7 billion as compared to December 31, 2009. Additionally, the decrease also reflects a shift in mix in our receivable portfolio to higher levels of first lien real estate secured as discussed above. Reserves as a percentage of receivables at December 31, 2009 (excluding the impact of the December 2009 Charge-off Policy Changes) increased as compared to December 31, 2008 due to the lower receivable levels in 2009 as well as the impact of additional reserve requirements in our Consumer Lending business due to higher delinquency levels in our real estate secured receivable portfolios resulting from the economic conditions in 2009 and backlogs in foreclosure proceedings and actions by local governments and certain states which resulted in delays in processing foreclosures. Also contributing to the increase was the impact of higher real estate secured TDR Loans including higher reserve requirements associated with these receivables at both Consumer Lending and Mortgage Services. Additionally, for 2009 as compared to 2008,                                           74 

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  Table of Contents                                                          HSBC Finance Corporation        reserves as a percentage of receivables were higher as a result of a shift in mix to higher levels of non-prime credit card receivables which carry a higher reserve requirement than prime credit card receivables. Reserves as a percentage of receivables at December 31, 2008 were higher than at December 31, 2007 due to the impact of additional reserve requirements as discussed above.  Reserves as a percentage of net charge-offs at December 31, 2011 increased significantly as compared to December 31, 2010 due to higher reserve levels on TDR Loans driven by the impact of adopting new accounting guidance related to TDR Loans during the third quarter of 2011 and significantly lower dollars of net charge-offs during 2011 as discussed more fully below. Reserves as a percentage of net charge-offs at December 31, 2010 increased as compared to December 31, 2009 as dollars of net charge-offs decreased at a faster pace than reserves largely due to higher reserve requirements on modified loans. Reserves as a percentage of net charge-offs for December 31, 2009 (excluding the impact of the December 2009 Charge-off Policy Changes) increased as compared to December 31, 2008 as the increase in reserve requirements in our Consumer Lending business outpaced the increase in charge-offs in our Consumer Lending real estate secured receivable portfolio largely due to the delays and backlogs in foreclosure proceedings. Reserves as a percentage of net charge-offs were lower in 2008 than 2007 as the increase in charge-offs outpaced the increase in reserve levels. This is primarily due to a significant increase in reserves during 2007 due to growing delinquency in our Consumer Lending and Mortgage Services real estate secured portfolios which migrated to charge-off in 2008.  Reserves as a percentage of two-months-and-over contractual delinquency at December 31, 2011 increased as compared to December 31, 2010. This ratio has been impacted by real estate secured receivables which are carried at fair value less cost to sell. Excluding receivables carried at fair value less cost to sell and any associated credit loss reserves from this ratio for both periods, reserves as a percentage of two-months-and-over contractual delinquency at December 31, 2011 increased significantly as compared to December 31, 2010 reflecting higher reserve levels on TDR Loans driven by the impact of adopting new accounting guidance for TDR Loans during the third quarter of 2011 and lower levels of two-months-and-over contractual delinquency on accounts less than 180 days contractually delinquent as discussed below. Excluding receivables carried at net realizable value less cost to sell from this ratio for both periods, reserves as a percentage of two-months-and-over contractual delinquency at December 31, 2010 increased as compared to December 2009 as dollars of delinquency decreased at a faster pace than reserve levels. This increase was largely driven by dollars of delinquency for personal non-credit card receivables decreasing at a faster pace than reserve levels due to higher loss estimates on bankrupt and TDR Loans as well as higher loss estimates for all products on recently modified loans. Reserves as a percentage of two-months-and-over contractual delinquency at December 31, 2009 (excluding the impact of the December 2009 Charge-off Policy Changes) as compared to December 31, 2008 increased due the increase in reserve requirements in our Consumer Lending business discussed above, partially offset by the lower dollars of delinquency for Mortgage Services real estate secured, credit card, and personal non-credit card receivables. Reserves as a percentage of two-months-and-over contractual delinquency at December 31, 2008 decreased as compared to December 31, 2007 due to a shift to significantly higher levels of contractually delinquent first lien real estate secured receivables which typically carry lower reserve requirements than second lien real estate secured and unsecured receivables.  Reserves as a percentage of nonperforming loans in 2011, 2010 and 2009 was impacted by nonperforming real estate secured receivables carried at fair value less cost to sell. Excluding receivables carried at fair value less cost to sell and any associated credit loss reserves from this ratio for all periods, reserves as a percentage of nonperforming loans increased significantly at December 31, 2011 as compared to December 31, 2010 reflecting higher reserve levels on TDR Loans as discussed above and lower levels of nonperforming receivables as discussed more fully below. Excluding receivables carried at net realizable value less cost to sell from this ratio for both December 31, 2010 and 2009, reserves as a percentage of nonperforming loans increased during 2010 due to nonperforming personal non-credit card receivables decreasing at a faster pace than reserve levels due to higher loss estimates on bankrupt and TDR Loans as well as higher loss estimates for all products on recently modified loans. Reserves as a percentage of nonperforming loans at December 31, 2009 (excluding the impact of the December 2009 Charge-off Policy Changes) were lower as compared to December 31, 2008 as the majority of the increase in non-performing loans was in the first lien portion of Consumer Lending's real estate secured receivable portfolio. First lien real estate secured receivables typically carry lower reserve requirements than second lien real estate secured and unsecured receivables. Reserves as a percentage of nonperforming loans decreased in 2008 as compared to 2007 as the majority of the increase in nonperforming loans was from the first lien real estate secured receivable portfolios in our Consumer Lending and Mortgage Services businesses which typically carry lower reserve requirements than second lien real estate secured and unsecured receivables.                                           75 

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  Table of Contents                                                          HSBC Finance Corporation        The following table summarizes the changes in credit loss reserves for continuing operations by product during the years ended December 31, 2011, 2010 and 2009:                                                    Real Estate Secured            Personal                                               First           Second         Non-Credit                                                Lien            Lien             Card             Total                                                                    (in millions) Year ended December 31, 2011: Balances at beginning of period             $    3,355       $    832       $      1,325       $   5,512 Provision for credit losses(1)                   3,227            758                433           4,418 Charge-offs                                     (2,527 )         (827 )           (1,127 )        (4,481 ) Recoveries                                          34             60                409             503  Net charge-offs                                 (2,493 )         (767 )             (718 )        (3,978 )  Balance at end of period                    $    4,089       $    823       

$ 1,040 $ 5,952

  Reserve components: Collectively evaluated for impairment       $      632       $    286       $        334       $   1,252 Individually evaluated for impairment(2)         3,026            534                706           4,266 Receivables carried at net realizable value less cost to sell                            423              2                  -             425 Loans acquired with deteriorated credit quality                                              8              1                  -               9  Total credit loss reserves                  $    4,089       $    823       $      1,040       $   5,952  Year ended December 31, 2010: Balances at beginning of period             $    3,997       $  1,430       $      1,848       $   7,275 Provision for credit losses                      3,126            789              1,431           5,346 Charge-offs                                     (3,811 )       (1,456 )           (2,329 )        (7,596 ) Recoveries                                          43             69                375             487  Net charge-offs                                 (3,768 )       (1,387 )           (1,954 )        (7,109 )  Balance at end of period                    $    3,355       $    832       

$ 1,325 $ 5,512

  Reserve components: Collectively evaluated for impairment       $    1,544       $    570       $        930       $   3,044 Individually evaluated for impairment(2)         1,701            258                395           2,354 Receivables carried at net realizable value less cost to sell                             94              1                  -              95 Loans acquired with deteriorated credit quality                                             16              3                  -              19  Total credit loss reserves                  $    3,355       $    832       $      1,325       $   5,512  Year ended December 31, 2009: Balances at beginning of period             $    4,998       $  2,115       $      2,668       $   9,781 Provision for credit losses                      3,354          1,558              2,992           7,904 Charge-offs                                     (4,381 )       (2,282 )           (4,039 )       (10,702 ) Recoveries                                          26             39                227             292  Net charge-offs                                 (4,355 )       (2,243 )           (3,812 )       (10,410 )  Balance at end of period                    $    3,997       $  1,430       

$ 1,848 $ 7,275

  Reserve components: Collectively evaluated for impairment       $    2,206       $  1,051       $      1,495       $   4,752 Individually evaluated for impairment(2)         1,766            373                353           2,492 Loans acquired with deteriorated credit quality                                             25              6                  -              31  Total credit loss reserves                  $    3,997       $  1,430       $      1,848       $   7,275       

(1) During 2011, provision for credit losses included $683 million for first

lien real estate secured receivables, $83 million for second lien real

estate secured receivables and $159 million for personal non-credit card

receivables related to the adoption of new accounting guidance for TDR Loans

     as discussed above.                                            76 

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(2) These amounts represent TDR Loans for which we evaluate reserves using a

discounted cash flow methodology. Each loan is individually identified as a

TDR Loan and then grouped together with other TDR Loans with similar

characteristics. The discounted cash flow impairment analysis is then

applied to these groups of TDR Loans. This amount excludes credit loss

reserves associated with TDR Loans that are carried at fair value less cost

to sell.

   See the "Analysis of Credit Loss Reserves Activity," "Reconciliations to U.S. GAAP Financial Measures" and Note 8, "Credit Loss Reserves," to the accompanying consolidated financial statements for additional information regarding our loss reserves.  Delinquency and Charge-off Policies and Practices Our delinquency and net charge-off ratios reflect, among other factors, changes in the mix of loans in our portfolio, the quality of our receivables, the average age of our loans, the success of our collection and customer account management efforts, general economic conditions such as national and local trends in housing markets, interest rates, unemployment rates, any changes to our charge-off policies such as occurred in 2009 and significant catastrophic events such as natural disasters and global pandemics. Levels of personal bankruptcies also have a direct effect on the asset quality of our overall portfolio and others in our industry.  Our credit and portfolio management procedures focus on risk-based pricing and ethical and effective collection and customer account management efforts for each loan. Our credit and portfolio management process is designed to give us a reasonable basis for predicting the credit quality of accounts although in a changing external environment this has become more difficult than in the past. This process is based on our experience with numerous marketing, credit and risk management tests. However, beginning in 2007 and continuing through 2011 we found consumer behavior has deviated from historical patterns due to the housing market deterioration, high unemployment levels and pressures from the economic conditions, creating increased difficulty in predicting credit quality. As a result, we have enhanced our processes to emphasize more recent experience, key drivers of performance, and a forward-view of expectations of credit quality. We also believe that our frequent and early contact with delinquent customers, as well as re-aging, modification and other customer account management techniques which are designed to optimize account relationships and home preservation, are helpful in maximizing customer collections on a cash flow basis and have been particularly appropriate in the unstable market. See Note 2, "Summary of Significant Accounting Policies and New Accounting Pronouncements," in the accompanying consolidated financial statements for a description of our charge-off and nonaccrual policies by product.  Delinquency Our policies and practices for the collection of consumer receivables, including our customer account management policies and practices, permit us to modify the terms of loans, either temporarily or permanently (a "modification"), and/or to reset the contractual delinquency status of an account that is contractually delinquent to current (a "re-age"), based on indicia or criteria which, in our judgment, evidence continued payment probability. Such policies and practices vary by product and are designed to manage customer relationships, improve collection opportunities and avoid foreclosure or repossession as determined to be appropriate. If a re-aged account subsequently experiences payment defaults, it will again become contractually delinquent and be included in our delinquency ratios.                                           77

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The following table summarizes dollars of two-months-and-over contractual delinquency and two-months-and-over contractual delinquency as a percent of consumer receivables and receivables held for sale ("delinquency ratio"):

                                                               2011                                                     2010                                     Dec. 31        Sept. 30       June 30       Mar. 31       Dec. 31       Sept. 30       June 30       Mar. 31                                                                        (dollars are in millions) Dollars of contractual delinquency: Continuing operations: Real estate secured: Receivables carried at net realizable value                    $  4,843      $    4,417      $  4,227      $  4,149      $  4,199      $   4,095      $  3,849      $  3,724 Remainder                              3,262           3,346         2,819         2,909         3,972          4,399         4,388         4,898  Total real estate secured(1)(2)        8,105           7,763         7,046         7,058         8,171          8,494         8,237         8,622 Personal non-credit card                 486             518           489           596           779            921           954         1,158  Total consumer - continuing operations                             8,591           8,281         7,535         7,654         8,950          9,415         9,191         9,780 Discontinued operations                  481             457           406           481           612            673           877         1,141  Total consumer                      $  9,072      $    8,738      $  7,941      $  8,135      $  9,562      $  10,088      $ 10,068      $ 10,921  Delinquency ratio: Continuing operations: Real estate secured: Receivables carried at net realizable value                       81.57 %         78.97 %       78.77 %       76.76 %       82.41 %        84.00 %       84.44 %       86.83 % Remainder                               8.87            8.67          7.01          6.96          8.98           9.41          8.86          9.31  Total real estate secured(1)(2)        18.98           17.57         15.45         14.95         16.56          16.45         15.23         15.15 Personal non-credit card                9.35            9.24          8.14          9.16         10.94          11.78         11.19         12.29  Total consumer - continuing operations                             17.93           16.63         14.60         14.25         15.85          15.84         14.68         14.74 Discontinued operations                 5.34            5.27          4.40          5.20          6.18           6.81          6.74          8.18  Total consumer                         15.94 %         14.94 %       13.06 %       12.92 %       14.41 %        14.55 %       13.31 %       13.60 %       

(1) Real estate secured two-months-and-over contractual delinquency dollars and

     as a percent of consumer receivables and receivables held for sale for our      Mortgage Services and Consumer Lending businesses are as follows:                                            78 

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  Table of Contents                                                          HSBC Finance Corporation                                                                        2011                                                      2010                                       Dec. 31        Sept. 30       June 30       Mar. 31       Dec. 31        Sept. 30       June 30       Mar. 31                                                                                 (dollars are in millions) Dollars of contractual delinquency: Mortgage Services: First lien                            $  2,582      $    2,470      $  2,254      $  2,338      $  2,643      $    2,734      $  2,682      $  2,824 Second lien                                155             169           163           184           243             266           276           305  Total Mortgage Services               $  2,737      $    2,639      $  2,417      $  2,522      $  2,886      $    3,000      $  2,958      $  3,129  Consumer Lending: First lien                            $  5,023      $    4,763      $  4,315      $  4,199      $  4,861      $    5,021      $  4,796      $  4,970 Second lien                                345             361           314           337           424             473           483           523  Total Consumer Lending                $  5,368      $    5,124      $  4,629      $  4,536      $  5,285      $    5,494      $  5,279      $  5,493  Delinquency ratio: Mortgage Services: First lien                               21.88 %         20.20 %       17.82 %       17.76 %       19.12 %         18.80 %       17.51 %       17.40 % Second lien                               9.25            9.43          8.61          9.14         11.23           11.38         11.01         11.22  Total Mortgage Services                  20.31 %         18.83 %       16.62 %       16.62 %       18.05 %         17.77 %       16.59 %       16.51 %  Consumer Lending: First lien                               19.00 %         17.49 %       15.39 %       14.52 %       16.18 %         16.11 %       14.80 %       14.75 % Second lien                              12.31           12.31         10.41         10.79         12.81           13.23         12.53         12.32  Total Consumer Lending                   18.36 %         16.98 %       14.91 %       14.16 %       15.85 %         15.81 %       14.56 %       14.47 %      (2)  The following reflects dollars of contractual delinquency and the 

Delinquency Ratio for interest-only loans and stated income real estate

     secured receivables:                                                               2011                                                          2010                                  Dec. 31         Sept. 30        June 30        Mar. 31        Dec. 31         Sept. 30        June 30        Mar. 31                                                                                (dollars are in millions) Dollars of contractual delinquency: Interest-only loans              $    370       $      410       $    395       $    404       $    423       $      412       $    394       $    436 Stated income loans                   590              617            576            609            683              722            737            820 Delinquency ratio: Interest-only loans                 38.54 %          39.84 %        35.61 %        33.11 %        31.76 %          28.50 %        25.28 %        25.54 % Stated income loans                 27.35            27.22          24.22          24.20          25.28            24.77          23.46          24.03   Overall dollars of delinquency for continuing operations increased as compared to September 30, 2011 due to higher dollars of delinquency for real estate secured receivables, partially offset by a decrease in dollars of delinquency for personal non-credit card receivables during the quarter. The increase in dollars of delinquency for real estate secured receivables reflects an increase in late stage delinquency reflecting the continuing impact of our temporary suspension of foreclosure activities as previously discussed as the rate at which receivables are being transferred to REO has slowed. Dollars of delinquency for real estate secured receivables associated with real estate secured receivables carried at the lower of amortized cost or fair value less cost to sell increased $426 million since September 30, 2011. These receivables, which are currently carried at the lower of amortized cost or fair value less cost to sell, are generally in the process of foreclosure and will remain in our delinquency totals until we obtain title to the property. The increase in dollars of delinquency for receivables carried at net realizable value less cost to sell was partially offset by a decrease in dollars of delinquency on accounts less than 180 days contractually delinquent in the real estate secured receivable portfolio which was driven by a modest increase in re-age volumes during the quarter and lower receivable levels. While it currently remains unclear, a portion of this decrease in dollars of delinquency for real estate secured receivables less than 180 days contractually delinquent may have been partially offset by changes in customer payment behavior due to the temporary suspension of foreclosure activities. Dollars of delinquency for our personal non-credit card decreased as compared to September 30, 2011 reflecting the impact of lower receivable levels and improved credit quality partially offset by seasonal trends for higher delinquency during the second half of the year and the impact of continuing high unemployment levels.                                           79

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  Table of Contents                                                          HSBC Finance Corporation        Dollars of two-month-and-over contractual delinquency for continuing operations decreased for both real estate secured and personal non-credit card receivables as compared to December 31, 2010. In our real estate secured receivable portfolio, dollars of two-months-and-over contractual delinquency decreased modestly as compared to December 31, 2010 as a significant increase in late stage delinquency driven by our earlier decision to temporarily suspend foreclosure activities was offset by a decrease in dollars of contractual delinquency on accounts less than 180 days contractually delinquent due to lower receivable levels and the impact of improvements in economic conditions. While it currently remains unclear, a portion of the decrease in dollars of delinquency for real estate secured receivables less than 180 days contractually delinquent may have been partially offset by changes in customer payment behavior due to the temporary suspension of foreclosure activities. Dollars of delinquency decreased in our personal non-credit card portfolio reflecting the impact of lower receivable levels and improved credit quality.  The delinquency ratio for continuing operations increased as compared to September 30, 2011 reflecting higher dollars of delinquency driven during the quarter by the continuing impact of our temporary suspension of foreclosure activities as discussed above and lower receivable levels. The delinquency ratio for continuing operations also increased as compared to December 31, 2010 as the decrease in receivable levels outpaced the decrease in dollars of delinquency during the year driven by the continuing impact of our temporary suspension of foreclosure activities as discussed above.  Dollars of delinquency for our discontinued credit card receivables at December 31, 2011 increased slightly as compared to September 30, 2011 but decreased as compared to December 31, 2010. The increase as compared to the prior quarter reflects seasonal trends for higher delinquency during the second half of the year. The decrease as compared to December 31, 2010 reflects the impact of lower receivable levels and improvements in credit quality. The delinquency ratio for credit card receivables has increased as compared to September 30, 2011 reflecting the higher delinquency levels discussed above. As compared to December 31, 2010, the delinquency ratio decreased as dollars of delinquency during the year decreased at a faster pace than receivable levels due to improvements in credit quality.  

See "Customer Account Management Policies and Practices" regarding the delinquency treatment of re-aged accounts and accounts subject to forbearance and other customer account management tools.

                                       80

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Net Charge-offs of Consumer Receivables The following table summarizes net charge-off of consumer receivables both in dollars and as a percent of average consumer receivables ("net charge-off ratio").

                                                                       2011                                                                   2010                                       2009                                        Full                          Quarter Ended(1)                         Full                          Quarter Ended(1)                          Full                                        Year        Dec. 31        Sept. 30       June 30       Mar. 31        Year        Dec. 31        Sept. 30       June 30       Mar. 31         Year                                                                                                      (dollars are in millions) Net charge-off dollars: Continuing operations: Real estate secured(1)                $ 3,260      $    757      $      724 

$ 763$ 1,016$ 5,155$ 1,022$ 1,196$ 1,452$ 1,485$ 6,598 Personal non-credit card

                  718           147             137           174           260        1,954           357             380           539           678         3,812  Total consumer - continuing operations                              3,978           904             861           937         1,276        7,109         1,379           1,576         1,991         2,163        10,410 Discontinued operations                   643             -             127           229           287        1,785           311             360           511           603         2,742  Total consumer                        $ 4,621      $    904      $      988      $  1,166      $  1,563      $ 8,894      $  1,690      $    1,936      $  2,502      $  2,766      $ 13,152  Net charge-off ratio: Continuing operations: Real estate secured(2)                   7.13 %        6.97 %          6.46 

% 6.59 % 8.43 % 9.50 % 8.12 % 9.05 %

    10.47 %       10.17 %        9.85 % Personal non-credit card                11.84         10.92            9.42         11.13         15.26        22.65         19.13           18.60      

24.03 27.32 27.96

  Total consumer - continuing operations                               7.69          7.41            6.80          7.13          9.27        11.30          9.54           10.32         12.36         12.66         12.91 Discontinued operations(3)              10.32             -            8.23          9.94         11.92        14.24         12.60           12.19         15.07         16.15         15.53  Total consumer                           7.97 %        7.41 %          6.95 %        7.55 %        9.67 %      11.79 %        9.98 %         10.63 %       12.83 %       13.28 %       13.38 %  Real estate charge-offs and REO expense as a percent of average real estate secured receivables - continuing operations                    7.58 %        7.27 %          6.80 %        6.84 %        9.31 %      10.01 %        9.07 %          9.61 %       10.76 %       10.43 %       10.14 %        (1)  The net charge-off ratio for all quarterly periods presented is net 

charge-offs for the quarter, annualized, as a percentage of average consumer

     receivables for the quarter.                                            81 

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(2) Real estate secured net charge-off of consumer receivables as a percent of

average consumer receivables for our Mortgage Services and Consumer Lending

      businesses are as follows:                                                                          2011                                                                   2010                                      2009                                         Full                           Quarter Ended                           Full                           Quarter Ended                           Full                                         Year        Dec. 31        Sept. 30       June 30       Mar. 31        Year        Dec. 31        Sept. 30       June 30       Mar. 31        Year                                                                                                       (dollars are in millions) Net charge-off dollars: Mortgage Services: First lien                             $ 1,001      $    221      $      226      $    242      $    312      $ 1,558      $    305      $      360      $    452      $    441      $ 2,204 Second lien                                339            73              70            86           110          619           132             134           157           196        1,052  Total Mortgage Services                $ 1,340      $    294      $      296      $    328      $    422      $ 2,177      $    437      $      494      $    609      $    637      $ 3,256  Consumer Lending: First lien                             $ 1,492      $    357      $      345      $    329      $    461      $ 2,210      $    433      $      537      $    643      $    597      $ 2,152 Second lien                                427           105              83           106           133          768           152             165           200           251        1,190  Total Consumer Lending                 $ 1,919      $    462      $      

428 $ 435$ 594$ 2,978$ 585 $ 702

    $    843      $    848      $ 3,342  Net charge-off ratio: Mortgage Services: First lien                                7.88 %        7.36 %          7.26 %        7.51 %        9.27 %      10.13 %        8.66 %          9.62 %       11.45 %       10.56 %      11.35 % Second lien                              17.85         16.93           15.23         17.62         21.10        24.52         23.52           22.16         24.25         27.46        28.72  Total Mortgage Services                   9.18 %        8.56 %         

8.28 %        8.83 %       10.85 %      12.16 %       10.68 %         11.36 %       13.26 %       13.04 %      14.11 %  Consumer Lending: First lien                                5.32 %        5.33 %          5.00 %        4.63 %        6.26 %       6.81 %        5.68 %          6.75 %        7.78 %        6.93 %       5.60 % Second lien                              14.11         14.66           11.18         13.78         16.63        19.62         17.54           17.80         19.73         22.61        21.93  Total Consumer Lending                    6.18 %        6.23 %          5.60 %        5.52 %        7.28 %       8.19 %        6.88 %          7.91 %        9.09 %        8.73 %       7.62 %     

(3) During a quarter that receivables are transferred to receivables held for

sale, those receivables continue to be included in the average consumer

receivable balances prior to such transfer and any charge-offs related to

those receivables prior to such transfer remain in our net charge-off

totals. However, for periods following the transfer to the held for sale

classification, the receivables are no longer included in average consumer

receivable balance as such loans are carried at the lower of amortized cost

or fair value and there are no longer any charge-offs reported associated

with these receivables.

   Full Year 2011 compared to Full Year 2010 Overall dollars of net charge-offs for continuing operations for the full year 2011 decreased significantly as compared to full year 2010 as all receivable portfolios were positively impacted by lower average dollars of delinquency as compared to the prior year and lower levels of personal bankruptcy filings. These decreases were partially offset for all receivable portfolios by the impact of continued high unemployment levels. The overall decrease in dollars of net charge-offs for real estate secured receivables reflects the impact of the decreases in average dollars of delinquency as fewer accounts have been migrating to charge-off due to lower receivable levels and the impact of our temporary suspension of foreclosure activities because once the foreclosure process commences a higher payment is required for an account to be re-aged and as a result more accounts are re-aging. However, we anticipate charge-off levels for real estate secured receivables may increase in future periods as delinquency levels which began to rise during the second half of 2011 will remain under pressure and these receivables begin to migrate to charge-off in future periods.  The net charge-off ratio for receivables from continuing operations for full year 2011 decreased 361 basis points as compared to the full year 2010 reflecting lower dollars of net charge-offs as discussed above which significantly outpaced the decrease in average receivables as the rate at which receivables are being transferred to REO has slowed as a result of our temporary suspension of foreclosure activities.  Real estate charge-offs and REO expenses as a percentage of average real estate secured receivables for full year 2011 decreased due to lower dollars of net charge-offs and lower REO expenses as a result of our temporary suspension of foreclosure activities partially offset by the impact of lower average receivable levels. See "Results of Operations" for further discussion of REO expenses.                                           82 

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  Table of Contents                                                          HSBC Finance Corporation        Dollars of net charge-offs for discontinued credit card receivables for full year 2011 decreased as compared to full year 2010; however, a portion of the decrease reflects fewer charge-offs beginning in the third quarter as we stopped recording charge-offs on our credit card receivable portfolio after it became part of the disposal group held for sale to Capital One in August 2011 which is carried at the lower of amortized cost or fair value. Assuming charge-off had been recorded for the full year 2011 in accordance with our existing charge-off policy, dollars of net charge-off would have remained lower due to the lower dollars of delinquency we have been experiencing over the past several quarters as a result of lower receivable levels and lower levels of personal bankruptcy filings, partially offset by the impact of continuing high unemployment levels.  The net charge-off ratio for our discontinued credit card receivable portfolio decreased 392 basis points for the full year 2011 as compared to the full year 2010. Excluding the impact of the transfer of the credit card receivable portfolio to held for sale in August 2011 as discussed above, the net charge-off ratio remained lower as the decrease in dollars of net charge-offs due to lower delinquency levels outpaced the decrease in average receivables.  Full Year 2010 compared to Full Year 2009 Dollars of net charge-offs for continuing operations decreased for the full year of 2010 for all products as compared to the full year 2009, reflecting lower delinquency levels as a result of lower average receivable levels, improvements in economic conditions since year-end 2009 and lower levels of personal bankruptcy filings during 2010, partially offset by the impact of continued high unemployment levels and as it relates to first lien real estate secured receivables in our Consumer Lending business, portfolio seasoning. Additionally, a portion of the decrease in dollars of net charge-offs reflects charge-off activity during 2009 that would have been recorded in prior periods had the changes made to the charge-off policy in December 2009 for real estate secured and personal non-credit card receivables been effective prior to 2009. Dollars of net charge-offs for real estate secured receivables for full year 2010 also reflect improvements in total loss severities as a result of an increase in the number of properties for which we accepted a deed-in-lieu and an increase in the number of short sales, both of which result in lower losses compared to loans which are subject to a formal foreclosure process for which average loss severities in 2010 have remained relatively flat to 2009 levels.  The net charge-off ratio for continuing operations decreased 161 basis points as the decrease in dollars of net charge-offs as discussed above outpaced the decrease in average receivables. The net charge-off ratio was also impacted by the December 2009 Charge-off Policy Changes as dollars of net charge-off in 2009 reflects charge-off activity that would have been recorded in prior periods had the changes been made to the charge-off policy in December 2009 been effective prior to 2009.  Real estate charge-offs and REO expenses as a percentage of average real estate secured receivables decreased during 2010 as a result of the decrease in dollars of net charge-offs as discussed above, partially offset by the impact of higher REO expense and lower average receivable levels. Higher REO expense during 2010 reflects a higher loss on sale of REO properties as home prices declined during the second half of 2010 as well as higher overall expenses for REO properties. See "Results of Operations" for further discussion of REO expenses.  Dollars of net charge-offs for our discontinued credit card receivables decreased for the full year 2010 as compared to full year 2009 reflecting lower delinquency levels as a result of lower average receivable levels as previously discussed, lower levels of personal bankruptcy filings and higher recoveries, partially offset by the impact of continued high unemployment levels. Lower dollars of net charge-offs also reflect improvements in economic conditions since year-end 2009.  The net charge-off ratio for our discontinued credit card receivable portfolio decreased 129 basis points for the full year 2010 as compared to the full year 2009 as the decrease in dollars of net charge-offs outpaced the decrease in average receivables.                                           83 

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  Table of Contents                                                          HSBC Finance Corporation        Nonperforming Assets Nonperforming assets are summarized in the following table.    At December 31,                                           2011          2010          2009                                                              (dollars are in millions) Continuing operations: Nonaccrual receivable portfolios(2): Real estate secured: First lien                                              $  6,200       $ 5,916       $ 6,306 Second lien                                                  344           444           689  Total real estate secured(3)                               6,544         6,360         6,995 Personal non-credit card                                     330           530           998  Total nonperforming receivables                            6,874         6,890         7,993 Real estate owned                                            299           962           592  Total nonperforming assets - continuing operations         7,173         7,852         8,585 Discontinued operations(1)                                   344           447         1,142  Total nonperforming assets                              $  7,517       $ 8,299       $ 9,727 

Credit loss reserves as a percent of nonperforming receivables - continuing operations

                         86.6 %        80.0 %        91.0 %       

(1) Includes credit card receivables which continue to accrue interest after

they become 90 or more days delinquent, consistent with industry practice.

    (2)  Nonaccrual receivables reflect all loans which are 90 or more days

contractually delinquent. Nonaccrual receivables do not include receivables

     which have made qualifying payments and have been re-aged and the      contractual delinquency status reset to current as such activity, in our      judgment, evidences continued payment probability. If a re-aged loan      subsequently experiences payment default and becomes 90 or more days      contractually delinquent, it will be reported as nonaccrual.     (3)  At December 31, 2011, 2010 and 2009, non-accrual real estate secured      receivables include $4.7 billion, $4.1 billion and $3.3 billion,      respectively, of receivables that are carried at fair value less cost to      sell.   Total nonperforming receivables were essentially flat as compared to December 31, 2010 as a significant decrease in nonperforming personal non-credit card receivables, due to lower delinquency levels during 2011 as a result of lower receivable levels and improved credit quality, was largely offset by higher nonperforming real estate secured receivables. The higher levels of nonperforming real estate secured receivables reflect the impact of higher late stage delinquency reflecting the continuing impact of our temporary suspension of foreclosure activities as discussed above.  The following table below summarizes TDR Loans for continuing operations that are shown as nonperforming receivables in the table above. As discussed more fully in Note 6, "Receivables," in the accompanying consolidated financial statements, during the third quarter of 2011 we adopted new accounting guidance for determining whether a restructuring of a receivable meets the criteria to be considered a TDR Loan. The TDR Loan balances in the table below as of December 31, 2010 and 2009 use our previous definition of TDR Loans as described in Note 2, "Summary of Significant Accounting Policies and New Accounting Pronouncements," in the accompanying consolidated financial statements and as such are not directly comparable to the balances at December 31, 2011.  

The following table below summarizes TDR Loans for continuing operations that are shown as nonperforming receivables in the table above.

                   At December 31,             2011        2010        2009                                                     (in millions)                 Real estate secured        $ 2,685     $ 1,825     $ 1,607                 Personal non-credit card       174          90         106                  Total                      $ 2,859     $ 1,915     $ 1,713                                             84 

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See Note 6, "Receivables," in the accompanying consolidated financial statements for further details regarding TDR Loan balances.

  Customer Account Management Policies and Practices Our policies and practices for the collection of consumer receivables, including our customer account management policies and practices, permit us to take action with respect to delinquent or troubled accounts based on criteria which, in our judgment, evidence continued payment probability, as well as, in the case of real estate secured receivables, a continuing desire for borrowers to stay in their homes. The policies and practices are designed to manage customer relationships, improve collection opportunities and avoid foreclosure as determined to be appropriate. From time to time we re-evaluate these policies and procedures and make changes as deemed appropriate.  

Currently, we utilize the following account management actions:

• Modification - Management action that results in a change to the terms and

conditions of the loan either temporarily or permanently without changing

the delinquency status of the loan. Modifications may include changes to

one or more terms of the loan including, but not limited to, a change in

interest rate, extension of the amortization period, reduction in payment

        amount and partial forgiveness or deferment of principal.    

• Collection Re-age - Management action that results in the resetting of the

contractual delinquency status of an account to current but does not

involve any changes to the original terms and conditions of the loan. If an

account which has been re-aged subsequently experiences a payment default,

it will again become contractually delinquent. We use collection re-aging

as an account and customer management tool in an effort to increase the

cash flow from our account relationships, and accordingly, the application

of this tool is subject to complexities, variations and changes from time

         to time.         •   Modification Re-age - Management action that results in a change to the

terms and conditions of the loan, either temporarily or permanently, and

also resets the contractual delinquency status of an account to current as

        discussed above. If an account which has been re-aged subsequently         experiences a payment default, it will again become contractually         delinquent.   It is our practice to defer past due interest on re-aged real estate secured and personal non-credit card accounts to the end of the loan period. We do not accrue interest on these past due interest payments consistent with our 2002 settlement agreement with the State Attorneys General. Our policies and practices for managing accounts are continually reviewed and assessed to assure that they meet the goals outlined above, and accordingly, we make exceptions to these general policies and practices from time to time. In addition, exceptions to these policies and practices may be made in specific situations in response to legal agreements, regulatory agreements or orders.  In April 2011, the FASB issued an Accounting Standards Update which provides additional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring. We adopted this new accounting guidance during the third quarter of 2011. Under this new guidance, we have determined that substantially all receivables modified as a result of a financial difficulty, regardless of whether the modification was permanent or temporary, including all modifications with trial periods should be reported as TDR Loans. Additionally, we have determined that all re-ages, except first time early stage delinquency re-ages where the customer has not been granted a prior modification or re-age since the first quarter of 2007, should be considered TDR Loans. The adoption of this new accounting guidance has resulted in significantly higher volumes of re-aged accounts and modified accounts being reported as TDR Loans. TDR Loans are typically reserved for using a discounted cash flow methodology which, in addition to credit losses, takes into consideration the time value of money and the difference between the current interest rate and the original effective interest rate. This methodology generally results in a higher reserve requirement for TDR Loans than the remainder of our receivable portfolio for which credit loss reserves are established using a roll rate migration analysis that only considers credit losses. As the level of TDR Loans increases, our overall credit loss reserves will increase due to the different methodology used to establish reserves on these receivables. See Note 6, "Receivables," in the accompanying consolidated financial statements for additional information on our adoption of this new accounting guidance.                                           85

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  Table of Contents                                                          HSBC Finance Corporation        The projected cash flows and timing of cash flows on non-performing loans is based on our recent historical migration statistics which we believe are the best estimate of future cash flows and timing of cash flows for this run-off portfolio. Historically, we more heavily utilized certain third party loan default estimates, adjusted for macro-economic assumptions, which were adjusted for trends in our portfolio. We now estimate cash flows incorporating more directly this internal data. Our estimates of home price severity are based on a 12-month average of broker price opinions received which are discounted from the date we expect to receive the proceeds.  The following table summarizes the general policies and procedures for account management actions for all real estate secured and personal non-credit card receivables in our Consumer Lending and Mortgage Services businesses which were implemented during the second quarter of 2010.                                                                  Real Estate(1)             Personal Non-Credit Card(1) 

Minimum time since prior account management action 6 or 12 months depending on

               6 months                                                      type of account management action Minimum qualifying monthly payments required            2 in 60 days after approval      2 in 60 days after approval Maximum number of account management actions                   5 in 5 years                     5 in 5 years       (1)  We employ account modification, re-aging and other customer account

management policies and practices as flexible customer account management

tools and the specific criteria may vary by product line. In addition to

variances in criteria by product, criteria may also vary within a product

line. Also, we continually review our product lines and assess modification

and re-aging criteria and, as such, they are subject to revision or

exceptions from time to time. Accordingly, the description of our account

modification and re-aging policies or practices provided in this table

should be taken only as general guidance to the modification and re-aging

approach taken within each product line, and not as assurance that accounts

not meeting these criteria will never be modified or re-aged, that every

account meeting these criteria will in fact be modified or re-aged or that

these criteria will not change or that exceptions will not be made in

individual cases. In addition, in an effort to determine optimal customer

account management strategies, management may run tests on some or all

accounts in a product line for fixed periods of time in order to evaluate

the impact of alternative policies and practices.

   With regard to real estate secured loans involving a bankruptcy, accounts whose borrowers are subject to a Chapter 13 plan filed with a bankruptcy court generally may be re-aged upon receipt of one qualifying payment. Accounts whose borrowers have filed for Chapter 7 bankruptcy protection may be re-aged upon receipt of a signed reaffirmation agreement. In addition, for some products, accounts may be re-aged without receipt of a payment in certain special circumstances (e.g. in the event of a natural disaster or a hardship program).  

The following summarizes our customer account management policies and practices for our discontinued credit card receivable portfolio.

Credit Card Re-aging Policies and Practices(1)

• Accounts qualify for re-aging if we receive three consecutive minimum

        monthly payments or a lump sum equivalent.    

• Accounts qualify for re-aging if the account has been in existence for a

        minimum of nine months and the account has not been re-aged in the prior         twelve months and not more than once in the prior five years.    

• Accounts entering third party debt counseling programs are limited to one

re-age in a five-year period in addition to the general limits of one

re-age in a twelve-month period and two re-ages in a five-year period,

(1) We employ account re-aging and other customer account management policies and

practices as flexible customer account management tools as criteria may vary

by product line. In addition to variances in criteria by product, criteria

may also vary within a product line. Also, we continually review our product

lines and assess re-aging criteria and they are subject to modification or

exceptions from time to time. Accordingly, the description of our account

re-aging policies or practices provided in this table should be taken only as

general guidance to the re-aging approach taken within each product line, and

not as assurance that accounts not meeting these criteria will never be

re-aged, that every account meeting these criteria will in fact be re-aged or

that these criteria will not change or that exceptions will not be made in

individual cases. In addition, in an effort to determine optimal customer

account management strategies, management may run more conservative tests on

some or all accounts in a product line for fixed periods of time in order to

    evaluate the impact of alternative policies and practices.                                            86 

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  Table of Contents                                                          HSBC Finance Corporation        As a result of the expansion of our modification and re-age programs in response to the marketplace conditions previously described, modification and re-age volumes since January 2007 for real estate secured receivables have increased. Since January 2007, we have cumulatively modified and/or re-aged approximately 373,400 real estate secured loans with an aggregate outstanding principal balance of $43.4 billion at the time of modification and/or re-age under our foreclosure avoidance programs which are described below and a proactive adjustable rate mortgage ("ARM") reset modification program which ended during the fourth quarter of 2009 and more fully described in our 2010 Form 10-K. The following provides information about the subsequent performance of all real estate secured loans granted a modification and/or re-age since January 2007, some of which may have received multiple account management actions:                                                                              Based on Outstanding                                                                           Receivable Balance at                                                      Number                  Time of Account Status as of December 31, 2011                      of Loans               Modification Action Current or less than 30-days delinquent                    36 %                               35 % 30- to 59-days delinquent                                   6                                  6 60-days or more delinquent                                 19                                 23 Paid-in-full                                                8                                  8 Charged-off, transferred to real estate owned or sold                                              31                                 28                                                            100 %                              100 %    The following table shows the number of real estate secured accounts remaining in our portfolio as well as the outstanding receivable balance of these accounts as of the period indicated for loans that we have taken an account management action by the type of action taken:                                                                                            Outstanding Receivable                                                  Number of Accounts(1)                      Balance (1)(4)                                               Consumer             Mortgage            Consumer           Mortgage                                               Lending              Services            Lending            Services                                               (accounts are in thousands)              (dollars are in millions)

December 31, 2011: Collection re-age only                               90.9                28.5       $        7,641        $   2,488 Modification only(2)                                  8.2                 5.4                  855              584 Modification re-age                                  66.9                43.3                7,732            4,936  Total loans modified and/or re-aged(3)              166.0                77.2       $       16,228        $   8,008  December 31, 2010: Collection re-age only                               90.0                32.0       $        7,707        $   2,843 Modification only(2)                                 11.8                 7.6                1,340              868 Modification re-age                                  67.2                46.8                8,222            5,683  Total loans modified and/or re-aged(3)              169.0                86.4       $       17,269        $   9,394  December 31, 2009: Collection re-age only                               91.3                36.5       $        7,779        $   3,331 Modification only(2)                                 16.6                10.6                2,096            1,274 Modification re-age                                  67.5                53.1                8,805            6,917  Total loans modified and/or re-aged(3)              175.4               100.2       $       18,680        $  11,522        (1)  See Note 6, "Receivables," in the accompanying consolidated financial

statements for additional information describing modified and /or re-aged

     loans which are accounted for as trouble debt restructurings.     (2)  Includes loans that have been modified under a proactive ARM reset      modification program which ended during the fourth quarter of 2009 as      described in our 2010 Form 10-K.                                            87 

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(3) The following table provides information regarding the delinquency status of

      loans remaining in the portfolio that were granted modifications of loan      terms and/or re-aged:                                                                                               Outstanding  Receivable                                                     Number of Accounts                            Balance                                               Consumer             Mortgage            Consumer              Mortgage                                               Lending              Services             Lending              Services December 31, 2011: Current or less than 30-days delinquent              62 %                  61 %                59 %                 62 % 30- to 59-days delinquent                            10                     9                  11                    9 60-days or more delinquent                           28                    30                  30                   29                                                      100 %                 100 %               100 %                100 %  December 31, 2010: Current or less than 30-days delinquent              65 %                  63 %                62 %                 63 % 30- to 59-days delinquent                            11                    10                  12                   11 60-days or more delinquent                           24                    27                  26                   26                                                      100 %                 100 %               100 %                100 %  December 31, 2009: Current or less than 30-days delinquent              62 %                  64 %                59 %                 65 % 30- to 59-days delinquent                            13                    11                  14                   11 60-days or more delinquent                           25                    25                  27                   24                                                      100 %                 100 %               100 %                100 %     

(4) The outstanding receivable balance included in this table reflects the

principal amount outstanding on the loan excluding any basis adjustments to

the loan such as unearned income, unamortized deferred fees and costs on

originated loans, purchase accounting fair value adjustments and premiums or

discounts on purchased loans.

   Another account management technique that we employ in respect of delinquent accounts is forbearance which may also be considered a modification. Under a forbearance agreement, we may agree not to take certain collection or credit agency reporting actions with respect to missed payments, often in return for the borrower's agreement to pay an additional amount with future required payments. We typically use forbearance with individual borrowers in transitional situations, usually involving borrower hardship circumstances or temporary setbacks that are expected to affect the borrower's ability to pay the contractually specified amount for a period of time. Additionally, in the past we also used loan rewrites to assist our customers which involved an extension of a new loan. We currently no longer offer loan rewrites. The amount of receivables subject to forbearance or rewrites is not significant.  In addition to the account management techniques discussed above, we have also increased the use of deed-in-lieu and short sales beginning in 2010 to assist our real estate secured receivable customers. In a deed-in-lieu, the borrower agrees to surrender the deed to the property without going through foreclosure proceedings and we release the borrower from further obligation. In a short sale, the property is offered for sale to potential buyers at a price which has been pre-negotiated between us and the borrower. This pre-negotiated price is based on updated property valuations and overall loss exposure given liquidation through foreclosure. Short sales also release the borrower from further obligation. From our perspective, total losses on deed-in-lieu and short sales are lower than expected total losses from foreclosed loans, or loans where we have previously decided not to pursue foreclosure, and provide resolution to the delinquent receivable over a shorter period of time. We currently anticipate the use of deed-in-lieu and short sales will continue to be elevated in future periods as we continue to work with our customers.  Modification programs Our Mortgage Services and Consumer Lending businesses actively use account modifications to reduce the rate and/or payment on a number of qualifying loans and generally re-age certain of these accounts upon receipt of two or more modified payments and other criteria being met. This account management practice is designed to assist borrowers who may have purchased a home with an expectation of continued real estate appreciation or whose income has subsequently declined. Additionally, our loan modification programs are designed to improve cash collections and avoid foreclosure as determined to be appropriate.                                           88 

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  Table of Contents                                                          HSBC Finance Corporation        Based on the economic environment and expected slow recovery of housing values, during 2008 we developed additional analytical review tools leveraging best practices to assist us in identifying customers who are willing to pay, but are expected to have longer term disruptions in their ability to pay. Using these analytical review tools, we expanded our foreclosure avoidance programs to assist customers who did not qualify for assistance under prior program requirements or who required greater assistance than available under the programs. The expanded program required certain documentation as well as receipt of two qualifying payments before the account could be re-aged. Prior to July 2008, for our Consumer Lending customers, receipt of one qualifying payment was required for a modified account before the account would be re-aged. We also increased the use of longer term modifications to provide assistance in accordance with the needs of our customers which may result in higher credit loss reserve requirements. For selected customer segments, this expanded program lowered the interest rate on fixed rate loans and for ARM loans the expanded program modified the loan to a lower interest rate than scheduled at the first interest rate reset date. The eligibility requirements for this expanded program allow more customers to qualify for payment relief and in certain cases can result in a lower interest rate than allowed under other existing programs. During the third quarter of 2009, in order to increase the long-term success rate of our modification programs we increased certain documentation requirements for participation in these programs. Late in the third quarter of 2011 the modification program was enhanced to improve underwriting and achieve a better balance between economics and customer-driven variables. The enhanced program offers a longer modification duration to select borrowers facing a temporary hardship and expands the treatment options to include term extension and principal forbearance.  By late 2009 and continuing into 2011, the volume of loans that qualified for a new modification had fallen significantly. We expect the volume of new modifications to continue to decline as we believe a smaller percentage of our customers with unmodified loans will benefit from loan modification in a way that will not ultimately result in a repeat default on their loans. Additionally, volumes of new loan modifications are expected to decrease due to the impact of improvements in economic conditions over the long-term, the continued seasoning of a liquidating portfolio and, beginning in the second quarter of 2010, the requirement for real estate secured and personal noncredit card borrowers to make two qualifying payments in 60 days before an account will be modified. Modification volumes will also be lower going forward as we are no longer originating real estate secured and personal noncredit card receivables.  We will continue to evaluate our consumer relief programs as well as all aspects of our account management practices to ensure our programs benefit our customers in accordance with their financial needs in ways that are economically viable for both our customers and our stakeholders. We have elected not to participate in the U.S. Treasury sponsored programs as we believe our long-standing home preservation programs provide more meaningful assistance to our customers. Loans modified under these programs are only included in the re-aging statistics table ("Re-age Table") that is included in our discussion of our re-age programs if the delinquency status of a loan was reset as a part of the modification or was re-aged in the past for other reasons. Not all loans modified under these programs have the delinquency status reset and, therefore, are not considered to have been re-aged.  

The following table summarizes loans modified during 2011 and 2010, some of which may have also been re-aged:

                                                                                          Outstanding Receivable                                                       Number of                          Balance at Time of                                                   Accounts Modified                         Modification                                              Consumer             Mortgage           Consumer           Mortgage                                              Lending              Services           Lending            Services                                              (accounts are in thousands)             (dollars are in billions) Foreclosure avoidance programs(1)(2): Year ended December 31, 2011                        16.6                12.3       $        2.3         $     1.6 Year ended December 31, 2010                        24.9                17.6                3.6               2.4      

(1) Includes all loans modified during the years ended December 31, 2011 and

     2010 regardless of whether the loan was also re-aged.                                            89 

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(2) If qualification criteria are met, loan modification may occur on more than

one occasion for the same account. For purposes of the table above, an

account is only included in the modification totals once in an annual period

and not for each separate modification in an annual period.

   A primary tool used during account modification, involves modifying the monthly payment through lowering the rate on the loan on either a temporary or permanent basis. The following table summarizes the weighted-average contractual rate reductions and the average amount of payment relief provided to customers that entered an account modification for the first time during the quarter indicated.                                                                                                        Quarter Ended                                        Dec. 31,          Sept. 30,          June 30,          Mar. 31,          Dec. 31,          Sept. 30,          June 30,          Mar. 31,                                          2011              2011               2011              2011              2010              2010               2010              2010 Weighted-average contractual rate reduction in basis points on account modifications during the period(1)(2)                                 340                343               336               340               333                341               339               329 Average payment relief provided on account modifications as a percentage of total payment prior to modification(2)                          26.2 %             27.1 %            27.1 %            27.2 %            25.4 %             27.6 %            27.3 %            26.5 %       (1)  The weighted-average rate reduction was determined based on the rate in 

effect immediately prior to the modification, which for ARMs may be lower

     than the rate on the loan at the time of origination.     (2)  Excludes any modifications on purchased receivable portfolios of our      Consumer Lending business. The purchase receivable portfolios of our

Consumer Lending business totaled $1.1 billion, $1.1 billion, $1.1 billion,

$1.1 billion, $1.2 billion, $1.2 billion, $1.3 billion and 1.4 billion as of

December 31, 2011, September 30, 2011, June 30, 2011, March 31,      2011, December 31, 2010, September 30, 2010, June 30, 2010 and March 31,      2010, respectively.   Re-age programs Our policies and practices include various criteria for an account to qualify for re-aging, but do not, however, require us to re-age the account. The extent to which we re-age accounts that are eligible under our existing policies will vary depending upon our view of prevailing economic conditions and other factors which may change from period to period. In addition, exceptions to our policies and practices may be made in specific situations in response to legal or regulatory agreements or orders. It is our practice to defer past due interest on certain re-aged real estate secured and personal non-credit card accounts to the end of the loan period. We do not accrue interest on these past due interest payments consistent with our 2002 settlement agreement with the State Attorneys General.  We continue to monitor and track information related to accounts that have been re-aged. At December 31, 2011, approximately 92 percent of all re-aged receivables are real estate secured products. First lien real estate secured products generally have less loss severity exposure than other products because of the underlying collateral. Credit loss reserves, including reserves on TDR Loans, take into account whether loans have been re-aged or are subject to forbearance, an external debt management plan, modification, extension or deferment. Our credit loss reserves, including reserves on TDR Loans, also take into consideration the expected loss severity based on the underlying collateral, if any, for the loan. TDR Loans are typically reserved for using a discounted cash flow methodology.  We used certain assumptions and estimates to compile our re-aging statistics. The systemic counters used to compile the information presented below exclude from the reported statistics loans that have been reported as contractually delinquent but have been reset to a current status because we have determined that the loans should not have been considered delinquent (e.g., payment application processing errors). When comparing re-aging statistics from different periods, the fact that our re-age policies and practices will change over time, that exceptions are made to those policies and practices, and that our data capture methodologies have been enhanced, should be taken into account.                                           90 

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   Table of Contents                                                          HSBC Finance Corporation        Re-age Table(1)(2)(3)(4)                 At December 31,                        2011         2010              Continuing operations:              Never re-aged                            50.0 %       52.7 %              Re-aged:              Re-aged in the last 6 months              9.5         12.3              Re-aged in the last 7-12 months          12.1         11.6              Previously re-aged beyond 12 months      28.4         23.4               Total ever re-aged                       50.0         47.3               Total continuing operations:            100.0 %      100.0 %               Discontinued operations:              Never re-aged                            96.9         95.8              Re-aged                                   3.1          4.2               Total discontinued operations           100.0 %      100.0 %   

Re-aged by Product(1)(2)(3)(4)

            At December 31,                        2011                     2010                                                  (dollars are in millions)         Continuing operations:         Real estate secured(5)          $ 22,080       51.7 %    $ 24,125       48.9 %         Personal non-credit card           1,874       36.1         2,565       36.0          Total - continuing operations     23,954       50.0        26,690       47.3         Discontinued operations              295        3.1           412        4.2          Total                           $ 24,249       42.6 %    $ 27,102       40.7 %       

(1) The tables above includes both Collection Re-ages and Modification Re-ages,

     as discussed above.     (2)  The outstanding receivable balance included in this table reflects the

principal amount outstanding on the loan net of unearned income, unamortized

deferred fees and costs on originated loans, purchase accounting fair value

     adjustments and premiums or discounts on purchased loans.     (3)  Excludes commercial and other.    

(4) The tables above exclude any accounts re-aged without receipt of a payment

which only occurs under special circumstances, such as re-ages associated

with disaster or in connection with a bankruptcy filing. At December 31,

2011 and 2010, the unpaid principal balance of re-ages without receipt of a

     payment totaled $783 million and $737 million, respectively.    

(5) The Mortgage Services and Consumer Lending businesses real estate secured

      re-ages are as shown in the following table:                                          At December 31,               2011         2010                                                                      (in millions)                                      Mortgage Services           $  7,728     $  8,914                                      Consumer Lending              14,352       15,211                                       Total real estate secured   $ 22,080     $ 24,125    The overall decrease in dollars of re-aged loans during 2011 reflects the lower receivable levels as discussed above. At December 31, 2011 and 2010, $6.9 billion (29 percent of total re-aged loans in the Re-age Table) and $7.0 billion (26 percent of total re-aged loans in the Re-age Table), respectively, of re-aged accounts have subsequently experienced payment defaults and are included in our two-months-and-over contractual delinquency at the period indicated.  We continue to work with advocacy groups in select markets to assist in encouraging our customers with financial needs to contact us. We have also implemented new training programs to ensure that our customer service representatives are focused on helping the customer through difficulties, are knowledgeable about the available re-aging and modification programs and are able to advise each customer of the best solutions for their individual circumstance.                                           91 

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We also support a variety of national and local efforts in homeownership preservation and foreclosure avoidance.

Geographic Concentrations The following table reflects the percentage of receivables and receivables held for sale by state which individually account for 5 percent or greater of our portfolio as of December 31, 2011 and 2010.

                                                Percentage of Receivables at                            Percentage of Receivables at                                                  December 31, 2011                                       December 31, 2010                                    Real Estate                                             Real Estate                                      Secured               Other            Total            Secured               Other            Total California                                   9.5 %             5.1 %           9.1 %                 9.9 %             5.8 %           9.4 % New York                                     7.2               6.8             7.2                   7.0               6.8             7.0 Pennsylvania                                 6.1               6.7             6.2                   5.9               6.4             6.0 Florida                                      5.9               5.8             5.9                   6.3               5.7             6.2 Ohio                                         5.5               6.3             5.6                   5.5               6.0             5.6  

Liquidity and Capital Resources

    During 2011, marketplace liquidity continued to be available for most sources of funding, except for mortgage securitizations. Companies in the financial sector continue to be able to issue debt, although during 2011 and in particular during the second half of 2011 credit spreads continued to be impacted by the European sovereign debt crisis and the current budgetary and economic environment in the United States.  HSBC Finance Corporation HSBC Finance Corporation, an indirect wholly owned subsidiary of HSBC Holdings plc., is the parent company that owns the outstanding common stock of its subsidiaries. In 2011 and 2010, HSBC Finance Corporation received cash dividends from its subsidiaries of $455 million and $64 million, respectively.  HSBC Finance Corporation has a number of obligations to meet with its available cash. It must be able to service its debt and meet the capital needs of its subsidiaries. It also must pay dividends on its preferred stock. We did not pay any dividends on our common stock to HINO in 2011 or 2010. We will maintain our capital at levels that we perceive to be consistent with our current credit ratings either by limiting the dividends to or through capital contributions from our parent.  HSBC Finance Corporation manages all of its operations directly and in 2011, funded these businesses primarily through cash generated from operations, issuances of commercial paper, retail-oriented medium-term notes, borrowings from HSBC affiliates and capital contributions from our parent. HSBC Finance Corporation markets its commercial paper primarily through an in-house sales force. Our term debt was generally marketed through subsidiaries of HSBC. Medium-term and long-term debt has historically also been marketed through unaffiliated investment banks.  Debt due to HSBC subsidiaries totaled $8.3 billion at both December 31, 2011 and 2010. The interest rates on funding from HSBC subsidiaries are market-based and comparable to those available from unaffiliated parties.  At various times, we will make capital contributions to our subsidiaries to comply with regulatory guidance, support operations or provide funding for long-term facilities and technological improvements. During 2011, HSBC Finance Corporation made net capital contributions to its subsidiaries of $1.1 billion. During 2010, capital contributions to certain subsidiaries were more than offset by dividends paid to HSBC Finance Corporation. This resulted in a net return of capital to HSBC Finance Corporation from certain subsidiaries of $630 million in 2010.                                           92 

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HSBC Related Funding Debt due to affiliates and other HSBC related funding are summarized in the following table:

   At December 31,                                                   2011            2010                                                                      (in billions) Debt issued to HSBC subsidiaries: Total debt                                                       $  8.3 (1) 

$ 8.3 (1)

  Debt outstanding to HSBC clients: Euro commercial paper                                                .4              .4 Term debt                                                            .1              .3  Total debt outstanding to HSBC clients                               .5     

.7

Cash received on bulk and subsequent sales of credit card receivables to HSBC Bank USA, net (cumulative)

                      7.6     

8.6

Cash received on bulk and subsequent sales of private label credit card receivables to HSBC Bank USA, net (cumulative) 12.8

13.5

Real estate secured receivable activity with HSBC Bank USA (cumulative): Cash received on sales

                                              3.7     

3.7

 Direct purchases from correspondents                                4.2     

4.2

Reductions in real estate secured receivables sold to HSBC Bank USA

                                                           (6.6 )   

(6.4 )

Total real estate secured receivable activity with HSBC Bank USA (cumulative)

                                                    1.3     

1.5

Cash received from sale of U.K. and Canadian operations to HSBC affiliates

                                                     3.4     

3.4

 Capital contributions by HINO (cumulative)                          9.5     

8.8

 Issuance of Series C Preferred Stock to HINO                        1.0             1.0  Total HSBC related funding                                       $ 44.4          $ 45.8       

(1) At December 31, 2011 and 2010, debt due to affiliates includes $447 million

and $436 million, respectively, carried at fair value.

At December 31, 2011 and 2010, funding from HSBC, including debt issuances to HSBC subsidiaries and clients, represented 18 percent and 15 percent of our total debt and preferred stock funding, respectively.

  At December 31, 2011 and 2010, we have committed back-up lines of credit totaling $2.0 billion with HSBC affiliates. There were no balances outstanding under these back-up lines of credit at December 31, 2011 and 2010. Additionally, we have a $1.5 billion uncommitted secured credit facility and a $1.0 billion committed unsecured credit facility from HSBC Bank USA. At December 31, 2011 and 2010, there were no balances outstanding under these facilities.  We have derivative contracts with a notional value of $40.4 billion, or approximately 99 percent of total derivative contracts, outstanding with HSBC affiliates at December 31, 2011 and $49.9 billion, or approximately 99 percent at December 31, 2010.  Interest Bearing Deposits with Banks and Other Short-Term Investments Interest bearing deposits with banks totaled $1.1 billion and $1.0 billion at December 31, 2011 and 2010, respectively. Securities purchased under agreements to resell totaled $920 million and $4.3 billionDecember 31, 2011 and 2010, respectively. Interest bearing deposits with banks increased as compared to December 31, 2010 as a result of the sale of certain available-for-sale securities in the fourth quarter of 2011 which offset the withdrawal in the third quarter of 2011 of a $1.0 billion deposit we had made with HSBC Bank plc to fund on-going operations. The decrease in securities purchased under agreements to resell reflects debt maturities and a decrease in collateral required from counterparties under our derivative agreements, partially offset by the generation of additional liquidity as a result of the run-off of our liquidating receivable portfolios and the sale of REO properties.  Commercial Paper totaled $4.0 billion and $3.2 billion at December 31, 2011 and 2010, respectively. Included in this total was outstanding Euro commercial paper sold to customers of HSBC of $368 million and $450 million at December 31, 2011 and 2010, respectively. Our funding strategies are structured such that committed bank credit facilities exceed 100 percent of outstanding commercial paper.                                           93 

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  Table of Contents                                                          HSBC Finance Corporation        In April 2011, we refinanced all of our third party back-up lines, totaling $4.3 billion, into a new $4.0 billion credit facility, split evenly between tenors of 364 days and three years. At December 31, 2011 and 2010, we also have credit facilities totaling $2.0 billion with HSBC affiliates to support our issuance of commercial paper as discussed above. In total, we have committed back-up lines of credit totaling $6.0 billion at December 31, 2011 compared to $6.3 billion at December 31, 2010.  Long-Term Debt decreased to $39.8 billion at December 31, 2011 from $54.4 billion at December 31, 2010. The following table summarizes issuances and repayments of long-term debt for continuing operations during the years ended December 31, 2011 and 2010:     Year Ended December 31,                                   2011           2010                                                               (in millions)  Long-term debt issued                                   $     245      $   1,519 (1)  Repayments of long-term debt                              (13,386 )      (14,734 )(1) 

Net long-term debt retired from continuing operations $ (13,141 ) $ (13,215 )

(1) In addition to the amounts of debt issued and repaid in the table above,

during 2010 we also exchanged $1.8 billion of senior debt for $1.9 billion

of subordinated debt.

The long-term debt issued during 2011 relates to InterNotesSM (retail-oriented medium-term notes).

  During the second quarter of 2011, we called $600 million of retail medium-term notes. This transaction was completed during July 2011. This transaction was funded through a $600 million loan agreement with HSBC North America which provided for three $200 million borrowings with maturities between 2034 and 2035. As of December 31, 2011, $600 million was outstanding under this loan agreement.  During 2011, the shelf registration statement under which we have historically issued long-term debt expired and we chose not to renew it. We currently do not expect third-party long-term debt to be a source of funding for us in the future given the run-off nature of our business subsequent to the sale of our Card and Retail Services business as previously discussed.  

Secured financings previously issued under public trusts of $3.3 billion at December 31, 2011 are secured by $5.3 billion of closed-end real estate secured receivables. Secured financings of $3.9 billion at December 31, 2010 were secured by $5.9 billion of closed-end real estate secured receivables.

In order to eliminate future foreign exchange risk, currency swaps are used at the time of issuance to fix in U.S. dollars substantially all foreign-denominated notes issued.

  As it relates to our discontinued credit card operations, we have secured conduit credit facilities with commercial banks which provide for secured financings of credit card receivables on a revolving basis totaling $650 million at both December 31, 2011 and 2010. At December 31, 2011, secured financings with a balance of $195 million were secured by $355 million of credit card receivables. At December 31, 2010, secured financings with a balance of $195 million were secured by $390 million of credit card receivables. These secured financings will be paid in full immediately prior to the sale of our Card and Retail Services business.  Preferred Shares During the fourth quarter of 2010, our Board of Directors approved the issuance of up to 1,000 shares of Series C preferred stock. As a result, in November 2010, we issued 1,000 shares of Series C preferred stock to HINO for $1.0 billion. Dividends on the Series C Preferred Stock are non-cumulative and payable quarterly at a rate of 8.625 percent. The Series C preferred stock may be redeemed at our option after November 30, 2025. Dividends paid during 2011 totaled $89 million. This transaction also enhanced both our common and preferred equity to total assets and tangible shareholders' equity to tangible assets ratios. It did not, however, impact our tangible common equity to tangible assets ratio.  In June 2005, we issued 575,000 shares of Series B Preferred Stock to third parties for $575 million. Dividends on the Series B preferred stock are non-cumulative and payable quarterly at a rate of 6.36 percent. The Series B preferred stock may be redeemed at our option after June 23, 2010. In 2011 and 2010, we paid dividends each year totaling $37 million on the Series B Preferred Stock.                                           94 

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  Table of Contents                                                          HSBC Finance Corporation        Common Equity In 2011, HINO made capital contributions to us totaling $690 million in exchange for two shares of common stock. In 2010, HINO made a capital contribution to us totaling $200 million in exchange for one share of common stock. These contributions were made to support ongoing operations and to maintain capital at levels we believe are necessary to support our operations. As we continue to liquidate our Consumer Lending and Mortgage Services receivable portfolios, HSBC's continued support will be required to properly manage our business and maintain appropriate levels of capital. HSBC has historically provided significant capital in support of our operations and has indicated that they remain fully committed and have the capacity to continue that support.  Selected capital ratios In managing capital, we develop a target for tangible common equity to tangible assets. This ratio target is based on discussions with HSBC and rating agencies, risks inherent in the portfolio and the projected operating environment and related risks. Additionally, we are required by our credit providing banks to maintain a minimum tangible common equity to tangible assets ratio of 6.75 percent. Our targets may change from time to time to accommodate changes in the operating environment or other considerations such as those listed above.  

Selected capital ratios are summarized in the following table:

            At December 31,                                 2011         2010          Tangible common equity to tangible assets(1)      7.12 %       7.31 %          Common and preferred equity to total assets      10.91        10.01      

(1) Tangible common equity to tangible assets represents a non-U.S. GAAP

financial ratio that is used by HSBC Finance Corporation management and

applicable rating agencies to evaluate capital adequacy and may differ from

similarly named measures presented by other companies. See "Basis of

Reporting" for additional discussion on the use of non-U.S. GAAP financial

measures and "Reconciliations to U.S. GAAP Financial Measures" for

quantitative reconciliations to the equivalent U.S. GAAP basis financial

measure.

2012 Funding Strategy Our current range of estimates for funding needs and sources for 2012 are summarized in the following table:

                                                                             (in billions) Funding needs: Commercial paper maturities                                           $   4       -     $  4 Increase in short term investment                                         1       -        1 Term debt maturities                                                     11       -       12 Secured financing maturities                                              1       -        2 Litigation bond                                                           3       -        4  Total funding needs                                                   $  20       -     $ 23  Funding sources: Net asset attrition(1)                                                $   3       -     $  2 Commercial paper issuances                                                4       -        5 Sale of Card and Retail Services business                                12       -       13 HSBC and HSBC subsidiaries, including capital infusions Term debt issuance                                                                  -       -        1 Other(2)                                                                  1       -        2  Total funding sources                                                 $  20       -     $ 23       

(1) Net of receivable charge-off.

(2) Primarily reflects cash provided by operating activities and sales of REO

properties.

   For 2012, the sale of the Card and Retail Services business and continued portfolio attrition will be key sources of liquidity. The combination of the sale of our Card and Retail Services business, cash generated from operations, potential asset sales should market pricing for receivables improve and commercial paper issuances will generate the liquidity necessary to meet our maturing debt obligations in 2012.                                           95

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  Table of Contents                                                          HSBC Finance Corporation        During 2011, our commercial paper balances outstanding were higher than during 2010 as it served as a cost effective source of funding in the current rate environment. We anticipate average commercial paper outstanding will be higher in 2012 than during 2011 as a result of the current low interest rate environment. The majority of outstanding commercial paper in 2012 is expected to be directly placed, domestic commercial paper. Euro commercial paper will continue to be marketed predominately to HSBC clients.  

Capital Expenditures We made capital expenditures of $4 million and $10 million for continuing operations during 2011 and 2010, respectively. Capital expenditures in 2012 for continuing operations are not expected to be significant.

  Commitments We also enter into commitments to meet the financing needs of our customers. In most cases, we have the ability to reduce or eliminate these open lines of credit. As a result, the amounts below, which primarily relate to our discontinued credit card operations, do not necessarily represent future cash requirements at December 31, 2011:                  As of December 31,                      2011        2010                                                        (in billions)               Private label and credit cards(1)(2)   $ 105.0     $ 99.2               Other consumer lines of credit              .5         .5                Open lines of credit                   $ 105.5     $ 99.7       

(1) Amounts at December 31, 2011 and 2010 include open lines of credit totaling

$94.5 billion and $88.2 billion related to private label credit cards and

the GM and UP Portfolios for which we sell all new receivable originations

     to HSBC Bank USA on a daily basis.    

(2) Includes an estimate for acceptance of credit offers mailed to potential

customers prior to December 31, 2011 and 2010.

   Contractual Cash Obligations The following table summarizes our long-term contractual cash obligations for our continuing operations at December 31, 2011 by period due:                                       2012         2013         2014         2015         2016         Thereafter       Total                                                                         (in millions) Principal balance of debt: Due to affiliates                $  1,250      $ 1,325      $ 1,805      $ 2,005      $   500      $      1,331     $  8,216 Long-term debt (including secured financings)                11,228        6,937        3,538        5,500        5,244             7,122       39,569  Total debt                         12,478        8,262        5,343        7,505        5,744             8,453       47,785  Operating leases: Minimum rental payments                10            7            6            6            5                 -           34 Minimum sublease income                (3 )         (3 )         (4 )         (4 )         (3 )               -          (17 )  Total operating leases                  7            4            2            2            2                 -           17  Obligation to the HSBC North America Pension Plan(1)                54           43           13            -            -                 -          110 Non-qualified postretirement benefit liability(2)                   26           25           24           24           23               270          392  Total contractual cash obligations                      $ 12,565      $ 8,334      $ 5,382      $ 7,531      $ 5,769      $      8,723     $ 48,304        (1)  Our contractual cash obligation to the HSBC North America Pension Plan 

included in the table above is based on the Pension Funding Policy which was

revised during the fourth quarter of 2011 and establishes required annual

contributions by HSBC North America through 2014. The amounts included in

the table above, reflect an estimate of our portion of those annual

contributions based on plan participants at December 31, 2011. See Note 18,

"Pension and Other Postretirement Benefits," in the accompanying

consolidated financial statements for further information about the HSBC

     North America Pension Plan.    

(2) Expected benefit payments calculated include future service component.

We currently anticipate entering into site-sharing agreements with Capital One for certain locations for a period of time which are not reflected in the operating lease obligations above.

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  Table of Contents                                                          HSBC Finance Corporation        These cash obligations could be funded primarily through cash generated from operations, the sale of our Card and Retail Services business, capital infusions from HSBC, or through affiliate funding.  

Our purchase obligations for goods and services at December 31, 2011 were not significant.

  Fair Value    Net income volatility arising from changes in either interest rate or credit components of the mark-to-market on debt designated at fair value and related derivatives affects the comparability of reported results between periods. Accordingly, gain on debt designated at fair value and related derivatives for the year ended December 31, 2011 should not be considered indicative of the results for any future period.  Control Over Valuation Process and Procedures A control framework has been established which is designed to ensure that fair values are either determined or validated by a function independent of the risk-taker. To that end, the ultimate responsibility for the determination of fair values rests with the HSBC Finance Valuation Committee. The HSBC Finance Valuation Committee establishes policies and procedures to ensure appropriate valuations. Fair values for debt securities and long-term debt for which we have elected fair value option are determined by a third-party valuation source (pricing service) by reference to external quotations on the identical or similar instruments. An independent price validation process is also utilized. For price validation purposes, we obtain quotations from at least one other independent pricing source for each financial instrument, where possible. We consider the following factors in determining fair values:    

• similarities between the asset or the liability under consideration and the

        asset or liability for which quotation is received;       •   whether the security is traded in an active or inactive market;       •   consistency among different pricing sources;    

• the valuation approach and the methodologies used by the independent

        pricing sources in determining fair value;    

• the elapsed time between the date to which the market data relates and the

        measurement date; and       •   the manner in which the fair value information is sourced.   Greater weight is given to quotations of instruments with recent market transactions, pricing quotes from dealers who stand ready to transact, quotations provided by market-makers who originally underwrote such instruments, and market consensus pricing based on inputs from a large number of participants. Any significant discrepancies among the external quotations are reviewed by management and adjustments to fair values are recorded where appropriate.  Fair values for derivatives are determined by management using valuation techniques, valuation models and inputs that are developed, reviewed, validated and approved by the Quantitative Risk and Valuation Group of an HSBC affiliate. These valuation models utilize discounted cash flows or an option pricing model adjusted for counterparty credit risk and market liquidity. The models used apply appropriate control processes and procedures to ensure that the derived inputs are used to value only those instruments that share similar risk to the relevant benchmark indexes and therefore demonstrate a similar response to market factors. In addition, a validation process is followed which includes participation in peer group consensus pricing surveys, to ensure that valuation inputs incorporate market participants' risk expectations and risk premium.  We have various controls over our valuation process and procedures for receivables held for sale. As these fair values are generally determined using modeling techniques, the controls may include independent development or validation of the logic within the valuation models, the inputs to those models, and adjustments required to outside valuation models. The inputs and adjustments to valuation models are reviewed with management and reconciled to inputs and assumptions used in other internal valuation processes. In addition, from time to time, certain portfolios are valued by independent third parties, primarily for related party transactions, which are used to validate our internal models.                                           97 

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  Table of Contents                                                          HSBC Finance Corporation        Fair Value Hierarchy Accounting principles related to fair value measurements establish a fair value hierarchy structure that prioritizes the inputs to valuation techniques used to determine the fair value of an asset or liability (the "Fair Value Framework"). The Fair Value Framework distinguishes between inputs that are based on observed market data and unobservable inputs that reflect market participants' assumptions. It emphasizes the use of valuation methodologies that maximize market inputs. For financial instruments carried at fair value, the best evidence of fair value is a quoted price in an actively traded market (Level 1). Where the market for a financial instrument is not active, valuation techniques are used. The majority of valuation techniques use market inputs that are either observable or indirectly derived from and corroborated by observable market data for substantially the full term of the financial instrument (Level 2). Because Level 1 and Level 2 instruments are determined by observable inputs, less judgment is applied in determining their fair values. In the absence of observable market inputs, the financial instrument is valued based on valuation techniques that feature one or more significant unobservable inputs (Level 3). The determination of the level of fair value hierarchy within which the fair value measurement of an asset or a liability is classified often requires judgment. We consider the following factors in developing the fair value hierarchy:    

• whether the pricing quotations vary substantially among independent pricing

         services;         •   whether the asset or liability is transacted in an active market with a

        quoted market price that is readily available;       •   the size of transactions occurring in an active market;       •   the level of bid-ask spreads;    

• a lack of pricing transparency due to, among other things, the complexity

        of the product structure and market liquidity;    

• whether only a few transactions are observed over a significant period of

         time;         •   whether the inputs to the valuation techniques can be derived from or

        corroborated with market data; and         •   whether significant adjustments are made to the observed pricing         information or model output to determine the fair value.   Level 1 inputs are unadjusted quoted prices in active markets that the reporting entity has the ability to access for the identical assets or liabilities. A financial instrument is classified as a Level 1 measurement if it is listed on an exchange or is an instrument actively traded in the OTC market where transactions occur with sufficient frequency and volume. We regard financial instruments that are listed on the primary exchanges of a country, such as equity securities and derivative contracts, to be actively traded. Non-exchange-traded instruments classified as Level 1 assets include securities issued by the U.S. Treasury.  Level 2 inputs are inputs that are observable either directly or indirectly but do not qualify as Level 1 inputs. We generally classify derivative contracts, corporate debt including asset-backed securities as well as our own debt issuance for which we have elected fair value option which are not traded in active markets, as Level 2 measurements. Currently, substantially all such items qualify as Level 2 measurements. These valuations are typically obtained from a third party valuation source which, in the case of derivatives, includes valuations provided by an affiliate, HSBC Bank USA.  Level 3 inputs are unobservable inputs for the asset or liability and include situations where there is little, if any, market activity for the asset or liability. Level 3 inputs incorporate market participants' assumptions about risk and the risk premium required by market participants in order to bear that risk. We develop Level 3 inputs based on the best information available in the circumstances. As of December 31, 2011 and 2010, our Level 3 instruments recorded at fair value on a recurring basis include $18 million and $24 million, respectively, primarily U.S. corporate debt securities and asset-backed securities. As of December 31, 2010, our Level 3 assets recorded at fair value on a non-recurring basis included receivables held for sale totaling $4 million. As of December 31, 2011, we had no Level 3 assets recorded at fair value on a non-recurring basis in continuing operations.                                           98

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Transfers between leveling categories are recognized at the end of each reporting period.

Transfers Between Level 1 and Level 2 Measurements There were no transfers between Level 1 and Level 2 during 2011. Transfers from Level 1 to Level 2 during 2010 totaled $59 million and transfers from Level 2 to Level 1 during 2010 totaled $9 million as a result of reclassifications in certain product groupings.

  Transfers Between Level 2 and Level 3 Measurements Assets recorded at fair value on a recurring basis at December 31, 2011 and 2010 which have been classified as using Level 3 measurements include certain U.S. corporate debt securities and mortgage-backed securities. Securities are classified as using Level 3 measurements when one or both of the following conditions are met:      •   An asset-backed security is downgraded below a AAA credit rating; or    

• An individual security fails the quarterly pricing comparison test with a

variance greater than 5 percent.

   Transfers into or out of Level 3 classifications, net, represents changes in the mix of individual securities that meet one or both of the above conditions. During 2011, we transferred $55 million of U.S. Corporate debt securities, asset-backed securities and foreign corporate debt securities from Level 2 to Level 3 which met one or both of the conditions described above, partially offset by the transfer of $39 million of U.S. corporate debt securities and securities of U.S. government sponsored enterprises from Level 3 to Level 2 as they no longer met one or both of the conditions described above.  During 2010, we transferred $27 million of U.S. government sponsored enterprises and corporate debt securities, from Level 3 to Level 2 as they no longer met one or both of the conditions described above, which was partially offset by the transfer of $12 million of U.S. government sponsored enterprises, corporate debt securities and asset-backed securities from Level 2 to Level 3 which met one or both of the conditions described above.  We reported a total of $18 million and $24 million of available-for-sale securities, or approximately 1 percent of our securities portfolio as Level 3 at both December 31, 2011 and 2010, respectively. At both December 31, 2011 and 2010, total Level 3 assets were 1 percent of total assets measured at fair value on a recurring basis.  

See Note 22, "Fair Value Measurements" in the accompanying consolidated financial statements for further details including our valuation techniques as well as the classification hierarchy associated with assets and liabilities measured at fair value.

  Risk Management    Overview Some degree of risk is inherent in virtually all of our activities. Accordingly, we have comprehensive risk management policies and practices in place to address potential risks, which include the following:    

• Credit risk is the risk that financial loss arises from the failure of a

customer or counterparty to meet its obligations under a contract. Our

credit risk arises primarily from our lending and treasury activities;

• Liquidity risk is the potential that an institution will be unable to meet

its obligations as they become due or fund its customers because of

inadequate cash flow or the inability to liquidate assets or obtaining

        funding itself;    

• Market risk is the potential for losses in daily mark-to-market positions

        due to adverse movements in money, foreign exchange, equity or other         markets and include net interest income and mark-to-market;    

• Interest rate risk is the potential impairment of net interest income due

to mismatched pricing between assets and liabilities as well as losses in

         value due to rate movements;         •   Operational risk is the risk of loss resulting from inadequate or failed

internal processes, people or systems or from external events (including

         legal risk but excluding strategic and reputational risk);         •   Compliance risk is the risk arising from failure to comply with relevant

        laws, regulations and regulatory requirements governing the conduct of         specific businesses;                                            99 

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• Reputational risk is the risk arising from a failure to safeguard our

reputation by maintaining the highest standards of conduct at all times and

by being aware of issues, activities and associations that might pose a

threat to the reputation of HSBC, locally, regionally or internationally;

        and    

• Strategic risk is the risk that the business will fail to identify, execute

and react appropriately to opportunities and/or threats arising from

changes in the market, some of which may emerge over a number of years such

as changing economic and political circumstances, customer requirements,

demographic trends, regulatory developments or competitor action.

The objective of our risk management system is to identify, measure, monitor and manage risks so that:

• potential costs can be weighed against the expected rewards from taking the

        risks;       •   appropriate disclosures can be made to all concerned parties;    

• adequate protections, capital and other resources can be put in place to

        weather all significant risks; and    

• compliance with all relevant laws, regulations and regulatory requirements

is ensured through staff education, adequate processes and controls, and

ongoing monitoring efforts.

   Our risk management policies are designed to identify and analyze these risks, to set appropriate limits and controls, and to monitor the risks and limits continually by means of reliable and up-to-date administrative and information systems. We continually modify and enhance our risk management policies and systems to reflect changes in markets and products and to better align overall risk management processes. Training, individual responsibility and accountability, together with a disciplined, conservative and constructive culture of control, lie at the heart of our management of risk.  Senior managers within an independent central risk organization under the leadership of HSBC North America Chief Risk Officer ensure risks are appropriately identified, measured, reported and managed. For all risk types, there are independent risk specialists that set standards, develop new risk methodologies, maintain central risk databases and conduct reviews and analysis. For instance, the HSBC North America Chief Risk Officer and the Chief Compliance Officer provide day-to-day oversight of these types of risk management activities within their respective areas and work closely with internal audit and other senior risk specialists at HSBC North America and HSBC. Market risk is managed by the HSBC North America Head of Market Risk. Operational risk is decentralized and is the responsibility of each business and support unit to manage under the direction of the HSBC North America Head of Operational Risk and a centralized team. Compliance risk is managed through an effective enterprise-wide compliance risk management program to prevent, detect and deter compliance issues, including money laundering and terrorist financing activities. Our risk management policies assign primary responsibility and accountability for the management of compliance risk in the lines of business to business line management. Under the oversight of the Compliance Committee of the Board of Directors and senior management, the HSBC North America Chief Compliance Officer oversees the design, execution and administration of the enterprise-wide compliance program.  Historically, our approach toward risk management has emphasized a culture of business line responsibility combined with central requirements for diversification of customers and businesses. As such, extensive centrally determined requirements for controls, limits, reporting and the escalation of issues have been detailed in our policies and procedures. Our risk management policies are primarily carried out in accordance with practice and limits set by the HSBC Group Management Board which consists of senior executives throughout the HSBC organization.  In the course of our regular risk management activities, we use simulation models to help quantify the risk we are taking. The output from some of these models is included in this section of our filing. By their nature, models are based on various assumptions and relationships. We believe that the assumptions used in these models are reasonable, but events may unfold differently than what is assumed in the models. In actual stressed market conditions, these assumptions and relationships may no longer hold, causing actual experience to differ significantly from the results predicted in the model. Consequently, model results may be considered reasonable                                          100

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estimates, with the understanding that actual results may vary significantly from model projections. Interest rate risk and liquidity metrics have been adjusted to reflect the impact of the pending sale of our Card and Retail Services business to Capital One. The risk metrics reflect current assumed transaction dates, with balances reduced at projected sale date.

Risk management oversight begins with the HSBC Finance Corporation Board of Directors and its Audit, Risk and Compliance Committees. An HSBC Finance Corporation Risk Management Committee, chaired by the Chief Risk Officer, focuses on governance, emerging issues, and risk management strategies.

  In addition, the HSBC Finance Corporation Asset Liability Committee ("ALCO") meets regularly to review liquidity and market risks and approve appropriate risk management strategies within the limits established by the HSBC Group Management Board and approved by our Audit and Risk Committee.  Further oversight is provided by a network of specialized subcommittees which function under the HSBC North America Risk Management Committee. These subcommittees are chaired by the Chief Risk Officer and his staff and include the Operational Risk and Internal Control Committee ("ORIC"), the Credit Risk Analytics Oversight Committee, a Capital Management Review Meeting, the HSBC North America Risk Executive Committee, the Risk Appetite Committee, and Stress Testing and Scenario Oversight Committee.  While the charters of the Risk Management Committee and each sub-committee are tailored to reflect the roles and responsibilities of each committee, they all have the following common themes:    

• defining and measuring risk and establishing policies, limits, and

         thresholds;         •   monitoring and assessing exposures, trends and the effectiveness of the

        risk management framework; and       •   reporting through the Chief Risk Officer to the Board of Directors.   HSBC North America's Risk Appetite framework describes through its Risk Appetite Statement and its Risk Appetite Limits the quantum and types of risk that it is prepared to take in executing its strategy. It develops and maintains the linkages between strategy, capital, risk management processes, and HSBC Group strategy and directs HSBC North America's businesses to be targeted along strategic and risk priorities and in line with the forward view of available capital under stress.  Oversight of all liquidity, interest rate and market risk is provided by ALCO which is chaired by the HSBC North America Chief Financial Officer. Subject to the approval of our Board of Directors and HSBC, ALCO sets the limits of acceptable risk, monitors the adequacy of the tools used to measure risk and assesses the adequacy of reporting. In managing these risks, we seek to protect both our income stream and the value of our assets. ALCO also conducts contingency planning with regard to liquidity.  

Credit Risk Management Credit risk is the risk that financial loss arises from the failure of a customer or counterparty to meet its obligations under a contract. Our credit risk arises primarily from lending and treasury activities.

  Day-to-day management of credit risk is administered by the HSBC North America Chief Retail Credit Officer who reports to the HSBC North America Chief Risk Officer. The HSBC North America Chief Risk Officer reports to the HSBC North America Chief Executive Officer and to the Group Managing Director and Chief Risk Officer of HSBC. We have established detailed policies to address the credit risk that arises from our lending activities. Our credit and portfolio management procedures focus on sound underwriting, effective collections and customer account management efforts for each loan. Our lending guidelines, which delineate the credit risk we are willing to take and the related terms, are specific not only for each product, but also take into consideration various other factors including borrower characteristics, return on equity, capital deployment and our overall risk appetite. We also have specific policies to ensure the establishment of appropriate credit loss reserves on a timely basis to cover probable losses of principal, interest and fees. Our customer account management policies and practices are described under the caption "Credit Quality - Customer Account Management Policies and Practices" in MD&A. Also see Note 2, "Summary of Significant Accounting Policies and New Accounting Pronouncements," in the accompanying consolidated financial statements for further                                          101 

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  Table of Contents                                                          HSBC Finance Corporation        discussion of our policies surrounding credit loss reserves. Our policies and procedures are consistent with HSBC standards and are regularly reviewed and updated both on an HSBC Finance Corporation and HSBC level. The credit risk function continues to refine "early warning" indicators and reporting, including stress testing scenarios on the basis of current experience. These risk management tools are embedded within our business planning process.  A Credit Review and Risk Identification ("CRRI") function is also in place in HSBC North America to identify and assess credit risk. The CRRI function consists of a Wholesale and Retail Credit Review function as well as functions responsible for the independent assessment of Wholesale and Retail models. The CRRI function provides an ongoing independent assessment of credit risk, the quality of credit risk management and in the case of wholesale credit risk, the accuracy of individual credit risk ratings. The functions independently and holistically assess the business units and risk management functions to ensure the business is operating in a manner that is consistent with HSBC Group strategy and appropriate local and HSBC Group credit policies, procedures and applicable regulatory guidelines. The Credit Risk Review functions examine asset quality, credit processes and procedures, as well as the risk management infra-structures in each commercial and retail lending unit. Selective capital markets based functions are included within this scope. CRRI also independently assesses the retail and wholesale credit risk and reserving models to determine if they are fit for purpose and consistent with regulatory requirements and HSBC Group Policy.  Credit risk is also inherent in our investment securities portfolio, particularly in relation to the corporate debt securities we hold in our investment securities portfolio. Prior to acquiring any investment securities, individual securities are subjected to our investment policies and to the requirements in our co-insurance agreements for securities purchased by our Insurance Services business. Our investment policies specify minimum rating levels as well as limitations on the total amount of investment in a particular industry or entity. For investment securities that have been acquired and have experienced an unrealized loss since the date of acquisition, we have established the Investment Impairment Assessment Committee to assess whether there have been any events or changes in economic circumstances to indicate that the investment security is impaired on an other-than-temporary basis. The Investment Impairment Assessment Committee, which meets on a quarterly basis or more frequently if warranted, includes individuals from a variety of areas of our operations, including investment portfolio management, treasury and corporate finance. The committee determines which securities in an unrealized loss position should be reviewed, performs an analysis of these investment securities on an individual basis, forms a conclusion as to whether an other-than-temporary impairment has occurred and, if so, recommends the impairment amount to be recorded. The committee considers many factors in their analysis including the severity and duration of the impairment; our intent and ability to hold the security for a period of time sufficient for recovery in value; recent events specific to the issuer or industry; and for corporate debt securities, external credit ratings and recent downgrades. For securities not deemed other-than-temporarily impaired, the committee verifies that we neither intend to nor expect to be required to sell the securities prior to recovery, even if that equates to holding securities until their individual maturities.  Counterparty credit risk is our primary exposure on our interest rate swap portfolio. Counterparty credit risk is the risk that the counterparty to a transaction fails to perform according to the terms of the contract. Currently the majority of our existing derivative contracts are with HSBC subsidiaries, making them our primary counterparty in derivative transactions. Most swap agreements, both with unaffiliated and affiliated third parties, require that payments be made to, or received from, the counterparty when the fair value of the agreement reaches a certain level. Generally, non-affiliate swap counterparties provide collateral in the form of cash which is recorded in our balance sheet as derivative financial assets or derivative related liabilities. We provided third party swap counterparties with collateral totaling $10 million and $33 million at December 31, 2011 and 2010, respectively. The fair value of our agreements with affiliate counterparties required the affiliate to provide cash collateral of $584 million and $2.5 billion at December 31, 2011 and 2010, respectively. These amounts are offset against the fair value amount recognized for derivative instruments that have been offset under the same master netting arrangement.  See Note 13, "Derivative Financial Instruments," in the accompanying consolidated financial statements for additional information related to interest rate risk management and Note 22, "Fair Value Measurements," for information regarding the fair value of our financial instruments.                                          102

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  Table of Contents                                                          HSBC Finance Corporation        Liquidity Risk Management The balance sheet and credit dynamics described above have had a significant impact on our liquidity risk management processes. Continued success in reducing the size of our run-off real estate secured and personal non-credit card receivable portfolios coupled with the planned sale of our Card and Retail Services business during the second quarter of 2012 as previously discussed will be the primary driver of our liquidity management process going forward. However, lower cash flow, as a result of declining receivable balances as well as lower cash generated from balance sheet attrition due to increased charge-offs, will not provide sufficient cash to fully cover maturing debt over the next four to five years. During 2011, the shelf registration statement under which we have historically issued long-term debt expired and we chose not to renew it. We currently do not expect third-party long-term debt to be a source of funding for us in the future given the run-off nature of our business subsequent to the sale of our Card and Retail Services business as previously discussed. We anticipate any required incremental funding will be integrated into the overall HSBC North America funding plans or through direct support from HSBC and its affiliates. HSBC has indicated it remains fully committed and has the capacity to continue to provide such support. Should market pricing for receivables improve in future years, our intent may change and a portion of this required funding could be generated through selected receivable portfolio sales in our run-off portfolios.  Maintaining our credit ratings is an important part of maintaining our overall liquidity profile. As indicated by the major rating agencies, our credit ratings are directly dependent upon the continued support of HSBC. A credit rating downgrade would increase borrowing costs, and depending on its severity, substantially limit access to capital markets, require cash payments or collateral posting, require delivery of secured financing collateral documents, and permit termination of certain contracts material to us.  

The following summarizes our credit ratings at December 31, 2011 and 2010:

                                       Standard &         Moody's                                       Poor's          Investors                                     Corporation        Service        Fitch, Inc.

        As of December 31, 2011:         Senior debt                            A              A3               AA-         Senior subordinated debt              A-            Baa1                A+         Commercial paper                     A-1             P-1               F1+         Series B preferred stock            BBB+            Baa2                 A   As of December 31, 2011, there were no pending actions in terms of changes to ratings for HSBC Finance Corporation from any of the rating agencies listed above. In December 2011, Fitch finalized a revised global criteria for assessing the credit ratings of non-common equity securities which qualify for treatment as bank regulatory capital. While the ratings of certain of our subordinated, trust preferred or preferred securities may be reduced as Fitch implements the criteria in the first quarter of 2012, we are unable to predict the likelihood or extent of any such action. On February 15, 2012, Moody's announced rating actions affecting 114 financial institutions in 16 European countries, including the ratings of HSBC. The rating action follows Moody's publications on January 19, 2012 where Moody's announced that they expect to place a number of bank ratings under review for downgrade during the first quarter of 2012 in order to assess the overall negative impact of the adverse trends affecting banks in advanced countries and notably in Europe. On February 22, 2012, Moody's put our long-term and short-term ratings on negative credit watch. We believe there is the potential for a multiple notch downgrade on our long-term rating. Any downgrade of the long-term rating would likely result in a minimum 1 notch downgrade of our short-term rating. Moody's review is expected to take up to 90 days.  Other conditions that could negatively affect our liquidity include unforeseen capital requirements, a strengthening of the U.S. dollar, failure to complete or a delay in completing the sale of our Card and Retail Services business to Capital One, a slowdown in the rate of attrition of our balance sheet and an inability to obtain expected funding from HSBC, its subsidiaries and clients.  The measurement and management of liquidity risk is a primary focus for us. Three standard analyses are utilized to accomplish this goal. First, a rolling 90 day funding plan is updated several times each week to quantify near-term needs and develop the appropriate strategies to fund those needs. As part of this process, debt maturity profiles (daily, monthly, annual) are generated to assist in planning and limiting any potential rollover risk (which is the risk that we will be unable to pay our debt or borrow additional funds as it becomes due). Second, comprehensive plans identifying monthly funding requirements for the next two calendar years are updated weekly. These plans compare funding inflows from projected balance sheet attrition and cash generated from                                          103

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  Table of Contents                                                          HSBC Finance Corporation        operations with debt maturities and determine both the timing and size of potential funding requirements. Lastly, contingency funding plans are maintained as part of the liquidity management process. Multiple funding scenarios are regularly evaluated for a variety of time horizons and assume limited or no access to secured and unsecured sources of liquidity. These alternative scenarios are designed to enable us to identify funding shortfalls well in advance of their occurrence and execute alternate liquidity management strategies to fund these shortfalls. The results of these analyses are presented to both our Asset/Liability Management Committee and HSBC's risk management function at least monthly.  Consistent with the experience of most other financial sector issuers, the quoted spreads on our primary and secondary market debt widened in 2011. Should our 2012 funding plans change and we elect to issue institutionally-placed senior debt, we anticipate a reduction in the total amount of debt that could be issued when compared to historical issuances.  

See "Liquidity and Capital Resources" for further discussion of our liquidity position.

  Market Risk Management The objective of our market risk management process is to manage and control market risk exposures in order to optimize return on risk while maintaining a market profile as a provider of financial products and services. Market risk is the risk that movements in market risk factors, including interest rates and foreign currency exchange rates, will reduce our income or the value of our portfolios. The Regional Head of Market Risk oversees the management of market risk.  Our exposure to interest rate risk is also changing as the balance sheet declines and a growing percentage of our remaining real estate receivables are modified and/or re-aged. Prior to the credit crisis, our real estate portfolio was assumed to have a duration (average life) of approximately three years. While the loans had original maturities of 30 years, active customer refinancing resulted in the shorter duration assumption used in the risk management process. Debt was typically issued in intermediate and longer term maturities to maximize the liquidity benefit. The interest rate risk created by combining short duration assets with long duration liabilities was reduced by entering into hedge positions that reduced the duration of the liabilities portfolio.  The progression of the credit crisis over the last three years is impacting this risk profile. Originally modeled as three years, the duration assumption for our fixed rate real estate portfolio is estimated to be 5.5 years at December 31, 2011 reflecting the impact of a higher percentage of loans staying on our balance sheet longer due to the impact of modification programs and/or lack of refinancing alternatives. At the same time, the duration of our liability portfolio continues to decline due to the passage of time and the absence of new term debt issuance. As our receivable portfolio becomes smaller, our ability to more accurately project exposure will increase as well as our ability to manage that risk.  We maintain an overall risk management strategy that primarily uses standard interest rate and currency derivative financial instruments to mitigate our exposure to fluctuations caused by changes in interest rates and currency exchange rates. We managed our exposure to interest rate risk primarily through the use of interest rate swaps, but have used forwards, futures, options, and other risk management instruments. We do not use leveraged derivative financial instruments.  We manage our exposure to foreign currency exchange risk primarily through the use of currency swaps, options and forwards. Our financial statements are affected by movements in exchange rates on our foreign currency denominated debt as well as by movements in exchange rates between the Canadian dollar and the U.S. dollar related to specialty insurance products offered in Canada. Prior to the sale of our foreign subsidiaries in 2008, we did not enter into foreign exchange contracts to hedge our investment in foreign subsidiaries. We do not currently have any foreign subsidiaries.  Interest rate risk Interest rate risk is defined as the impact of changes in market interest rates on our earnings. We use simulation models to measure the impact of anticipated changes in interest rates on net interest income and execute appropriate risk management actions. The key assumptions used in these models include projected balance sheet attrition, cash flows from derivative financial instruments and changes in market conditions. While these assumptions are based on our best estimates of future conditions, we can not precisely predict our earnings due to the uncertainty inherent in the macro-economic environment. We use derivative financial instruments, principally interest rate swaps, to manage these exposures.                                          104

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  Table of Contents                                                          HSBC Finance Corporation        HSBC has certain limits and benchmarks that serve as additional guidelines in determining the appropriate levels of interest rate risk. One such limit is expressed in terms of the Present Value of a Basis Point, which reflects the change in value of the balance sheet for a one basis point movement in all interest rates without considering other correlation factors or assumptions. At December 31, 2011 and 2010, our absolute PVBP limit was $5.50 million and $8.20 million, respectively, which included the risk associated with the hedging instruments we employed. Thus, for a one basis point change in interest rates, the policy at December 31, 2011 and 2010 dictated that the value of the balance sheet could not increase or decrease by more than $5.50 million or $8.20 million, respectively. During the second quarter of 2011, the PVBP limit was decreased after we performed a comprehensive review of the projected cash flows to be generated by our remaining real estate secured receivable portfolio as well as the results of our portfolio of non-qualifying hedges. The results of this analysis supported a decrease in our reported PVBP limit, which we concluded would be sustainable for the foreseeable future.  

The following table shows the components of our absolute PVBP position at December 31, 2011 and 2010 broken down by currency risk:

                          At December 31,       2011        2010                                                (in millions)                        USD                  $ 1.679     $ 6.351                        JPY                     .151        .132                         Absolute PVBP risk   $ 1.830     $ 6.483    We have issued debt in a variety of currencies and simultaneously executed currency swaps to hedge the future interest and principal payments. As a result of the loss of hedge accounting on currency swaps outstanding at the time of our acquisition, the recognition of the change in the currency risk on these swaps is recorded differently than the corresponding risk on the underlying foreign denominated debt. Currency risk on the swap is now recognized immediately in the net present value of all future swap payments. On the corresponding debt, currency risk is recognized on the principal outstanding which is converted at the period end spot translation rate and on the interest accrual which is converted at the average spot rate for the reporting period.  We also monitor the impact that an immediate hypothetical increase or decrease in interest rates of 25 basis points applied at the beginning of each quarter over a 12 month period would have on our net interest income assuming for 2011 and 2010 a declining balance sheet and the current interest rate risk profile. These estimates include the impact on net interest income of debt and related derivatives carried at fair value and also assume we would not take any corrective actions in response to interest rate movements and, therefore, exceed what most likely would occur if rates were to change by the amount indicated. The estimates as of December 31, 2011 have been adjusted to reflect the impact of the pending Capital One transaction previously discussed. The estimates reflect the current assumed transaction date, with balances reduced at the projected sale date and the associated impact of that reduction is included in these estimates. The following table summarizes such estimated impact, excluding any impacts on our portfolio of non-qualifying hedges:    As of December 31,                                                    2011         2010                                                                         (in millions)

Increase (decrease) in net interest income following a hypothetical 25 basis points rise in interest rates applied at the beginning of each quarter over the next 12 months

                $    

27 $ (38 ) Increase (decrease) in net interest income following a hypothetical 25 basis points fall in interest rates applied at the beginning of each quarter over the next 12 months

(20 ) 43

   The increase in net interest income following a hypothetical rate rise and decrease in net interest income following a hypothetical rate fall as compared to December 31, 2010 reflect the impact of the sale of the credit card operations as described above, regular adjustments of asset and liability behavior assumptions, updates of economic stress scenarios, and model enhancements. A principal consideration supporting both of the PVBP and margin at risk analyses is the projected prepayment of loan balances for a given economic scenario. Individual                                          105 

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  Table of Contents                                                          HSBC Finance Corporation        loan underwriting standards in combination with housing valuations, loan modification program, changes to our foreclosure processes and macroeconomic factors related to available mortgage credit are the key assumptions driving these prepayment projections. While we have utilized a number of sources to refine these projections, we cannot currently project precise prepayment rates with a high degree of certainty in all economic environments given recent, significant changes in both subprime mortgage underwriting standards and property valuations across the country.  Operational Risk Management Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events, including legal risk. Operational risk is inherent in all of our business activities and, as with other types of risk, is managed through our overall framework designed to balance strong corporate oversight with well-defined independent risk management.  We have established an independent Operational Risk and Internal Control management discipline in North America, which is led by the HSBC North America Head of Operational Risk and Internal Control who reports to the HSBC North America Chief Risk Officer. The Operational Risk and Internal Control Committee, chaired by the HSBC North America Chief Risk Officer is responsible for oversight of operational risk management, including internal controls to mitigate risk exposure and comprehensive reporting. Results from this committee are communicated to the Risk Management Committee and subsequently to the Risk Committee of the Board of Directors. Business management is responsible for managing and controlling operational risk and for communicating and implementing control standards. A central Operational Risk and Internal Control function provides functional oversight by coordinating the following activities:      •   developing Operational Risk Management policies and procedures;         •   developing and managing methodologies and tools to support the         identification, assessment, and monitoring of operational risks;    

• providing firm-wide operational risk and control reporting and facilitating

<pre> resulting action plan development; • identifying emerging risks and monitoring operational risks and internal

        controls to reduce foreseeable, future loss exposure;       •   perform root-cause analysis on large operational risk losses;    

• providing general and/or specific operational risk training and awareness

        programs for employees throughout the firm;    

• communicating with Business Risk Control Managers to ensure the operational

risk management framework is executed within their respective business or

        function;    

• independently reviewing the operational risk and control assessments and

        communicating results to business management; and    

• modeling operational risk losses and scenarios for capital management

purposes.

   Management of operational risk includes identification, assessment, monitoring, mitigation, rectification, and reporting of the results of risk events, including losses and compliance with local regulatory requirements. These key components of the operational risk management process have been communicated by issuance of HSBC standards. Details and local application of the standards have been documented and communicated by issuance of a HSBC North America Operational Risk and Internal Control policy. Key elements of the policy and our operational risk management framework include:    

• business and function management is responsible for the assessment,

identification, management, and reporting of their operational risks and

        monitoring the ongoing effectiveness of key controls;    

• material risks are assigned an overall risk prioritization / rating based

on the typical and extreme assessments and considers the direct financial

        costs and the indirect financial impacts to the business. An                                           106 

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assessment of the effectiveness of key controls that mitigate these risks is

made. An operational risk database records the risk and control assessments

and tracks risk mitigation action plans. The risk assessments are reviewed

     at least annually, or as business conditions change;    

• key risk indicators are established and monitored where appropriate; and

• the database is also used to track operational losses for analysis of root

causes, comparison with risk assessments, lessons learned and capital

modeling.

   Management practices include standard monthly reporting to senior management and the Operational Risk and Internal Control Committee of high risks, control deficiencies, risk mitigation action plans, losses and key risk indicators. We also monitor external operational risk events to ensure that the firm remains in line with best practice and takes into account lessons learned from publicized operational failures within the financial services industry. Operational risk management is an integral part of the new product development and approval process and the employee performance management process, as applicable. An online certification process, attesting to the completeness and accuracy of operational risk assessments and losses, is completed by senior business management on an annual basis.  Internal audits provide an important independent check on controls and test institutional compliance with the operational risk management framework. Internal audit utilizes a risk-based approach to determine its audit coverage in order to provide an independent assessment of the design and effectiveness of key controls over our operations, regulatory compliance and reporting. This includes reviews of the operational risk framework, the effectiveness and accuracy of the risk assessment process, and the loss data collection and reporting activities.  Compliance Risk Compliance risk is the risk arising from failure to comply with relevant laws, regulations, and regulatory requirements governing the conduct of specific businesses. It is a composite risk that can result in regulatory sanctions, financial penalties, litigation exposure and loss of reputation. Compliance risk is inherent throughout our organization.  The Compliance Committee of the Board of Directors oversees the compliance risk management program. The compliance function is led by the Chief Compliance Officer ("CCO") for HSBC North America, who reports directly to the HSBC North America Chief Risk Officer, the HSBC North America Chief Executive Officer, and the HSBC Head of Group Compliance. Further, the line of business compliance personnel functionally report to the CCO for HSBC North America. This reporting relationship enables the CCO to have direct access to HSBC Group Compliance, the Chief Risk Officer and the HSBC North America Chief Executive Officer as well as allowing for line of business personnel to be independent. The CCO for HSBC North America has broad authority from the Board of Directors and senior management to develop the enterprise-wide compliance program and oversee the compliance activities across all business units, jurisdictions and legal entities. This broad authority enables the CCO for HSBC North America to identify and resolve compliance issues in a timely and effective manner, and to escalate issues promptly to senior management, the Board of Directors, and HSBC as appropriate.  We are committed to delivering the highest quality financial products and services to our customers. Critical to our relationship with our customers is their trust in us, as fiduciary, advisor and service provider. That trust is earned not only through superior service, but also through the maintenance of the highest standards of integrity and conduct. We must, at all times, comply with high ethical standards, treat customers fairly, and comply with both the letter and spirit of all applicable laws, codes, rules, regulations and standards of good market practice, and HSBC policies and standards. It is also our responsibility to foster good relations with regulators, recognizing and respecting their role in ensuring adherence with laws and regulations. An important element of this commitment to our customers and shareholders is our compliance risk management program, which is applied enterprise-wide.  Our enterprise-wide program in HSBC North America is designed in accordance with HSBC policy and the principles established by the Federal Reserve in Supervision and Regulation Letter 08-8 (SR 08-8) dated October 16, 2008. By leveraging industry-leading practices and taking an enterprise-wide, integrated approach to                                          107 

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  Table of Contents                                                          HSBC Finance Corporation        managing our compliance risks, we can better identify and understand our compliance requirements, monitor our compliance risk profile, and assess and report our compliance performance across the organization. Consistent with the expectations of HSBC North America's regulators, our enterprise-wide compliance risk management program is designed to promote a consistent understanding of roles and responsibilities, as well as consistency in compliance program activities. The program is structured to pro-actively identify as well as quickly react to emerging issues and to assess, control, measure, monitor and report compliance risks across the company, both within and across business lines, support units, jurisdictions and legal entities.  Reputational Risk Management The safeguarding of our reputation is of paramount importance to our continued prosperity and is the responsibility of every member of our staff. Reputational risk can arise from social, ethical or environmental issues, or as a consequence of operations risk events. Our good reputation depends upon the way in which we conduct our business, but can also be affected by the way in which customers, to whom we provide financial services, conduct themselves.  Reputational risk is considered and assessed by the HSBC Group Management Board, our Board of Directors and senior management during the establishment of standards for all major aspects of business and the formulation of policy and products. These policies, which are an integral part of the internal control systems, are communicated through manuals and statements of policy, internal communication and training. The policies set out operational procedures in all areas of reputational risk, including money laundering deterrence, environmental impact, anti-corruption measures and employee relations.  

We have established a strong internal control structure to minimize the risk of operational and financial failure and to ensure that a full appraisal of reputational risk is made before strategic decisions are taken. The HSBC Internal Audit function monitors compliance with our policies and standards.

  Reputational risk is managed at the regional level across HSBC Group. All HSBC businesses and corporate risk functions within HSBC North America are represented on the HSBC North America Reputational Risk Policy Committee. The HSBC North America Reputational Risk Policy Committee was established in 2011 and was chaired by the HSBC North America Regional Compliance Officer. In early 2012, the Reputational Risk Policy Committee will be chaired by the HSBC North America Chief Executive Officer. The Reputational Risk Policy Committee is responsible for assessing reputational risk policy matters regionally and for advising HSBC Group Management and local senior management on matters relating to reputational risk. Notwithstanding the Reputational Risk Policy Committee, the responsibility of the practical implementation of such policies and the compliance with the letter and spirit of them rests with our Chief Executive Officer and senior management of our businesses.  Strategic Risk Management Strategic risk is the risk that the business will fail to identify, execute, and react appropriately to opportunities and threats arising from changes in the market, some of which may emerge over a number of years such as changing economic and political circumstances, customer requirements, demographic trends, regulatory developments or competitor action. Risk may be mitigated by consideration of the potential opportunities and/or challenges through the strategic planning process.  This risk is also a function of the compatibility of an organization's strategic goals, the business strategies developed to achieve those goals, the resources deployed against those goals and the quality of implementation.  We have established a strong internal control structure to minimize the impact of strategic risk to our earnings and capital. All changes in strategy as well as the process in which new strategies are implemented are subject to detailed reviews and approvals at business line, functional, regional, board and HSBC Group levels. This process is monitored by the Strategy and Implementation Group to ensure compliance with our policies and standards.  Business Continuity Planning  We are committed to the protection of employees, customers and shareholders by a quick response to all threats to the organization, whether they are of a physical or financial nature. We are governed by the HSBC North America Crisis Management Framework, which provides an enterprise-wide response and communication approach for managing major business continuity events or incidents. It is designed to be flexible and is scaled to the scope and magnitude of the event or incident.                                          108

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  Table of Contents                                                          HSBC Finance Corporation        The Crisis Management Framework works in tandem with the HSBC North America Corporate Contingency Planning Policy, business continuity plans and key business continuity committees to manage events. The North American Crisis Management Committee, a 24/7 standing committee, is activated to manage the Crisis Management process in concert with our senior management. This committee provides critical strategic management of business continuity crisis issues, risk management, communication, coordination and recovery management. In particular, the HSBC North America Crisis Management Committee has implemented an enterprise-wide plan, response and communication approach for pandemic preparedness. Tactical management of business continuity issues is handled by the Corporate and Local Incident Response Teams in place at each major site. We have also designated an Institutional Manager for Business Continuity who plays a key role on the Crisis Management Committee. All major business and support functions have a senior representative assigned to our Business Continuity Planning Committee, which is chaired by the Institutional Manager.  We test business continuity and disaster recovery resiliency and capability through routine contingency tests and actual events. Business continuity and disaster recovery programs have been strengthened in numerous areas as a result of these tests or actual events. There is a continuing effort to enhance the program well beyond the traditional business resumption and disaster recovery model.  

New Accounting Pronouncements to be Adopted in Future Periods

    Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts In October 2010, the FASB issued guidance which amends the accounting rules that define which costs associated with acquiring or renewing insurance contracts qualify as deferrable acquisition costs by insurance entities. The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. Early adoption is permitted, but must be applied as of the beginning of an entity's annual reporting period. The adoption of this guidance is not expected to have a material impact on our financial position or results of operations.  Repurchase Agreements In April 2011, the FASB issued a new Accounting Standards Update related to repurchase agreements. This new guidance removes the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and the related collateral maintenance guidance from the assessment of effective control. As a result, an entity is no longer required to consider the sufficiency of the collateral exchanged but will evaluate the transferor's contractual rights and obligations to determine whether it maintains effective control over the transferred assets. The new guidance is required to be applied prospectively for all transactions that occur on or after January 1, 2012. Adoption is not expected to have a material impact on our financial position or results of operations.  Fair Value Measurements and Disclosures In May 2011, the FASB issued an Accounting Standards Update to converge with newly issued IFRS 13, Fair Value Measurement. The new guidance clarifies that the application of the highest and best use and valuation premise concepts are not relevant when measuring the fair value of financial assets or liabilities. This Accounting Standards Update also requires new and enhanced disclosures on the quantification and valuation processes for significant unobservable inputs, transfers between Levels 1 and 2, and the categorization of all fair value measurements into the fair value hierarchy, even where those measurements are only for disclosure purposes. The guidance is effective prospectively from January 1, 2012. Adoption is not expected to have a material impact on our financial position or results of operations.  Presentation of Comprehensive Income In June 2011, the FASB issued a new Accounting Standards Update on the presentation of other comprehensive income. This Update requires entities to present net income and other comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. The option to present items of other comprehensive income in the statement of changes in equity is eliminated. The new guidance is effective from January 1, 2012 with full retrospective application. We will adopt this Accounting Standards Update in the first quarter of 2012.                                          109 

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  Table of Contents                                                          HSBC Finance Corporation        GLOSSARY OF TERMS   

Basis point - A unit that is commonly used to describe changes in interest rates. The relationship between percentage changes and basis points can be summarized as a 1 percent change equals a 100 basis point change or .01 percent change equals 1 basis point.

  Collateralized Funding Transaction - A transaction in which we use a pool of our consumer receivables as a source of funding and liquidity through either a Secured Financing or Securitization. Collateralized funding transactions allow us to limit our reliance on unsecured debt markets and can be a more cost-effective source of funding.  Contractual Delinquency - A method of determining aging of past due accounts based on the status of payments under the loan. An account is generally considered to be contractually delinquent when payments have not been made in accordance with the loan terms. Delinquency status may be affected by customer account management policies and practices such as the re-aging of accounts, forbearance agreements, extended payment plans, modification arrangements, external debt management plans, loan rewrites and deferments.  

Delinquency Ratio - Two-months-and-over contractual delinquency expressed as a percentage of receivables and receivables held for sale at a given date.

Effective Hedge or Qualifying Hedge - A hedging relationship which qualifies for fair value or cash flow hedge accounting treatment.

Efficiency Ratio - Total operating expenses less policyholders' benefits expressed as a percentage of the sum of net interest income and other revenues less policyholders' benefits.

Federal Reserve - The Federal Reserve Board, the principal regulator of HSBC North America.

  Fee Income and Enhancement Services Revenue - Income associated with interchange on credit cards and late and other fees from the origination, acquisition or servicing of loans as well as ancillary credit card revenue from products such as Account Secure (debt protection) and Identity Protection Plan.  Forbearance - The act of refraining from taking legal actions against a borrower despite the fact that the borrower is in arrears and is usually only granted when a borrower makes satisfactory arrangements to pay the amounts owed. Depending on state law, the borrower may be required to execute an agreement.  

Foreign Exchange Contract - A contract used to minimize our exposure to changes in foreign currency exchange rates.

Futures Contract - An exchange-traded contract to buy or sell a stated amount of a financial instrument or index at a specified future date and price.

  GM Portfolio - Our General Motors MasterCard receivable portfolio that was sold to HSBC Bank USA in January 2009 with new General Motors MasterCard receivable originations sold to HSBC Bank USA on a daily basis.  

Goodwill - The excess of purchase price over the fair value of identifiable net assets acquired, reduced by liabilities assumed in a business combination.

HBEU - HSBC Bank plc, a U.K. based subsidiary of HSBC Holdings plc.

HINO - HSBC Investments (North America) Inc., which is the immediate parent of HSBC Finance Corporation.

HMUS - HSBC Markets (USA) Inc.; an indirect wholly-owned subsidiary of HSBC North America and a holding company for investment banking and markets subsidiaries in the U.S.

HSBC or HSBC Group - HSBC Holdings plc.; HSBC North America's U.K. parent company.

HSBC Affiliate - Any direct or indirect subsidiary of HSBC outside of our consolidated group of entities.

HSBC Bank USA - HSBC Bank USA, National Association and its subsidiaries; the principal banking subsidiary of HSBC North America.

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  Table of Contents                                                          HSBC Finance CorporationHSBC North America - HSBC North America Holdings Inc., a wholly-owned subsidiary of HSBC. HSBC's top-tier bank holding company in North America and the immediate parent of HINO.  

HOHU - HSBC Overseas Holdings (UK) Limited, a U.K. based subsidiary of HSBC.

HTCD - HSBC Trust Company (Delaware); a wholly-owned banking subsidiary of HSBC USA Inc.

HTSU - HSBC Technology & Services (USA) Inc., an indirect wholly-owned subsidiary of HSBC North America which provides information technology and centralized operational services, such as human resources, tax, finance, compliance, legal, corporate affairs and other services shared among HSBC Affiliates, primarily in North America.

HUSI - HSBC USA Inc. and its subsidiaries, an indirect wholly-owned bank holding company subsidiary of HSBC. HSBC Bank USA is the principal U.S. banking subsidiary of HUSI.

  IFRS Basis - A non-U.S. GAAP measure of reporting results in accordance with International Financial Reporting Standards. IFRS Basis also assumes that all purchase accounting fair value adjustments relating to our acquisition by HSBC have been "pushed down" to HSBC Finance Corporation.  Intangible Assets - Assets (excluding financial assets) which lack physical substance. Our acquired intangibles include purchased credit card relationships and related programs, other loan related relationships, technology and customer lists.  

Interchange Fees - Fees received for processing a credit card transaction through the MasterCard, Visa, American Express or Discover network.

Interest Rate Swap - Contract between two parties to exchange interest payments on a stated principal amount (notional principal) for a specified period. Typically, one party makes fixed rate payments, while the other party makes payments using a variable rate.

LIBOR - London Interbank Offered Rate; A widely quoted market rate which is frequently the index used to determine the rate at which we borrow funds.

Liquidity - A measure of how quickly we can convert assets to cash or raise additional cash.

Loan-to-Value ("LTV") Ratio - The loan balance at time of origination expressed as a percentage of the appraised property value at the time of origination.

Net Charge-off Ratio - Net charge-offs of consumer receivables expressed as a percentage of average consumer receivables outstanding for a given period.

Net Interest Income - Interest income from receivables and noninsurance investment securities reduced by interest expense.

Net Interest Margin - Net interest income expressed as a percentage of average interest-earning assets.

  Nonaccrual Receivables - Receivables which are 90 or more days contractually delinquent. Nonaccrual receivables do not include receivables which have made qualifying payments and have been re-aged and the contractual delinquency status reset to current as such activity, in our judgment, evidences continued payment probability. If a re-aged loan subsequently experiences payment default and becomes 90 or more days contractually delinquent, it will be reported as nonaccrual. Nonaccrual receivables also do not include credit card receivables which, consistent with industry practice, continue to accrue until charge-off.  

Non-qualifying hedge - A hedging relationship that does not qualify for hedge accounting treatment but which may be an effective economic hedge.

Personal Non-Credit Card Receivables - Unsecured lines of credit or closed-end loans made to individuals.

Portfolio Seasoning - Relates to the aging of origination vintages. Loss patterns emerge slowly over time as new accounts are booked.

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Real Estate Secured Receivable - Closed-end loans and revolving lines of credit secured by first or subordinate liens on residential real estate.

  Refreshed Loan-to-Value - For first liens, the current loan balance expressed as a percentage of the current property value. For second liens, the current loan balance plus the senior lien amount at origination expressed as a percentage of the current property value. Current property values are derived from the property's appraised value at the time of loan origination updated by the change in the Federal Housing Finance Agency's (formerly known as the Office of Federal Housing Enterprise Oversight) house pricing index ("HPI") at either a Core Based Statistical Area or state level. The estimated current value of the home could vary from actual fair values due to changes in condition of the underlying property, variations in housing price changes within metropolitan statistical areas and other factors.  

Return on Average Assets - Net income as a percentage of average assets.

Return on Average Common Shareholder's Equity - Net income less dividends on preferred stock as a percentage of average common shareholder's equity.

SEC - The Securities and Exchange Commission.

  Secured Financing - A type of Collateralized Funding Transaction in which the interests in a dedicated pool of consumer receivables, typically real estate secured, credit card, auto finance or personal non-credit card receivables, are sold to investors. Generally, the pool of consumer receivables are sold to a special purpose entity which then issues securities that are sold to investors. Secured Financings do not receive sale treatment for accounting purposes and, as a result, the receivables and related debt remain on our balance sheet.  

Stated Income (Low Documentation) - Loans underwritten based upon the loan applicant's representation of annual income, which is not verified by receipt of supporting documentation.

Tangible Assets - Total assets less intangible assets, goodwill and derivative financial assets.

  Tangible Common Equity - Common shareholder's equity excluding unrealized gains and losses on cash flow hedging instruments, postretirement benefit plan adjustments and unrealized gains and losses on investments and interest-only strip receivables, as well as subsequent changes in fair value recognized in earnings associated with debt and related derivatives for which we elected fair value option accounting, less intangible assets and goodwill.  

Tangible Shareholders' Equity - Tangible common equity plus preferred stock and company obligated mandatorily redeemable preferred securities of subsidiary trusts (including amounts due to affiliates).

Taxpayer Financial Services ("TFS") Revenue - Our taxpayer financial services business provided consumer tax refund lending in the United States. This income primarily consisted of fees received from the consumer for a short term loan which will be repaid from their Federal income tax return refund. During the fourth quarter of 2010, we discontinued the operations of our TFS business and it is now reported in discontinued operations.  UP Portfolio - A Union Plus MasterCard/Visa receivable portfolio that was sold to HSBC Bank USA in January 2009 with new Union Plus MasterCard/Visa receivable originations sold to HSBC Bank USA on a daily basis.                                          112

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CREDIT QUALITY STATISTICS - CONTINUING OPERATIONS

                                               2011          2010          2009              2008          2007                                                               (dollars are in millions) Two-Month-and-Over Contractual Delinquency Ratios Continuing operations: Real estate secured(1)                     18.98 %       16.56 %       15.78 %(5)        14.17 %        7.49 % Private label(4)                               -             -             -             26.91         21.24 Personal non-credit card                    9.35         10.94         13.65 (5)         19.06         14.48  Total consumer - continuing operations                                 17.93         15.85         15.46 (5)         15.04          8.74 Discontinued operations                     5.34          6.18          9.07              6.57          5.28  Total consumer                             15.94 %       14.41 %       14.27 %           12.52 %        7.56 %  Ratio of Net Charge-offs to Average Receivables for the Year(6) Continuing operations: Real estate secured(2)                      7.13 %        9.50 %        9.85 %(5)         5.47 %        2.37 % Private label(4)                               -             -             -             31.19         16.55 Personal non-credit card                   11.84         22.65         27.96 (5)         13.46          8.28  Total consumer - continuing operations                                  7.69         11.30         12.91 (5)          6.91          3.42 Discontinued operations                    10.32         14.24         15.53              9.12          5.89  Total                                       7.97 %       11.79 %       13.38 %            7.58 %        4.22 %  Real estate charge-offs and REO expense as a percent of average real estate secured receivables (6)              7.58 %       10.01 %       

10.14 %(5) 5.91 % 2.74 %

  Nonaccrual Receivables (Including Nonaccrual Receivables Held For Sale) Continuing operations: Real estate secured(3)                   $ 6,544       $ 6,360       $ 6,995 (5)      $  7,705       $ 4,752 Private label(4)                               -             -             -                12            25 Personal non-credit card                     330           530           998 (5)         2,420         2,092  Total consumer - continuing operations                                 6,874         6,890         7,993 (5)        10,137         6,869 Discontinued operations                        -             -           252               537           919  Total                                    $ 6,874       $ 6,890       $ 8,245          $ 10,674       $ 7,788  Accruing Consumer Receivables 90 or More Days Delinquent Discontinued operations                      344           447           890             1,333         1,277  Total                                    $   344       $   447       $   890          $  1,333       $ 1,277  Real Estate Owned Continuing operations                    $   299       $   962       $   592          $    885       $ 1,008 Discontinued operations                        -             -             -                 -            15  Total                                    $   299       $   962       $   592          $    885       $ 1,023     

(1) Real estate secured two-months-and-over contractual delinquency ratios for

      our Mortgage Services and Consumer Lending businesses are below.                                      2011         2010         2009         2008         2007       Mortgage Services:       First lien                  21.88 %      19.12 %      17.62 %      18.07 %      11.70 %       Second lien                  9.25        11.23        12.87        18.37        15.61        Total Mortgage Services     20.31 %      18.05 %      16.91 %      18.11 %      12.47 %        Consumer Lending:       First lien                  19.00 %      16.18 %      15.37 %      11.64 %       3.72 %       Second lien                 12.31        12.81        14.03        14.45         6.93 

Total Consumer Lending 18.36 % 15.85 % 15.21 % 12.00 % 4.15 %

                                           113 

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CREDIT QUALITY STATISTICS (Continued)

(2) Real estate secured net charge-off ratios for our Mortgage Services and

      Consumer Lending businesses are below.                                      2011         2010         2009         2008         2007       Mortgage Services:       First lien                   7.88 %      10.13 %      11.35 %       5.82 %       1.60 %       Second lien                 17.85        24.52        28.72        30.52        12.15        Total Mortgage Services      9.18 %      12.16 %      14.11 %      10.38 %       3.77 %        Consumer Lending:       First lien                   5.32 %       6.81 %       5.60 %       1.31 %        .79 %       Second lien                 14.11        19.62        21.93        10.41         3.79        Total Consumer Lending       6.18 %       8.19 %       7.62 %       2.52 %       1.20 %     

(3) Real estate nonaccrual receivables are comprised of the following:

                                        2011        2010        2009        2008        2007        Real estate secured:        Closed-end:        First lien                  $ 6,191     $ 5,910     $ 6,304     $ 6,452     $ 3,583        Second lien                     232         320         510         931         801        Revolving:        First lien                        9           6           2           8          19        Second lien                     112         124         179         314         349         Total real estate secured   $ 6,544     $ 6,360     $ 6,995     $ 7,705     $ 4,752     

   receivables assuming the December 2009 Charge-off Policy Changes had not    occurred.)    

     principal balance of the portfolio can result in significant changes in      these ratios. In 2009, we began reporting this liquidating portfolio      prospectively within our personal non-credit card portfolio.    

     for detailed discussion of these changes. This resulted in incremental      charge-offs in December 2009 of $2.4 billion and $1.1 billion for real      estate secured and personal non-credit card receivables, respectively. The      following table presents credit quality statistics as reported as well as      assuming the charge-off policy changes had not occurred:                                                                                  Excluding Policy                                                      As Reported                  Change                                                             (dollars are in 

 Contractual Delinquency Ratios: Real estate secured                                         15.78 %                      19.05 % Personal non-credit card                                    13.65                        21.66 Total consumer - continuing operations                      15.46                        19.46 Net Charge-off Ratios: Real estate secured                                          9.85 %                       6.26 % Personal non-credit card                                    27.96                        20.11 Total consumer - continuing operations                      12.91                         8.60 Nonaccrual Receivables (Including Nonaccrual Receivables Held For Sale): Real estate secured                                 $       6,995           $            9,397 Personal non-credit card                                      998                        2,069 Total consumer - continuing operations                      7,993                       11,466 Real estate charge-offs and REO expenses as a percentage of average real estate secured receivables                                                 10.14 %                       6.56 %    

     secured receivables.                                           114 

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                                                2011           2010           2009            2008           2007                                                                (dollars are in millions) Total Credit Loss Reserves at January 1                                $  5,512       $  7,275       $   

  Provision for Credit Losses                 4,418          5,346           

 Real estate secured(1)                     (3,354 )       (5,267 )        (6,663 )       (4,318 )       (2,199 ) Private label                                   -              -               -            (34 )          (45 ) Personal non-credit card                   (1,127 )       (2,329 )        

  Total consumer                             (4,481 )       (7,596 )       (10,702 )       (6,826 )       (3,973 ) Commercial and other                            -              -               -             (1 )            -  Total receivables charged off              (4,481 )       (7,596 )       (10,702 )       (6,827 )       (3,973 )  Recoveries: Real estate secured(2)                         94            112              65             49             72 Private label                                   -              -               -              7              9 Personal non-credit card                      409            375             227            222            211  Total consumer                                503            487             292            278            292 Commercial and other                            -              -               -              -              -  Total recoveries on receivables               503            487             292            278            292  Reserves on Receivables Transferred to Held For Sale: Real estate secured                             -              -               -           (224 )            - Personal non-credit card                        -              -               -              -              -  Total consumer                                  -              -               -           (224 )            - Commercial and other                            -              -               -              -              -  Total reserves on receivables transferred to held for sale                    -              -               -           (224 )            -  Other, net                                      -              -               -            (10 )          (22 )  Credit Loss Reserves(4): Real estate secured                         4,912          4,187           5,427          7,113          4,954 Private label                                   -              -               -             13             26 Personal non-credit card                    1,040          1,325           1,848          2,655          2,511  Total consumer                              5,952          5,512           7,275          9,781          7,491 Commercial and other                            -              -               -              -              1  Total Credit Loss Reserves at December 31                              $  5,952       $  5,512       $   

  Ratio of Credit Loss Reserves to: Net charge-offs(3)(4)                       149.6 %         77.5 %          69.9 %        149.4 %        203.5 % Receivables: Consumer(3)(4)                              12.42           9.76           10.39          11.21           7.30 Commercial                                      -              -               -              -            .69  Total(3)                                    12.42 %         9.76 %         10.38 %        11.19 %         7.29 %  Nonperforming loans: Consumer(3)(4)                               86.6 %         80.0 %          91.1 %         96.8 %        109.5 % Commercial                                      -              -               -              -              -  Total(3)                                     86.6 %         80.1 %          91.1 %         96.8 %        109.5 %       

                             2011          2010          2009          2008          2007          Closed end:          First lien    $ (2,522 )    $ (3,804 )    $ (4,373 )    $ (1,942 )    $   (879 )          Second lien       (660 )      (1,146 )      (1,787 )      (1,822 )        (928 )          Revolving:          First lien          (5 )          (7 )          (8 )         (14 )         (20 )          Second lien       (167 )        (310 )        (495 )        (540 )        (372 )           Total         $ (3,354 )    $ (5,267 )    $ (6,663 )    $ (4,318 )    $ (2,199 )                                            115 

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                                     2011      2010      2009      2008      2007                    Closed end:                    First lien    $  28     $  37     $  22     $  10     $  45                    Second lien      51        58        30        30        20                    Revolving:                    First lien        6         6         3         1         2                    Second lien       9        11        10         8         5                     Total         $  94     $ 112     $  65     $  49     $  72     

     corresponding credit loss reserves.    

     for detailed discussion of these changes. This resulted in incremental      charge-offs in December 2009 of $2.4 billion and $1.1 billion for real      estate secured and personal non-credit card receivables, respectively. See

     Policy Changes.                                           116 

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    The following table shows the average balances of the principal components of assets, liabilities and shareholders' equity together with their respective interest amounts and rates earned or paid and the average rate by each component for the years ended December 31, 2011 and 2010. Interest expense, the average rate on debt as well as net interest margin includes interest expense of $94 million and $263 million for the years ended December 31, 2011 and 2010, respectively, that has been allocated to our discontinued operations in accordance with our existing internal transfer pricing policies as external interest expense is unaffected by the classification of businesses as discontinued operations.                                                                                                           Finance and                         

                                              Average                     Average                   Interest Income/                                           Outstanding (1)                 Rate(7)                   Interest Expense             Total               Volume              Rate                                          2011          2010         2011          2010           2011              2010         Variance          Variance(2)         Variance(2)                                                                                                 (dollars are in millions) Receivables: Real estate secured(5)                 $ 45,689      $ 54,264         6.43 

     (552 )    $         (29 ) Personal non-credit card(5)               6,059         8,623        16.78         15.91            1,017            1,372           (355 )                (427 )               72 Commercial and other(6)                      67            44         4.49        117.04                3               52            (49 )                  18                (67 )  Total receivables                        51,815        62,931         7.63          7.85            3,956            4,941           (985 )                (852 )             (133 ) Noninsurance investments                  6,165         6,728          .83           .79               51               53             (2 )                  (5 )                3 Interest related to income tax receivables                                   -             -            -             -              117                6            111                   111                  -  Total interest-earning assets (excluding insurance investments)      $ 57,980      $ 69,659         7.11 %        7.18 %    $     4,124       $    5,000     $     (876 )      $         (831 )    $         (45 ) Insurance investments                     2,049         2,107 Other assets                              1,236         3,636  Total Assets                           $ 61,265      $ 75,402  Debt: Commercial paper                       $  3,815      $  3,732          .24 %         .30 %    $         9       $       11     $       (2 )      $            -      $          (2 ) Due to related party                      8,447         8,473         1.94          1.73              164              147             17                     -                 17 Long-term debt                           47,576        62,285         4.77          4.84            2,269            3,016           (747 )                (702 )              (45 )  Total debt                             $ 59,838      $ 74,490         4.08 %        4.26 %    $     2,442       $    3,174     $     (732 )      $         (602 )    $        (130 ) Other liabilities                        (5,067 )      (5,312 )  Total liabilities                        54,771        69,178 Preferred securities                      1,575           663 Common shareholder's equity               4,919         5,561  Total Liabilities and Shareholders' Equity                                 $ 61,265      $ 75,402  Net Interest Margin(3)                                                2.90 %        2.62 %    $     1,682       $    1,826     $     (144 )      $         (229 )    $          85  Interest Spreads(4)                                                   3.03          2.92     

     an arithmetic sum of the individual components.    

     assets.    

     assets and the cost of the debt used to fund the assets.    

     rounding.                                           117 

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    The following table shows the average balances of the principal components of assets, liabilities and shareholders' equity together with their respective interest amounts and rates earned or paid and the average rate by each component for the years ended December 31, 2010 and 2009. Interest expense, the average rate on debt as well as net interest margin includes interest expense of $263 million and $519 million for the years ended December 31, 2010 and 2009, respectively, that has been allocated to our discontinued operations in accordance with our existing internal transfer pricing policies as external interest expense is unaffected by the classification of businesses as discontinued operations.                                                                                                          Finance and                       

                                            Average                                               Interest Income/                                         Outstanding (1)              Average Rate(7)              Interest Expense             Total             Volume               Rate                                       2010           2009           2010          2009           2010           2009          Variance         Variance(2)         Variance(2)                                                                                              (dollars are in millions) Receivables: Real estate secured(5)              $ 54,264       $ 67,083           6.48 

            8,623         13,634          15.91         14.02           1,372         1,912             (540 )             

(772 )               232 Commercial and other(6)                   44            (28 )       117.04         35.74              52           (11 )             63                  58                   5  Total receivables                     62,931         80,689           7.85          7.56           4,941         6,097           (1,156 )            (1,385 )               229 Noninsurance investments               6,728          5,614            .79           .74              53            42               11                   8                   3 Interest related to income tax receivables                                -              -              -             -               6             -                6                   6                   -  Total interest-earning assets (excluding insurance investments)                        $ 69,659       $ 86,303           7.18 %        7.11 %     $   5,000       $ 6,139       $   (1,139 )     $      (1,194 )     $          55 Insurance investments                  2,107          2,062 Other assets                           3,636           (473 )  Total Assets                        $ 75,402       $ 87,892  Debt: Commercial paper                    $  3,732       $  5,412            .30 %         .90 %     $      11       $    49       $      (38 )     $         (12 )     $         (26 ) Due to related party                   8,473         10,942           1.73          2.25             147           246              (99 )               (49 )               (50 ) Long-term debt                        62,285         74,210           4.84          5.17           3,016         3,837             (821 )              (589 )              (232 )  Total debt                          $ 74,490       $ 90,564           4.26 %        4.56 %     $   3,174       $ 4,132       $     (958 )     $        (698 )     $        (260 ) Other liabilities                     (5,312 )       (6,607 )  Total liabilities                     69,178         83,957 Preferred securities                     663            575 Common shareholder's equity            5,561          3,360  Total Liabilities and Shareholders' Equity                $ 75,402       $ 87,892  Net Interest Margin(3)                                                2.62 %        2.33 %     $   1,826       $ 2,007       $     (181 )     $        (496 )     $         315  Interest Spreads(4)                                                   2.92          2.55     

     an arithmetic sum of the individual components.    

     assets.    

     assets and the cost of the debt used to fund the assets.    

    rounding.                                           118 

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    Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). In addition to the U.S. GAAP financial results reported in our consolidated financial statements, MD&A includes reference to the following information which is presented on a non-U.S. GAAP basis:  

  Equity Ratios In managing capital, we develop targets for tangible common equity to tangible assets. This ratio target is based on discussions with HSBC and rating agencies, risks inherent in the portfolio, the projected operating environment and related risks, and any acquisition objectives. We, certain rating agencies and our credit providing banks monitor ratios excluding the equity impact of unrealized gains losses on cash flow hedging instruments, postretirement benefit plan adjustments and unrealized gains on investments as well as subsequent changes in fair value recognized in earnings associated with debt and the related derivatives for which we elected the fair value option. Our targets may change from time to time to accommodate changes in the operating environment or other considerations such as those listed above.  

                                      119

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                                             2011           2010           2009           2008            2007                                                             (dollars are in millions) Tangible common equity: Common shareholder's equity           $  5,351       $  6,145       $  7,804       $  12,862       $  13,584 Exclude: Fair value option adjustment              (755 )         (453 )         (518 )        (2,494 )          (545 ) Unrealized (gains) losses on cash flow hedging instruments                   494            575            633           1,316             718 Postretirement benefit plan adjustments, net of tax                     11              -             (8 )            (4 )             3 Unrealized (gains) losses on investments and interest-only strip receivables                         (102 )          (74 )          (31 )            55              13 Intangible assets                         (514 )         (605 )         (748 )          (922 )        (1,107 ) Goodwill                                     -              -              -          (2,294 )        (2,827 )  Tangible common equity                $  4,485       $  5,588       $  7,132       $   8,519       $   9,839  Tangible shareholders' equity: Tangible common equity                $  4,485       $  5,588       $  7,132       $   8,519       $   9,839 Preferred stock                          1,575          1,575            575             575             575 Mandatorily redeemable preferred securities of Household Capital Trusts                                   1,000          1,000          1,000           1,275           1,275  Tangible shareholders' equity         $  7,060       $  8,163       $  8,707       $  10,369       $  11,689  Tangible assets: Total assets                          $ 63,469       $ 77,131       $ 94,806       $ 131,067       $ 165,504 Exclude: Intangible assets                         (514 )         (605 )         (748 )          (922 )        (1,107 ) Goodwill                                     -              -              -          (2,294 )        (2,827 ) Derivative financial assets                  -            (75 )            -              (8 )           (48 )  Tangible assets                       $ 62,955       $ 76,451       $ 94,058       $ 127,843       $ 161,522  Equity ratios: Common and preferred equity to total assets                             10.91 %        10.01 %         8.84 %         10.25 %          8.56 % Tangible common equity to tangible assets(1)                                 7.12           7.31           7.58            6.66            6.09 Tangible shareholders' equity to tangible assets(1)                       11.21          10.68           9.26            8.11            7.24    

     shows the tangible managed asset balances prior to 2008 as well as the      ratios above calculated using total managed assets:                                                                         2007                                                                 (dollars are                                                                 in millions)     Total owned assets                                         $      

     Receivables serviced with limited recourse                            124      Total managed assets                                              165,628     Exclude:     Intangible assets                                                  (1,107 )     Goodwill                                                           (2,827 )     Derivative financial assets                                           (48 )      Tangible managed assets                                    $      161,646      Equity ratios:     Tangible common equity to tangible managed assets                    

     Tangible shareholders' equity to tangible managed assets             7.23                                           120 

                                                          HSBC Finance