Receivables Held for Sale

Real Estate Secured Receivables As discussed in prior filings, we have been engaged in an on-going evaluation of our balance sheet taking into consideration our liquidity, capital and funding requirements as well as capital requirements of HSBC. As part of this on-going evaluation, we identified a pool of real estate secured receivables, all of which at one time were greater than 180 days past due, for which we no longer had the intent to hold for the foreseeable future and, as a result, transferred this pool of real estate secured receivables to receivables held for sale during the second quarter of 2012. The receivable pool identified comprised first lien partially charged-off accounts as of June 30, 2012, with an unpaid principal balance of approximately $8.1 billion at the time of transfer. The net realizable value of these receivables after considering the fair value of the property less cost to sell was approximately $4.6 billion prior to transfer. Selling these types of assets is expected to be capital accretive and will reduce funding requirements, accelerate portfolio wind-down and also alleviate some operational burden given that these receivables are servicing intense and subject to foreclosure delays. Receivables which were at one time greater than 180 days past due require substantial amounts of capital under U.K. banking regulatory requirements and the extension of the foreclosure timeline in the U.S. has increased the capital requirements for this run-off book of business. These factors combined with the increase in the market's appetite for this asset class, led us to the decision that the sale of certain of these assets would be the best financial decision.

On June 1, 2013, we completed the sale of a pool of real estate secured receivables with an unpaid principal balance of $439 million (carrying value of $230 million) at the time of sale to a third-party investor for cash consideration of $229 million which resulted in a loss on sale of $9 million during the second quarter of 2013 primarily related to transaction fees. On August 1, 2013, we completed the sale of an additional pool of real estate secured receivables with an unpaid principal balance of $685 million (carrying value of $396 million) at the time of sale to a third-party investor for cash consideration of $405 million. As these receivables were carried at the lower of amortized cost or fair value at June 30, 2013, we do not expect any significant impact to our earnings will be recorded during the third quarter of 2013.

The market demand for first lien partially charged-off accounts has been strong throughout the first half of 2013. As a direct result of this increased market demand, in June 2013, we decided we no longer have the intent to hold for investment first lien real estate secured receivables once they have been written down to the lower of amortized cost or fair value of the collateral less cost to sell, subject to certain exceptions, principally receivables associated with secured financings which are not saleable. As a result, we adopted a formal program to initiate sale activities for real estate secured receivables in our held for investment portfolio when a receivable meeting pre-determined criteria is written down to the lower of amortized cost or fair value of the collateral less cost to sell in accordance with our existing charge-off policies (generally 180 days past due). During the second quarter of 2013, we transferred real estate secured receivables to held for sale with an unpaid principal balance of approximately $2.6 billion at the time of transfer. The net realizable value (carrying value) of these receivables after considering the fair value of the property less cost to sell was approximately $1.8 billion prior to transfer.

As we now plan to sell these receivables to a third party investor, fair value represents the price we believe a third party investor would pay to acquire the receivable portfolios. A third party investor would incorporate a number of assumptions in predicting future cash flows, such as differences in overall cost of capital assumptions, which may result in a lower estimate of fair value for the cash flows associated with the receivables. Accordingly, during the second quarter of 2013 we recorded a lower of amortized cost or fair value adjustment of $99 million to the newly transferred loans, all of which was attributable to non-credit related factors and was recorded as a component of total other revenues in the consolidated statement of income (loss).

We expect that receivables held for sale at June 30, 2013 will be sold in multiple transactions generally over the next 18 months or, if the foreclosure process is completed prior to sale, the underlying properties acquired in satisfaction of the receivables will be classified as real estate owned (“REO”) and sold. As we continue to work with borrowers, we may also agree to a short sale whereby the property is sold by the borrower at a price which has been pre-negotiated with us and the borrower is released from further obligation. Accordingly, based on the projected timing of loan sales and the expected flow of foreclosure volume into REO over the next 18 months, a portion of the real estate secured receivables classified as held for sale will ultimately become REO. Upon classification of the underlying properties acquired in satisfaction of these loans as REO, the properties will be recorded at the fair value of the collateral less cost to sell, which we expect will represent a higher value than the price a third party investor would have paid to acquire the receivables as explained above. As a result, a portion of the fair value adjustment on receivables held for sale may be reversed in earnings over time. This estimate of fair value is highly dependent upon the timing and size of future receivable sales as well as the volume and timelines associated with foreclosure activity. During the three and six months ended June 30, 2013, we transferred a portion of our real estate secured receivable portfolio held for sale with a carrying value of $118 million and $230 million, respectively, to REO after obtaining title to the underlying collateral and reversed a portion of the lower of amortized cost or fair value adjustment previously recorded totaling $16 million and $49 million, respectively. Additionally, during the three and six months ended June 30, 2013, we completed short sales on real estate secured receivables with a carrying value of $53 million and $88 million, respectively. As a result of these short sales, we reversed a portion of the lower of amortized cost or fair value adjustment previously recorded totaling $2 million and $11 million during the three and six months ended June 30, 2013, respectively, as the agreed price was higher than the carrying value.

Personal Non-Credit Card Receivables In the second quarter of 2012, we determined that, given market conditions for the personal non-credit card receivable portfolio, a sale of our remaining personal non-credit card receivables would reduce a significant amount of risk-weighted assets which would provide net capital relief, reduce funding requirements and allow us to exit an entire product line, reducing both the related cost infrastructure and operational risk. As such, during the second quarter of 2012, we made the decision to pursue a sale of the personal non-credit card receivable portfolio. The personal non-credit card receivable portfolio was previously held for investment purposes and was transferred to held for sale during the second quarter of 2012 as we no longer had the intention to hold our portfolio of personal non-credit card receivables for the foreseeable future and expected these receivables would be sold in the near term. The personal non-credit card receivable portfolio has not been reported as discontinued operations as it does not qualify as a component of our business as the cash flows and operations related to our personal non-credit card receivable portfolio are not clearly distinguishable from the cash flows and operations of our real estate secured receivable portfolio.

On March 5, 2013, we entered into an agreement to sell our personal non-credit card receivable portfolio to trusts for which affiliates of Springleaf Finance, Inc. ("Springleaf"), Newcastle Investment Corp. and Blackstone Tactical Opportunities Advisors L.L.C. are the sole beneficiaries (collectively, the "Purchasers"). On March 5, 2013, we also entered into an agreement to sell a loan servicing facility and related assets located in London, Kentucky (the "Facility") to Springleaf. On April 1, 2013, we completed the sale of our personal non-credit card receivable portfolio with a carrying value of $2.9 billion at March 31, 2013 to the Purchasers. Total cash consideration received was $3.0 billion. During the second quarter of 2013, we recorded a loss on sale of $11 million primarily related to transaction fees. We will continue to service these personal non-credit card receivables for the Purchasers for a fee for a period of time as the Purchasers convert the receivables to their systems. Upon the conversion of these receivable to their systems, the majority of the employees who are performing these servicing activities are expected to transfer to the Purchaser. Servicing fee revenues recorded for servicing these personal non-credit card receivables during the second quarter of 2013 totaled $12 million. It is currently expected that this conversion and the sale of the Facility in London, Kentucky will be completed during the second half of 2013.

The following table summarizes receivables held for sale which are carried at the lower of amortized cost or fair value:



	June 30, 2013		December 31, 2012
	(in millions)
First lien real estate secured	$	4,991	$	3,022
Personal non-credit card	—		3,181
Total receivables held for sale	$	4,991	$	6,203

The table below summarizes the activity in receivables held for sale during the three and six months ended June 30, 2013.



	Real Estate Secured			Personal Non-Credit Card			Total
	(in millions)
Three Months Ended June 30, 2013:
Receivables held for sale at beginning of period	$	3,407		$	2,947		$	6,354
Receivable sales:
First lien real estate secured	(230		)	—			(230		)
Personal non-credit card receivables	—			(2,947		)	(2,947		)
Lower of amortized cost or fair value adjustment on receivables held for sale	471			—			471
Carrying value of real estate secured receivables held for sale settled through short sale or transfer to REO	(171		)	—			(171		)
Change in receivable balance, including collections	(23		)	—			(23		)
Transfer of first lien real estate secured into held for sale at the lower of amortized cost or fair value	1,537			—			1,537
Receivables held for sale at end of period⁽¹⁾	$	4,991		$	—		$	4,991

Six Months Ended June 30, 2013:
Receivables held for sale at beginning of period	$	3,022		$	3,181		$	6,203
Receivable sales:
First lien real estate secured	(230		)	—			(230		)
Personal non-credit card receivables	—			(2,947		)	(2,947		)
Lower of amortized cost or fair value adjustment on receivables held for sale	1,007			(82		)	925
Carrying value of real estate secured receivables held for sale settled through short sale or transfer to REO	(318		)	—			(318		)
Change in receivable balance, including collections	(27		)	(152		)	(179		)
Transfer of first lien real estate secured into held for sale at the lower of amortized cost or fair value	1,537			—			1,537
Receivables held for sale at end of period⁽¹⁾	$	4,991		$	—		$	4,991


⁽¹⁾	Net of a valuation allowance of $309 million at June 30, 2013. The following table provides a rollforward of our valuation allowance for the three and six months ended June 30, 2013:



	Three Months Ended June 30, 2013			Six Months Ended June 30, 2013
	(in millions)
Balance at beginning of period	$	898		$	1,452
Initial valuation allowance for receivables transferred to held for sale during the period	99			99
Release of valuation allowance resulting from improvements in fair value	(471		)	(925		)
Release of valuation allowance for collections, loans sold, charged-off, transferred to REO or short sale	(217		)	(317		)
Balance at June 30, 2013	$	309		$	309

During the three and six months ended June 30, 2013, we reversed $453 million and $947 million, respectively, of the lower of amortized cost or fair value adjustment recorded during the year ended December 31, 2012 primarily due to an increase in the relative fair value of the real estate secured receivables held for sale during the first half of 2013 largely due to improved conditions in the housing industry driven by increased property values and, to a lesser extent, lower required market yields and increased investor demand for these types of receivables. During the first quarter of 2013, the fair value of the personal non-credit card receivables held for sale decreased by $82 million, reflecting the excess of the interest and fee income on the loans over the fees received from the Purchasers as the sale agreement called for interest and fees on the loans to pass to the Purchasers after December 31, 2012 in return for a cost of carry and servicing fee to be paid to the seller.

The following table summarizes the components of the lower of amortized cost or fair value adjustment recorded in other revenues during the three and six months ended June 30, 2013 and 2012:



	Lower of Amortized Cost or Fair Value Adjustments Associated With
	Fair Value			REO			Short Sales			Total
	(in millions)
(Income)/Expense:
Three Months Ended June 30, 2013:
Lower of amortized cost or fair value adjustments recorded as a component of:
Provision for credit losses	$	—		$	—		$	—		$	—
Other revenues:
Initial lower of amortized cost or fair value adjustment	99			—			—			99
Subsequent to initial transfer to held for sale⁽¹⁾	(453		)	(16		)	(2		)	(471		)
Total recorded through other revenues	(354		)	(16		)	(2		)	(372		)
Lower of amortized cost or fair value adjustment	$	(354	)	$	(16	)	$	(2	)	$	(372	)

Three Months Ended June 30, 2012:
Lower of amortized cost or fair value adjustments recorded as a component of:
Provision for credit losses	$	112		$	—		$	—		$	112
Other revenues:
Initial lower of amortized cost or fair value adjustment	1,547			—			—			1,547
Total recorded through other revenues	1,547			—			—			1,547
Lower of amortized cost or fair value adjustment	$	1,659		$	—		$	—		$	1,659

Six Months Ended June 30, 2013:
Lower of amortized cost or fair value adjustments recorded as a component of:
Provision for credit losses	$	—		$	—		$	—		$	—
Other revenues:
Initial lower of amortized cost or fair value adjustment	99			—			—			99
Subsequent to initial transfer to held for sale⁽¹⁾	(865		)	(49		)	(11		)	(925		)
Total recorded through other revenues	(766		)	(49		)	(11		)	(826		)
Lower of amortized cost or fair value adjustment	$	(766	)	$	(49	)	$	(11	)	$	(826	)


Six Months Ended June 30, 2012:
Lower of amortized cost or fair value adjustments recorded as a component of:
Provision for credit losses	$	112		$	—		$	—		$	112
Other revenues:
Initial lower of amortized cost or fair value adjustment	1,547			—			—			1,547
Total recorded through other revenues	1,547			—			—			1,547
Lower of amortized cost or fair value adjustment	$	1,659		$	—		$	—		$	1,659

⁽¹⁾

For the three months ended June 30, 2013, the fair value amount relates to an increase in the relative fair value of real estate secured receivables held for sale. For the six months ended June 30, 2013, the fair value of the lower of amortized cost or fair value adjustment reflects an increase in the relative fair value of $947 million related to real estate secured receivables held for sale and an additional charge of $82 million related to personal non-credit card receivables prior to the sale of this portfolio on April 1, 2013.