-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WEz/N/sgAZeYvOzI0blCNRVnVD4lqXihq3tVreUP4NraM6dQo16T8YXlfGm1QuPb ISI1RjkkGDEIXEvUhLTz9A== 0000950137-98-002672.txt : 19980703 0000950137-98-002672.hdr.sgml : 19980703 ACCESSION NUMBER: 0000950137-98-002672 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19980630 ITEM INFORMATION: ITEM INFORMATION: ITEM INFORMATION: FILED AS OF DATE: 19980702 SROS: CSX SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: HOUSEHOLD INTERNATIONAL INC CENTRAL INDEX KEY: 0000354964 STANDARD INDUSTRIAL CLASSIFICATION: PERSONAL CREDIT INSTITUTIONS [6141] IRS NUMBER: 363121988 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: SEC FILE NUMBER: 001-08198 FILM NUMBER: 98659516 BUSINESS ADDRESS: STREET 1: 2700 SANDERS RD CITY: PROSPECT HEIGHTS STATE: IL ZIP: 60070 BUSINESS PHONE: 8475645000 MAIL ADDRESS: STREET 1: 2700 SANDERS ROAD CITY: PROSPECT HEIGHTS STATE: IL ZIP: 60070 8-K 1 FORM 8-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------------- FORM 8-K CURRENT REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 Date of report (Date of earliest event reported): June 30, 1998 HOUSEHOLD INTERNATIONAL, INC. (Exact Name of Registrant as Specified in Charter) Delaware (State or Other Jurisdiction of Incorporation) 1-8198 36-3121988 (Commission File Number) (IRS Employer Identification No.) 2700 SANDERS ROAD, PROSPECT HEIGHTS, ILLINOIS 60070 (Address of Principal Executive Offices ) (Zip Code) Registrant's telephone number, including area code: (847) 564-5000 2 ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS. On June 30, 1998, subject to the terms and conditions of the Agreement and Plan of Merger (the "Merger Agreement") dated as of April 7, 1998 between Household International, Inc. ("Household"), Household Acquisition Corporation II, a wholly-owned subsidiary of Household, and Beneficial Corporation ("Beneficial"), Household Acquisition Corporation II was merged with and into Beneficial, with Beneficial being the surviving corporation (the "Merger"). In accordance with the Merger Agreement, each share of the common stock, par value $1.00 per share, of Beneficial ("Beneficial Common Stock") outstanding immediately prior to the effective time of the Merger was converted into the right to receive 3.0666 shares of the common stock, $1.00 par value, of Household ("Household Common Stock"). The Merger was accounted for as a "pooling of interests" under generally accepted accounting principles. A copy of the press release, dated June 30, 1998, issued by Household relating to the closing of the Merger is attached as Exhibit 99.3 hereto and is incorporated herein by reference. Certain information regarding the Merger, Household and Beneficial, including, but not limited to, the date and manner of the Merger, a description of the assets involved, the nature and amount of consideration paid by Household therefor, the method used for determining the amount of such consideration ,the nature of any material relationships between Household and Beneficial or any officer or director of Household or any associate of such officer or director, the nature of Beneficial's business and Household's intended use of the assets acquired in the Merger is set forth in the Joint Proxy Statement-Prospectus dated June 2, 1998 included in Household's Registration Statement on Form S-4 (Registration No. 333-55707). Such Joint Proxy Statement-Prospectus is incorporated herein by reference as Exhibit 99.5 3 ITEM 5. OTHER EVENTS. As reported above under Item 2, on June 30, 1998, Household completed its merger with Beneficial. The Merger was accounted for as a "pooling of interests" under generally accepted accounting principles. The following supplemental consolidated financial statements of Household restating Household's historical consolidated financial statements as of and for the three years ended December 31, 1997 to reflect the Merger are incorporated herein by reference to Exhibit 99.1 filed herewith: 1. Management's Discussion and Analysis. 2. Consolidated Balance Sheets as of December 31, 1997 and 1996. 3. Consolidated Statements of Income for the three years ended December 31, 1997. 4. Consolidated Statements of Changes in Stockholders' Equity for the three years ended December 31, 1997. 5. Consolidated Statements of Cash Flows for the three years ended December 31, 1997. 6. Notes to the Consolidated Financial Statements. The report of Arthur Andersen LLP, independent accountants, on the supplemental consolidated financial statements of Household as of December 31, 1997 and 1996 and for the three years ended December 31, 1997 is filed herewith as part of Exhibit 99.1 and the related consent is filed herewith as Exhibit 23.1. Both the opinion and the consent are incorporated herein by reference. The following unaudited supplemental interim condensed consolidated financial statements of Household restating Household's historical unaudited condensed consolidated financial statements as of March 31, 1998 and for the three months ended March 31, 1998 and 1997 to reflect the Merger are incorporated herein by reference to Exhibit 99.2 filed herewith: 1. Condensed Consolidated Balance Sheets as of March 31, 1998 (Unaudited) and December 31, 1997. 2. Condensed Consolidated Statements of Income for the three months ended March 31, 1998 and 1997 (Unaudited). 3. Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 1998 and 1997 (Unaudited). 4. Notes to the Condensed Consolidated Financial Statements (Unaudited). 4 ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS. (a) Financial Statements of Businesses Acquired. The historical financial statements of Beneficial as filed in its Annual Report on Form 10-K for the fiscal year ended December 31, 1997, as amended by Amendment No. 1 on Form 10-K/A and in its Form 10-Q for the quarter ended March 31, 1998 are incorporated herein by reference to Exhibit 99.4 filed herewith. (b) Pro Forma Financial Information. UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION The following unaudited pro forma condensed combined financial information and explanatory notes are presented to show the impact on the historical financial position and results of operations of Household of the Merger under the "pooling of interests" method of accounting. The unaudited pro forma condensed combined financial information combines the historical financial information of Household and Beneficial at March 31, 1998, for the three months ended March 31, 1998 and 1997, and for each of the three years ended December 31, 1997. All Household share information has been adjusted for Household's 3-for-1 stock split effected in the form of a stock dividend and paid on June 1, 1998. The pro forma condensed combined financial information for the three months ended March 31, 1998 and 1997 and for each of the three years ended December 31, 1997 is based on and derived from, and should be read in conjunction with, (a) the historical consolidated financial statements and the related notes thereto of Household (as previously filed) and (b) the historical consolidated financial statements and the related notes thereto of Beneficial, which are included herein under item 7(a). 5 HOUSEHOLD INTERNATIONAL. INC. AND SUBSIDIARIES PRO FORMA CONDENSED COMBINED BALANCE SHEET AT MARCH 31, 1998 (UNAUDITED) (IN MILLIONS, EXCEPT SHARE DATA)
HOUSEHOLD BENEFICIAL ADJUSTMENTS PRO FORMA --------- ---------- ----------- --------- ASSETS Cash.................................................. $ 195.1 $ 224.6 $ 419.7 Investment securities................................. 2,625.5 633.9 3,259.4 Receivables, net...................................... 25,672.1 14,243.6 39,915.7 Acquired intangibles and goodwill, net................ 1,894.7 50.6 1,945.3 Properties and equipment, net......................... 279.6 233.0 $(127.0)(c) 385.6 Real estate owned..................................... 139.6 75.1 214.7 Other assets.......................................... 2,090.3 835.2 (159.0)(c) 2,766.5 --------- --------- ------- --------- Total assets.................................... $32,896.9 $16,296.0 $(286.0) $48,906.9 ========= ========= ======= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Debt: Deposits........................................... $ 1,881.6 $ 509.7 $ 2,391.3 Commercial paper, bank and other borrowings........................................ 6,769.0 3,935.6 10,704.6 Senior and senior subordinated debt (with original maturities over one year)................ 16,297.1 8,662.7 24,959.8 --------- --------- --------- Total debt...................................... 24,947.7 13,108.0 38,055.7 Insurance policy and claim reserves................... 1,140.5 357.8 1,498.3 Other liabilities..................................... 1,646.4 782.2 $ 465.0(c) 2,893.6 --------- --------- ------- --------- Total liabilities............................... 27,734.6 14,248.0 465.0 42,447.6 Company obligated mandatorily redeemable preferred securities of subsidiary trusts (b)........ 375.0 375.0 Preferred stock....................................... 150.0 114.8 (0.3)(a) 264.5 Common shareholders' equity: Common stock....................................... 373.0 (d) 54.4 1.4 (a) 428.8 Additional paid-in capital......................... 1,283.5 (d) 349.7 (1.1)(a) 1,632.1 Retained earnings.................................. 3,701.3 1,551.4 (751.0)(c) 4,501.7 Foreign currency translation adjustments........... (129.1) (27.4) (156.5) Unrealized gain on investments, net................ 7.6 5.1 12.7 Less common stock in treasury...................... (599.0) (599.0) --------- --------- ------- --------- Total common shareholders' equity............... 4,637.3 1,933.2 (750.7) 5,819.8 --------- --------- ------- --------- Total liabilities and shareholders' equity......................................... $32,896.9 $16,296.0 $(286.0) $48,906.9 ========= ========= ======= =========
---------- (a) The pro forma amount (including the deemed conversion of the Beneficial $5.50 Convertible Preferred Stock at the time of the Merger) assumes 167,262,834 shares of Household Common Stock are issued in the Merger, based on the exchange ratio of 3.0666 shares of Household Common Stock for each share of Beneficial Common Stock outstanding as of March 31, 1998 (after giving effect to the deemed conversion of all outstanding shares of Beneficial Convertible Preferred Stock). The actual number of shares of Household Common Stock to be issued will be determined at the time the Merger is consummated, based upon the number of shares of Beneficial Common Stock and Beneficial Convertible Preferred Stock then outstanding. (b) The sole assets of the three trusts are Junior Subordinated Deferrable Interest Notes issued by Household in March 1998, June 1996 and June 1995, bearing interest at 7.25, 8.70 and 8.25 percent, respectively, with principal balances of $206.2, $103.1 and $77.3 million, respectively, and due December 31, 2037, June 30, 2036 and June 30, 2025, respectively. (c) Reflects the effect of the Merger and integration costs. See Note 2. (d) Common stock and additional paid-in capital for Household have been adjusted for Household's 3-for-1 stock split effected in the form of a stock dividend and paid on June 1, 1998. See Notes to the Unaudited Pro Forma Condensed Combined Financial Information. 6 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME FOR THE THREE MONTHS ENDED MARCH 31, 1998 (UNAUDITED) (IN MILLIONS, EXCEPT PER SHARE DATA)
HOUSEHOLD BENEFICIAL PRO FORMA --------- ---------- --------- Finance and other interest income................................ $ 783.6 $ 565.8 $ 1,349.4 Interest expense................................................. 388.6 223.6 612.2 ------- -------- --------- Net interest margin.............................................. 395.0 342.2 737.2 Provision for credit losses on owned receivables................. 261.5 139.8 401.3 ------- -------- --------- Net interest margin after provision for credit losses............ 133.5 202.4 335.9 ------- -------- --------- Total other revenues............................................. 596.2 410.9 1,007.1 ------- -------- --------- Total costs and expenses......................................... 476.7 300.0 776.7 ------- -------- --------- Income before income taxes....................................... 253.0 313.3 566.3 Income taxes..................................................... 82.7 125.8 208.5 ------- -------- --------- Net income....................................................... $ 170.3 $ 187.5 $ 357.8 ======= ======== ========= Net income....................................................... $ 170.3 $ 187.5 $ 357.8 Preferred dividends.............................................. (2.9) (1.3) (4.2) ------- -------- --------- Earnings available to common shareholders........................ $ 167.4 $ 186.2 $ 353.6 ======= ======== ========= Basic weighted average common shares outstanding................. 321.7 53.4 485.5 ======= ======== ========= Diluted weighted average common shares outstanding............... 326.2 55.7 497.0 ======= ======== ========= Basic earnings per common share (a).............................. $ 0.52 $ 3.49 $ 0.73 ======= ======== ========= Diluted earnings per common share (a)............................ $ 0.51 $ 3.34 $ 0.71 ======= ======== =========
- ----------- (a) The calculation of basic and diluted earnings per common share for the pro forma financial statements uses the applicable weighted average number of outstanding shares of Household Common Stock and Beneficial Common Stock adjusted to equivalent shares of Household Common Stock. See Notes to the Unaudited Pro Forma Condensed Combined Financial Information. 7 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME FOR THE THREE MONTHS ENDED MARCH 31, 1997 (UNAUDITED) (IN MILLIONS, EXCEPT PER SHARE DATA)
HOUSEHOLD BENEFICIAL PRO FORMA --------- ---------- --------- Finance and other interest income.............................. $ 759.9 $ 538.3 $ 1,298.2 Interest expense............................................... 365.1 214.7 579.8 ------- ------- --------- Net interest margin............................................ 394.8 323.6 718.4 Provision for credit losses on owned receivables............... 293.4 93.1 386.5 ------- ------- --------- Net interest margin after provision for credit losses.......... 101.4 230.5 331.9 ------- ------- --------- Total other revenues........................................... 575.8 234.3 810.1 ------- ------- --------- Total costs and expenses....................................... 476.6 302.4 779.0 ------- ------- --------- Income before income taxes..................................... 200.6 162.4 363.0 Income taxes................................................... 69.1 61.7 130.8 ------- ------- --------- Net income..................................................... $ 131.5 $ 100.7 $ 232.2 ======= ======= ========= Net income..................................................... $ 131.5 $ 100.7 $ 232.2 Preferred dividends............................................ (3.2) (1.3) (4.5) ------- ------- --------- Earnings available to common shareholders...................... $ 128.3 $ 99.4 $ 227.7 ======= ======= ========= Basic weighted average common shares outstanding............... 291.6 53.6 456.0 ======= ======= ========= Diluted weighted average common shares outstanding............. 295.9 55.3 465.5 ======= ======= ========= Basic earnings per common share (a)............................ $ 0.44 $ 1.85 $ 0.50 ======= ======= ========= Diluted earnings per common share (a).......................... $ 0.43 $ 1.80 $ 0.49 ======= ======= =========
- ------------ (a) The calculation of basic and diluted earnings per common share for the pro forma financial statements uses the applicable weighted average number of outstanding shares of Household Common Stock and Beneficial Common Stock adjusted to equivalent shares of Household Common Stock. See Notes to the Unaudited Pro Forma Condensed Combined Financial Information. 8 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1997 (UNAUDITED) (IN MILLIONS, EXCEPT PER SHARE DATA)
HOUSEHOLD BENEFICIAL PRO FORMA --------- ---------- --------- Finance and other interest income............................... $ 3,094.0 $ 2,140.3 $ 5,234.3 Interest expense................................................ 1,503.4 855.0 2,358.4 --------- --------- --------- Net interest margin............................................. 1,590.6 1,285.3 2,875.9 Provision for credit losses on owned receivables................ 1,042.0 485.3 1,527.3 --------- --------- --------- Net interest margin after provision for credit losses........... 548.6 800.0 1,348.6 --------- --------- --------- Total other revenues............................................ 2,409.1 815.4 3,224.5 --------- --------- --------- Total costs and expenses........................................ 1,928.5 1,183.3 3,111.8 --------- --------- --------- Provision for loss on German disposal........................... -- 58.8 58.8 --------- --------- --------- Income before income taxes...................................... 1,029.2 373.3 1,402.5 Income taxes.................................................... 342.6 119.6 462.2 --------- --------- --------- Net income...................................................... $ 686.6 $ 253.7 $ 940.3 ========= ========= ========= Net income...................................................... $ 686.6 $ 253.7 $ 940.3 Preferred dividends............................................. (11.8) (5.2) (17.0) --------- --------- --------- Earnings available to common shareholders....................... $ 674.8 $ 248.5 $ 923.3 ========= ========= ========= Basic weighted average common shares outstanding................ 307.1 53.0 469.6 ========= ========= ========= Diluted weighted average common shares outstanding.............. 311.4 54.7 479.1 ========= ========= ========= Basic earnings per common share (a)............................. $ 2.20 $ 4.68 $ 1.97 ========= ========= ========= Diluted earnings per common share (a)........................... $ 2.17 $ 4.54 $ 1.93 ========= ========= =========
- ------------ (a) The calculation of basic and diluted earnings per common share for the pro forma financial statements uses the applicable weighted average number of outstanding shares of Household Common Stock and Beneficial Common Stock adjusted to equivalent shares of Household Common Stock. See Notes to the Unaudited Pro Forma Condensed Combined Financial Information. 9 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1996 (UNAUDITED) (IN MILLIONS, EXCEPT PER SHARE DATA)
HOUSEHOLD BENEFICIAL PRO FORMA --------- ---------- --------- Finance and other interest income............................ $ 3,030.5 $ 2,040.0 $ 5,070.5 Interest expense............................................. 1,520.6 812.8 2,333.4 --------- --------- --------- Net interest margin.......................................... 1,509.9 1,227.2 2,737.1 Provision for credit losses on owned receivables............. 759.6 398.8 1,158.4 --------- --------- --------- Net interest margin after provision for credit losses........ 750.3 828.4 1,578.7 --------- --------- --------- Total other revenues......................................... 2,028.3 731.9 2,760.2 --------- --------- --------- Total costs and expenses..................................... 1,956.3 1,101.8 3,058.1 --------- --------- --------- Income before income taxes................................... 822.3 458.5 1,280.8 Income taxes................................................. 283.7 177.5 461.2 --------- --------- --------- Net income................................................... $ 538.6 $ 281.0 $ 819.6 ========= ========= ========= Net income................................................... $ 538.6 $ 281.0 $ 819.6 Preferred dividends.......................................... (16.7) (5.2) (21.9) --------- --------- --------- Earnings available to common shareholders.................... $ 521.9 $ 275.8 $ 797.7 ========= ========= ========= Basic weighted average common shares outstanding............. 291.2 53.1 454.0 ========= ========= ========= Diluted weighted average common shares outstanding........... 294.9 54.6 462.3 ========= ========= ========= Basic earnings per common share (a).......................... $ 1.79 $ 5.19 $ 1.76 ========= ========= ========= Diluted earnings per common share (a)........................ $ 1.77 $ 5.05 $ 1.73 ========= ========= =========
- ------------ (a) The calculation of basic and diluted earnings per common share for the pro forma financial statements uses the applicable weighted average number of outstanding shares of Household Common Stock and Beneficial Common Stock adjusted to equivalent shares of Household Common Stock. See Notes to the Unaudited Pro Forma Condensed Combined Financial Information. 10 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1995 (UNAUDITED) (IN MILLIONS, EXCEPT PER SHARE DATA)
HOUSEHOLD BENEFICIAL PRO FORMA Finance and other interest income............................ $ 3,002.2 $ 1,926.8 $ 4,929.0 Interest expense............................................. 1,557.1 816.2 2,373.3 --------- --------- --------- Net interest margin.......................................... 1,445.1 1,110.6 2,555.7 Provision for credit losses on owned receivables............. 761.3 280.2 1,041.5 --------- --------- --------- Net interest margin after provision for credit losses........ 683.8 830.4 1,514.2 --------- --------- --------- Total other revenues......................................... 2,142.2 471.4 2,613.6 --------- --------- --------- Total costs and expenses..................................... 2,072.3 1,006.6 3,078.9 --------- --------- --------- Provision for restructuring and other........................ -- 24.8 24.8 --------- --------- --------- Income before income taxes................................... 753.7 270.4 1,024.1 Income taxes................................................. 300.5 119.9 420.4 --------- --------- --------- Net income................................................... $ 453.2 $ 150.5 $ 603.7 ========= ========= ========= Net income................................................... $ 453.2 $ 150.5 $ 603.7 Preferred dividends.......................................... (26.4) (5.2) (31.6) --------- --------- --------- Earnings available to common shareholders.................... $ 426.8 $ 145.3 $ 572.1 ========= ========= ========= Basic weighted average common shares outstanding............. 292.4 52.5 453.4 ========= ========= ========= Diluted weighted average common shares outstanding........... 297.3 53.7 462.0 ========= ========= ========= Basic earnings per common share (a).......................... $ 1.46 $ 2.77 $ 1.26 ========= ========= ========= Diluted earnings per common share (a)........................ $ 1.44 $ 2.71 $ 1.24 ========= ========= =========
- ------------- (a) The calculation of basic and diluted earnings per common share for the pro forma financial statements uses the applicable weighted average number of outstanding shares of Household Common Stock and Beneficial Common Stock adjusted to equivalent shares of Household Common Stock. See Notes to the Unaudited Pro Forma Condensed Combined Financial Information. 11 NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION NOTE 1. BASIS OF PRESENTATION The unaudited pro forma condensed combined financial information reflects the Merger using the "pooling of interests" method of accounting and is based on the historical consolidated financial statements of Household and Beneficial. The Unaudited Pro Forma Condensed Combined Balance Sheet assumes that the Merger was consummated on March 31, 1998. The Unaudited Pro Forma Condensed Combined Statements of Income give effect to the Merger as if it occurred on January 1, 1995. All share information has been adjusted for Household's 3-for-1 stock split effected in the form of a stock dividend and paid on June 1, 1998. Certain amounts in the historical financial statements of Beneficial have been reclassified to conform with Household's historical financial statement presentation. The unaudited pro forma condensed combined financial information should be read in conjunction with the historical consolidated financial statements and the related notes thereto of each of Household (as previously filed) and Beneficial incorporated herein by reference to Exhibit 99.4. NOTE 2. MERGER AND INTEGRATION RELATED COSTS In connection with the Merger, Household intends to merge corporate functions, sell Beneficial's commercial bank business, sell or combine overlapping branches, sell or merge Beneficial's mortgage operations into Household's, close Beneficial's United Kingdom ("UK") headquarters and merge Beneficial's UK operations into Household's existing UK business. Household will incur pre-tax Merger and integration related costs of approximately $1 billion ($751 million after-tax) during the quarter ended June 30, 1998. These costs include approximately $284 million in lease exit costs, $161 million in fixed asset write-offs related to closed facilities, $240 million in severance and change in control payments, $140 million in asset writedowns to reflect modified business plans, $66 million in investment banking fees, $34 million in legal and other expenses, and $75 million in prepayment premiums related to debt. The estimated Merger and integration related costs include approximately $286 million in noncash charges. Cash payments of approximately $714 million will be funded through Household's existing operations and commercial paper and other borrowings. In addition, Household expects to receive tax benefits of approximately $249 million. Substantially all of the cash payments are expected to be made by the end of 1998. 12 NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION--(CONTINUED) These amounts, including the related tax effect, have been reflected in the Unaudited Pro Forma Condensed Combined Balance Sheet as of March 31, 1998 and are not reflected in the Unaudited Pro Forma Condensed Combined Statements of Income as they are not expected to have a continuing impact on the combined company. NOTE 3. OPERATING COSTS SAVINGS The combined company expects to achieve substantial annual pre-tax cost savings of approximately $450 million (approximately $300 million after-tax) through the elimination of redundant staff functions and corporate overhead, consolidation of product lines, data processing and back office functions, and the elimination of certain duplicate or excess office facilities. Based on Household management's current estimates, approximately 90% of the operating cost savings are expected to be achieved on a run-rate basis by the end of 1999 (which estimates as to timing and amount have been modestly refined since the public announcement of the Merger and the time that the analyses were performed by Household's and Beneficial's financial advisors in connection with their respective fairness opinions). These savings should continue to benefit the combined company in future years. No adjustment has been included in the unaudited pro forma financial information for the anticipated operating cost savings. There can be no assurance that the anticipated cost savings will be in the expected amounts or at the times anticipated. NOTE 4. SHAREHOLDERS' EQUITY In connection with the Merger, Household will exchange 3.0666 shares of Household Common Stock for each share of Beneficial Common Stock. Beneficial had 54,543,414 shares of common stock outstanding (assuming conversion of the Beneficial Convertible Preferred Stock) as of March 31, 1998. Treasury stock of Beneficial is included as a deduction from common stock and additional paid-in capital and is not presented separately within shareholders' equity. Pro forma combined retained earnings reflect the adjustments for anticipated Merger and integration costs as described above. (c) Exhibits. Exhibit 2.1 Agreement and Plan of Merger dated as of April 7, 1998 between Household International, Inc. Household Acquisition Corporation II and Beneficial Corporation (incorporated by reference from Exhibit 2.1 to the Household International, Inc. Current Report on Form 8-K dated April 20, 1998 (File No. 1-8198)). Exhibit 23.1 Consent of Arthur Andersen LLP Exhibit 23.2 Consent of Deloitte & Touche LLP Exhibit 27 Restated Financial Data Schedule Exhibit 27.1 Restated Financial Data Schedule Exhibit 99.1 Supplemental Consolidated Financial Statements of Household International, Inc. as of December 31, 1997 and 1996 and for the three years ended December 31, 1997. Exhibit 99.2 Unaudited Supplemental Interim Condensed Consolidated Financial Statements of Household International, Inc. as of March 31, 1998 and for the three months ended March 31, 1998 and 1997. Exhibit 99.3 Household International, Inc. Press Release dated June 30, 1998 titled "Household International Completes Acquisition of Beneficial Corporation." Exhibit 99.4 Financial Statements of Beneficial as filed in its Annual Report on Form 10-K for the fiscal years ended December 31, 1997, as amended by Amendment No. 1 on Form 10-K/A and its Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. Exhibit 99.5 Joint Proxy Statement-Prospectus of Household International, Inc. contained within the Registration Statement of Household International, Inc. on Form S-4 (File No. 333-55707) is incorporated herein by reference. 13 SIGNATURE Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. Dated: July 1, 1998 Household International, Inc. ------------ ---------------------------- Registrant By: /s/ John W. Blenke ------------------------- John W. Blenke Assistant Secretary EX-23.1 2 CONSENT OF ARTHUR ANDERSEN LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report dated June 30, 1998 included in this Current Report on Form 8-K of Household International, Inc. for the year ended December 31, 1997, into the Company's previously filed Registration Statements No. 2-86383, No. 33-21343, No. 2-97495, No. 33-45454, No. 33-45455, No. 33-52211, No. 33-58727, No. 333-00397, No. 33-44066, No. 333-03673, No. 333-39639, No. 333-36589, No. 333-58287, No. 333-58289 and No. 333-58291 on Form S-8, Registration Statements No. 33-48854, No. 33-56599, No. 33-57249, No. 333-1025 and No. 333-27305 on Form S-3, and Registration Statement No. 333-35657 on Form S-4. /s/ ARTHUR ANDERSEN LLP Chicago, Illinois July 1, 1998 EX-23.2 3 CONSENT OF DELOITTE & TOUCHE LLP 1 EXHIBIT 23.2 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 333-27305 of Household International, Inc. on Form S-3 of our report dated January 28, 1998, appearing in this Current Report on Form 8-K of Household International, Inc. and the reference to us under the heading "Experts" in the prospectus. /s/ DELOITTE & TOUCHE LLP Parsippany, New Jersey July 1, 1998 EX-27 4 RESTATED FINANCIAL DATA SCHEDULE
5 1,000 YEAR YEAR YEAR DEC-31-1997 DEC-31-1996 DEC-31-1995 DEC-31-1997 DEC-31-1996 DEC-31-1995 534,300 518,800 543,500 2,898,600 2,843,000 6,130,900 38,682,000 38,447,500 35,011,900 2,523,000 2,109,000 1,591,500 0 0 0 0 0 0 1,279,500 1,294,100 1,316,800 740,800 736,100 742,000 47,040,900 45,529,200 44,903,500 0 0 0 23,736,200 23,433,100 19,020,400 0 0 0 264,500 319,500 319,500 536,900 511,900 509,300 5,812,100 4,184,600 3,645,100 47,040,900 45,529,200 44,903,500 0 0 0 8,458,800 7,830,700 7,542,600 0 0 0 3,170,600 3,058,100 3,103,700 0 0 0 1,527,300 1,158,400 1,041,500 2,358,400 2,333,400 2,373,300 1,402,500 1,280,800 1,024,100 462,200 461,200 420,400 940,300 819,600 603,700 0 0 0 0 0 0 0 0 0 940,300 819,600 603,700 1.97 1.76 1.26 1.93 1.73 1.24 RESTATED FINANCIAL STATEMENTS OF THE COMPANY WERE PREPARED IN ACCORDANCE WITH FINANCIAL INSTITUTION INDUSTRY STANDARDS. ACCORDINGLY, THE COMPANY'S BALANCE SHEETS WERE NON-CLASSIFIED. REPRESENTS BASIC EPS COMPUTED IN ACCORDANCE WITH STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 128, "EARNINGS PER SHARE." AMOUNTS HAVE BEEN RESTATED AS A RESULT OF HOUSEHOLD'S MERGER WITH BENEFICIAL, ACCOUNTED FOR AS A POOLING OF INTERESTS, AND FOR HOUSEHOLD'S 3-FOR-1 STOCK SPLIT EFFECTED IN THE FORM OF A STOCK DIVIDEND AND PAID ON JUNE 1, 1998. REPRESENTS DILUTED EPS COMPUTED IN ACCORDANCE WITH STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 128, "EARNINGS PER SHARE." AMOUNTS HAVE BEEN RESTATED AS A RESULT OF HOUSEHOLD'S MERGER WITH BENEFICIAL, ACCOUNTED FOR AS A POOLING OF INTERESTS, AND FOR HOUSEHOLD'S 3-FOR-1 STOCK SPLIT EFFECTED IN THE FORM OF A STOCK DIVIDEND AND PAID ON JUNE 1, 1998.
EX-27.1 5 RESTATED FINANCIAL DATA SCHEDULE
5 1,000 3-MOS 3-MOS DEC-31-1998 DEC-31-1997 MAR-31-1998 MAR-31-1997 419,700 543,200 3,259,400 2,618,800 40,048,300 36,180,400 2,573,000 2,206,000 0 0 0 0 1,144,800 1,219,800 632,200 676,200 49,192,900 45,060,100 0 0 24,959,800 23,001,600 0 0 264,500 264,500 540,300 511,500 6,405,500 4,328,900 49,192,900 45,060,100 0 0 2,356,500 2,108,300 0 0 776,700 779,000 0 0 401,300 386,500 612,200 579,800 566,300 363,000 208,500 130,800 357,800 232,200 0 0 0 0 0 0 357,800 232,200 .73 .50 .71 .49 RESTATED FINANCIAL STATEMENTS OF THE COMPANY WERE PREPARED IN ACCORDANCE WITH FINANCIAL INSTITUTION INDUSTRY STANDARDS. ACCORDINGLY, THE COMPANY'S BALANCE SHEETS WERE NON-CLASSIFIED. REPRESENTS BASIC EPS COMPUTED IN ACCORDANCE WITH STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 128, "EARNINGS PER SHARE." AMOUNTS HAVE BEEN RESTATED AS A RESULT OF HOUSEHOLD'S MERGER WITH BENEFICIAL, ACCOUNTED FOR AS A POOLING OF INTERESTS, AND FOR HOUSEHOLD'S 3-FOR-1 STOCK SPLIT EFFECTED IN THE FORM OF A STOCK DIVIDEND AND PAID ON JUNE 1, 1998. REPRESENTS DILUTED EPS COMPUTED IN ACCORDANCE WITH STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 128, "EARNINGS PER SHARE." AMOUNTS HAVE BEEN RESTATED AS A RESULT OF HOUSEHOLD'S MERGER WITH BENEFICIAL, ACCOUNTED FOR AS A POOLING OF INTERESTS, AND FOR HOUSEHOLD'S 3-FOR-1 STOCK SPLIT EFFECTED IN THE FORM OF A STOCK DIVIDEND AND PAID ON JUNE 1, 1998.
EX-99.1 6 SUPPLEMENTAL FINANCIAL INFORMATION 1 EXHIBIT 99.1 Household International, Inc. INDEX TO SUPPLEMENTAL FINANCIAL INFORMATION Introduction...................................................... 2 Supplemental Selected Financial Data.............................. 3 Supplemental Credit Quality Statistics............................ 4 Supplemental Management's Discussion and Analysis of Financial Condition and Results of Operations............................ 5 Supplemental Glossary of Terms.................................... 27 Supplemental Analysis of Credit Loss Reserves Activity - Owned Basis.......................................... 30 Supplemental Analysis of Credit Loss Reserves Activity - Managed Basis........................................ 31 Supplemental Net Interest Margin.................................. 32 Supplemental Selected Quarterly Financial Data.................... 35 Supplemental Financial Highlights................................. 36 Supplemental Consolidated Financial Statements.................... 37 Notes to Supplemental Financial Statements........................ 41 Report of Independent Public Accountants.......................... 71 2 INTRODUCTION Effective June 30, 1998, Household International, Inc. ("Household") completed its merger with Beneficial Corporation ("Beneficial") bringing together two of the oldest brands in the consumer finance industry which we believe will create a preeminent branch based consumer finance company. At March 31, 1998, the combined company had owned assets of $49.2 billion. The merger has been accounted for as a pooling of interests and, accordingly, the amounts for all periods reported in this supplemental filing are reported on a combined basis including both Household and Beneficial. 2 3 Household International, Inc. and Subsidiaries
All dollar amounts except per share data are stated in millions. 1997 1996 1995 1994 1993 - ---------------------------------------------------------------------------------------------------------- STATEMENT OF INCOME DATA--YEAR ENDED DECEMBER 31 Net interest margin and other revenues $ 6,100.4 $ 5,497.3 $ 5,169.3 $ 4,824.4 $ 4,629.3 Provision for credit losses on owned receivables 1,527.3 1,158.4 1,041.5 805.5 907.6 Operating expenses 2,914.7 2,746.2 2,548.8 2,613.6 2,340.8 Policyholders' benefits 255.9 311.9 554.9 550.9 615.0 Income taxes 462.2 461.2 420.4 309.1 281.2 Extraordinary loss - - - - 2.8 - ---------------------------------------------------------------------------------------------------------- Net income $ 940.3 $ 819.6 $ 603.7 $ 545.3 $ 481.9 ========================================================================================================== PER COMMON SHARE DATA Basic earnings per share(1) $ 1.97 $ 1.76 $ 1.26 $ 1.15 $ 1.04 Diluted earnings per share(1) 1.93 1.73 1.24 1.13 1.01 Dividends declared(1) .54 .49 .44 .41 .39 Book value(1) 12.81 9.96 8.96 7.72 7.37 - ---------------------------------------------------------------------------------------------------------- BALANCE SHEET DATA AT DECEMBER 31 Total assets(2): Owned $47,040.9 $45,529.2 $44,903.5 $48,715.0 $45,878.4 Managed 71,519.4 66,380.4 60,901.6 61,840.5 55,898.7 - ---------------------------------------------------------------------------------------------------------- Managed receivables(3): First mortgage $ 396.6 $ 725.6 $ 2,066.9 $ 3,364.2 $ 3,534.1 Home equity 19,824.8 16,197.5 16,506.7 14,734.5 14,532.5 Auto finance(4) 883.4 - - - - MasterCard/Visa 19,211.7 19,528.2 13,894.5 11,458.9 9,048.7 Private label 10,381.9 10,252.5 7,774.3 5,873.1 4,614.1 Other unsecured 11,505.1 11,557.6 9,375.1 7,784.9 6,519.6 Commercial 957.0 1,037.3 1,392.5 2,058.0 3,045.1 - ---------------------------------------------------------------------------------------------------------- Total managed receivables 63,160.5 59,298.7 51,010.0 45,273.6 41,294.1 Receivables serviced with limited recourse (24,478.5) (20,851.2) (15,998.1) (13,125.5) (10,020.3) - ---------------------------------------------------------------------------------------------------------- Owned receivables $38,682.0 $38,447.5 $35,011.9 $32,148.1 $31,273.8 ========================================================================================================== Deposits(5) $ 2,344.2 $ 3,000.1 $ 5,351.3 $ 9,093.4 $ 8,132.3 Total other debt 34,402.3 34,030.5 29,703.7 25,444.9 24,445.1 Company obligated mandatorily redeemable preferred securities of subsidiary trusts 175.0 175.0 75.0 - - Convertible preferred stock - - - 2.6 19.3 Preferred stock 264.5 319.5 319.5 434.6 434.7 Common shareholders' equity(6) 6,174.0 4,521.5 4,079.4 3,486.1 3,275.8 - ---------------------------------------------------------------------------------------------------------- SELECTED FINANCIAL RATIOS Return on average owned assets 2.02% 1.82% 1.25% 1.15% 1.08% Return on average managed assets 1.33 1.25 .97 .94 .91 Return on average common shareholders' equity 16.9 18.2 14.6 14.7 14.3 Total shareholders' equity as a percent of owned assets(7) 14.06 11.02 9.96 8.05 8.09 Total shareholders' equity as a percent of managed assets(7) 9.25 7.56 7.35 6.34 6.64 Managed net interest margin 7.83 7.55 7.14 7.32 7.52 Managed consumer net chargeoff ratio 3.90 2.99 2.54 2.38 2.49 Common dividends to net income 30.3 30.1 36.8 37.0 38.2 - ----------------------------------------------------------------------------------------------------------
(1) We adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" (FAS No. 128). Under FAS No. 128, basic earnings per common share is computed excluding dilution caused by common stock equivalents such as stock options. Diluted earnings per common share includes the effect of dilutive common stock equivalents. Prior years have been restated. All share information has been adjusted for our 3-for-1 stock split effected in the form of a stock dividend and paid on June 1, 1998. (2) In 1996, Beneficial sold its annuity product line. In late 1995, Household sold its individual life and annuity product lines of its life insurance business. In 1995, Household sold its first mortgage servicing portfolio and servicing business. In 1994, Household sold its Australian subsidiary and retail securities brokerage business. (3) In 1997, we acquired the capital stock of Transamerica Financial Services Holding Company ("TFS"). We paid $1.1 billion for the stock of TFS and repaid about $2.8 billion of TFS debt owed to its affiliates. The acquisition included $3.1 billion of home equity receivables. We also sold our entire portfolio of student loans totaling about $900 million in 1997, as we exited this business. In 1996, we acquired credit card portfolios with outstandings of $4.1 billion and sold $1.7 billion of lower margin loans primarily from the previously divested mortgage and consumer banking businesses. (4) In October 1997, we purchased ACC Consumer Finance Corporation, an auto finance company. Prior to the fourth quarter of 1997, auto finance receivables were not significant and were included in other unsecured receivables. (5) We sold our domestic consumer banking operations, including deposits of $2.8 billion in 1996 and $3.4 billion in 1995. Our Canadian subsidiary also sold $725 million in deposits in 1995. (6) In 1997, we issued 27.3 million shares of common stock in a public offering, raising about $1.0 billion. The net proceeds were used to repay certain short-term borrowings incurred in connection with the acquisition of TFS. (7) Total shareholders' equity at December 31, 1997, 1996 and 1995 includes common shareholders' equity, preferred stock and company obligated mandatorily redeemable preferred securities of subsidiary trusts. Total shareholders' equity excludes convertible preferred stock that was fully converted or redeemed during 1995. 3 4 SUPPLEMENTAL CREDIT QUALITY STATISTICS Household International, Inc. and Subsidiaries All dollar amounts are stated in millions
At December 31, unless otherwise indicated. 1997 1996 1995 1994 1993 - ----------------------------------------------------------------------------------------------------------------------------------- MANAGED CONSUMER TWO-MONTH-AND-OVER CONTRACTUAL DELINQUENCY RATIOS First mortgage 10.35% 9.49% 3.29% 1.81% 1.33% Home equity 3.69 3.04 2.76 2.49 2.95 Auto finance(1) 2.09 - - - - MasterCard/Visa 3.10 2.73 2.19 2.23 2.42 Private label 5.81 4.60 3.93 3.50 3.86 Other unsecured 7.81 6.21 5.68 5.25 6.41 - ----------------------------------------------------------------------------------------------------------------------------------- Total 4.64% 3.92% 3.36% 3.00% 3.38% =================================================================================================================================== RATIO OF NET CHARGEOFFS TO AVERAGE MANAGED RECEIVABLES FOR THE YEAR First mortgage 1.05% .45% .35% .41% .37% Home equity .64 .60 .64 .83 .86 Auto finance(1) 4.60 - - - - MasterCard/Visa 5.55 4.54 4.12 4.18 4.18 Private label 4.96 3.58 4.00 2.45 3.11 Other unsecured 5.48 4.29 3.60 4.01 5.30 - ----------------------------------------------------------------------------------------------------------------------------------- Total consumer 3.90 2.99 2.54 2.38 2.49 Commercial 1.66 .92 2.10 3.10 4.59 - ----------------------------------------------------------------------------------------------------------------------------------- Total 3.86% 2.94% 2.53% 2.42% 2.63% =================================================================================================================================== NONACCRUAL OWNED RECEIVABLES Domestic: First mortgage $ 31.7 $ 50.0 $ 39.6 $ 38.6 $ 25.6 Home equity 378.4 198.3 205.8 155.9 183.4 Private label(2) 25.0 22.5 58.3 30.2 26.9 Other unsecured 283.6 240.6 245.2 209.1 210.6 Foreign 189.1 177.4 169.2 165.5 179.0 - ----------------------------------------------------------------------------------------------------------------------------------- Total consumer 907.8 688.8 718.1 599.3 625.5 Commercial 31.2 60.0 146.8 117.7 279.2 - ------------------------------------------------------------------------------------ ---------------------------------------------- Total $ 939.0 $ 748.8 $ 864.9 $717.0 $ 904.7 =================================================================================================================================== NONACCRUAL MANAGED RECEIVABLES Domestic: First mortgage $ 31.7 $ 50.0 $ 39.6 $ 38.6 $ 25.6 Home equity 492.1 315.7 310.8 257.8 298.1 Private label(2) 25.0 22.5 80.4 46.7 31.8 Other unsecured 565.2 399.1 295.0 209.1 210.6 Foreign 219.7 198.8 179.3 165.5 179.0 - ----------------------------------------------------------------------------------------------------------------------------------- Total consumer 1,333.7 986.1 905.1 717.7 745.1 Commercial 31.2 60.0 146.8 117.7 279.2 - ----------------------------------------------------------------------------------------------------------------------------------- Total $1,364.9 $1,046.1 $1,051.9 $835.4 $1,024.3 =================================================================================================================================== ACCRUING OWNED RECEIVABLES 90 OR MORE DAYS DELINQUENT(3) Domestic $ 468.3 $ 415.9 $ 181.1 $147.3 $ 145.4 Foreign 31.3 23.8 12.2 7.5 10.3 - ----------------------------------------------------------------------------------------------------------------------------------- Total $ 499.6 $ 439.7 $ 193.3 $154.8 $ 155.7 =================================================================================================================================== ACCRUING MANAGED RECEIVABLES 90 OR MORE DAYS DELINQUENT(3) Domestic $ 776.5 $ 621.7 $ 308.1 $239.8 $ 210.6 Foreign 31.3 23.8 12.2 7.5 10.3 - ----------------------------------------------------------------------------------------------------------------------------------- Total $ 807.8 $ 645.5 $ 320.3 $247.3 $ 220.9 =================================================================================================================================== RENEGOTIATED COMMERCIAL LOANS $ 12.4 $ 12.9 $ 21.2 $ 41.8 $ 28.7 - ------------------------------------------------------------------------------------------------------------------------------------ REAL ESTATE OWNED Domestic $ 200.0 $ 217.2 $ 208.4 $206.7 $ 439.2 Foreign 12.8 19.6 29.3 47.3 62.2 - ----------------------------------------------------------------------------------------------------------------------------------- Total $ 212.8 $ 236.8 $ 237.7 $254.0 $ 501.4 ===================================================================================================================================
(1) Prior to the fourth quarter of 1997, credit quality statistics for auto finance receivables were not significant. Credit quality data for these receivables were included in other unsecured receivables. Net chargeoff data includes ACC subsequent to our acquisition in October 1997. (2) Represents nonaccrual sales contract receivables which are included in private label receivables. (3) Includes MasterCard and Visa and private label credit card receivables, consistent with industry practice. There were no commercial loans 90 or more days past due which remained on accrual status. 4 5 - ------------------------------------------------------------------------------- HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES SUPPLEMENTAL MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- Household International, Inc., through its subsidiaries, provides consumers with several types of loan products. We offer home equity loans, auto finance loans, MasterCard* and Visa* and private label credit cards, tax refund anticipation loans and other unsecured loans. We serve middle-market customers primarily in the United States, Canada and the United Kingdom. At December 31, 1997, we had managed receivables of $63.2 billion. Our managed receivable portfolio includes receivables on our balance sheet and those that we service for investors as part of our asset securitization program. On June 30, 1998, Household International ("Household") merged with Beneficial Corporation ("Beneficial"), a consumer finance holding company headquartered in Wilmington, Delaware. Pursuant to the merger, each outstanding share of Beneficial common stock has been converted into 3.0666 shares of Household's common stock, resulting in the issuance of approximately 167.3 million shares of common stock. Each share of Beneficial $5.50 Convertible Preferred Stock (the "Beneficial Convertible Stock") has been converted into the number of shares of Household common stock the holder would have been entitled to receive in the merger had such Beneficial Convertible Stock been converted into shares of Beneficial common stock immediately prior to the merger. Additionally, each other share of Beneficial preferred stock outstanding has been converted into one share of a newly created series of Household preferred stock with terms substantially similar to those of existing Beneficial preferred stock. The merger has been accounted for as a pooling of interests and, therefore, the supplemental consolidated financial statements include the results of operations, financial position and changes in cash flows of Beneficial for all periods. In connection with the merger, Household will incur pre-tax merger and integration related costs of approximately $1 billion ($751 million after-tax) in the quarter ended June 30, 1998. These costs include approximately $284 million in lease exit costs, $161 million in fixed asset write-offs related to closed facilities, $240 million in severance and change in control payments, $140 million in asset writedowns to reflect modified business plans, $66 million in investment banking fees, $34 million in legal and other expenses, and $75 million in prepayment premiums related to debt. The estimated merger and integration related costs include approximately $286 million in non-cash charges. Cash payments of approximately $714 million will be funded through Household's existing operations and commercial paper and other borrowings. In addition, Household expects to receive tax benefits of approximately $249 million. Substantially all of the cash payments are expected to be made by the end of 1998. On March 10, 1998, the Board of Directors approved a three-for-one split of Household's common stock, effected in the form of a dividend, issued on June 1, 1998, to shareholders of record as of May 14, 1998. The split was subject to shareholder approval to increase authorized shares which was received on May 13, 1998. Accordingly, all common share and per common share data in the following discussion includes the effect of Household's stock split. * MasterCard is a registered trademark of MasterCard International, Incorporated and Visa is a registered trademark of VISA USA, Inc. 5 6 OPERATIONS SUMMARY - - Our net income in 1997 was a record $940.3 million, an increase of 15 percent over 1996. Net income in 1996 was $819.6 million, 36 percent higher than 1995 earnings of $603.7 million. Diluted earnings per share were $1.93 in 1997, up 12 percent from $1.73 in 1996, which was up 40 percent from $1.24 in 1995. The difference between the percentage increases in net income and earnings per share in 1997 was due to issuing over 27 million common shares in late June. Results in 1997 were impacted by an after-tax provision of $27.8 million for the disposition of Beneficial's German operations, an $8.2 million after-tax addition to Beneficial's litigation reserves and a $10.6 million after-tax charge to write down Beneficial's real estate holdings in Tampa, Florida and Houston, Texas that are being sold and other Beneficial related reorganization and restructuring efforts. In addition, the tax anticipation refund loan business ("RAL") profits decreased in 1997 compared with 1996 which benefited from strong collections of previously written off loans. Results in 1996 were impacted from the turnaround of the RAL business whose results were severely impacted in 1995 due to the Internal Revenue Service releasing certain portions of refunds directly to taxpayers. Our return on average common shareholders' equity ("ROE") was 16.9 percent in 1997, compared to 18.2 percent in 1996, and up from 14.6 percent in 1995. The decrease in 1997 was a result of the June common stock offering which decreased our leverage, resulting in more of our assets being funded by equity as compared to the prior year. Our return on average owned assets ("ROA") was 2.02 percent, up from 1.82 percent in 1996 and 1.25 percent in 1995. Our return on average managed assets ("ROMA") was 1.33 percent, up from 1.25 percent in 1996 and .97 percent in 1995. Our net income, ROA and ROMA increased over the past three years because we focused on our core businesses, which earn higher returns compared to the businesses that we sold or exited beginning in late 1994. - - In June, we purchased Transamerica Financial Services Holding Company ("TFS"), the branch-based consumer finance subsidiary of Transamerica Corporation, for $1.1 billion. We also repaid $2.8 billion of debt that TFS owed to affiliates of Transamerica Corporation. This acquisition included $3.1 billion of home equity receivables secured primarily by home mortgages, and $100 million of other unsecured receivables. The acquisition strengthened our core consumer finance operations by adding new markets, new customer accounts, seasoned employees and receivables secured by collateral. This type of security helps to reduce the amount of loss we might incur if borrowers do not pay off their loans. The integration of TFS into Household Finance Corporation, our wholly-owned subsidiary, is complete. We closed all redundant branches and consolidated back office operations. In connection with this acquisition, in June 1997, we completed a public offering of 27.3 million shares of common stock for $1.0 billion. We used the net proceeds from the offering to repay short-term borrowings related to the acquisition. In October 1997, we purchased all of the outstanding capital stock of ACC Consumer Finance Corporation ("ACC"), an auto finance company, for about 4.2 million shares of our common stock and cash. ACC makes loans to non-prime borrowers secured by automobiles, primarily used vehicles sold through franchised dealers. This purchase increased our market share in the non-prime auto finance market and added key managers to grow this business. 6 7 In late December 1997, Beneficial acquired Endeavour Personal Finance Ltd., including receivables of approximately $250 million for cash, expanding our presence in the United Kingdom. We accounted for each of these acquisitions as purchases. Thus, we have included the results of operations of TFS, ACC and Endeavour in our statement of income for 1997 from the closing dates of the transactions. These acquisitions were not material to our financial statements. In 1997, Beneficial announced its intent to sell the German operations and recorded an after-tax loss of approximately $27.8 million after consideration of a $31.0 million tax benefit primarily generated by the expected utilization of capital losses. The sale of Beneficial's German operations was completed in April 1998. No additional losses were realized as a result of the sale. During the first quarter of 1998, the sale of Beneficial's Canadian operations was completed. An after-tax gain of approximately $118.5 million was recorded. As of December 31, 1997, the net assets of these sold operations were $121.5 million for Canada and $15.7 million for Germany. In 1997, the sold Canadian operations reported pre-tax earnings of $21.2 million, while the German operating pre-tax loss was $6.7 million. - - In 1996, 1995 and late 1994, we also exited several businesses that were providing insufficient returns on our investment. Over the course of 1996 and 1995, we sold our consumer banking branches in Illinois, California, Maryland, Virginia, Ohio and Indiana. This included the sale of about $6.2 billion of deposits and $340 million of home equity and other unsecured receivables. We wrote off acquired intangibles related to these deposits of $110 million in 1996 and $93 million in 1995. On March 31, 1996, Beneficial sold a $957 million annuity portfolio through a co-insurance agreement. Approximately $900 million of investment securities were sold as part of this disposition. In October 1995, we sold certain of the individual life and annuity product lines of our individual life insurance business. However, we retained our credit life insurance business, which complements our consumer lending and provides us additional revenue. We sold $6.1 billion of assets, which were virtually all investment securities. We retained two product lines of the individual life insurance business, but are no longer pursuing new business in this area. From late 1994 through 1995, we also exited our first mortgage origination and servicing businesses in the United States and Canada. Because we no longer originate first mortgage loans, this portfolio continues to decrease as loans pay off or are sold. 7 8 - - The following summarizes operating results for our key businesses for 1997 compared to 1996 and 1995: Our domestic consumer finance business reported higher earnings due mainly to higher levels of average managed receivables, particularly in unsecured loans. These loans typically carry higher rates than secured products because they carry more risk. More receivables, coupled with higher interest rates charged on loans, resulted in higher net interest margin. The increase in margin was partially offset by higher credit losses because more of our borrowers declared personal bankruptcy. Personal bankruptcy filings in the U.S. were at an all-time high in 1997. Our MasterCard and Visa credit card business achieved higher earnings due to higher net interest margin and fee income, and improved efficiency. These factors were offset to some degree by higher credit losses resulting primarily from increased personal bankruptcy filings. In late 1996 we started a program designed to increase the return on our MasterCard and Visa portfolio. We sold certain non-strategic portfolios, increased fees, and systematically eliminated unprofitable accounts. This business continued to benefit from our co-branding and affinity relationship strategies. This includes our alliance with General Motors Corporation ("GM") to issue the GM Card, a co-branded credit card. The GM Card continues to represent a substantial portion of our credit card portfolio. The MasterCard and Visa business also includes the AFL-CIO's Union Privilege affinity relationship which we acquired in June 1996. Union Privilege was created by the AFL-CIO to market benefits to union members. Our private label credit card business reported higher income resulting from a wider net interest margin and higher late fees, partially offset by higher credit losses due to the end of certain special promotions and increased personal bankruptcies. Results in 1997 also benefited from the renegotiation of contracts with several merchant partners. Additionally, in 1997, we began to implement various initiatives to control the mix and increase the profitability of promotional activity. Results in 1996 were impacted by Beneficial's $65 million up-front loan loss provision on strong receivables growth and $10 million in start-up costs relating to two of its merchants. Our RAL program reported lower profits in 1997 as compared with 1996, which benefited from very strong collections on loans previously written off during the 1995 season. Additionally, 1997 earnings were reduced by the July 1996 agreement with H&R Block Tax Services Inc. that gave them a share in both the revenue and credit risk of certain RAL's. RAL program fundamentals, however, remained strong as the number of loans made in 1997 increased by 12% to 2.96 million from 2.65 million in 1996, while gross revenues grew 31%. The RAL business incurred a pre-tax loss in 1995, which was severely impacted by the Internal Revenue Service sending certain refunds directly to taxpayers. Our United Kingdom operation's net income increased because of revenue growth from a larger receivable base. Managed receivables increased to $5.4 billion at year-end 1997, up 25 percent from the end of 1996. The majority of this increase was due to the success of the United Kingdom's co-branded credit card relationships, including the Goldfish Card issued in alliance with the Centrica Group and the Beneficial acquisition of Endeavour Personal Finance Ltd. Profits from our Canadian operation were relatively unchanged from 1996 as higher net interest margin and improved efficiency were offset by higher credit losses and higher operating expenses from Beneficial's Canadian operations which were sold during the first quarter of 1998. 8 9 Harbour Island, Inc., our real estate subsidiary in Tampa, Florida, recorded pre-tax losses in each of the prior three years, representing interest cost to carry and non cash depreciation charges. The 1997 results reflected the sale of the Athletic Club and residential land, and a writedown from the anticipated loss on the sale of a People Mover System and its infrastructure. Our commercial operations benefited from gains on the disposition of assets while continuing to minimize credit losses. - - Our managed net interest margin expanded to 7.83 percent in 1997 from 7.55 percent in 1996 and 7.14 percent in 1995. Our margins have increased over the past three years because we have continued to raise the interest rates we charge on most of our products. In addition, Household's product mix has shifted towards unsecured receivables, which have higher rates than secured products because they carry more risk. The overall rate of increase has been tempered by the impact of Beneficial's product mix which carries a higher percentage of real estate secured receivables which carry a lower yield compared to unsecured products. - - Our capital ratios improved over the past three years because of our issuance of common stock in 1997, the sale of businesses and assets in 1996 and 1995 and strong earnings growth. - - Our combined normalized managed basis efficiency ratio was 41.1 percent in 1997, 45.2 percent in 1996 and 50.7 percent in 1995. The efficiency ratio is the ratio of operating expenses to the sum of our managed net interest margin and other revenues less policyholders' benefits. We normalize, or adjust for, items that are not indicative of ongoing operations. They include gains on the sales of loan portfolios and non-recurring restructuring expenses. The improvement in the 1997 ratio was due to continued cost control in our remaining businesses and to the sales of less-efficient businesses in 1996 and 1995. - ------------------------------------------------------------------------------- BALANCE SHEET REVIEW - - Managed assets (total assets on our balance sheet plus receivables serviced with limited recourse) increased to $71.5 billion at December 31, 1997 from $66.4 billion at year-end 1996. The increase was due to receivable growth in our core businesses. Owned assets totaled $47.0 billion at December 31, 1997, up slightly from $45.5 billion at year-end 1996. Owned assets may vary from period to period depending on the timing and size of asset securitization transactions. We securitized $8.3 billion of receivables in 1997 and $8.8 billion of receivables during 1996. We refer to the securitized receivables that are serviced for investors and not on our balance sheet as our off-balance sheet portfolio. 9 10 - - Our core products and total portfolio grew during 1997, as shown in the following table:
All dollar amounts are stated INCREASE (DECREASE) Increase (Decrease) in millions. DECEMBER 31, 1997 IN 1997 / 1996 in 1996 / 1995 - ---------------------------------------------------------------------------------------------- MANAGED RECEIVABLES: Home equity $19,824.8 22% (2)% Auto finance(1) 883.4 - - MasterCard/Visa 19,211.7 (2) 41 Private label 10,381.9 1 32 Other unsecured 11,505.1 - 23 - ---------------------------------------------------------------------------------------------- CORE PRODUCTS 61,806.9 7 21 - ---------------------------------------------------------------------------------------------- First mortgage 396.6 (45) (65) Commercial 957.0 (8) (26) - ---------------------------------------------------------------------------------------------- Total $63,160.5 7% 16% ==============================================================================================
(1)Prior to 1997, auto finance receivables were not significant and were included in other unsecured receivables. Growth in home equity and auto finance receivables benefited from acquisitions during 1997. MasterCard and Visa receivables were down somewhat from 1996 due to the sale and planned runoff of non-strategic and less profitable receivables. Private label credit card receivables were up slightly from last year. The balance of other unsecured receivables at December 31, 1997 reflects the fourth quarter sale of our entire portfolio of student loans totaling about $900 million, as we exited this business due to its lower returns. Excluding the sale of these loans, other unsecured receivables experienced steady growth in both the domestic consumer finance and United Kingdom businesses. - - The managed consumer two-months-and-over contractual delinquency ratio increased to 4.64 percent at December 31, 1997 from 3.92 percent at December 31, 1996. The 1997 managed consumer net chargeoff ratio was 3.90 percent compared to 2.99 percent in 1996 and 2.54 percent in 1995. - - We increased managed credit loss reserves 19 percent in 1997, to $2.5 billion compared to $2.1 billion at December 31, 1996. This compares to an increase of 7 percent in total managed receivables in 1997. The increase in managed reserves was due to continuing uncertainty about consumer payment patterns, the maturing of our unsecured loan portfolios and the increase in our off-balance sheet portfolio. Credit loss reserves as a percent of managed receivables increased to 3.99 percent at year-end 1997 from 3.56 percent a year ago. Reserves as a percent of nonperforming managed receivables were 115.5 percent compared to 123.7 percent at December 31, 1996. - - The ratio of total shareholders' equity to owned assets was 14.06 percent, an increase from 11.02 percent at year-end 1996. The ratio of total shareholders' equity to managed assets was 9.25 percent, up from 7.56 percent at December 31, 1996. The increase in the ratios was primarily due to our issuance of common stock in June 1997. 10 11 - ------------------------------------------------------------------------------- PRO FORMA MANAGED STATEMENTS OF INCOME Securitizations of consumer receivables have been, and will continue to be, an important source of funding. We continue to service securitized receivables after they have been sold and retain a limited recourse liability for future credit losses. We include revenues and credit-related expenses related to the off-balance sheet portfolio in one line item in our owned statements of income. Specifically, we report net interest margin, fee and other income, and provision for credit losses for securitized receivables as a net amount in securitization income. We monitor our operations on a managed basis as well as on the owned basis shown in our statements of income. The managed basis assumes that the securitized receivables have not been sold and are still on our balance sheet. The income and expense items discussed above are reclassified from securitization income into the appropriate caption. Pro forma managed statements of income, which reflect these reclassifications, are presented below. For purposes of this analysis, the managed results do not reflect the differences between our accounting policies for owned receivables and the off-balance sheet portfolio. Therefore, net income on a pro forma managed basis equals net income on an owned basis. - ------------------------------------------------------------------------------- PRO FORMA MANAGED STATEMENTS OF INCOME
In millions. Year ended December 31 1997 1996 1995 - ------------------------------------------------------------------------------- Finance income $ 8,429.2 $ 7,578.4 $ 6,717.4 Other interest income 49.8 93.3 136.6 Interest expense 3,692.2 3,413.2 3,262.5 - ------------------------------------------------------------------------------- Net interest margin 4,786.8 4,258.5 3,591.5 Provision for credit losses 2,654.9 2,047.5 1,555.1 - ------------------------------------------------------------------------------- Net interest margin after provision for credit losses 2,131.9 2,211.0 2,036.4 - ------------------------------------------------------------------------------- Insurance revenues 454.2 422.1 474.8 Investment income 173.1 220.7 524.8 Fee income 1,458.2 1,065.5 772.4 Other income 355.7 419.6 319.4 - ------------------------------------------------------------------------------- Total other revenues 2,441.2 2,127.9 2,091.4 - ------------------------------------------------------------------------------- Salaries and fringe benefits 1,074.4 976.9 939.9 Occupancy and equipment expense 327.4 328.7 337.9 Other marketing expenses 449.6 431.5 307.9 Other servicing and administrative expenses 904.9 865.4 853.3 Amortization of acquired intangibles and goodwill 158.4 143.7 109.8 Policyholders' benefits 255.9 311.9 554.9 - ------------------------------------------------------------------------------- Total costs and expenses 3,170.6 3,058.1 3,103.7 - ------------------------------------------------------------------------------- Income before income taxes 1,402.5 1,280.8 1,024.1 Income taxes 462.2 461.2 420.4 - ------------------------------------------------------------------------------- Net income $ 940.3 $ 819.6 $ 603.7 =============================================================================== Average managed receivables $60,447.2 $54,959.0 $48,024.3 Average noninsurance investments 661.4 1,477.6 2,252.4 - ------------------------------------------------------------------------------- Average managed interest-earning assets $61,108.6 $56,436.6 $50,276.7 ===============================================================================
The following discussion on revenues, where applicable, and provision for credit losses includes comparisons to amounts reported on our historical owned statements of income ("Owned Basis"), as well as on the above pro forma managed statements of income ("Managed Basis"). 11 12 NET INTEREST MARGIN Net interest margin on an Owned Basis was $2,875.9 million for 1997, up from $2,737.1 million in 1996 and $2,555.7 million in 1995. As a percent of average owned interest-earning assets, net interest margin was 7.30 percent in 1997, 7.13 percent in 1996 and 6.98 percent in 1995. The dollar increase over 1996 and 1995 was due to growth in average owned interest-earning assets and higher interest spreads. The interest spread represents the difference between the yield earned on interest-earning assets and the cost of the debt used to fund the assets. See our supplemental net interest margin analysis for detail on our Owned Basis net interest margin. Net interest margin on a Managed Basis increased to $4,786.8 million for 1997 from $4,258.5 million in 1996. The increase was due to receivable growth and higher interest spreads. The net interest margin percentage on a Managed Basis increased to 7.83 percent from 7.55 percent in 1996 and 7.14 percent in 1995. The increase over the prior two years was due to higher interest rates charged on loans and the continued shift in Household's product mix towards unsecured receivables, somewhat tempered by the impact of Beneficial's product mix which carries a higher percentage of secured receivables. Net interest margin on a Managed Basis is greater than on an Owned Basis because MasterCard and Visa and other unsecured receivables, which have wider spreads, are a larger portion of the off-balance sheet portfolio than of the owned portfolio. PROVISION FOR CREDIT LOSSES The provision for credit losses includes current period credit losses. It also includes an amount which, in our judgment, is sufficient to maintain reserves for credit losses at a level that reflects known and inherent risks in the portfolio. The Managed Basis provision for credit losses also includes the over-the-life reserve requirement established on the off-balance sheet portfolio when receivables are securitized. The provision for credit losses on an Owned Basis totaled $1,527.3 million in 1997, compared to $1,158.4 million in 1996 and $1,041.5 million in 1995. As a percent of average owned receivables, the provision was 3.94 percent compared to 3.14 percent in 1996 and 3.03 percent in 1995. The increase in 1997 was due to higher chargeoffs on our unsecured portfolios. Over the past three years, we recorded provisions for credit losses in excess of chargeoffs because of continued uncertainty regarding consumer payment patterns, high levels of personal bankruptcies and the maturing of our unsecured products. In 1996, Beneficial recorded a $65 million up-front loan loss provision for the strong private label receivables growth experienced during the year. The maturing or seasoning of a product is the effect of a growing portfolio reaching expected levels of chargeoffs as loans age. Owned provision in excess of owned chargeoffs was $197 million in 1997, $184 million in 1996 and $171 million in 1995. The provision for credit losses on a Managed Basis totaled $2,654.9 million in 1997, $2,047.5 million in 1996 and $1,555.1 million in 1995. The provision as a percent of average managed receivables was 4.39 percent in 1997, 3.73 percent in 1996 and 3.24 percent in 1995. Managed provision in excess of managed chargeoffs was $323 million in 1997, $430 million in 1996 and $292 million in 1995. OTHER REVENUES Securitization income was $1,638.4 million in 1997, $1,341.3 million in 1996 and $997.2 million in 1995. Securitization income increased over the three year period because of growth in average securitized receivables. The components of securitization income are reclassified to the appropriate caption in the statements of income on a Managed Basis. 12 13 Insurance revenues of $454.2 million in 1997 were up from $422.1 million in 1996 but down from $474.8 million in 1995. The increase in 1997 was primarily due to increased insurance sales on a larger portfolio. The decrease in 1996 from 1995 was due to the sale of Beneficial's annuity product line in the first quarter of 1996 and Household's individual life and annuity product lines in the fourth quarter of 1995. Investment income includes interest income on investment securities in the retained insurance business as well as realized gains and losses from the sale of investment securities. Investment income was $173.1 million in 1997 compared to $220.7 million in 1996 and $524.8 million in 1995. The decrease in 1997 from 1996 was due to lower average investment balances and lower yields on the securities in the portfolio. The large decline in 1996 from 1995 was because of the sale of our insurance businesses. Fee income on an Owned Basis includes revenues from fee-based products such as credit cards and, through mid-1996, consumer banking deposits. Fee income was $603.1 million in 1997, up from $356.5 million in 1996 and $297.4 million in 1995. The increase in fee income in 1997 reflected higher credit card fees and interchange income. Fee income on a Managed Basis which, in addition to the items discussed above, includes fees and other income related to the off-balance sheet portfolio. Managed Basis fee income increased to $1,458.2 million in 1997 from $1,065.5 million in 1996 and $772.4 million in 1995. The increases were primarily due to higher credit card fees and interchange income as a result of increased average managed credit card receivables. In addition, fee income for 1997 included higher securitization gains which were offset by establishing higher over-the-life provisions related to securitizations. Other income was $355.7 million in 1997, $419.6 million in 1996 and $319.4 million in 1995. Other income includes earnings from our RAL program, gains and losses from the disposition of assets and businesses and, in 1995, income from servicing receivable portfolios without recourse. Other income was down in 1997 reflecting a decrease in RAL income from the prior year somewhat offset by gains on sales of certain non-strategic assets which included the sale of certain non co-branded MasterCard and Visa receivables and student loans. RAL income in 1996 benefited from very strong collections on loans previously written off during the 1995 season. Other income in 1996 included the premium from the sale of our Illinois banking operations and the gain related to the sale of our annuity portfolio in the first quarter. Other income for 1995 included the premium from our non-Illinois banking operations and first mortgage servicing business which we exited in 1995. 13 14 EXPENSES Operating expenses were $2,914.7 million in 1997, $2,746.2 million in 1996 and $2,548.8 million in 1995. During 1997, we recorded non-operating pretax charges of $90 million. These charges included a $59 million provision for the planned disposition of Beneficial's German operations, a $13 million addition to Beneficial's litigation reserves, a $14 million writedown of Beneficial's real estate holdings in both Tampa, Florida, and Houston, Texas, that are being sold, and a $4 million charge for other Beneficial related reorganization and restructuring efforts. During 1996, we recorded non-operating charges of $78 million related to settling legal matters with a former subsidiary, closing office space and other matters. In 1995, we recorded non-operating charges of $40 million. These charges included a $15 million provision for Beneficial's additional potential losses relating to a significant liquidating loan portfolio in Germany, a $10 million restructuring charge related to Beneficial's annuity business and a $15 million charge to combine space and staff in certain operations. The combined company's overall managed normalized efficiency ratio was 41.1% in 1997 compared to 45.2% in 1996. Excluding the impact of Beneficial, our managed normalized efficiency ratio was 36.0% in 1997 and 40.8% in 1996. Salaries and fringe benefits were $1,074.4 million in 1997, up from $976.9 million in 1996 and $939.9 million in 1995. The increase was mostly due to a higher number of sales people in our consumer finance branch network and a higher number of collectors. The average number of employees during 1997 was 24,950 compared to 22,950 in 1996 and 22,750 in 1995. Occupancy and equipment expense was $327.4 million in 1997, about the same as $328.7 million in 1996 and down from $337.9 million in 1995. Excluding non-recurring costs of $14 million in 1996, these expenses were up 4 percent from 1996 because of the new branches we operated in the last half of 1997. Both 1997 and 1996 expenses were lower than 1995 due to initiatives to reduce office space and sell less efficient businesses. Other marketing expenses include payments for advertising, direct mail programs and other marketing expenditures. These expenses were $449.6 million in 1997, compared to $431.5 million in 1996 and $307.9 million in 1995. Although we deferred major mailings during the first six months of 1997 as we worked on individual marketing plans with the participating AFL-CIO unions in the Union Privilege program, we increased our marketing spending during the last half of the year. The increases from 1995 were primarily due to marketing initiatives for our credit card portfolio. Other servicing and administrative expenses were $904.9 million in 1997, $865.4 million in 1996 and $853.3 million in 1995. Excluding non-recurring costs of $90 million in 1997, $64 million in 1996 and $40 million in 1995, these expenses were up slightly compared to 1996 and relatively unchanged from 1995. The increase from 1996 was due to higher expenses related to the TFS and ACC acquisitions. Amortization of acquired intangibles and goodwill was $158.4 million in 1997, $143.7 million in 1996 and $109.8 million in 1995. The increase reflects our acquisitions of TFS in mid-1997 and ACC in late 1997, and the Union Privilege portfolio in mid-1996. Policyholders' benefits were $255.9 million in 1997, $311.9 million in 1996 and $554.9 million in 1995. Expense was lower in 1997 compared to 1996 because we have fewer policies in our retained life insurance business. The decrease in 1996 from 1995 was due to the sale of our annuity product lines in 1996 and late 1995. 14 15 Income taxes. The 1997 effective tax rate was 33.0 percent compared to 36.0 percent in 1996 and 41.1 percent in 1995. The effective rate in 1997 recognized tax benefits related to the anticipated sale of Beneficial's German operations. The 1995 effective rate was affected by additional taxes on the sale of certain of our insurance operations. In 1992, the Internal Revenue Service ("IRS") completed its examination of Beneficial's federal income tax returns for 1984 through 1987. The IRS proposed $142 million in adjustments that relate principally to activities of a former subsidiary, American Centennial Insurance Company ("ACIC"), prior to its sale in 1987. In order to limit the further accrual of interest on the proposed adjustments, Beneficial paid $105.5 million of tax and interest during 1992. The issues were not resolved during the administrative appeals process, and the IRS issued a statutory Notice of Deficiency asserting the unresolved adjustments and increased the disallowance to $195 million in 1996. Beneficial has initiated litigation in the United States Tax Court to oppose the disallowance. While the conclusion of this matter in its entirety cannot be predicted with certainty, we do not anticipate the ultimate resolution to differ materially from amounts accrued. - ------------------------------------------------------------------------------- CREDIT QUALITY Our delinquency and net chargeoff ratios reflect, among other factors, the quality of receivables, the average age of our loans, the success of our collection efforts and general economic conditions. Specifically, the high levels of personal bankruptcies experienced by our industry over the last two years has had a direct effect on the asset quality of our overall portfolio. During 1997 our delinquency and net chargeoff levels were impacted by higher consumer bankruptcies in our unsecured portfolios and the continued maturing of our receivables. We continued to tighten and refine our credit standards throughout the year and increased the number of collectors. During the fourth quarter of 1997, we recognized the first drop in our quarterly chargeoff ratio since the first quarter of 1996, due to a decrease in our MasterCard and Visa portfolio. Until June 1997, when we acquired virtually all secured loans from TFS, the percentage of unsecured loans in our portfolio had been increasing. Unsecured loans were 66 percent of our managed consumer receivables at year-end 1997 compared to 71 percent in 1996 and 63 percent in 1995. Generally, unsecured loans have higher delinquency and chargeoff rates than secured loans. The high proportion of unsecured receivables increases the delinquency and chargeoff statistics of the entire portfolio. We compensate for this by charging higher interest rates and fees on these loans, which benefits our revenue. 15 16 We track delinquency and chargeoff levels on a managed basis. We include the off-balance sheet portfolio since we apply the same credit and portfolio management procedures as on our owned portfolio. This results in a similar credit loss exposure for us. Our focus is to continue using risk-based pricing and effective collection efforts for each loan. We have a process that gives us a reasonable basis for predicting the asset quality of new accounts. This process is based on our experience with numerous marketing, credit and risk management tests. We also believe that our frequent and early contact with delinquent customers is helpful in managing net credit losses. Despite these efforts to manage the current credit environment, bankruptcies remain an industry-wide issue and are unpredictable. Our chargeoff policy for consumer receivables varies by product. Receivables for Household are written off, or for secured products written down to net realizable value, at the following stages of contractual delinquency: auto finance - 5 months; first mortgage, home equity and MasterCard and Visa - 6 months; private label - 9 months; and other unsecured - 9 months and no payment received in 6 months. Beneficial, in general, charges off unsecured receivables after no payment has been made in six months and secured receivables are written down to net realizable value at the time of foreclosure. Commercial receivables are written off when it becomes apparent that an account is uncollectible. The state of California accounts for 20 percent of our managed domestic consumer portfolio. It is the only state with more than 10 percent of this portfolio. Because of our centralized underwriting, collections and processing functions, we can quickly change our credit standards and intensify collection efforts in specific locations. We will be able to extend this capability as the centralization of underwriting, collections and processing functions contained within the Beneficial branch network is completed. Our foreign consumer operations located in the United Kingdom and Canada accounted for 9 and 3 percent, respectively, of managed consumer receivables at December 31, 1997. German receivables accounted for less than one percent of managed consumer receivables at year-end 1997. - ------------------------------------------------------------------------------- MANAGED CONSUMER TWO-MONTH-AND-OVER CONTRACTUAL DELINQUENCY RATIOS
1997 QUARTER END 1996 Quarter End --------------------------- ------------------------------- 4 3 2 1 4 3 2 1 - ------------------------------------------------------------------------------- First mortgage 10.35% 9.27% 10.27% 8.19% 9.49% 3.82% 3.64% 3.28% Home equity 3.69 3.16 2.97 3.23 3.04 3.17 2.94 2.85 Auto finance(1) 2.09 - - - - - - - MasterCard/Visa 3.10 3.20 3.13 3.15 2.73 2.60 2.07 2.38 Private label 5.81 5.72 5.15 4.78 4.60 4.70 4.33 4.04 Other unsecured 7.81 7.14 6.70 6.68 6.21 6.13 6.08 5.86 - ------------------------------------------------------------------------------- Total 4.64% 4.47% 4.18% 4.25% 3.92% 3.84% 3.47% 3.51% ===============================================================================
(1) Prior to the fourth quarter of 1997, delinquency statistics for auto finance receivables were not significant. For prior periods, delinquency data for these receivables were included in other unsecured receivables. 16 17 Our managed consumer delinquency ratio at year end was 17 basis points higher than the third quarter level. This increase was lower than the third quarter increase of 29 basis points. The increases in these two quarters were due to the expiration of certain special no-interest and no-payment promotions in our private label portfolio, and seasoning of the other unsecured portfolio. Home equity delinquency was up due to the maturing of acquired receivables. MasterCard and Visa delinquency was down in the quarter. Dollars of delinquency in the first mortgage portfolio were down as this portfolio continues to liquidate. The increase in the managed delinquency ratio from a year ago was mainly due to the seasoning of all portfolios and the expiration of certain special no-interest and no-payment promotions in our private label portfolio. The owned consumer delinquency ratio was 4.87 percent at December 31, 1997 and 4.15 percent at December 31, 1996. - -------------------------------------------------------------------------------- MANAGED CONSUMER NET CHARGEOFF RATIOS
1997 QUARTER ANNUALIZED 1996 Quarter Annualized FULL YEAR ----------------------------- Full Year ------------------------------ Full Year 1997 4 3 2 1 1996 4 3 2 1 1995 - ---------------------------------------------------------------------------------------------------------------- First mortgage 1.05% 1.29% 1.21% .87% .94% .45% .30% .50% .46% .51% .35% Home equity .64 .62 .53 .67 .75 .60 .76 .60 .51 .54 .64 Auto finance(1) 4.60 5.31 - - - - - - - - - MasterCard/Visa 5.55 5.56 6.22 5.66 4.79 4.54 4.58 4.57 4.70 4.28 4.12 Private label 4.96 5.58 5.12 4.69 4.47 3.58 4.09 3.79 3.80 4.19 4.00 Other unsecured 5.48 5.85 5.66 5.23 5.09 4.29 4.46 4.60 3.85 4.20 3.60 - ---------------------------------------------------------------------------------------------------------------- Total 3.90% 4.01% 4.04% 3.92% 3.61% 2.99% 3.27% 3.13% 2.90% 2.85% 2.54% ================================================================================================================
(1) Includes ACC net chargeoffs subsequent to our acquisition in October 1997. Prior to the fourth quarter of 1997, chargeoff statistics for auto finance receivables were not significant and were included in other unsecured receivables. The annualized fourth quarter chargeoff ratio was down slightly from the third quarter. The improvement was driven by a 66 basis point decline in the MasterCard and Visa chargeoff ratio to 5.56 percent. For the MasterCard and Visa portfolio, actual dollars of chargeoffs were down over $25 million in the quarter, reflecting reductions in both bankruptcies and credit chargeoffs. In the private label portfolio, increased chargeoffs reflected the maturing of promotional balances and higher personal bankruptcies. In our other unsecured portfolio, higher chargeoffs resulted from continued seasoning and high levels of personal bankruptcies. The managed consumer net chargeoff ratio for full year 1997 was 3.90 percent, up from 2.99 percent in 1996 and 2.54 percent in 1995. The increase was due to higher bankruptcy chargeoffs in our MasterCard and Visa portfolio, the expiration of certain private label promotional programs and seasoning of other unsecured receivables. The owned consumer net chargeoff ratio was 3.48 percent in 1997, 2.70 percent in 1996 and 2.56 percent in 1995. 17 18 - -------------------------------------------------------------------------------- NONPERFORMING ASSETS
All dollar amounts are stated in millions. At December 31 1997 1996 1995 - -------------------------------------------------------------------------------- Nonaccrual managed receivables $1,364.9 $1,046.1 $1,051.9 Accruing managed consumer receivables 90 or more days delinquent 807.8 645.5 320.3 Renegotiated commercial loans 12.4 12.9 21.2 - -------------------------------------------------------------------------------- Total nonperforming managed receivables 2,185.1 1,704.5 1,393.4 Real estate owned 212.8 236.8 237.7 - -------------------------------------------------------------------------------- Total nonperforming managed assets $2,397.9 $1,941.3 $1,631.1 ================================================================================ Managed credit loss reserves as a percent of nonperforming managed receivables 115.5% 123.7% 114.2% - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
CREDIT LOSS RESERVES We maintain credit loss reserves to cover probable losses of principal and interest in both our owned and off-balance sheet portfolios. We estimate losses for consumer receivables based on delinquency status and past loss experience. For securitized receivables, we also record a provision for estimated probable losses that we will incur over the life of the transaction. For commercial loans, we calculate probable losses by using expected amounts and timing of future cash flows to be received on loans. In addition, we provide for general loss reserves on consumer and commercial receivables to reflect our assessment of portfolio risk factors. Loss reserve estimates are reviewed periodically and adjustments are reported in earnings when they become known. These estimates are influenced by factors outside of our control, such as economic conditions and consumer payment patterns. As a result, there is uncertainty inherent in these estimates, making it reasonably possible that they could change. Owned credit loss reserves increased 17 percent to $1,642.1 million from $1,398.4 million at December 31, 1996. The ratio of credit loss reserves to total owned receivables was 4.25 percent, up from 3.64 percent at December 31, 1996. Total managed credit loss reserves increased 20 percent to $2,523.0 million from $2,109.0 million at December 31, 1996. The ratio of credit loss reserves to total managed receivables was 3.99 percent, up from 3.56 percent at December 31, 1996. We increased credit loss reserves because of seasoning of unsecured products and increased personal bankruptcies. Additionally, in 1996, Beneficial recorded a $65 million up-front loan loss provision for the strong private label receivables growth experienced during the year. The ratio of total credit loss reserves to total nonperforming managed receivables was 115.5 percent compared to 123.7 percent at December 31, 1996. Over the past five years, we have increased our credit loss reserves for managed receivables to reflect the change in mix to unsecured products and seasoning. Unsecured products historically have higher chargeoff rates than secured products. We have continued to refine and improve our underwriting standards and account management techniques to better manage our credit risk. 18 19 The following table sets forth the managed credit loss reserves for the periods indicated:
All dollar amounts are stated in millions. At December 31 1997 1996 1995 1994 1993 - -------------------------------------------------------------------------------------------------------- Managed credit loss reserves $2,523.0 $2,109.0 $1,591.5 $1,219.2 $1,123.7 Reserves as a % of managed receivables 3.99% 3.56% 3.12% 2.69% 2.72% ======================================================================================================== - --------------------------------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES We continued to strengthen our capital ratios in 1997 by issuing additional common stock, increasing our retained earnings and controlling asset growth. In managing capital, both Household and Beneficial develop targets for equity to managed assets based on discussions with rating agencies, reviews of regulatory requirements and competitor capital positions, credit loss reserve strength, risks inherent in the projected operating environment and acquisition objectives. We also specifically consider the level of intangibles arising from completed acquisitions. Targets are set for each legal entity that raises funds to protect debt investors. These targets include capital levels against both on-balance sheet assets and our off-balance sheet portfolio. Consolidated capital ratios were as follows:
At December 31 1997 1996 - ----------------------------------------------------------------------------- Total shareholders' equity(1) as a percent of owned assets 13.83% 10.80% Total shareholders' equity(1) as a percent of managed assets 9.15 7.45 Tangible equity to tangible managed assets 6.91 6.17 - ----------------------------------------------------------------------------- (1) Includes trust preferred securities.
PARENT COMPANY Household International, Inc. is the holding or parent company that owns the outstanding stock of its subsidiaries. The parent company's main source of funds is cash received from its subsidiaries in the form of dividends and intercompany borrowings. The parent company received dividends from its subsidiaries of $313 million in 1997 and $265 million in 1996. In addition, the parent company receives cash from third parties by issuing debt and common stock. This includes commercial paper that we sell through an in-house sales force totaling $281.5 million at December 31, 1997 and $203.3 million at December 31, 1996. At December 31, 1997, the parent company had $400 million in committed back-up lines of credit that it can use on short notice. These lines are available either to the parent company or its subsidiary, Household Finance Corporation ("HFC"). None of these back-up lines were utilized at December 31, 1997. The lines of credit expire in 1998 and they do not contain material adverse change clauses that could restrict availability. The only financial covenant contained in the terms of the parent company's credit agreements is that we must maintain minimum shareholders' equity of $2.0 billion. 19 20 The parent company has a number of obligations it has 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 and may pay dividends to the holders of its common stock. The parent company made capital contributions of $1.2 billion to a subsidiary in 1997 and $200 million in 1996. The parent company paid $302.0 million in common and preferred dividends to shareholders in 1997 and $268.9 million in 1996. Beneficial paid cash dividends of $120.7 million in 1997, $110.5 million in 1996 and $99.7 million in 1995. In October 1997, the parent company and a wholly-owned subsidiary purchased all of the outstanding capital stock of ACC for about 4.2 million shares of our common stock and cash. After the purchase was completed, the parent company contributed the capital stock of ACC to HFC. In June 1997, the parent company issued 27.3 million shares of common stock, raising $1.0 billion. The parent company contributed this amount to HFC to pay off debt related to the purchase of TFS. In January 1997, the parent company redeemed, at par of $55 million, all outstanding shares of its 9.50% Preferred Stock, Series 1991-A, for $10 per depositary share plus accrued and unpaid dividends. In July 1996, the parent company issued junior preferred share purchase rights for its common stock which may be exercised in the event of the expressed intent to acquire or actual acquisition of 15 percent or more of our common stock by a third party or an associated group. SUBSIDIARIES We have three major subsidiaries: HFC, Household Bank, f.s.b. ("the Bank"), and Household Global Funding ("Global"). These subsidiaries use cash to originate loans, purchase loans or investment securities or acquire businesses. Their main sources of cash are the collection of receivable balances; maturities or sales of investment securities; proceeds from the issuance of debt and deposits and securitization of receivables; capital contributions from the parent company; and cash provided by operations. HFC HFC, along with its wholly-owned subsidiary, Beneficial Corporation, funds its operations by issuing commercial paper, medium- and long-term debt to mainly wholesale investors, securitizing consumer receivables and receiving capital contributions from its parent. HFC's outstanding commercial paper totaled $9.1 billion at December 31, 1997 and 1996. HFC markets its commercial paper through an in-house sales force. HFC actively manages the level of commercial paper outstanding to ensure availability to core investors and proper utilization of any excess capacity within internally established targets. Beneficial is in the third year of a five year, $3 billion syndicated revolving credit agreement supporting commercial paper issuances. 20 21 HFC also markets domestic medium-term notes through investment banks and its in-house sales force, issuing a total of $5.1 billion in 1997. To obtain a broader investment base, HFC and its subsidiary, Household Bank (Nevada) N.A., periodically issue medium-term notes in European and Asian markets. These markets provide HFC with a broader investor base as compared with domestic markets. During 1997, $1.9 billion in medium-term notes were issued in European and Asian markets compared to $.9 billion in European markets in 1996. These notes were issued in various European and Asian currencies and currency swaps were used to convert the notes to U.S. dollars in order to eliminate future foreign exchange risk. During 1997, HFC also issued $.3 billion of long-term debt with an original maturity of 10 years. In August 1997, HFC redeemed, at par of $100 million, all outstanding shares of its 7.25% term cumulative preferred Series 1992-A, for $100 per depositary share plus accrued and unpaid dividends. HFC had committed back-up lines of credit totaling $10.5 billion at December 31, 1997, of which $400 million were also available to its parent company. Unused back-up lines at December 31, 1997 totaled $10.1 billion. In addition, none of these lines contained a material adverse change clause which could restrict availability. These back-up lines expire on various dates from 1998 through 2002. The only financial covenants contained in the terms of HFC's credit agreements are the maintenance of minimum shareholder's equity of $1.5 billion as well as a $1 billion net worth test for Beneficial Corporation, an HFC subsidiary. HFC paid $1.1 billion for the stock of TFS and repaid about $2.7 billion of TFS debt owed to affiliates of Transamerica Corporation. HFC funded this acquisition through the issuance of commercial paper, bank and other borrowings. In addition, HFC received a capital contribution of $1.0 billion from the parent company to repay debt. HFC also has foreign operating subsidiaries located in the United Kingdom, Canada and Germany. These operating subsidiaries are directly owned by Beneficial Corporation, a wholly owned subsidiary of HFC and represent Beneficial's operations in these countries prior to its merger with Household International, HFC's parent, and subsequent contribution to HFC. Each foreign subsidiary conducts its operations using its local currency, raising funds chiefly on its own, with the guarantee of Beneficial Corporation attached to maximize market depth and minimize cost. The Canadian and United Kingdom subsidiaries both issue commercial paper through dealers. Canadian commercial paper outstandings totaled $346 million at year-end 1997 and $230 million at year-end 1996. United Kingdom commercial paper outstanding totaled $181 million at year-end 1997 and $267 million at year-end 1996. During 1997, the Canadian and United Kingdom subsidiaries issued $110 million and $315 million, respectively, in medium-term notes and other public debt offerings. The German subsidiary obtains funding primarily through deposits. As previously discussed, Beneficial sold its Canadian and German operations during the first and second quarters of 1998. THE BANK The Bank primarily uses wholesale funding for its operations. At December 31, 1997, these sources included securitizations of credit card receivables, domestic and European medium-term notes, deposits, Federal Home Loan Bank advances and Federal funds borrowings. 21 22 The Bank is subject to the capital adequacy guidelines adopted by the Office of Thrift Supervision. At December 31, 1997, the leverage, tier 1 and total risk-based capital ratio levels for a "well capitalized" institution were 5.0, 6.0 and 10.0 percent, respectively. The Bank's ratios for each of these categories at December 31, 1997 were 18.4, 20.8 and 31.0 percent, respectively. In the fourth quarter of 1997, the Bank sold its entire portfolio of student loans totaling about $900 million and exited this business. We used the proceeds from the sale to repay debt. During the fourth quarter of 1996, HFC and the Bank sold around $1.7 billion of lower margin loans, primarily from the previously divested mortgage and consumer banking businesses. The cash proceeds from the sales were used to repay debt. During 1996 and 1995, we sold all of our consumer banking branch operations. These transactions did not have a material impact on our ability to raise funds sufficient to operate the business. GLOBAL Other foreign subsidiaries are also located in the United Kingdom and Canada. Global was formed to combine ownership of these businesses which were in existence prior to the merger with Beneficial Corporation. Global's assets were $4.3 billion at year-end 1997. Consolidated shareholders' equity reflects the increase or decrease from translating our foreign subsidiaries' assets, liabilities and operating results from their local currency into U.S. dollars. We have entered into foreign exchange contracts to hedge portions of our investment in foreign subsidiaries to protect ourselves from fluctuations in foreign currencies that are beyond our control. The potential loss in net income, including Beneficial's foreign operations, associated with a 10 percent adverse change in the British pound/US dollar or Canadian dollar/US dollar exchange rates is not material. Each foreign subsidiary conducts its operations using its local currency. While each foreign subsidiary usually borrows funds in their local currency, both our United Kingdom and Canadian subsidiaries have borrowed funds directly in the United States capital markets. This allowed the subsidiaries to achieve a lower cost of funds than that available at that time in their local markets. These borrowings were converted from U.S. dollars to their local currencies using currency swaps. Net realized gains and losses in foreign currency swap transactions were not material to our results of operations or financial position in any of the three years presented. Global's United Kingdom operation is funded with wholesale deposits, short- and intermediate-term bank lines of credit, long-term debt and securitizations of consumer receivables. Deposits at year-end 1997 were $777 million compared to $815 million a year earlier. Borrowings from bank lines of credit at year-end 1997 were $864 million compared to $838 million a year ago. Long-term debt at year-end 1997 was $592 million compared to $512 million a year earlier. The parent company has guaranteed payment of all debt obligations, except for certain deposits, of Global's United Kingdom subsidiary. Committed back-up lines of credit for the United Kingdom were approximately $1.8 billion at December 31, 1997. These lines have varying maturities from 1998 through 2004. 22 23 Global's Canadian operation is funded with commercial paper, intermediate- and long-term debt. Intermediate- and long-term debt totaled $749 million at year-end 1997 compared with $856 million a year ago. Committed back-up lines of credit for Canada were approximately $471 million at December 31, 1997. The parent company has guaranteed payment of the debt obligations of Global's subsidiaries. ASSET SECURITIZATIONS Securitizations of consumer receivables have been, and will continue to be, an important source of funds for HFC, the Bank and Global's United Kingdom subsidiary. The market for securities backed by receivables is a reliable and cost-effective source of funds. These subsidiaries plan to use securitizations in the future. During 1997 these subsidiaries securitized about $8.3 billion of home equity, MasterCard and Visa, private label and other unsecured receivables. As of December 31, 1997, we have not securitized new auto loan originations subsequent to the acquisition of ACC. The 1997 total securitization volume compares to $8.8 billion in sales in 1996 and $6.5 billion in 1995. At December 31, 1997, HFC, the Bank and Global's United Kingdom subsidiary had $24.5 billion of receivables sold under securitization transactions. At December 31, 1997, the expected weighted average remaining life of these transactions was 2.3 years. The following table summarizes the expected amortization of our securitizations by type:
In millions. At December 31, 1997 1998 1999 2000 2001 2002 Thereafter - ------------------------------------------------------------------------------------ Home equity $1,985.8 $1,374.7 $ 823.9 $ 577.8 $ 458.8 $ 817.6 Auto finance(1) 144.8 124.6 79.2 36.7 10.6 - MasterCard/Visa 1,305.8 5,568.0 3,699.0 1,195.8 568.4 - Private label 213.5 161.5 - 650.0 - - Other unsecured 1,001.5 758.7 783.4 661.3 583.4 893.7 - ------------------------------------------------------------------------------------ Total $4,651.4 $7,987.5 $5,385.5 $3,121.6 $1,621.2 $1,711.3 ==================================================================================== (1) Auto finance receivables were previously securitized by ACC before its acquisition in October 1997.
For MasterCard and Visa and private label securitizations, the issued securities may pay off sooner than originally scheduled if certain events occur. One example of such an event is if the annualized portfolio yield (defined as the sum of finance income and applicable fees, less net chargeoffs) for a certain period drops below a base rate (generally equal to the sum of the rate paid to the investors and the servicing fee). For home equity and other unsecured securitizations, early pay off of the securities begins if the annualized portfolio yield falls below various limits, or if certain other events occur. We do not presently believe that any of these events will take place. If any such event occurred, our funding requirements would increase. These additional requirements could be met through securitizations, issuance of various types of debt or borrowings under existing back-up lines of credit. We believe we would continue to have adequate sources of funds if an early payoff event occurred. HFC and the Bank have facilities with commercial banks under which they may securitize up to $6.6 billion of receivables. These facilities are renewable on an annual basis. At December 31, 1997, these facilities were fully utilized. The amount available under these facilities will vary based on the timing and volume of public securitization transactions. 23 24 At December 31, 1997, the long-term debt of the parent company, HFC, the Bank and Beneficial and the preferred stock of the parent company, have been assigned an investment grade rating by four rating agencies. Furthermore, these agencies included the commercial paper of HFC in their highest rating category. Three of these agencies also include the parent company's commercial paper in their highest rating category. With our back-up lines of credit and securitization programs, we believe we have sufficient funding of the parent company, HFC, the Bank and Beneficial capacity to refinance maturing debts and fund business growth. CAPITAL EXPENDITURES During 1997 we made $128 million in capital expenditures compared to the prior-year level of $160 million. YEAR 2000 The conversion of certain computer systems to permit continued use in the Year 2000 and beyond began in prior years. The Year 2000 issue exists because many computer systems and applications currently use two-digit date fields to designate a year. As the century date change occurs, date-sensitive systems may recognize the Year 2000 as 1900, or not at all. The inability to recognize or properly treat the Year 2000 may cause systems to process critical financial and operational information incorrectly. We have identified our Year 2000 issues and are scheduled to complete conversion and substantially complete testing of our significant systems by the end of 1998. The costs for Year 2000 compliance have not been, and are not expected to be, material to our operations. While we are reviewing our third-party vendors' Year 2000 compliance, we cannot assure that the systems of our vendors, upon which we rely, will be converted in a timely manner, or that their failure to convert would not have an adverse effect on our systems. - -------------------------------------------------------------------------------- RISK MANAGEMENT We have a comprehensive program to address potential financial risks. These risks include interest rate, counterparty and currency risk. The Finance Committee of the Board of Directors sets acceptable limits for each of these risks annually and reviews the limits semi-annually. Interest rate risk is defined as the impact of changes of market interest rates on our earnings. Household utilizes simulation models to measure the impact on net interest margin of changes in interest rates. The key assumptions used in this model include the rate at which we expect our loans to pay off, loan volumes and pricing, cash flows from derivative financial instruments and changes in market conditions. The assumptions we make are based on our best estimates of actual conditions. The model cannot precisely predict the actual impact of changes in interest rates on net income because these assumptions are highly uncertain. At December 31, 1997, the combined company's interest rate risk levels were substantially below those allowed by Household's policy. We generally fund our assets with liabilities that have similar interest rate features. This reduces structural interest rate risk. Over time, customer demand for our receivable products shifts between fixed rate and floating rate products, based on market conditions and preferences. These shifts result in different funding strategies and produce different interest rate risk exposures. To manage these exposures, as well as our liquidity position, we may use derivatives to synthetically alter the terms of our assets or liabilities, or off-balance sheet transactions. We do not use any exotic or leveraged derivatives. 24 25 At December 31, 1997, we managed about $31 billion of domestic receivables that have variable interest rates, including credit card, home equity and other unsecured products. These receivables have been funded with $8.3 billion of short-term debt, with the remainder funded by long-term liabilities. This position exposes us to interest rate risk. We primarily use interest rate swaps to alter our exposure to interest rate risk while still controlling liquidity risk. Interest rate swaps also are used sometimes to synthetically alter our exposure to basis risk. This type of risk exists because the pricing of some of our assets is tied to the prime rate, while the funding for these assets is tied to LIBOR. The prime rate and LIBOR react differently to changes in market interest rates; that is, the prime rate does not change as quickly as LIBOR. We assign all of our synthetic alteration and hedge transactions to specific groups of assets, liabilities or off-balance sheet items. The economic risk related to our interest rate swap portfolio is minimal. The face amount of a swap transaction is referred to as the notional amount. The notional amount is used to determine the interest payment to be paid by each counterparty, but does not result in an exchange of principal payments. For example, let's assume we have entered into a swap with the counterparty whom we will call Bank A. Bank A agrees to pay us a fixed interest rate while we agree to pay a variable rate. If variable rates for the accrual period are below the fixed rate in the swap, Bank A owes us the difference between the fixed rate and variable rate multiplied by the notional amount. The primary exposure on our interest rate swap portfolio is the risk that the counterparty (Bank A in this example) does not pay us the money they owe us. We protect ourselves against counterparty risk in several ways. Counterparty limits have been set and are closely monitored as part of the overall risk management process. These limits ensure that we do not have significant exposure to any individual counterparty. Based on peak exposure at December 31, 1997, about 79 percent of our derivative counterparties were rated AA- or better. (Virtually all of our derivative counterparties are rated A+ or better.) We have never suffered a loss due to counterparty failure. Certain swap agreements that we have entered into require that payments be made to, or received from, the counterparty when the fair value of the agreement reaches a certain level. We also utilize interest rate futures, and purchased put and call options in our hedging strategy to reduce interest rate risk. We use these instruments to hedge the changes in interest rates on our variable rate assets and liabilities. For example, short-term borrowings expose us to interest rate risk because the interest rate we must pay to others may change faster than the rate we received from borrowers on the asset our borrowings are funding. We use futures and options to fix our interest cost on these borrowings at a desired rate. We hold these contracts until the interest rate on the variable rate asset or liability change. We then terminate, or close out the contracts. These terminations are necessary because the date the interest rate changes is usually not the same as the expiration date of the futures contract or option. At December 31, 1997, we estimate that our earnings would decline by about $45 million following a gradual 200 basis point increase in interest rates over a twelve month period and would increase by about $53 million following a gradual 200 basis point decrease in interest rates. These estimates assume we would not take any corrective action to lessen the impact and, therefore, exceed what most likely would occur if rates were to change. 25 26 We enter into currency swaps in order to minimize currency risk. These swaps convert both principal and interest payments on debt issued from one currency to another. For example, we may issue debt based on the French franc and then execute a currency swap to convert the obligation to U. S. dollars. See Note 9, "Derivative Financial Instruments and Other Financial Instruments With Off-Balance Sheet Risk," for additional information related to interest rate risk management. In the accompanying consolidated financial statements, Note 13, "Fair Value of Financial Instruments," provides information regarding the fair value of certain financial instruments. 26 27 HOUSEHOLD INTERNATIONAL, INC. SUPPLEMENTAL GLOSSARY OF TERMS ACQUIRED INTANGIBLES AND GOODWILL - Intangible assets reflected on our consolidated balance sheet resulting from the market value premium attributable to our credit card accounts in excess of the aggregate outstanding managed credit card loans acquired. Goodwill represents the purchase price over the fair value of identifiable assets acquired less liabilities assumed from business combinations. AFFINITY CREDIT CARD - A MasterCard or Visa account that is jointly sponsored by an organization that has a membership with a common interest (e.g., the AFL-CIO Union Privilege Credit Card Program). ASSET SECURITIZATION - The process where interests in a pool of financial assets, such as credit card or home equity receivables, are sold to investors. Typically, the receivables are sold to a trust that issues interests that are sold to investors. AUTO FINANCE LOANS - Closed-end loans secured by a first lien on a vehicle. CO-BRANDED CREDIT CARD - A MasterCard or Visa account that is jointly sponsored by the issuer of the card and another corporation. The account holder typically receives some form of added benefit for using the card (e.g., the GM Card). CONSUMER NET CHARGEOFF RATIO - Net chargeoffs of receivables divided by average receivables outstanding. CONTRACTUAL DELINQUENCY - A method of determining delinquent accounts based on the contractual terms of the original loan agreement. CREDIT LIFE INSURANCE - Insurance products that either pay off or continue repaying a debt in the event of death, or temporary or permanent disability of the borrower. DIVIDEND PAYOUT RATIO - Dividends divided by net income. FEE INCOME - Income associated with interchange on credit cards and annual, late and other fees and from the origination or acquisition of loans. FIRST MORTGAGE - Loan secured by a first lien on residential real estate. 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. HOME EQUITY LOAN - Closed-end loans and revolving lines of credit secured by first or second mortgages on residential real estate. INTERCHANGE FEES - Fees received for processing a credit card transaction through the MasterCard or Visa network. 27 28 HOUSEHOLD INTERNATIONAL, INC. SUPPLEMENTAL GLOSSARY OF TERMS - CONTINUED 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 that rate at which we borrow funds. LIQUIDITY - A measure of how quickly we can convert assets to cash or raise additional cash by issuing debt. MANAGED BASIS - Method of reporting whereby net interest margin, other revenues and credit losses on securitized receivables are reported as if those receivables were still held on our balance sheet. MANAGED EFFICIENCY RATIO - Ratio of operating expenses to managed net interest margin and other revenues less policyholders' benefits. The normalized efficiency ratio excludes nonrecurring gains, losses and charges. MANAGED NET INTEREST MARGIN - Interest income from managed receivables and noninsurance investment securities reduced by interest expense. MANAGED RECEIVABLES - The sum of receivables on our balance sheet and those that we service for investors as part of our asset securitization program. MASTERCARD/VISA RECEIVABLES - Receivables generated through customer usage of MasterCard and Visa credit cards. NONACCRUAL LOANS - Loans on which we no longer accrue interest because ultimate collection is unlikely. OPTIONS - A contract giving the owner the right, but not the obligation, to buy or sell a specified item at a fixed price for a specified period. OTHER UNSECURED RECEIVABLES - Unsecured lines of credit or closed-end loans made to individuals. OVER-THE-LIFE RESERVES - Credit loss reserves established for securitized receivables to cover the estimated probable losses that we expect to incur over the life of the transaction. PRIVATE LABEL CREDIT CARD - A line of credit made available to customers of retail merchants evidenced by a credit card bearing the merchant's name. PROMOTIONAL ACCOUNT - A private label credit card account that allows for limited or deferred interest and/or principal payments for a certain period. RAL PROGRAM - A cooperative program with H&R Block Tax Services, Inc. and certain of its franchises, along with other independent tax preparers, to provide loans to customers who are entitled to tax refunds and who electronically file their returns with the Internal Revenue Service. RECEIVABLES OWNED - Those receivables held on our balance sheet. 28 29 HOUSEHOLD INTERNATIONAL, INC. SUPPLEMENTAL GLOSSARY OF TERMS - CONTINUED RECEIVABLES SERVICED WITH LIMITED RECOURSE - Those receivables that we have securitized and for which we have some level of potential loss if defaults occur. RETURN ON ASSETS - Net income divided by average assets. RETURN ON AVERAGE COMMON SHAREHOLDERS' EQUITY - Net income less dividends on preferred stock divided by average common shareholders' equity. SYNTHETIC ALTERATION - Process by which derivative financial instruments are used to alter the risk characteristics of an asset, liability or off-balance sheet item. TOTAL SHAREHOLDERS' EQUITY - Includes company obligated mandatorily redeemable preferred securities of subsidiary trusts, preferred stock and common shareholders' equity. 29 30 SUPPLEMENTAL ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY - OWNED RECEIVABLES Household International, Inc. and Subsidiaries
All dollar amounts are stated in millions. 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------------------------------------------ TOTAL CREDIT LOSS RESERVES FOR OWNED RECEIVABLES AT JANUARY 1 $1,398.4 $1,126.5 $ 877.6 $900.9 $826.5 - ------------------------------------------------------------------------------------------------------------------------------ PROVISION FOR CREDIT LOSSES - OWNED RECEIVABLES 1,527.3 1,158.4 1,041.5 805.5 907.6 - ------------------------------------------------------------------------------------------------------------------------------ OWNED RECEIVABLES CHARGED OFF Domestic: First mortgage (8.2) (8.6) (6.6) (10.3) (13.5) Home equity (46.3) (47.1) (45.7) (61.8) (60.6) Auto finance(1) (6.4) - - - - MasterCard/Visa (415.8) (270.0) (260.0) (204.4) (172.4) Private label (442.2) (252.8) (191.9) (135.6) (117.0) Other unsecured (384.6) (374.7) (328.1) (314.5) (314.1) Foreign (197.6) (172.2) (160.5) (129.1) (163.5) - ------------------------------------------------------------------------------------------------------------------------------ Total consumer (1,501.1) (1,125.4) (992.8) (855.7) (841.1) Commercial (18.6) (15.4) (41.0) (87.7) (148.2) - ------------------------------------------------------------------------------------------------------------------------------ Total owned receivables charged off (1,519.7) (1,140.8) (1,033.8) (943.4) (989.3) - ------------------------------------------------------------------------------------------------------------------------------ RECOVERIES ON OWNED RECEIVABLES Domestic: First mortgage 2.3 2.5 2.2 2.9 2.6 Home equity 3.0 2.6 3.3 5.2 4.3 Auto finance(1) .3 - - - - MasterCard/Visa 46.9 17.2 19.8 17.6 12.5 Private label 47.4 24.8 24.1 30.9 24.5 Other unsecured 38.0 70.7 74.5 60.1 56.2 Foreign 50.9 43.9 36.7 31.6 27.1 - ------------------------------------------------------------------------------------------------------------------------------ Total consumer 188.8 161.7 160.6 148.3 127.2 Commercial 1.0 4.4 2.9 3.2 2.7 - ------------------------------------------------------------------------------------------------------------------------------ Total recoveries on owned receivables 189.8 166.1 163.5 151.5 129.9 Portfolio acquisitions, net 46.3 88.2 77.7 (36.9) 26.2 - ------------------------------------------------------------------------------------------------------------------------------ TOTAL CREDIT LOSS RESERVES FOR OWNED RECEIVABLES Domestic: First mortgage 2.4 4.3 4.1 5.1 4.1 Home equity 172.4 62.4 52.9 50.1 51.2 Auto finance(1) 14.6 - - - - MasterCard/Visa 290.4 268.6 134.5 127.5 124.0 Private label 396.2 363.1 281.4 152.3 123.3 Other unsecured 499.4 388.5 358.2 289.2 262.3 Foreign 179.2 172.1 141.2 99.2 97.5 - ------------------------------------------------------------------------------------------------------------------------------ Total consumer 1,554.6 1,259.0 972.3 723.4 662.4 Commercial 87.5 139.4 154.2 154.2 213.5 Unallocated corporate - - - - 25.0 - ------------------------------------------------------------------------------------------------------------------------------ TOTAL CREDIT LOSS RESERVES FOR OWNED RECEIVABLES AT DECEMBER 31 $1,642.1 $1,398.4 $1,126.5 $877.6 $900.9 - ------------------------------------------------------------------------------------------------------------------------------ RATIO OF CREDIT LOSS RESERVES TO OWNED RECEIVABLES Consumer 4.12% 3.37% 2.89% 2.40% 2.35% Commercial 9.14 13.44 11.07 7.49 7.01 - ------------------------------------------------------------------------------------------------------------------------------ Total(2) 4.25% 3.64% 3.22% 2.73% 2.88% ============================================================================================================================== RATIO OF CREDIT LOSS RESERVES TO OWNED NONPERFORMING LOANS Consumer 110.5% 111.6% 106.7% 95.9% 84.8% Commercial 200.7 191.2 91.8 96.7 69.3 - ------------------------------------------------------------------------------------------------------------------------------ Total(2) 113.2% 116.4% 104.4% 96.1% 82.7% ==============================================================================================================================
(1) Includes ACC subsequent to our acquisition in October 1997. Prior to the fourth quarter of 1997, auto finance receivables were not significant and were included in other unsecured receivables. (2) 1993 amount includes the unallocated corporate reserve. 30 31 SUPPLEMENTAL ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY - MANAGED RECEIVABLES
Household International, Inc. and Subsidiaries All dollar amounts are stated in millions. 1997 1996 1995 1994 1993 - --------------------------------------------------------------------------------------------------------------------- TOTAL CREDIT LOSS RESERVES FOR MANAGED RECEIVABLES AT JANUARY 1 $2,109.0 $1,591.5 $1,219.2 $1,123.7 $987.2 - --------------------------------------------------------------------------------------------------------------------- PROVISION FOR CREDIT LOSSES - MANAGED RECEIVABLES 2,654.9 2,047.5 1,555.1 1,173.6 1,188.6 - --------------------------------------------------------------------------------------------------------------------- MANAGED RECEIVABLES CHARGED OFF Domestic: First mortgage (8.2) (8.6) (6.6) (10.3) (13.5) Home equity (106.3) (86.4) (92.4) (107.2) (99.7) Auto finance (1) (13.6) - - - - MasterCard/Visa (1,106.7) (771.3) (563.7) (401.1) (284.6) Private label (470.3) (284.1) (249.3) (156.7) (142.0) Other unsecured (639.8) (465.7) (332.5) (314.5) (330.7) Foreign (225.8) (186.6) (160.5) (129.1) (163.5) - --------------------------------------------------------------------------------------------------------------------- Total consumer (2,570.7) (1,802.7) (1,405.0) (1,118.9) (1,034.0) Commercial (18.6) (15.4) (41.0) (87.7) (148.2) - --------------------------------------------------------------------------------------------------------------------- Total managed receivables charged off (2,589.3) (1,818.1) (1,446.0) (1,206.6) (1,182.2) - --------------------------------------------------------------------------------------------------------------------- RECOVERIES ON MANAGED RECEIVABLES Domestic: First mortgage 2.3 2.5 2.2 2.9 2.6 Home equity 5.8 2.8 3.6 5.2 4.3 Auto finance (1) .6 - - - - MasterCard/Visa 94.8 42.5 33.6 25.7 15.8 Private label 50.0 28.2 29.4 32.7 26.0 Other unsecured 50.3 75.5 74.4 60.1 56.2 Foreign 52.8 44.4 36.7 31.6 27.1 - --------------------------------------------------------------------------------------------------------------------- Total consumer 256.6 195.9 179.9 158.2 132.0 Commercial 1.0 4.4 2.9 3.2 2.7 - --------------------------------------------------------------------------------------------------------------------- Total recoveries on managed receivables 257.6 200.3 182.8 161.4 134.7 Portfolio acquisitions, net 90.8 87.8 80.4 (32.9) (4.6) - --------------------------------------------------------------------------------------------------------------------- TOTAL CREDIT LOSS RESERVES FOR MANAGED RECEIVABLES Domestic: First mortgage 2.4 4.3 4.1 5.1 4.1 Home equity 235.7 169.0 139.7 132.9 109.8 Auto finance (1) 49.7 - - - - MasterCard/Visa 704.9 568.7 347.5 319.8 275.9 Private label 462.1 383.2 312.7 205.2 135.6 Other unsecured 759.6 639.1 470.9 289.2 262.3 Foreign 221.1 205.3 162.4 112.8 97.5 - --------------------------------------------------------------------------------------------------------------------- Total consumer 2,435.5 1,969.6 1,437.3 1,065.0 885.2 Commercial 87.5 139.4 154.2 154.2 213.5 Unallocated corporate - - - - 25.0 - --------------------------------------------------------------------------------------------------------------------- TOTAL CREDIT LOSS RESERVES FOR MANAGED RECEIVABLES AT DECEMBER 31 $2,523.0 $2,109.0 $1,591.5 $1,219.2 $1,123.7 ===================================================================================================================== RATIO OF CREDIT LOSS RESERVES TO MANAGED RECEIVABLES Consumer 3.92% 3.38% 2.90% 2.46% 2.31% Commercial 9.14 13.44 11.07 7.49 7.01 - --------------------------------------------------------------------------------------------------------------------- Total (2) 3.99% 3.56% 3.12% 2.69% 2.72% ===================================================================================================================== RATIO OF CREDIT LOSS RESERVES TO MANAGED NONPERFORMING LOANS Consumer 113.7% 120.7% 117.3% 110.4% 91.6% Commercial 200.7 191.2 91.8 96.7 69.3 - --------------------------------------------------------------------------------------------------------------------- Total (2) 115.5% 123.7% 114.2% 108.4% 88.2% =====================================================================================================================
(1) Includes ACC subsequent to our acquisition in October 1997. Prior to the fourth quarter of 1997, auto finance receivables were not significant and were included in other unsecured receivables. (2) 1993 amount includes the unallocated corporate reserve. 31 32 SUPPLEMENTAL NET INTEREST MARGIN - 1997 COMPARED TO 1996 (OWNED BASIS) Household International, Inc. and Subsidiaries
Finance and Average Interest Income/ Outstanding (2) Average Rate Interest Expense All dollar amounts are -------------------- -------------- ------------------ stated in millions. 1997 1996 1997 1996 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ Receivables: First mortgage $ 565.8 $ 1,717.8 7.5% 7.6% $ 42.6 $ 130.7 Home equity 11,695.2 10,573.0 11.9 11.8 1,391.8 1,247.6 MasterCard/Visa 7,693.7 7,663.5 11.4 12.8 880.3 980.8 Private label 8,809.0 7,071.7 13.9 13.2 1,227.3 934.2 Other unsecured 8,921.4 8,665.9 17.8 18.7 1,583.7 1,619.8 Commercial 1,057.2 1,219.4 5.6 5.3 58.8 64.1 ==================================================================================================================================== Total receivables $38,742.3 $36,911.3 13.4% 13.5% $5,184.5 $4,977.2 Noninsurance investments 661.4 1,477.6 7.5 6.3 49.8 93.3 ==================================================================================================================================== Total interest-earning assets (excluding insurance investments) $39,403.7 $38,388.9 13.3% 13.2% $5,234.3 $5,070.5 Insurance investments 2,555.0 2,946.4 Other assets 4,518.8 3,630.6 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL ASSETS $46,477.5 $44,965.9 ==================================================================================================================================== Debt: Deposits $ 2,976.1 $ 4,520.0 5.2% 5.2% $ 155.3 $ 235.2 Commercial paper 8,974.7 8,846.5 5.6 5.3 499.9 472.7 Bank and other borrowings 1,458.8 1,597.9 6.3 7.0 92.5 111.7 Senior and senior subordinated debt (with original maturities over one year) 23,743.4 21,340.7 6.8 7.1 1,610.7 1,513.8 ==================================================================================================================================== Total debt $37,153.0 $36,305.1 6.3% 6.4% $2,358.4 $2,333.4 Other liabilities 3,533.2 3,954.1 - ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities 40,686.2 40,259.2 Preferred securities 442.1 449.0 Common shareholders' equity 5,349.2 4,257.7 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $46,477.5 $44,965.9 ==================================================================================================================================== NET INTEREST MARGIN - OWNED BASIS (1) (5) 7.3% 7.1% $2,875.9 $2,737.1 ==================================================================================================================================== INTEREST SPREAD - OWNED BASIS (4) 7.0% 6.8% ==================================================================================================================================== Increase/(Decrease) Due to: ----------------------------------------------- All dollar amounts are Volume Rate Vari- stated in millions. Variance Variance(3) ance (3) - ---------------------------------------------------------------------------------------------- Receivables: First mortgage $(88.1) $(86.4) $ (1.7) Home equity 144.2 133.5 10.7 MasterCard/Visa (100.5) 4.0 (104.5) Private label 293.1 241.1 52.0 Other unsecured (36.1) 45.5 (81.6) Commercial (5.3) (8.9) 3.6 ============================================================================================ Total receivables $207.3 $244.6 $(37.3) Noninsurance investments (43.5) (58.7) 15.2 ============================================================================================ Total interest-earning assets (excluding insurance investments) $163.8 $127.3 $ 36.5 Insurance investments Other assets - -------------------------------------------------------------------------------------------- TOTAL ASSETS ============================================================================================ Debt: Deposits $(79.9) $(79.9) - Commercial paper 27.2 5.5 $ 21.7 Bank and other borrowings (19.2) (8.9) (10.3) Senior and senior subordinated debt (with original maturities over one year) 96.9 163.6 (66.7) ============================================================================================ Total debt $ 25.0 $ 58.5 $(33.5) Other liabilities - -------------------------------------------------------------------------------------------- Total liabilities Preferred securities Common shareholders' equity - -------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ============================================================================================ NET INTEREST MARGIN - OWNED BASIS (1) (5) $138.8 $ 68.8 $ 70.0 ============================================================================================ INTEREST SPREAD - OWNED BASIS (4) ============================================================================================
(1) Represents net interest margin as a percent of average interest-earning assets. See page 34 for net interest margin on a managed basis for 1997, 1996 and 1995. (2) Nonaccrual loans are included in average outstanding balances. (3) Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total interest variance. For total receivables, total interest-earning assets and total debt, the rate and volume variances are calculated based on the relative weighting of the individual components comprising these totals. These totals do not represent an arithmetic sum of the individual components. (4) Represents the difference between the yield earned on interest-earning assets and the cost of the debt used to fund the assets. (5) The net interest margin analysis includes the following for foreign businesses:
1997 1996 1995 - -------------------------------------------------------------------------------- Average interest-earning assets $6,274.2 $5,334.8 $5,697.7 Average interest-bearing liabilities 5,274.8 4,734.2 5,189.4 Net interest margin 527.3 474.1 435.0 Net interest margin percentage 8.4% 8.9% 7.6% - --------------------------------------------------------------------------------
32 33 SUPPLEMENTAL NET INTEREST MARGIN - 1996 COMPARED TO 1995 (OWNED BASIS) Household International, Inc. and Subsidiaries
Finance and Average Interest Income/ Outstanding (2) Average Rate Interest Expense All dollar amounts are stated -------------------- -------------- -------------------- in millions. 1996 1995 1996 1995 1996 1995 - --------------------------------------------------------------------------------------------------------- Receivables: First mortgage $ 1,717.8 $ 2,941.1 7.6% 8.1% $ 130.7 $ 237.1 Home equity 10,573.0 10,194.7 11.8 12.1 1,247.6 1,232.5 MasterCard/Visa 7,663.5 5,545.7 12.8 14.2 980.8 786.8 Private label 7,071.7 4,915.1 13.2 14.9 934.2 731.1 Other unsecured 8,665.9 8,939.5 18.7 18.9 1,619.8 1,687.7 Commercial 1,219.4 1,825.4 5.3 6.4 64.1 117.2 ========================================================================================================= Total receivables $36,911.3 $34,361.5 13.2% 13.9% $4,977.2 $4,792.4 Noninsurance investments 1,477.6 2,252.4 6.3 6.1 93.3 136.6 ========================================================================================================= Total interest-earning assets (excluding insurance investments) $38,388.9 $36,613.9 13.2% 13.5% $5,070.5 $4,929.0 Insurance investments 2,946.4 7,508.4 Other assets 3,630.6 4,304.3 - --------------------------------------------------------------------------------------------------------- TOTAL ASSETS $44,965.9 $48,426.6 ========================================================================================================= Debt: Deposits $ 4,520.0 $ 7,768.7 5.2% 5.2% $ 235.2 $ 404.5 Commercial paper 8,846.5 7,475.4 5.3 6.1 472.7 453.3 Bank and other borrowings 1,597.9 2,041.1 7.0 7.4 111.7 150.1 Senior and senior subordinated debt (with original maturities over one year) 21,340.7 17,878.6 7.1 7.6 1,513.8 1,365.4 ========================================================================================================= Total debt $36,305.1 $35,163.8 6.4% 6.7% $2,333.4 $2,373.3 Other liabilities 3,954.1 9,042.0 - --------------------------------------------------------------------------------------------------------- Total liabilities 40,259.2 44,205.8 Preferred securities 449.0 423.9 Common shareholders' equity 4,257.7 3,796.9 - --------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $44,965.9 $48,426.6 ========================================================================================================= Net Interest Margin - Owned Basis (1) (5) 7.1% 7.0% $2,737.1 $2,555.7 ========================================================================================================= Interest Spread - Owned Basis (4) 6.8% 6.8% ========================================================================================================= Increase/(Decrease) Due to: -------------------------------------- All dollar amounts are stated Volume Vari- Rate Vari- in millions. Variance ance (3) ance (3) - -------------------------------------------------------------------------------------- Receivables: First mortgage $(106.4) $ (93.7) $ (12.7) Home equity 15.1 45.7 (30.6) MasterCard/Visa 194.0 277.6 (83.6) Private label 203.1 293.8 (90.7) Other unsecured (67.9) (50.5) (17.4) Commercial (53.1) (35.0) (18.1) ====================================================================================== Total receivables $ 184.8 $ 331.2 $(146.4) Noninsurance investments (43.3) (47.8) 4.5 ====================================================================================== Total interest-earning assets (excluding insurance investments) $ 141.5 $ 247.7 $(106.2) Insurance investments Other assets - -------------------------------------------------------------------------------------- TOTAL ASSETS ====================================================================================== Debt: Deposits $(169.3) $(169.3) - Commercial paper 19.4 81.1 $ (61.7) Bank and other borrowings (38.4) (30.7) (7.7) Senior and senior subordinated debt (with original maturities over one year) 148.4 244.2 (95.8) ====================================================================================== Total debt $ (39.9) $ 71.9 $(111.8) Other liabilities - -------------------------------------------------------------------------------------- Total liabilities Preferred securities Common shareholders' equity - -------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ====================================================================================== Net Interest Margin - Owned Basis (1) (5) $ 181.4 $ 175.8 $ 5.6 ====================================================================================== Interest Spread - Owned Basis (4) ======================================================================================
33 34 SUPPLEMENTAL NET INTEREST MARGIN - 1997 COMPARED TO 1996 AND 1995 (MANAGED BASIS) Net Interest Margin on a Managed Basis - As receivables are securitized rather than held in our portfolio, net interest income is reclassified to securitization income. We retain a substantial portion of the profit inherent in the receivable while increasing liquidity. Due to the growing level of securitized receivables, the comparability of net interest margin between periods may be impacted by the level and type of receivables securitized. The following table presents a summarized net interest margin analysis on a managed basis.
Household International, Inc. and Subsidiaries Finance and Interest Average Outstanding (1) Average Rate Income/Interest Expense All dollar amounts are stated ------------------------------- ---------------- ---------------------------- in millions. 1997 1996 1995 1997 1996 1995 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------------- Receivables: First mortgage $ 565.8 $ 1,717.8 $ 2,941.1 7.5% 7.6% 8.1% $ 42.6 $ 130.7 $ 237.1 Home equity 18,011.5 16,625.0 16,175.8 12.4 12.3 12.6 2,229.9 2,036.6 2,035.8 MasterCard/Visa 18,506.2 16,385.2 11,874.4 13.1 13.5 14.3 2,431.1 2,212.7 1,699.9 Private label 9,245.5 7,747.8 5,734.0 14.1 13.8 14.9 1,303.5 1,068.1 857.1 Other unsecured 13,061.0 11,263.8 9,473.6 18.1 18.3 18.7 2,363.3 2,066.2 1,770.3 Commercial 1,057.2 1,219.4 1,825.4 5.6 5.3 6.4 58.8 64.1 117.2 - ----------------------------------------------------------------------------------------------------------------------------------- Total receivables 60,447.2 54,959.0 48,024.3 13.9 13.8 14.0 8,429.2 7,578.4 6,717.4 Noninsurance investments 661.4 1,477.6 2,252.4 7.5 6.3 6.1 49.8 93.3 136.6 - ----------------------------------------------------------------------------------------------------------------------------------- Total interest-earning assets (excluding insurance investments) 61,108.6 56,436.6 50,276.7 13.9 13.6 13.6 8,479.0 7,671.7 6,854.0 - ----------------------------------------------------------------------------------------------------------------------------------- Total debt $58,857.9 $54,352.4 $48,826.5 6.3 6.3 6.7 3,692.2 3,413.2 3,262.5 - ----------------------------------------------------------------------------------------------------------------------------------- NET INTEREST MARGIN - MANAGED BASIS (2) 7.8% 7.5% 7.1% $4,786.8 $4,258.5 $3,591.5 =================================================================================================================================== INTEREST SPREAD - MANAGED BASIS (3) 7.6% 7.3% 6.9% ===================================================================================================================================
(1) Nonaccrual loans are included in average outstanding balances. (2) As a percent of average interest-earning assets. (3) Represents the difference between the yield earned on interest-earning assets and cost of the debt used to fund the assets. 34 35 SUPPLEMENTAL SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Household International, Inc. and Subsidiaries 1997--THREE MONTHS ENDED 1996--Three Months Ended All dollar amounts except per share -------------------------------------- ---------------------------------------- data are stated in millions. DEC. SEPT. JUNE MARCH Dec. Sept. June March - ------------------------------------------------------------------------------------------------------------------------------------ Finance income $1,318.7 $1,327.5 $1,251.3 $1,287.0 $1,324.4 $1,262.5 $1,192.0 $1,198.3 Other interest income 10.3 9.5 18.8 11.2 12.3 15.0 42.4 23.6 Interest expense 598.9 605.4 574.3 579.8 602.3 586.8 581.9 562.4 - ------------------------------------------------------------------------------------------------------------------------------------ Net interest margin 730.1 731.6 695.8 718.4 734.4 690.7 652.5 659.5 Provision for credit losses on owned receivables 396.9 384.9 359.0 386.5 365.4 263.2 256.8 273.0 - ------------------------------------------------------------------------------------------------------------------------------------ Net interest margin after provision for credit losses 333.2 346.7 336.8 331.9 369.0 427.5 395.7 386.5 - ------------------------------------------------------------------------------------------------------------------------------------ Securitization income 401.1 448.9 422.2 366.2 345.6 349.5 341.8 304.4 Insurance revenues 121.7 109.9 111.3 111.3 113.4 104.9 99.8 104.0 Investment income 44.1 43.9 39.9 45.2 36.4 46.3 47.0 91.0 Fee income 200.7 158.8 122.2 121.4 106.4 91.9 81.8 76.4 Other income 59.6 68.5 61.6 166.0 55.6 50.4 185.0 128.6 - ------------------------------------------------------------------------------------------------------------------------------------ Total other revenues 827.2 830.0 757.2 810.1 657.4 643.0 755.4 704.4 - ------------------------------------------------------------------------------------------------------------------------------------ Salaries and fringe benefits 279.5 277.6 264.6 252.7 261.6 242.3 234.6 238.4 Occupancy and equipment expense 82.0 81.5 79.2 84.7 78.0 78.1 92.1 80.5 Other marketing expenses 123.9 112.1 98.8 114.8 110.1 113.6 117.6 90.2 Other servicing and administrative expenses 303.9 195.2 185.6 220.2 200.3 200.7 254.8 209.6 Amortization of acquired intangibles and goodwill 42.1 42.4 37.1 36.8 36.7 35.9 41.5 29.6 Policyholders' benefits 59.1 61.9 65.1 69.8 66.2 76.8 73.0 95.9 - ------------------------------------------------------------------------------------------------------------------------------------ Total costs and expenses 890.5 770.7 730.4 779.0 752.9 747.4 813.6 744.2 - ------------------------------------------------------------------------------------------------------------------------------------ Income before income taxes 269.9 406.0 363.6 363.0 273.5 323.1 337.5 346.7 Income taxes 65.1 141.3 125.0 130.8 86.6 115.3 130.5 128.8 - ------------------------------------------------------------------------------------------------------------------------------------ Net income $ 204.8 $ 264.7 $ 238.6 $ 232.2 $ 186.9 $ 207.8 $ 207.0 $ 217.9 ==================================================================================================================================== Basic earnings per share(1,2) $ .41 $ .54 $ .51 $ .50 $ .40 $ .45 $ .44 $ .47 ==================================================================================================================================== Diluted earnings per share(1,2) .41 .53 .50 .49 .39 .44 .44 .46 ==================================================================================================================================== Weighted average common and common equivalent shares outstanding(1) 493.2 492.3 465.9 465.5 463.6 462.3 462.6 461.4 ==================================================================================================================================== Dividends declared(1) $ .14 $ .14 $ .13 $ .13 $ .13 $ .13 $ .11 $ .11 ====================================================================================================================================
(1) We adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" (FAS No. 128). Under FAS No. 128, basic earnings per common share is computed excluding dilution caused by common stock equivalents such as stock options. Diluted earnings per common share includes the effect of dilutive common stock equivalents. For comparative purposes, all common share and per common share amounts have been restated to reflect the adoption of FAS No. 128 and for our 3-for-1 common stock split effected in the form of a stock dividend and paid on June 1, 1998. (2) Quarterly earnings per share amounts are computed on the basis of the weighted average number of shares outstanding for each quarter. Changes between quarters in the number of shares outstanding result in the annual computation differing from the aggregate of the quarterly amounts. 35 36 SUPPLEMENTAL FINANCIAL HIGHLIGHTS
Household International, Inc. and Subsidiaries All dollar amounts except per share data are stated in millions. Percent Year ended December 31, unless otherwise indicated. 1997 1996 Change - ------------------------------------------------------------------------------------------------ NET INCOME $ 940.3 $ 819.6 15% - ------------------------------------------------------------------------------------------------ PER COMMON SHARE (1) Basic earnings $ 1.97 $ 1.76 12% Diluted earnings 1.93 1.73 12 Dividends declared .54 .49 10 Book value 12.81 9.96 29 - ------------------------------------------------------------------------------------------------ KEY PERFORMANCE RATIOS Return on average owned assets 2.02% 1.82% 11% Return on average managed assets (2) 1.33 1.25 6 Return on average common shareholders' equity 16.9 18.2 (7) Total shareholders' equity as a percent of managed assets (2)(3) 9.25 7.56 22 Managed net interest margin 7.83 7.55 4 Managed consumer net chargeoff ratio 3.90 2.99 30 Managed basis efficiency ratio, normalized 41.1 45.2 (9) - ------------------------------------------------------------------------------------------------ AT DECEMBER 31 Total assets: Owned $47,040.9 $45,529.2 3% Managed (2) 71,519.4 66,380.4 8 Managed receivables (2) 63,160.5 59,298.7 7 - ------------------------------------------------------------------------------------------------
(1) All per share information has been adjusted for Household's 3-for-1 stock split effected in the form of a stock dividend and paid on June 1, 1998. (2) Our managed data includes assets on our balance sheet and those assets that we service for investors as part of our asset securitization program. (3) Total shareholders' equity includes common shareholders' equity, preferred stock and company obligated mandatorily redeemable preferred securities of subsidiary trusts. 36 37 SUPPLEMENTAL CONSOLIDATED STATEMENTS OF INCOME
Household International, Inc. and Subsidiaries In millions, except per share data. Year ended December 31 1997 1996 1995 - -------------------------------------------------------------------------------- Finance income $5,184.5 $4,977.2 $4,792.4 Other interest income 49.8 93.3 136.6 Interest expense 2,358.4 2,333.4 2,373.3 - -------------------------------------------------------------------------------- Net interest margin 2,875.9 2,737.1 2,555.7 Provision for credit losses on owned receivables 1,527.3 1,158.4 1,041.5 - -------------------------------------------------------------------------------- Net interest margin after provision for credit losses 1,348.6 1,578.7 1,514.2 - -------------------------------------------------------------------------------- Securitization income 1,638.4 1,341.3 997.2 Insurance revenues 454.2 422.1 474.8 Investment income 173.1 220.7 524.8 Fee income 603.1 356.5 297.4 Other income 355.7 419.6 319.4 - -------------------------------------------------------------------------------- Total other revenues 3,224.5 2,760.2 2,613.6 - -------------------------------------------------------------------------------- Salaries and fringe benefits 1,074.4 976.9 939.9 Occupancy and equipment expense 327.4 328.7 337.9 Other marketing expenses 449.6 431.5 307.9 Other servicing and administrative expenses 904.9 865.4 853.3 Amortization of acquired intangibles and goodwill 158.4 143.7 109.8 Policyholders' benefits 255.9 311.9 554.9 - -------------------------------------------------------------------------------- Total costs and expenses 3,170.6 3,058.1 3,103.7 - -------------------------------------------------------------------------------- Income before income taxes 1,402.5 1,280.8 1,024.1 Income taxes 462.2 461.2 420.4 - -------------------------------------------------------------------------------- Net income $ 940.3 $ 819.6 $ 603.7 ================================================================================ EARNINGS PER COMMON SHARE Net income $ 940.3 $ 819.6 $ 603.7 Preferred dividends (17.0) (21.9) (31.6) - -------------------------------------------------------------------------------- Earnings available to common shareholders $ 923.3 $ 797.7 $ 572.1 ================================================================================ Average common and common equivalent shares 479.1 462.3 462.0 - -------------------------------------------------------------------------------- Basic earnings per common share $ 1.97 $ 1.76 $ 1.26 - -------------------------------------------------------------------------------- Diluted earnings per common share $ 1.93 $ 1.73 $ 1.24 - --------------------------------------------------------------------------------
The accompanying notes are an integral part of these supplemental consolidated financial statements. 37 38 SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
Household International, Inc. and Subsidiaries In millions, except share data. At December 31 1997 1996 - -------------------------------------------------------------------------------------------------- ASSETS Cash $ 534.3 $ 518.8 Investment securities 2,898.6 2,843.0 Receivables, net 38,561.5 38,385.3 Acquired intangibles and goodwill, net 1,798.4 984.0 Properties and equipment, net 538.7 558.0 Real estate owned 212.8 236.8 Other assets 2,496.6 2,003.3 - -------------------------------------------------------------------------------------------------- Total assets $47,040.9 $45,529.2 ================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY Debt: Deposits $ 2,344.2 $ 3,000.1 Commercial paper, bank and other borrowings 10,666.1 10,597.4 Senior and senior subordinated debt (with original maturities over one year) 23,736.2 23,433.1 - -------------------------------------------------------------------------------------------------- Total debt 36,746.5 37,030.6 Insurance policy and claim reserves 1,606.5 1,564.0 Other liabilities 2,074.4 1,918.6 - -------------------------------------------------------------------------------------------------- Total liabilities 40,427.4 40,513.2 Company obligated mandatorily redeemable preferred securities of subsidiary trusts (Note 9)* 175.0 175.0 Preferred stock (Note 10) 264.5 319.5 Common shareholders' equity: Common stock, $1.00 par value, 750,000,000 shares authorized (increased as of May 13, 1998); 536,870,946 and 511,925,714 shares issued at December 31, 1997 and 1996, respectively 536.9 511.9 Additional paid-in capital 1,423.5 360.2 Retained earnings 4,978.6 4,340.3 Foreign currency translation adjustments (176.5) (172.1) Unrealized gain (loss) on investments, net 8.8 (10.3) Less common stock in treasury, 51,519,429 and 54,497,763 shares at December 31, 1997 and 1996, respectively, at cost (597.3) (508.5) - -------------------------------------------------------------------------------------------------- Total common shareholders' equity 6,174.0 4,521.5 - -------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $47,040.9 $45,529.2 ==================================================================================================
* The sole assets of the two trusts are Junior Subordinated Deferrable Interest Notes issued by Household International, Inc. in June 1996 and June 1995, bearing interest at 8.70 and 8.25 percent, respectively, with principal balances of $103.1 and $77.3 million, respectively, and due June 30, 2036 and June 30, 2025, respectively. The accompanying notes are an integral part of these supplemental consolidated financial statements. 38 39 SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
Household International, Inc. and Subsidiaries In millions. Year ended December 31 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------------------- CASH PROVIDED BY OPERATIONS Net income $ 940.3 $ 819.6 $ 603.7 Adjustments to reconcile net income to net cash provided by operations: Provision for credit losses on owned receivables 1,527.3 1,158.4 1,041.5 Provision for loss on German disposal 58.8 - 15.0 Insurance policy and claim reserves 98.3 (862.5) 585.5 Depreciation and amortization 303.5 290.1 312.5 Net realized gains from sales of assets (102.5) (137.3) (188.7) Deferred income tax provision 75.9 (116.1) (37.5) Other, net (473.6) 294.2 (274.6) - ---------------------------------------------------------------------------------------------------------------------------- Cash provided by operations 2,428.0 1,446.4 2,057.4 - ---------------------------------------------------------------------------------------------------------------------------- INVESTMENTS IN OPERATIONS Investment securities available-for-sale: Purchased (2,028.0) (2,712.3) (4,613.2) Matured 399.9 1,229.2 1,056.6 Sold 1,721.3 3,705.5 3,178.6 Investment securities held-to-maturity: Purchased - - (636.9) Matured - - 486.2 Sold - - 34.2 Short-term investment securities, net change (49.0) 117.2 348.5 Receivables: Originations, net (29,356.5) (31,269.3) (26,474.2) Purchased (1,737.5) (5,514.7) (2,533.6) Sold 32,621.0 31,915.2 25,489.6 Purchase of Transamerica Financial Services Holding Company capital stock (1,065.0) - - Disposition of consumer banking operations: Assets sold, net - 472.3 975.6 Deposits and other liabilities sold, net - (2,809.8) (4,061.9) Disposition of product lines of life insurance business - - 575.0 (Acquisition) disposition of portfolios, net - (640.7) (58.7) Properties and equipment purchased (127.7) (159.7) (113.6) Properties and equipment sold 8.6 14.9 35.9 - ---------------------------------------------------------------------------------------------------------------------------- Cash increase (decrease) from investments in operations 387.1 (5,652.2) (6,311.9) - ---------------------------------------------------------------------------------------------------------------------------- FINANCING AND CAPITAL TRANSACTIONS Short-term debt and demand deposits, net change (332.2) (78.7) 2,483.7 Time certificates, net change (438.2) 395.0 728.8 Senior and senior subordinated debt issued 7,730.0 10,378.6 6,360.1 Senior and senior subordinated debt retired (7,383.3) (6,052.6) (5,075.7) Repayment of Transamerica Financial Services Holding Company debt (2,795.0) - - Policyholders' benefits paid (123.5) (512.4) (805.3) Cash received from policyholders 98.0 258.5 669.0 Shareholders' dividends (186.5) (163.6) (159.2) Shareholders' dividends - pooled affiliate (115.5) (105.3) (94.5) Issuance of company obligated mandatorily redeemable preferred securities of subsidiary trusts - 100.0 75.0 Redemption of preferred stock (55.0) - (115.0) Purchase of treasury stock (155.7) (56.7) (59.7) Treasury stock activity - pooled affiliate (80.0) - - Issuance of common stock 1,022.3 15.2 24.7 - ---------------------------------------------------------------------------------------------------------------------------- Cash increase (decrease) from financing and capital transactions (2,814.6) 4,178.0 4,031.9 - ---------------------------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash 15.0 3.1 35.4 - ---------------------------------------------------------------------------------------------------------------------------- Increase (decrease) in cash 15.5 (24.7) (187.2) Cash at January 1 518.8 543.5 730.7 - ---------------------------------------------------------------------------------------------------------------------------- Cash at December 31 $ 534.3 $ 518.8 $ 543.5 ============================================================================================================================ Supplemental Cash Flow Information: Interest paid $ 2,348.9 $ 2,371.6 $ 2,331.6 Income taxes paid 308.7 544.8 325.8 - ---------------------------------------------------------------------------------------------------------------------------- Supplemental Non-Cash Investing and Financing Activities: Common stock issued for acquisition $ 157.3 - - - ----------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these supplemental consolidated financial statements. 39 40 SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CHANGES IN PREFERRED STOCK AND COMMON SHAREHOLDERS' EQUITY
Common Shareholders' Equity ----------------------------------------------------------- Household International, Inc. and Subsidiaries Additional Total Common All amounts except per share data are stated Preferred Common Paid-in Retained Shareholders' in millions. Stock Stock Capital Earnings Other (1) Equity - -------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1994 $434.6 $506.6 $ 269.8 $3,439.6 $(729.9) $3,486.1 Net income 603.7 603.7 Cash dividends: Preferred at stated rates (31.7) (31.7) Common, $.44 per share (127.5) (127.5) Pooled affiliate (2) (94.5) (94.5) Foreign currency translation adjustments (2.9) (2.9) Conversion of preferred stock .6 3.1 3.7 Exercise of stock options 2.1 27.3 21.7 51.1 Issuance of common stock 12.6 13.4 26.0 Purchase of treasury stock (59.7) (59.7) Redemption of preferred stock (115.1) Unrealized gain on investments, net 225.1 225.1 - ---------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1995 319.5 509.3 312.8 3,789.6 (532.3) 4,079.4 Net income 819.6 819.6 Cash dividends: Preferred at stated rates (21.9) (21.9) Common, $.49 per share (141.7) (141.7) Pooled affiliate (2) (105.3) (105.3) Foreign currency translation adjustments 1.4 1.4 Exercise of stock options 2.6 38.6 11.9 53.1 Issuance of common stock 8.8 7.8 16.6 Purchase of treasury stock (56.7) (56.7) Unrealized loss on investments, net (123.0) (123.0) - ---------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1996 319.5 511.9 360.2 4,340.3 (690.9) 4,521.5 Net income 940.3 940.3 Cash dividends: Preferred at stated rates (17.0) (17.0) Common, $.54 per share (169.5) (169.5) Pooled affiliate (2) (115.5) (115.5) Foreign currency translation adjustments (4.4) (4.4) Exercise of stock options 1.4 36.5 16.2 54.1 Issuance of common stock 27.3 984.1 12.4 1,023.8 Purchase of treasury stock, net (3.7) 42.7 (117.4) (78.4) Redemption of preferred stock (55.0) Unrealized gain on investments, net 19.1 19.1 - ---------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1997 $264.5 $536.9 $1,423.5 $4,978.6 $(765.0) $6,174.0 ============================================================================================================================
(1) At December 31, 1997, 1996, 1995 and 1994 items in the other column include cumulative adjustments for: foreign currency translation adjustments of $(176.5), $(172.1), $(173.5) and $(170.6) million, respectively; common stock in treasury of $(597.3), $(508.5), $(471.5) and $(446.9) million, respectively; and unrealized gains (losses) on marketable equity securities and available-for-sale investments of $8.8, $(10.3), $112.7 and $(112.4) million, respectively. The gross unrealized gain (loss) on available-for-sale investments at December 31, 1997, 1996 and 1995 of $13.1, $(16.0) and $170.5 million, respectively, is recorded net of income taxes (benefit) of $4.3, $(5.7) and $57.8 million, respectively. (2) Represents historical common stock dividends of Beneficial Corporation.
Common Stock ------------------------------------- Shares Outstanding Preferred Stock Issued In Treasury Net Outstanding - --------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1994 3,198,279 506,669,727 (55,218,423) 451,451,304 Exercise of common stock options 2,719,556 2,719,556 Conversion of $6.25 preferred stock 2,437,728 2,437,728 Issuance of common stock 1,571,757 1,571,757 Purchase of treasury stock (3,000,000) (3,000,000) Redemption of preferred stock (1,150,000) - --------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1995 2,048,279 509,389,283 (54,208,938) 455,180,345 Exercise of common stock options 2,536,431 1,389,636 3,926,067 Issuance of common stock 844,539 844,539 Purchase of treasury stock (2,523,000) (2,523,000) - --------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1996 2,048,279 511,925,714 (54,497,763) 457,427,951 Exercise of common stock options 1,390,283 1,618,671 3,008,954 Issuance of common stock 27,340,697 1,359,738 28,700,435 Issuance of common stock - ACC 4,101,825 4,101,825 Purchase of treasury stock (4,101,900) (4,101,900) Purchase of stock - pooled affiliates (3,785,748) (3,785,748) Redemption of preferred stock (550,000) - --------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1997 1,498,279 536,870,946 (51,519,429) 485,351,517 ===================================================================================================
The accompanying notes are an integral part of these supplemental consolidated financial statements. 40 41 NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS Household International, Inc. and Subsidiaries - -------------------------------------------------------------------------------- Household International, Inc. and subsidiaries (the "company") is a leading provider of consumer lending products to middle-market customers in the United States, Canada and the United Kingdom, with $63.2 billion of managed receivables at December 31, 1997. The company's lending products include: home equity loans, auto finance loans, MasterCard* and Visa* and private label credit cards, tax refund anticipation loans and other unsecured loans. The company also offers credit and specialty insurance in the United States, the United Kingdom and Canada. The company also has traditional first mortgages, commercial loans and leases, periodic payment annuities, and corporate owned life insurance products, which it no longer offers. - -------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The consolidated financial statements include the accounts of Household International, Inc. and all subsidiaries. All significant intercompany accounts and transactions have been eliminated. Certain prior year amounts have been reclassified to conform with the current year's presentation. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. On March 10, 1998, the Board of Directors approved a three-for-one split of the company's common stock, effected in the form of a dividend, issued on June 1, 1998, to shareholders of record as of May 14, 1998. The split was subject to shareholders approval to increase authorized shares which was received on May 13, 1998. Accordingly, all common share and per common share data in these supplemental consolidated financial statements includes the effect of the company's stock split. INVESTMENT SECURITIES The company maintains investment portfolios in both its noninsurance and insurance operations. These portfolios are comprised primarily of debt securities. The company's entire investment securities portfolio was classified as available-for-sale at December 31, 1997 and 1996. Available-for-sale investments are intended to be invested for an indefinite period but may be sold in response to events reasonably expected in the foreseeable future. These investments are carried at fair value. Unrealized holding gains and losses on available-for-sale investments are recorded as adjustments to common shareholders' equity, net of income taxes. Any decline in the fair value of investments which is deemed to be other than temporary is charged against current earnings. * MasterCard and Visa are registered trademarks of MasterCard International, Incorporated and VISA USA, Inc., respectively. 41 42 Cost of investment securities sold is determined using the specific identification method. Interest income earned on the noninsurance investment portfolio is classified in the statements of income in net interest margin. Realized gains and losses from the investment portfolio and investment income from the insurance portfolio are recorded in investment income. Accrued investment income is classified with investment securities. RECEIVABLES Receivables are carried at amortized cost. The company periodically sells receivables from its home equity, auto finance, MasterCard and Visa, private label and other unsecured portfolios. Because these receivables were originated with variable rates of interest or rates comparable to those currently offered by the company, carrying value approximates fair value. Finance income is recognized using the effective yield method. Origination fees are deferred and amortized to finance income over the estimated life of the related receivables, except to the extent they offset directly related lending costs. Annual fees are netted with direct lending costs associated with the issuance of MasterCard and Visa receivables and are deferred and amortized on a straight-line basis over one year. Net deferred lending costs (fees) related to these receivables totaled $7.8 and $(5.7) million at December 31, 1997 and 1996, respectively. Premiums and discounts on purchased receivables are recognized as adjustments of the yield of the related receivables. Insurance reserves applicable to credit risks on consumer receivables are treated as a reduction of receivables in the balance sheets, since payments on such policies generally are used to reduce outstanding receivables. PROVISION AND CREDIT LOSS RESERVES Provision for credit losses on owned receivables is made in an amount sufficient to maintain credit loss reserves at a level considered adequate to cover probable losses of principal and interest in the existing owned portfolio. Probable losses are estimated for consumer receivables based on contractual delinquency status and historical loss experience. For commercial loans, probable losses are calculated using estimates of amounts and timing of future cash flows expected to be received on loans. In addition, general loss reserves on consumer and commercial receivables are maintained to reflect management's judgment of portfolio risk factors. Loss reserve estimates are reviewed periodically and adjustments are reported in earnings when they become known. As these estimates are influenced by factors outside the company's control, such as consumer payment patterns and economic conditions, there is uncertainty inherent in these estimates, making it reasonably possible that they could change. The company's chargeoff policy for consumer receivables varies by product. Receivables for Household are written off, or for secured products written down to net realizable value, at the following stages of contractual delinquency: auto finance - 5 months; first mortgage, home equity and MasterCard and Visa - 6 months; private label - 9 months; and other unsecured - 9 months and no payment received in 6 months. Beneficial, in general, charges off unsecured receivables after no payment has been made in six months and secured receivables are written down to net realizable value at the time of foreclosure. Commercial receivables are written off when it becomes apparent that an account is uncollectible. 42 43 NONACCRUAL LOANS Nonaccrual loans are loans on which accrual of interest has been suspended. Interest income is suspended on all loans when principal or interest payments are more than three months contractually past due, except for MasterCard and Visa and private label credit cards and auto finance receivables. On credit card receivables, interest continues to accrue until the receivable is charged off. On auto finance receivables, accrual of interest income is discontinued when payments are more than two months contractually past due. There were no commercial loans at December 31, 1997 which were 90 days or more past due which remained on accrual status. Accrual of income on nonaccrual consumer receivables is not resumed until such receivables become less than three months contractually past due (two months for auto finance receivables). Accrual of income on nonaccrual commercial loans is not resumed until such loans become contractually current. Cash payments received on nonaccrual commercial loans are either applied against principal or reported as interest income, according to management's judgment as to the collectibility of principal. RECEIVABLES SOLD AND SERVICED WITH LIMITED RECOURSE AND SECURITIZATION INCOME Certain home equity, auto finance, MasterCard and Visa, private label and other unsecured receivables have been securitized and sold to investors with limited recourse. The servicing rights to these receivables have been retained by the company. Upon sale, the receivables are removed from the balance sheet, and a gain on sale is recognized for the difference between the carrying value of the receivables and the adjusted sales proceeds. The adjusted sales proceeds are based on a present value estimate of future cash flows to be received over the lives of the receivables. Future cash flows are based on estimates of prepayments, the impact of interest rate movements on yields of receivables sold and securities issued, delinquency of receivables sold, servicing fees, operating expenses and other factors. The resulting gain is adjusted by establishing a reserve for estimated probable losses under the recourse provisions. Gains on sale, recourse provisions and servicing cash flows on receivables sold are reported in the accompanying supplemental consolidated statements of income as securitization income. Unamortized securitization assets are reviewed for impairment whenever events indicate that the carrying value may not be recovered. Effective January 1, 1997, the company adopted Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("FAS No. 125"), which provides accounting and reporting standards for transfers and servicing of financial assets and extinguishment of liabilities based on a derecognition approach that focuses on control of the assets and extinguishment of the liabilities. The statement was effective for securitization transactions occurring subsequent to December 31, 1996. The adoption of FAS No. 125 did not have a material impact on the company's consolidated financial statements. PROPERTIES AND EQUIPMENT Properties and equipment, which include leasehold improvements, are recorded at cost, net of accumulated depreciation and amortization of $740.8 and $736.1 million at December 31, 1997 and 1996, respectively. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets for financial reporting purposes. Leasehold improvements are amortized over the lesser of the economic useful life of the improvement or the term of the lease. REPOSSESSED COLLATERAL Real estate owned is valued at the lower of cost or fair value less estimated costs to sell. These values are periodically reviewed and reduced, if appropriate. Costs of holding real estate, and related gains and losses on disposition, are credited or charged to operations as incurred. 43 44 Vehicles acquired for nonpayment of indebtedness are recorded at the lower of the estimated fair market value or the outstanding receivable balance. Such assets are generally sold within 60 days of repossession and any difference between the sales price, net of expenses, and the carrying value is credited or charged to operations as incurred. INSURANCE Insurance revenues on revolving credit insurance policies are recognized when billed. Insurance revenues on the remaining insurance contracts are recorded as unearned premiums and recognized into income based on the nature and term of the underlying contracts. Liabilities for credit insurance policies are based upon estimated settlement amounts for both reported and incurred but not yet reported losses. Liabilities for future benefits on annuity contracts and specialty and corporate owned life insurance products are based on actuarial assumptions as to investment yields, mortality and withdrawals. ACQUIRED INTANGIBLES AND GOODWILL Acquired intangibles consist of acquired credit card relationships which are amortized on a straight-line basis over their estimated remaining lives, not to exceed 10 years. Goodwill represents the purchase price over the fair value of identifiable assets acquired less liabilities assumed from business combinations and is amortized over 25 years on a straight-line basis. Goodwill is reviewed for impairment whenever events indicate that the carrying amount may not be recoverable. TREASURY STOCK The company accounts for repurchases of common stock using the cost method with common stock in treasury classified in the balance sheets as a reduction of common shareholders' equity. Treasury stock reissued is removed from the accounts at average cost. INTEREST RATE CONTRACTS The nature and composition of the company's assets and liabilities and off-balance sheet items expose the company to interest rate risk. The company enters into a variety of interest rate contracts for managing its interest rate exposure. Interest rate swaps are the principal vehicle used to manage interest rate risk; however, interest rate futures, options, caps and floors, and forward contracts also are utilized. The company also has entered into currency swaps to convert both principal and interest payments on debt issued from one currency to the appropriate functional currency. Interest rate swaps are designated, and effective, as synthetic alterations of specific assets or liabilities (or specific groups of assets or liabilities) and off-balance sheet items. The interest rate differential to be paid or received on these contracts is accrued and included in net interest margin in the statements of income. Interest rate futures, forwards, options, and caps and floors used in hedging the company's exposure to interest rate fluctuations are designated, and effective, as hedges of balance sheet items. Correlation between all interest rate contracts and the underlying asset, liability or off-balance sheet item is direct because the company uses interest rate contracts which mirror the underlying item being hedged/synthetically altered. If correlation between the hedged/synthetically altered item and related interest rate contract would cease to exist, the interest rate contract would be recorded at fair value and the associated unrealized gain or loss would be included in net interest margin, with any future realized and unrealized gains or losses recorded in other income. 44 45 Interest rate contracts are recorded at amortized cost. If interest rate contracts are terminated early, the realized gains and losses are deferred and amortized over the life of the hedged/synthetically altered item as adjustments to net interest margin. These deferred gains and losses are recorded on the accompanying supplemental consolidated balance sheets as adjustments to the carrying value of the hedged items. In circumstances where the underlying assets or liabilities are sold, any remaining carrying value adjustments or cumulative change in value on any open positions are recognized immediately as a component of the gain or loss upon disposition. Any remaining interest rate contracts previously designated to the sold hedged/synthetically altered item are recorded at fair value with realized and unrealized gains and losses included in other income. FOREIGN CURRENCY TRANSLATION Foreign subsidiary assets and liabilities are located in the United Kingdom and Canada. The functional currency for each subsidiary is its local currency. Assets and liabilities of these subsidiaries are translated at the rate of exchange in effect on the balance sheet date; income and expenses are translated at the average rate of exchange prevailing during the year. Resulting translation adjustments are accumulated as a separate component of common shareholders' equity. The company enters into forward exchange contracts to hedge its investment in foreign subsidiaries. After-tax gains and losses on contracts to hedge foreign currency fluctuations are included in the foreign currency translation adjustment in common shareholders' equity. Effects of foreign currency translation in the statements of cash flows are offset against the cumulative foreign currency adjustment, except for the impact on cash. Foreign currency transaction gains and losses are included in income as they occur. STOCK-BASED COMPENSATION The company accounts for stock option and stock purchase plans in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). In accordance with APB 25, no compensation expense is recognized for stock options issued. INCOME TAXES Federal income taxes are accounted for utilizing the liability method. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The company and its subsidiaries file a consolidated federal income tax return. Beneficial Corporation will be included in Household International's consolidated federal and state income tax returns for periods subsequent to the merger. Investment tax credits generated by leveraged leases are accounted for using the deferral method. 45 46 - -------------------------------------------------------------------------------- 2. HOUSEHOLD INTERNATIONAL MERGER WITH BENEFICIAL CORPORATION On June 30, 1998, Household International ("Household") merged with Beneficial Corporation ("Beneficial"), a consumer finance holding company headquartered in Wilmington, Delaware. Pursuant to the merger, each outstanding share of Beneficial common stock has been converted into 3.0666 shares of Household's common stock, resulting in the net issuance of approximately 167.3 million shares of common stock. Each share of Beneficial $5.50 Convertible Preferred Stock has been converted into the number of shares of Household common stock the holder thereof would have been entitled to receive in the merger had such holder converted such shares of Beneficial $5.50 Convertible Preferred Stock into shares of Beneficial common stock immediately prior to the merger. Additionally, each other share of preferred stock of Beneficial outstanding immediately prior to the merger has been converted into one share of a newly created series of preferred stock of Household with terms substantially similar to those of existing Beneficial preferred stock. The merger has been accounted for as a pooling of interests and therefore, these supplemental consolidated financial statements include the results of operations, financial position, and changes in cash flows of Beneficial for all periods. On March 31, 1998 Beneficial's total assets were $16.3 billion and common shareholders' equity was $1.9 billion. In connection with the merger, the company will incur pre-tax merger and integration related costs of approximately $1 billion ($751 million after-tax) in the quarter ended June 30, 1998. These costs include approximately $284 million in lease exit costs, $161 million in fixed asset write-offs related to closed facilities, $240 million in severance and change in control payments, $140 million in asset writedowns to reflect modified business plans, $66 million in investment banking fees, $34 million in legal and other expenses, and $75 million in prepayment premiums related to debt. The separate results of operations for Household and Beneficial were as follows:
In millions Year ended December 31, 1997 1996 1995 - -------------------------------------------------------------------------- Net interest margin and other revenues (1) Household $3,814.9 $3,309.1 $3,112.8 Beneficial 2,029.6 1,876.3 1,501.6 - -------------------------------------------------------------------------- Total $5,844.5 $5,185.4 $4,614.4 ========================================================================== Net Income Household $ 686.6 $ 538.6 $ 453.2 Beneficial 253.7 281.0 150.5 - -------------------------------------------------------------------------- Total $ 940.3 $ 819.6 $ 603.7 ========================================================================== (1) Policyholders' benefits have been netted against other revenues.
- -------------------------------------------------------------------------- 3. OTHER BUSINESS COMBINATIONS AND DIVESTITURES During the fourth quarter of 1997, Beneficial announced its intent to sell its German consumer banking operations and its Canadian consumer finance operations. An after-tax loss of $27.8 million was recorded after consideration of a $31.0 million tax benefit, primarily generated by the expected utilization of capital losses at December 31, 1997 to cover the expected loss associated with disposing of the German operations. On April 28, 1998, sale of the German operations was completed. No additional losses were realized as a result of the sale. 46 47 On March 2, 1998, the sale of Beneficial's Canadian operations was completed. An after-tax gain of $118.5 million was recorded upon consummation of the transaction. On June 23, 1997, Household International and a wholly-owned subsidiary of Household Finance Corporation (a wholly-owned subsidiary of Household International) acquired the capital stock of Transamerica Financial Services Holding Company ("TFS"), the branch-based consumer finance subsidiary of Transamerica Corporation ("TA"). The company paid $1.1 billion for the stock of TFS and repaid approximately $2.8 billion of TFS debt owed to affiliates of TA. The acquisition added approximately $3.2 billion of receivables, of which approximately $3.1 billion were home equity loans secured primarily by home mortgages. The acquisition of TFS was accounted for as a purchase, and accordingly, earnings from TFS' operations have been included in the company's results of operations from June 24, 1997. The acquisition of TFS was not material to the company's consolidated financial statements. In June 1997, the company completed a public underwritten offering of 27.3 million shares of its common stock for approximately $1.0 billion. Net proceeds from the offering were used to repay certain short-term borrowings in connection with the acquisition of TFS. On October 21, 1997, Household International and a wholly-owned subsidiary acquired the capital stock of ACC Consumer Finance Corporation ("ACC"), a non-prime auto finance company, for approximately 4.2 million shares of common stock and cash. The acquisition of ACC was accounted for as a purchase, and accordingly, earnings from ACC's operations have been included in the company's results of operations from October 22, 1997. The acquisition of ACC was not material to the company's consolidated financial statements. In December 1997, Beneficial acquired Endeavour Personal Finance Ltd., ("Endeavour") a consumer lending business in the United Kingdom for cash. The acquisition of Endeavour was accounted for as a purchase, and accordingly earnings from Endeavour's operations have been included in the company's results of operations from the acquisition date. The acquisition of Endeavour was not material to the company's consolidated financial statements. - -------------------------------------------------------------------------------- 4. INVESTMENT SECURITIES
In millions. At December 31 1997 1996 - -------------------------------------------------------------------------------- AVAILABLE-FOR-SALE INVESTMENTS Marketable equity securities $ 132.5 $ 213.7 Corporate debt securities 1,600.5 1,394.9 U.S. government and federal agency debt securities 380.5 425.1 Other 746.5 768.4 - -------------------------------------------------------------------------------- Subtotal 2,860.0 2,802.1 - -------------------------------------------------------------------------------- Accrued investment income 38.6 40.9 - -------------------------------------------------------------------------------- Total investment securities $2,898.6 $2,843.0 ================================================================================
Proceeds from the sale of available-for-sale investments totaled approximately $1.7, $4.1 and $3.2 billion in 1997, 1996 and 1995, respectively. Gross gains of $27.4, $50.5 and $22.4 million and gross losses of $3.3, $5.9 and $5.3 million in 1997, 1996 and 1995, respectively, were realized on those sales. 47 48 The gross unrealized gains (losses) of investment securities were as follows:
1997 1996 ------------------------------------------- -------------------------------------------- GROSS GROSS Gross Gross In millions. AMORTIZED UNREALIZED UNREALIZED FAIR Amortized Unrealized Unrealized Fair At December 31 COST GAINS LOSSES VALUE Cost Gains Losses Value - --------------------------------------------------------------------------------------------------------------------------- AVAILABLE-FOR-SALE INVESTMENTS Marketable equity securities $ 129.0 $ 3.7 $ (.2) $ 132.5 $ 213.3 $ 1.9 $ (1.5) $ 213.7 Corporate debt securities 1,581.8 36.9 (18.2) 1,600.5 1,403.9 22.3 (31.3) 1,394.9 U.S. government and federal agency debt securities 390.3 3.3 (13.1) 380.5 433.0 2.9 (10.8) 425.1 Other 745.8 .8 (.1) 746.5 767.9 .6 (.1) 768.4 - -------------------------------------------------------------------------------------------------------------------------- Total available-for-sale investments $2,846.9 $44.7 $(31.6) $2,860.0 $2,818.1 $27.7 $(43.7) $2,802.1 ==========================================================================================================================
See Note 13, "Fair Value of Financial Instruments," for further discussion of the relationship between the fair value of the company's assets, liabilities and off-balance sheet financial instruments. Contractual maturities of and yields on investments in debt securities were as follows:
All dollar amounts are U.S. Government and Federal stated in millions. Corporate Debt Securities Agency Debt Securities ------------------------------- ------------------------------- Amortized Fair Amortized Fair At December 31, 1997 Cost Value Yield* Cost Value Yield* - ---------------------------------------------------------------------------------------------------- Due within 1 year $ 178.9 $ 178.6 6.23% $ 30.7 $ 30.7 5.50% After 1 but within 5 years 187.1 189.4 6.88 79.5 81.1 6.63 After 5 but within 10 years 433.1 439.5 6.82 145.8 146.0 6.64 After 10 years 782.7 793.0 7.64 134.3 122.7 6.49 - ---------------------------------------------------------------------------------------------------- Total $1,581.8 $1,600.5 7.17% $390.3 $380.5 6.48% ====================================================================================================
* Computed by dividing annualized interest by the amortized cost of the respective investment securities. - -------------------------------------------------------------------------------- 5. RECEIVABLES
In millions. At December 31 1997 1996 - ------------------------------------------------------------------------------- First mortgage $ 396.6 $ 725.6 Home equity 13,786.2 9,535.2 Auto finance(1) 487.5 - MasterCard/Visa 6,874.7 9,378.5 Private label 9,356.9 9,735.5 Other unsecured 6,823.1 8,035.4 Commercial 957.0 1,037.3 - ----------------------------------------------------------------------------- Total owned receivables 38,682.0 38,447.5 Accrued finance charges 536.7 553.3 Credit loss reserve for owned receivables (1,642.1) (1,398.4) Unearned credit insurance premiums and claims reserves (228.4) (184.6) Amounts due and deferred from receivables sales 2,094.2 1,678.1 Reserve for receivables serviced with limited recourse (880.9) (710.6) - ---------------------------------------------------------------------------- Total owned receivables, net 38,561.5 38,385.3 Receivables serviced with limited recourse 24,478.5 20,851.2 - ----------------------------------------------------------------------------- Total managed receivables, net $63,040.0 $59,236.5 =============================================================================
(1) Prior to the fourth quarter of 1997, auto finance receivables were not significant and were included in other unsecured receivables. At December 31, 1997 net receivables relating to Beneficial's disposed Canadian and German operations were $775.1 million and $271.6 million, respectively. 48 49 Foreign receivables included in owned receivables were as follows:
UNITED KINGDOM CANADA GERMANY ----------------- ----------------- --------------- In millions. At December 31 1997 1996 1997 1996 1997 1996 - ------------------------------------------------------------------------------------ First mortgage $ 3.1 $ 3.7 $ 7.8 $ 22.1 Home equity 784.0 473.8 632.8 625.2 $ 20.9 $145.2 MasterCard/Visa 1,350.8 1,101.2 - - .5 - Private label 975.4 857.1 790.2 773.6 134.3 112.2 Other unsecured 1,133.2 969.2 617.9 568.6 53.3 131.7 Commercial - - 18.7 43.2 74.4 - - ------------------------------------------------------------------------------------ Total $4,246.5 $3,405.0 $2,067.4 $2,032.7 $283.4 $389.1 ====================================================================================
Foreign managed receivables represented 12 and 11 percent of total managed receivables at December 31, 1997 and 1996, respectively. The company has securitized certain receivables which it services with limited recourse. Securitizations of receivables, including replenishments of certificateholder interests, were as follows:
In millions. Year ended December 31 1997 1996 1995 - -------------------------------------------------------------------------------------- Home equity $ 1,920.4 $ 3,675.2 $ 2,239.0 MasterCard/Visa 23,439.6 22,828.3 20,181.2 Private label 2,270.2 697.4 644.0 Other unsecured 2,912.2 2,851.2 1,535.3 - -------------------------------------------------------------------------------------- Total $30,542.4 $30,052.1 $24,599.5 ======================================================================================
The outstanding balance of receivables serviced with limited recourse consisted of the following:
In millions. At December 31 1997 1996 - ------------------------------------------------------------------------------------------ Home equity $ 6,038.6 $ 6,662.3 Auto finance (1) 395.9 - MasterCard/Visa 12,337.0 10,149.7 Private label 1,025.0 517.0 Other unsecured 4,682.0 3,522.2 - ------------------------------------------------------------------------------------------ Total $24,478.5 $20,851.2 ==========================================================================================
(1) Auto finance receivables were previously securitized by ACC before its acquisition in October 1997. At December 31, 1997, the expected weighted average remaining life of these securitization transactions was 2.3 years. The combination of receivables owned and receivables serviced with limited recourse, which the company considers its managed portfolio, is shown below:
In millions. At December 31 1997 1996 - ----------------------------------------------------------------------------------------- First mortgage $ 396.6 $ 725.6 Home equity 19,824.8 16,197.5 Auto finance (1) 883.4 - MasterCard/Visa 19,211.7 19,528.2 Private label 10,381.9 10,252.5 Other unsecured 11,505.1 11,557.6 Commercial 957.0 1,037.3 - ------------------------------------------------------------------------------------------ Managed receivables $63,160.5 $59,298.7 ==========================================================================================
(1) Prior to the fourth quarter of 1997, auto finance receivables were not significant and were included in other unsecured receivables. 49 50 At December 31, 1997 and 1996, the amounts due and deferred from receivables sales of $2,094.2 and $1,678.1 million, respectively, included unamortized securitization assets and funds established pursuant to the recourse provisions for certain sales totaling $1,819.0 and $1,304.9 million, respectively. The amounts due and deferred also included customer payments not yet remitted by the securitization trustee to the company of $226.1 and $174.8 million at December 31, 1997 and 1996, respectively. The company made guarantees relating to certain securitizations of $90.2 million plus unpaid interest at December 31, 1996. The company made no such guarantees at December 31, 1997. The company has subordinated interests in certain transactions, which were recorded as receivables, of $1,098.1 and $485.0 million at December 31, 1997 and 1996, respectively. The company has agreements with a "AAA"-rated third party who will indemnify the company for up to $21.2 million in losses related to certain securitization transactions. The company maintains credit loss reserves pursuant to the recourse provisions for receivables serviced with limited recourse which are based on estimated probable losses under such provisions. These reserves totaled $880.9 and $710.6 million at December 31, 1997 and 1996, respectively, and represent the company's best estimate of probable losses on receivables serviced with limited recourse. The providers of the credit enhancements have no recourse to the company. The company maintains facilities with third parties which provide for the securitization of receivables on a revolving basis totaling $6.6 billion through the issuance of commercial paper. These facilities were fully utilized at December 31, 1997. The amount available under these facilities will vary based on the timing and volume of public securitization transactions. Contractual maturities of owned receivables were as follows:
In millions There- At December 31, 1997 1998 1999 2000 2001 2002 after Total - -------------------------------------------------------------------------------------------------- First mortgage $ 17.6 $ 3.3 $ 1.0 $ 1.5 $ 1.7 $ 371.5 $ 396.6 Home equity 3,359.4 2,222.6 1,786.3 1,551.8 1,347.4 3,518.7 13,786.2 Auto finance 79.8 94.2 106.5 110.0 84.1 12.9 487.5 MasterCard/Visa 1,108.7 680.8 550.3 478.2 408.7 3,648.0 6,874.7 Private label 3,522.1 1,044.2 703.8 506.7 454.9 3,125.2 9,356.9 Other unsecured 2,691.5 1,674.1 995.2 438.6 328.9 694.8 6,823.1 Commercial 221.3 101.7 55.4 68.1 44.7 465.8 957.0 - -------------------------------------------------------------------------------------------------- Total $11,000.4 $5,820.9 $4,198.5 $3,154.9 $2,670.4 $11,836.9 $38,682.0 ==================================================================================================
A substantial portion of consumer receivables, based on the company's experience, will be renewed or repaid prior to contractual maturity. The above maturity schedule should not be regarded as a forecast of future cash collections. The ratio of annual cash collections of principal to average principal balances, excluding MasterCard and Visa receivables, approximated 57 and 50 percent in 1997 and 1996, respectively. The following table summarizes contractual maturities of owned receivables due after one year by repricing characteristic:
Over 1 In millions. But Within Over At December 31, 1997 5 years 5 years - -------------------------------------------------------------------- Receivables at predetermined interest rates $ 9,119.4 $ 5,190.1 Receivables at floating or adjustable rates 8,522.0 5,385.6 - -------------------------------------------------------------------- Total $ 17,641.4 $10,575.7 ====================================================================
50 51 Nonaccrual owned consumer receivables totaled $907.8 and $688.8 million at December 31, 1997 and 1996, respectively, including $189.1 and $177.4 million, respectively, relating to foreign operations. Interest income that would have been recorded in 1997 and 1996 if such nonaccrual receivables had been current and in accordance with contractual terms was approximately $132.4 and $98.4 million, respectively, including $32.4 and $30.6 million, respectively, relating to foreign operations. Interest income that was included in net income for 1997 and 1996, prior to these loans being placed on nonaccrual status, was approximately $73.3 and $52.4 million, respectively, including $15.3 and $14.0 million, respectively, relating to foreign operations. For an analysis of reserves for credit losses, see our Supplemental Analysis of Credit Loss Reserves Activity on an owned and managed basis. - -------------------------------------------------------------------------------- 6. DEPOSITS
1997 1996 ---------------- ---------------- WEIGHTED Weighted All dollar amounts are stated in millions. AVERAGE Average At December 31 AMOUNT RATE Amount Rate - ---------------------------------------------------------------------------------- DOMESTIC Time certificates $ 936.7 6.9% $1,382.7 6.8% Savings accounts 181.6 4.5 212.8 4.4 Demand accounts 82.6 - 136.3 - - ----------------------------------------------------------------------------------- Total domestic deposits 1,200.9 6.0 1,731.8 6.0 - ----------------------------------------------------------------------------------- FOREIGN Time certificates 564.3 6.4 727.4 5.9 Savings accounts 474.1 6.5 428.3 5.9 Demand accounts 104.9 5.7 112.6 5.4 - ----------------------------------------------------------------------------------- Total foreign deposits 1,143.3 6.4 1,268.3 5.9 - ----------------------------------------------------------------------------------- Total deposits $2,344.2 6.2% $3,000.1 5.9% ====================================================================================
Average deposits and related weighted average interest rates for 1997, 1996 and 1995 were as follows:
1997 1996 1995 ------------------ ----------------- ----------------- All dollar amounts are WEIGHTED Weighted Weighted stated in millions. AVERAGE AVERAGE Average Average Average Average At December 31 DEPOSITS RATE Deposits Rate Deposits Rate - ------------------------------------------------------------------------------------------------ DOMESTIC Time certificates $1,167.1 6.8% $1,997.2 6.6% $3,107.2 6.2% Savings and demand accounts 617.3 1.4 1,305.5 2.3 2,805.7 3.0 - ------------------------------------------------------------------------------------------------ Total domestic deposits 1,784.4 4.9 3,302.7 4.9 5,912.9 4.6 - ------------------------------------------------------------------------------------------------ FOREIGN Time certificates 609.0 6.0 719.1 6.1 1,392.8 7.2 Savings and demand accounts 582.7 5.6 498.2 5.0 353.8 5.9 - ------------------------------------------------------------------------------------------------ Total foreign deposits 1,191.7 5.8 1,217.3 5.7 1,746.6 6.9 - ------------------------------------------------------------------------------------------------ Total deposits $2,976.1 5.3% $4,520.0 5.2% $7,659.5 5.1% ================================================================================================
Interest expense on deposits was $155.3, $235.2 and $404.5 million for 1997, 1996 and 1995, respectively. Interest expense on domestic deposits was $90.4, $167.1 and $275.3 million for 1997, 1996 and 1995, respectively. Maturities of time certificates in amounts of $100,000 or more were:
All dollar amounts are stated in millions. At December 31, 1997 Domestic Foreign Total - ------------------------------------------------------------------------------------------------- 3 months or less $13.0 $ 36.7 $ 49.7 Over 3 months through 6 months 4.3 2.0 6.3 Over 6 months through 12 months 4.8 5.6 10.4 Over 12 months 9.1 244.7 253.8 - ------------------------------------------------------------------------------------------------ Total $31.2 $289.0 $320.2 ================================================================================================
51 52 Contractual maturities of time certificates within each interest rate range were as follows:
All dollar amounts are stated in millions. There- At December 31, 1997 1998 1999 2000 2001 2002 after Total - ----------------------------------------------------------------------------------------------- INTEREST RATE < 4.00% $111.4 $ .9 - - - - $ 112.3 4.00% - 5.99% 158.2 73.6 $ 7.7 $ 12.0 $5.3 $ .6 257.4 6.00% - 7.99% 141.9 281.5 256.7 303.9 2.3 78.3 1,064.6 8.00% - 9.99% 4.4 7.4 54.5 - - .4 66.7 - ------------------------------------------------------------------------------------------------ Total $415.9 $363.4 $318.9 $315.9 $7.6 $79.3 $1,501.0 ================================================================================================
7. COMMERCIAL PAPER, BANK AND OTHER BORROWINGS
Bank and All dollar amounts are stated in millions. Commercial Other At December 31 Paper* Borrowings Total - --------------------------------------------------------------------------------------------- 1997 Balance $9,064.7 $1,601.4 $10,666.1 Highest aggregate month-end balance 11,654.6 Average borrowings 8,992.5 1,419.5 10,412.0 Weighted average interest rate: At year end 5.7% 7.5% 6.0% Paid during year 5.6 6.5 5.7 - ----------------------------------------------------------------------------------------------- 1996 Balance $9,114.1 $1,483.3 $10,597.4 Highest aggregate month-end balance 12,027.4 Average borrowings 8,743.7 1,584.1 10,327.8 Weighted average interest rate: At year end 5.4% 7.1% 5.6% Paid during year 5.4 7.0 5.7 - ----------------------------------------------------------------------------------------------- 1995 Balance $8,104.7 $2,578.6 $10,683.3 Highest aggregate month-end balance 10,863.6 Average borrowings 7,462.0 2,020.5 9,482.5 Weighted average interest rate: At year end 5.8% 6.9% 6.1% Paid during year 6.1 7.4 6.4 - -----------------------------------------------------------------------------------------------
* Included in outstanding balances at year-end 1997, 1996 and 1995 were commercial paper obligations of foreign subsidiaries of $958.4, $881.4 and $715.8 million, respectively. Interest expense for commercial paper, bank and other borrowings totaled $592.4, $584.4 and $603.4 million for 1997, 1996 and 1995, respectively. The company maintains various bank credit agreements primarily to support commercial paper borrowings. At December 31, 1997 and 1996, the company had committed back-up lines of $12.7 and $11.7 billion, respectively, including a $3 billion syndicated revolving credit agreement, of which $11.8 and $10.4 billion, respectively, were unused. Formal credit lines are reviewed annually, and expire at various dates from 1998 to 2004. Borrowings under these lines generally are available at a surcharge over LIBOR. Annual commitment fee requirements to support availability of these lines at December 31, 1997 totaled $10.1 million. 52 53 - ---------------------------------------------------------------------------- 8. SENIOR AND SENIOR SUBORDINATED DEBT (WITH ORIGINAL MATURITIES OVER ONE YEAR)
All dollar amounts are stated in millions. At December 31 1997 1996 - --------------------------------------------------------------------- SENIOR DEBT 3.50% to 6.49%; due 1998 to 2009 $ 2,529.0 $ 3,101.8 6.50% to 6.99%; due 1998 to 2013 3,421.1 2,441.7 7.00% to 7.49%; due 1998 to 2023 1,782.6 1,597.0 7.50% to 7.99%; due 1998 to 2012 1,612.7 1,817.9 8.00% to 8.99%; due 1998 to 2005 1,962.4 2,008.5 9.00% and greater; due 1998 to 2013 1,353.2 1,765.8 Variable interest rate debt; 3.85% to 9.00%; due 1998 to 2034 10,372.4 9,850.5 SENIOR SUBORDINATED DEBT 9.00% to 9.63%; due 2000 to 2001 685.0 685.0 10.25%; due 2003 20.0 75.0 PREFERRED STOCK OF SUBSIDIARY Household Finance Corporation 7.25% term cumulative preferred Series 1992-A - 100.0 Unamortized discount (2.2) (10.1) - --------------------------------------------------------------------- Total senior and senior subordinated debt $23,736.2 $23,433.1 =====================================================================
Weighted average coupon interest rates were 6.8 and 6.6 percent at December 31, 1997 and 1996, respectively. Interest expense for senior and senior subordinated debt was $1,610.7, $1,513.8 and $1,365.4 million for 1997, 1996 and 1995, respectively. The only financial covenants contained in the terms of the company's debt agreements are the maintenance of a minimum shareholders' equity of $2.0 billion for Household International, Inc., the maintenance of a minimum shareholder's equity of $1.5 billion for Household Finance Corporation ("HFC"), a wholly-owned subsidiary of the company, and a $1 billion net worth test for an HFC subsidiary. Maturities of senior and senior subordinated debt were:
In millions. At December 31, 1997 - ----------------------------------------------------------------------------- 1998 $ 4,627.5 1999 5,042.3 2000 3,049.4 2001 3,092.7 2002 2,454.7 Thereafter 5,469.6 - ----------------------------------------------------------------------------- Total $23,736.2 =============================================================================
On August 15, 1997, the company redeemed at par of $100 million, plus accrued and unpaid dividends, all outstanding shares of the 7.25 percent term cumulative preferred Series 1992-A of Household Finance Corporation. - ----------------------------------------------------------------------------- 9. DERIVATIVE FINANCIAL INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK In the normal course of business and in connection with its asset/liability management program, the company enters into various transactions involving derivative and other off-balance sheet financial instruments. These instruments primarily are used to manage the company's exposure to fluctuations in interest rates and foreign exchange rates. The company does not serve as a financial intermediary to make markets in any derivative financial instruments. For further information on the company's strategies for managing interest rate and foreign exchange rate risk, see the Risk Management section within the Supplemental Management's Discussion and Analysis of Financial Condition and Results of Operations. 53 54 The financial instruments used by the company include interest rate contracts and foreign exchange rate contracts and have varying degrees of credit risk and/or market risk. CREDIT RISK Credit risk is the possibility that a loss may occur because the counterparty to a transaction fails to perform according to the terms of the contract. The company's exposure to credit loss related to interest rate swaps, cap and floor transactions, forward and futures contracts and options is the amount of uncollected interest or premium related to these instruments. These interest rate related instruments are generally expressed in terms of notional principal or contract amounts which are much larger than the amounts potentially at risk for nonpayment by counterparties. The company controls the credit risk of its off-balance sheet financial instruments through established credit approvals, risk control limits and ongoing monitoring procedures. The company has never experienced nonperformance by any derivative instrument counterparty. MARKET RISK Market risk is the possibility that a change in interest rates or foreign exchange rates will cause a financial instrument to decrease in value or become more costly to settle. The company mitigates this risk by establishing limits for positions and other controls. INTEREST RATE AND FOREIGN EXCHANGE CONTRACTS The following table summarizes the activity in interest rate and foreign exchange contracts for 1997, 1996 and 1995: 54 55
Exchange Traded --------------------------------------------- Interest Rate Futures Contracts Options ----------------------- -------------------- In millions. Purchased Sold Purchased Written - --------------------------------------------------------------------------------------- HEDGING/SYNTHETIC ALTERATION INSTRUMENTS 1995 Notional amount, 1994 -- $ (96.0) -- -- New contracts $ 2,003.0 (2,100.0) $ 300.0 $ (300.0) Matured or expired contracts -- 293.0 -- -- Terminated contracts -- -- -- -- In-substance maturities (1) (1,653.0) 1,653.0 (300.0) 300.0 - --------------------------------------------------------------------------------------- NOTIONAL AMOUNT, 1995 $ 350.0 $ (250.0) -- -- ======================================================================================= Fair value, 1995 (2) $ .1 -- -- -- - --------------------------------------------------------------------------------------- 1996 Notional amount, 1995 $ 350.0 $ (250.0) -- -- New contracts 6,611.9 (4,202.9) $ 440.0 $ (440.0) Matured or expired contracts (1,471.0) 300.0 -- -- Terminated contracts -- -- -- -- In-substance maturities (1) (4,152.9) 4,152.9 (440.0) 440.0 - --------------------------------------------------------------------------------------- NOTIONAL AMOUNT, 1996 $ 1,338.0 -- -- -- ======================================================================================= Fair value, 1996 (2) -- -- -- -- - --------------------------------------------------------------------------------------- 1997 Notional amount, 1996 $ 1,338.0 -- -- -- New contracts 8,584.0 $(7,350.0) -- -- Matured or expired contracts (2,020.0) 120.0 -- -- Terminated contracts -- -- -- -- In-substance maturities (1) (7,030.0) 7,030.0 -- -- - --------------------------------------------------------------------------------------- NOTIONAL AMOUNT, 1997 $ 872.0 $ (200.0) -- -- ======================================================================================= Fair value, 1997 (2) $ -- $ -- -- -- - --------------------------------------------------------------------------------------- Non-Exchange Traded - ------------------------------------------------------------------------------------------------------------------------------------ Foreign Exchange Interest Rate Rate Contracts Forward Contracts Other Risk Interest Currency --------------------- --------------------- Management In millions. Rate Swaps Swaps Purchased Sold Purchased Sold Instruments - ------------------------------------------------------------------------------------------------------------------------------------ HEDGING/SYNTHETIC ALTERATION INSTRUMENTS 1995 Notional amount, 1994 $19,605.6 $ 1,158.8 $ 530.6 $(1,319.5) $ 936.1 $ (140.8) $ 613.9 New contracts 3,312.5 152.6 5,029.5 (5,426.7) 1,887.2 (173.7) 180.4 Matured or expired contracts (7,069.3) (231.0) (1,245.3) 1,510.8 (1,840.4) 167.9 (351.4) Terminated contracts (4,983.7) -- (545.0) 553.1 (255.9) 53.5 -- In-substance maturities (1) -- -- (3,345.3) 3,477.1 -- -- -- - ------------------------------------------------------------------------------------------------------------------------------------ NOTIONAL AMOUNT, 1995 $10,865.1 $ 1,080.4 $ 424.5 $(1,205.2) $ 727.0 $ (93.1) $ 442.9 ==================================================================================================================================== Fair value, 1995 (2) $ 124.7 $ 63.5 $ 4.2 $ 1.7 $ (1.0) -- $ 2.2 - ------------------------------------------------------------------------------------------------------------------------------------ 1996 Notional amount, 1995 $10,865.1 $ 1,080.4 $ 424.5 $(1,205.2) $ 727.0 $ (93.1) $ 442.9 New contracts 5,379.8 1,494.5 5,723.6 (6,150.0) 3,641.8 (1,036.0) 2,242.2 Matured or expired contracts (3,779.8) (117.0) (894.1) 1,319.1 (2,636.9) 859.9 (8.9) Terminated contracts (1,690.5) -- (391.6) 391.6 -- -- -- In-substance maturities (1) -- -- (4,692.7) 4,692.7 -- -- -- - ------------------------------------------------------------------------------------------------------------------------------------ NOTIONAL AMOUNT, 1996 $10,774.6 $ 2,457.9 $ 169.7 $ (951.8) $ 1,731.9 $ (269.2) $ 2,676.2 ==================================================================================================================================== Fair value, 1996 (2) $ 50.5 $ (156.1) $ (.1) $ (57.0) $ (1.2) $ .2 $ 24.6 - ----------------------------------------------------------------------------------------------------------------------- ------------ 1997 Notional amount, 1996 $10,774.6 $ 2,457.9 $ 169.7 $ (951.8) $ 1,731.9 $ (269.2) $ 2,676.2 New contracts 3,854.0 988.5 4,256.6 (4,548.5) 6,055.8 (1,326.3) 372.4 Matured or expired contracts (3,168.3) (397.3) (652.6) 843.4 (4,477.7) 1,489.5 (495.9) Terminated contracts (1,175.9) (205.4) (95.6) 95.6 -- -- (85.3) In-substance maturities (1) -- -- (3,242.2) 3,242.2 -- -- -- - ------------------------------------------------------------------------------------------------------------------------------------ NOTIONAL AMOUNT, 1997 $10,284.4 $ 2,843.7 $ 435.9 $(1,319.1) $ 3,310.0 $ (106.0) $ 2,467.4 ==================================================================================================================================== Fair value, 1997 (2) $ 152.4 $ (126.0) $ 4.5 $ (6.4) $ 1.7 $ -- $ 11.3 - ------------------------------------------------------------------------------------------------------------------------------------
(1) Represent contracts terminated as the market execution technique of closing the transaction either (a) just prior to maturity to avoid delivery of the underlying instrument, or (b) at the maturity of the underlying items being hedged. (2) (Bracketed) unbracketed amounts represent amounts to be (paid) received by the company had these positions been closed out at the respective balance sheet date. Bracketed amounts do not necessarily represent risk of loss for hedging instruments, as the fair value of the hedging instrument and the items being hedged must be evaluated together. See Note 13, "Fair Value of Financial Instruments" for further discussion of the relationship between the fair value of the company's assets, liabilities and off-balance sheet financial instruments. The company operates in three functional currencies, the US dollar, the British pound and the Canadian dollar. Of the above instruments the US dollar is the functional currency for exchange traded interest rate futures and options. The remaining instruments are restated in US dollars by country as follows:
Interest Foreign Exchange Interest Rate Other Risk Rate Currency Forward Contracts Forward Contracts Management In millions. Swaps Swaps Purchased Sold Purchased Sold Instruments - ---------------------------------------------------------------------------------------------------------------- 1995 United States $ 9,516.6 $ 207.7 $424.5 $ (1,203.2) - - $ 100.0 Canada 415.6 295.1 - (2.0) $ 606.8 - 38.1 United Kingdom 932.9 577.6 - - 120.2 $ (93.1) 304.8 - ---------------------------------------------------------------------------------------------------------------- $10,865.1 $1,080.4 $424.5 $ (1,205.2) $ 727.0 $ (93.1) $ 442.9 ============================================================================================================== 1996 United States $ 9,519.5 $1,128.5 $169.7 $ (951.8) - - $1,350.0 Canada 518.1 450.1 - - $ 472.1 $(252.1) 135.0 United Kingdom 737.0 879.3 - - 1,259.8 (17.0) 1,191.2 - ---------------------------------------------------------------------------------------------------------------- $10,774.6 $2,457.9 $169.7 $ (951.8) $1,731.9 $(269.2) $2,676.2 ================================================================================================================ 1997 United States $ 8,883.5 $1,762.1 $435.9 $ (1,319.1) - - $1,350.0 Canada 361.6 427.3 - - $ 447.5 $(106.0) 7.0 United Kingdom 1,039.3 654.3 - - 2,862.5 - 1,110.4 - ---------------------------------------------------------------------------------------------------------------- $10,284.4 $2,843.7 $435.9 $ (1,319.1) $3,310.0 $(106.0) $2,467.4 ================================================================================================================
55 56 Interest rate swaps are contractual agreements between two counterparties for the exchange of periodic interest payments generally based on a notional principal amount and agreed-upon fixed or floating rates. The company primarily enters into interest rate swap transactions to synthetically alter balance sheet items. These transactions are specifically designated to a particular asset/liability, off-balance sheet item or anticipated transaction of a similar characteristic. Specific assets or liabilities may consist of groups of individually small dollar homogeneous assets or liabilities of similar economic characteristics. Credit and market risk exists with respect to these instruments. The following table reflects the items so altered at December 31, 1997:
In millions. - --------------------------------------------------------------------------------------------- Investment securities $ 70.7 Receivables: Home equity 775.0 MasterCard/Visa 550.0 Private label 20.3 Other unsecured 19.3 - --------------------------------------------------------------------------------------------- Total owned receivables 1,364.6 Deposits 150.0 Commercial paper, bank and other borrowings 2,816.2 Senior and senior subordinated debt 5,849.5 Receivables serviced with limited recourse 33.4 - --------------------------------------------------------------------------------------------- Total items synthetically altered with interest rate swaps $10,284.4 ============================================================================================= Note: In all instances, the notional amount is not greater than the carrying value of the related asset/liability or off-balance sheet item.
The company manages its exposure to interest rate risk primarily through the use of interest rate swaps. These swaps synthetically alter the interest rate risk inherent in balance sheet assets, liabilities or off-balance sheet items. The majority of the company's interest rate swaps are used to convert floating rate assets to fixed rate, fixed rate debt to floating rate, floating rate assets or debt from one floating rate index to another, fixed rate assets to a floating rate, or floating rate debt to fixed rate. Interest rate swaps also are used to synthetically alter interest rate characteristics on certain receivables that are sold and serviced with limited recourse. These off-balance sheet items expose the company to the same interest rate risk as on-balance sheet items. Interest rate swaps are used to synthetically alter the interest rate provisions of the securitization transaction whereby the underlying receivables pay a fixed (floating) rate and the pass-through rate to the investor is floating (fixed). The company also has entered into currency swaps to convert both principal and interest payments on debt issued from one currency to the appropriate functional currency. 56 57 The following table summarizes the maturities and related weighted average receive/pay rates of interest rate swaps outstanding at December 31, 1997:
All dollar amounts are stated in millions. 1998 1999 2000 2001 2002 2003 Thereafter Total - ----------------------------------------------------------------------------------------------------------------------- Pay a fixed rate/receive a floating rate: Notional value $ 756.8 $ 773.3 $ 565.1 $ 214.6 $181.7 - - $ 2,491.5 Weighted average receive rate 6.00% 6.20% 7.20% 7.51% 7.54 - - 6.57% Weighted average pay rate 6.67 6.90 7.22 7.41 7.07 - - 6.96 Pay a floating rate/receive a fixed rate: Notional value $ 667.9 $ 313.9 $ 375.6 $ 881.8 $315.9 $ 430.0 $1,927.8 $ 4,912.9 Weighted average receive rate 6.72% 7.04% 6.47% 6.59% 6.42% 6.68% 6.93% 6.76% Weighted average pay rate 5.92 5.60 5.47 5.69 5.78 5.93 5.93 5.82 Pay a floating rate/receive a different floating rate: Notional value $ 980.0 $1,598.0 $ 237.0 $ 55.0 $ 10.0 - - $ 2,880.0 Weighted average receive rate 5.70% 6.02% 5.85% 6.05% 6.50% - - 5.90% Weighted average pay rate 5.88 5.96 5.91 6.02 5.81 - - 5.93 - ----------------------------------------------------------------------------------------------------------------------- Total notional value $2,404.7 $2,685.2 $1,177.7 $1,151.4 $507.6 $ 430.0 $1,927.8 $10,284.4 ======================================================================================================================= Total weighted average rates on swaps: Receive rate 6.08% 6.11% 6.38% 6.73% 7.05% 6.74% 6.93% 6.45% - ----------------------------------------------------------------------------------------------------------------------- Pay rate 6.06 6.23 6.40 6.26 6.52 5.97 5.93 6.14 - -----------------------------------------------------------------------------------------------------------------------
The floating rates paid or received by the company are based on spot rates from independent market sources for the index contained in each interest rate swap contract, which generally are based on either 1-, 3- or 6-month LIBOR. These current floating rates are different than the floating rates in effect when the contracts were initiated. Changes in spot rates impact the variable rate information disclosed above. However, these changes in spot rates also impact the interest rate on the underlying assets or liabilities. Hedging/synthetic alteration instruments are used by the company to manage the volatility of net interest margin resulting from changes in interest rates on the underlying hedged/synthetically altered items. Owned net interest margin would have declined by 9 and 14 basis points in 1997 and 1996, respectively, had these instruments not been utilized. These instruments did not impact owned net interest margin in 1995. Forwards and futures are agreements between two parties, committing one to sell and the other to buy a specific quantity of an instrument on some future date. The parties agree to buy or sell at a specified price in the future, and their profit or loss is determined by the difference between the arranged price and the level of the spot price when the contract is settled. The company has both interest rate and foreign exchange rate forward contracts and interest rate futures contracts. Foreign exchange contracts are utilized by the company to reduce its exposure to foreign currency exchange risk. Interest rate forward and futures contracts are used to hedge resets of interest rates on the company's floating rate assets and liabilities. The company's exposure to credit risk for futures is limited, as these contracts are traded on organized exchanges. Each day, changes in contract values are settled in cash. In contrast, forward contracts have credit risk relating to the performance of the counterparty. These instruments also are subject to market risk. Cash requirements for forward contracts include the receipt or payment of cash upon the sale or purchase of the instrument. 57 58 Purchased options grant the purchaser the right, but not the obligation, to either purchase or sell a financial instrument at a specified price within a specified period. The seller of the option has written a contract which creates an obligation to either sell or purchase the financial instrument at the agreed-upon price if, and when, the purchaser exercises the option. Other risk management instruments consist of caps and floors. Caps and floors written expose the company to market risk but not to credit risk. Market risk associated with caps and floors purchased is limited to the premium paid which is recorded on the balance sheets in other assets. Deferred gains of $41.8 and $45.8 million and deferred losses of $4.1 and $13.0 million from hedging/synthetic alteration instruments were recorded on the balance sheets at December 31, 1997 and 1996, respectively. The weighted average amortization period associated with the deferred gains was 5.1 and 6.6 years at December 31, 1997 and 1996, respectively. The weighted average amortization period for the deferred losses was 1.3 and 1.5 years at December 31, 1997 and 1996, respectively. At December 31, 1997 and 1996, the accrued interest, unamortized premium and other assets recorded for agreements which would be written off should all related counterparties fail to meet the terms of their contracts was $65.4 and $53.3 million, respectively. CONCENTRATIONS OF CREDIT RISK A concentration of credit risk is defined as a significant credit exposure with an individual or group engaged in similar activities or affected similarly by economic conditions. Because the company primarily lends to consumers, it does not have receivables from any industry group that equal or exceed 10 percent of total managed receivables at December 31, 1997 and 1996. The company lends nationwide, with the following geographic areas comprising more than 10 percent of total managed domestic receivables at December 31, 1997: California -20 percent; Midwest (IL, IN, IA, KS, MI, MN, MO, NE, ND, OH, SD, WI) -23 percent; Middle Atlantic (DE, DC, MD, NJ, PA, VA, WV) -14 percent; Northeast (CT, ME, MA, NH, NY, RI, VT) - -12 percent; and Southeast (AL, FL, GA, KY, MS, NC, SC, TN) -15 percent. - -------------------------------------------------------------------------------- 10. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUSTS In June 1996 Household Capital Trust II ("HCT II"), a wholly-owned subsidiary of the company, issued 4 million 8.70 percent Trust Preferred Securities ("preferred securities") at $25 per preferred security. The sole asset of HCT II is $103.1 million of 8.70 percent Junior Subordinated Deferrable Interest Notes issued by the company. The junior subordinated notes held by HCT II mature on June 30, 2036 and are redeemable by the company in whole or in part beginning on June 30, 2001, at which time the HCT II preferred securities are callable. Net proceeds from the issuance of preferred securities were used for general corporate purposes. 58 59 In June 1995 Household Capital Trust I ("HCT I"), a wholly-owned subsidiary of the company, issued 3 million 8.25 percent preferred securities at $25 per preferred security. The sole asset of HCT I is $77.3 million of 8.25 percent Junior Subordinated Deferrable Interest Notes issued by the company. The junior subordinated notes held by HCT I mature on June 30, 2025 and are redeemable by the company in whole or in part beginning on June 30, 2000, at which time the HCT I preferred securities are callable. HCT I may elect to extend the maturity of the preferred securities to June 30, 2044. The obligations of the company with respect to the junior subordinated notes, when considered together with certain undertakings of the company with respect to HCT I and HCT II, constitute full and unconditional guarantees by the company of HCT I's and HCT II's obligations under the respective preferred securities. The preferred securities are classified in the company's balance sheets as company obligated mandatorily redeemable preferred securities of subsidiary trusts (representing the minority interest in the trusts) at their face and redemption amount of $175 million at December 31, 1997 and 1996. The preferred securities have a liquidation value of $25 per preferred security. Dividends on the preferred securities are cumulative, payable quarterly in arrears and are deferrable at the company's option for up to five years from date of issuance. The company cannot pay dividends on its preferred and common stocks during such deferments. Dividends on the preferred securities have been classified as interest expense in the statements of income. - -------------------------------------------------------------------------------- 11. PREFERRED STOCK
All dollar amounts are stated in millions. At December 31 1997 1996 - ----------------------------------------------------------------------------------------------------------- $4.30 Preferred Stock, 836,585 shares $ 83.7 $ 83.7 $4.50 Preferred Stock, 103,976 shares 10.4 10.4 5.00% Preferred Stock, 407,718 shares 20.4 20.4 7.35% Preferred Stock, Series 1993-A, 4,000,000 depositary shares (1) 100.0 100.0 8.25% Preferred Stock, Series 1992-A, 2,000,000 depositary shares (1) 50.0 50.0 9.50% Preferred Stock, Series 1991-A, 5,500,000 depositary shares (2) - 55.0 - ----------------------------------------------------------------------------------------------------------- Total preferred stock $264.5 $319.5 ===========================================================================================================
(1) Depositary share represents 1/40 share of preferred stock. (2) Depositary share represents 1/10 share of preferred stock. Dividends on the $4.30 preferred stock are cumulative and payable semiannually. The company may, at its option, redeem in whole or in part the $4.30 preferred stock for $100 per share plus accrued and unpaid dividends. This stock has a liquidation value of $100 per share plus accrued and unpaid dividends in the event of an involuntary liquidation or $100 in the event of a voluntary liquidation. Dividends on the $4.50 preferred stock are cumulative and payable semiannually. The company may, at its option, redeem in whole or in part the $4.50 preferred stock for $103 per share plus accrued and unpaid dividends. This stock has a liquidation value of $100 per share. Dividends on the 5.00 percent preferred stock are cumulative and payable semiannually. The company may, at its option, redeem in whole or in part the 5.00 percent preferred stock for $50 per share plus accrued and unpaid dividends. This stock has a liquidation value of $50 per share. 59 60 Dividends on the 7.35 percent preferred stock, Series 1993-A, are cumulative and payable quarterly. The company may, at its option, redeem in whole or in part the 7.35 percent preferred stock, Series 1993-A, on any date after October 15, 1998 for $25 per depositary share plus accrued and unpaid dividends. This stock has a liquidation value of $1,000 per share. Dividends on the 8.25 percent preferred stock, Series 1992-A, are cumulative and payable quarterly. The company may, at its option, redeem in whole or in part the 8.25 percent preferred stock, Series 1992-A, on any date after October 15, 2002 for $25 per depositary share plus accrued and unpaid dividends. This stock has a liquidation value of $1,000 per share. Holders of all issues of preferred stock are entitled to payment before any capital distribution is made to common shareholders. All issues of preferred shares are nonvoting except for the $4.30 preferred, $4.50 preferred and 5% preferred stock classes. Holders of these voting classes of preferred stock will be entitled to vote as a separate class to elect two directors if the equivalent of three or more semiannual dividends shall be in arrears, until the dividends in arrears are paid in full. On January 23, 1997, the company redeemed, at par, all outstanding shares of its 9.50 percent $55 million preferred stock, Series 1991-A, for $10 per depositary share, plus accrued and unpaid dividends. The company's Board of Directors has adopted a resolution creating an Offering Committee of the Board with the power to authorize the issuance and sale of one or more series of preferred stock. The Offering Committee has the authority to determine the particular designations, powers, preferences and relative, participating, optional or other special rights (other than voting rights which shall be fixed by the Board of Directors) and qualifications, limitations or restrictions of such issuance. At December 31, 1997, up to $4.3 million shares of preferred stock were authorized for issuance. - -------------------------------------------------------------------------------- 12. JUNIOR PREFERRED SHARE PURCHASE RIGHTS In 1996, the company issued one preferred share purchase right (a "Right") for each outstanding share of common stock of the company. Under certain conditions, each Right may be exercised to purchase one three-thousandth of a share of a new series of junior participating preferred stock at an exercise price of $100 per one three-thousandth of a share, subject to further adjustment. The Rights may be exercised only after the earlier of: (a) a public announcement that a party or an associated group acquired 15 percent or more of the company's common stock and (b) ten business days (or later date as determined by the Board of Directors of the company) after a party or an associated group initiates or announces its intention to make an offer to acquire 15 percent or more of the company's common stock. The Rights, which cannot vote or receive dividends, expire on July 31, 2006 and may be redeemed by the company at a price of $.0033 per Right at any time prior to expiration or acquisition of 15 percent of the company's common stock. 60 61 - -------------------------------------------------------------------------------- 13. FAIR VALUE OF FINANCIAL INSTRUMENTS The company has estimated the fair value of its financial instruments in accordance with Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments" ("FAS No. 107"). Fair value estimates, methods and assumptions set forth below for the company's financial instruments are made solely to comply with the requirements of FAS No. 107 and should be read in conjunction with the financial statements and notes in this Annual Report. For a significant portion of the company's financial instruments, fair values for items lacking a quoted market price were estimated by discounting estimated future cash flows at estimated current market discount rates. Assumptions used to estimate future cash flows are consistent with management's assessments regarding ultimate collectibility of assets and related interest and with estimates of product lives and repricing characteristics used in the company's asset/liability management process. All assumptions are based on historical experience adjusted for future expectations. Assumptions used to determine fair values for financial instruments for which no active market exists are inherently judgmental, and changes in these assumptions could significantly affect fair value calculations. As required under generally accepted accounting principles, a number of other assets recorded on the balance sheets (such as acquired credit card relationships) and other intangible assets not recorded on the balance sheets (such as the value of consumer lending relationships for originated receivables and the franchise values of the company's business units) are not considered financial instruments and, accordingly, are not valued for purposes of this disclosure. The company believes there is substantial value associated with these assets based on current market conditions and historical experience. Accordingly, the estimated fair value of financial instruments, as disclosed, does not fully represent the entire value, nor the changes in the entire value, of the company. The following is a summary of the carrying value and estimated fair value of the company's financial instruments:
1997 1996 ------------------------------- ------------------------------- ESTIMATED Estimated In millions. CARRYING FAIR Carrying Fair At December 31 VALUE VALUE DIFFERENCE Value Value Difference - ----------------------------------------------------------------------------------------------------- Cash $ 534 $ 534 - $ 519 $ 519 - Investment securities 2,899 2,899 - 2,843 2,843 - Receivables 38,562 39,856 $ 1,294 38,386 39,823 $1,437 - ----------------------------------------------------------------------------------------------------- Subtotal 41,995 43,289 1,294 41,748 43,185 1,437 - ----------------------------------------------------------------------------------------------------- Deposits (2,344) (2,351) (7) (3,000) (3,016) (16) Commercial paper, bank and other borrowings (10,666) (10,666) - (10,597) (10,597) - Senior and senior subordinated debt (23,736) (24,125) (389) (23,433) (23,834) (401) Insurance reserves (2,394) (2,623) (229) (2,472) (2,689) (217) - ----------------------------------------------------------------------------------------------------- Subtotal (39,140) (39,765) (625) (39,502) (40,136) (634) - ----------------------------------------------------------------------------------------------------- Interest rate and foreign exchange contracts 41 38 (3) 38 (139) (177) Commitments to extend credit and guarantees - 50 50 - 40 40 - ----------------------------------------------------------------------------------------------------- Subtotal 41 88 47 38 (99) (137) - ----------------------------------------------------------------------------------------------------- Total $ 2,896 $ 3,612 $ 716 $ 2,284 $ 2,950 $ 666 =====================================================================================================
61 62 The following methods and assumptions were used to estimate the fair value of the company's financial instruments: Cash: The carrying value approximates fair value for this instrument due to its liquid nature. Investment securities: Investment securities are classified as available-for-sale and are carried at fair value on the balance sheets. Receivables: The fair value of adjustable rate consumer receivables was determined to approximate existing carrying value because interest rates on these receivables adjust with changing market interest rates. The fair value of fixed rate consumer receivables was estimated by discounting future expected cash flows at interest rates approximating those offered by the company on such products at the respective valuation dates. This approach to estimating fair value for fixed rate receivables results in a disclosed fair value that is less than amounts the company believes could be currently realizable on a sale of these receivables. These receivables are relatively insensitive to changes in overall market interest rates and, therefore, have additional value compared to alternative uses of funds. The fair value of commercial receivables was determined by discounting estimated future cash flows at estimated market interest rates. The fair value of consumer receivables also included an estimate, on a present value basis, of cash flows associated with securitizations of certain home equity, auto finance, MasterCard and Visa, private label and other unsecured receivables. Deposits: The fair value of the company's savings and demand accounts equaled the carrying amount as stipulated in FAS No. 107. The fair value of fixed rate time certificates was estimated by discounting future expected cash flows at interest rates offered by the company on such products at the respective valuation dates. Commercial paper, bank and other borrowings: The fair value of these instruments was determined to approximate existing carrying value because interest rates on these instruments adjust with changes in market interest rates due to their short-term maturity or repricing characteristics. Senior and senior subordinated debt: The estimated fair value of these instruments was computed by discounting future expected cash flows at interest rates offered for similar types of debt instruments. Insurance reserves: The fair value of insurance reserves for periodic payment annuities was estimated by discounting future expected cash flows at estimated market interest rates at December 31, 1997 and 1996. The fair value of other insurance reserves is not required to be determined in accordance with FAS No. 107. Interest rate and foreign exchange contracts: Where practical, quoted market prices were used to determine fair value of these instruments. For non-exchange traded contracts, fair value was determined through the use of accepted and established valuation methods (including input from independent third parties) which consider the terms of the contracts and market expectations on the valuation date for forward interest rates (for interest rate contracts) or forward foreign currency exchange rates (for foreign exchange contracts). See Note 8, "Derivative Financial Instruments and Other Financial Instruments with Off-Balance Sheet Risk," for a discussion of the nature of these items. 62 63 Commitments to extend credit and guarantees: These commitments were valued by considering the company's relationship with the counterparty, the creditworthiness of the counterparty and the difference between committed and current interest rates. - -------------------------------------------------------------------------------- 14. LEASES The company leases certain offices, buildings and equipment for periods of up to 47 years with various renewal options. The office space leases generally require the company to pay certain operating expenses. The majority of the company's leases are noncancelable operating leases. Net rental expense under operating leases was $135.5, $122.5 and $123.3 million for 1997, 1996 and 1995, respectively. Future net minimum lease commitments under noncancelable operating lease arrangements were:
In millions. At December 31, 1997 - -------------------------------------------------------------------------------- 1998 $126.0 1999 105.4 2000 84.8 2001 68.4 2002 59.2 Thereafter 387.0 - -------------------------------------------------------------------------------- Net minimum lease commitments $830.8 ================================================================================
- -------------------------------------------------------------------------------- 15. INCENTIVE COMPENSATION AND STOCK OPTION PLANS The company's executive compensation plans provide for issuance of nonqualified stock options and restricted stock rights (RSRs). Stock options permit the holder to purchase, under certain limitations, the company's common stock at a price not less than 100 percent of the market value of the stock on the date the option is granted. Employee stock options vest equally over four years and expire 10 years from the date of grant. An equity participation plan was adopted in 1997 by Beneficial that provides for grants of options to each eligible employee. Under the plan, the option price is 120% of the fair market value on the date the option is granted. Options are fully exercisable when granted and expire after 10 years. This plan has been terminated effective with the merger of Household and Beneficial. Beginning in 1997, non-employee directors annually receive an option to purchase 7,500 shares of the company's common stock at the stock's fair market value the day the option is granted. The first option grant was made in November 1997. Prior to this, directors received an annual grant of 7,500 options each May ending with the May 1997 grant. Director options have a term of ten years and one day, fully vest six months from the date granted, and once vested are exercisable at any time during the option term. 63 64 Common stock data for the stock option plans is summarized as follows:
1997 1996 1995 ---------------------- ---------------------- ---------------------- PRICE PER Price per Price per SHARES SHARE Shares Share Shares Share - --------------------------------------------------------------------------------------------------- Outstanding at beginning of year 23,779,041 $14.81 23,480,063 $12.13 21,948,509 $10.13 Granted 11,362,485 29.03 4,736,971 24.04 7,247,802 16.01 Exercised (3,081,428) 11.35 (3,926,067) 10.11 (4,492,053) 8.83 Expired or canceled (1,893,621) 23.49 (511,926) 13.43 (1,224,195) 11.30 - --------------------------------------------------------------------------------------------------- Outstanding at end of year 30,166,477 $19.90 23,779,041 $14.81 23,480,063 $12.13 =================================================================================================== Exercisable at end of year 17,870,085 $17.24 11,254,478 $11.09 9,651,033 $ 9.37 =================================================================================================== Weighted average fair value of options granted $10.82 $10.55 $ 5.84 ===================================================================================================
The following table summarizes information about stock options outstanding at December 31, 1997:
Options Outstanding Options Exercisable ----------------------------------------------------- ----------------------------------- Number Number Range of Outstanding at Weighted Average Weighted Average Outstanding at Weighted Average Exercise Prices December 31, 1997 Remaining Life Exercise Price December 31, 1997 Exercise Price - --------------- ----------------- ---------------- ---------------- ----------------- ---------------- $5.90-$15.81 11,940,966 5.7 years $11.29 10,071,659 $11.01 $16.92-$39.06 18,225,511 9.2 years $25.55 7,798,426 $25.29
RSRs entitle an employee to receive a stated number of shares of the company's common stock if the employee satisfies the conditions set by the Compensation Committee for the award. Household maintains an Employee Stock Purchase Plan (the "ESPP"). The ESPP provides a means for employees to purchase shares of the company's common stock at 85% of the lesser of its market price at the beginning or end of a one year subscription period. Beneficial previously maintained an Employee Stock Purchase Plan ("BESPP") whereby participants could elect to purchase stock subject to certain limitations. Employee stock purchases were eligible to be matched by Beneficial up to certain amounts and vested over a three year period. This plan has been terminated effective with the merger of Household and Beneficial. The company accounts for options and shares issued under the ESPP in accordance with APB 25, pursuant to which no compensation cost has been recognized. Under the BESPP, compensation cost on matching contributions was recognized. Had compensation cost been determined consistent with FAS No. 123, the company's net income and earnings per share, on a pro forma basis, would have been as follows:
In millions, except per share data. 1997 1996 1995 --------------- --------------- --------------- Year ended December 31 DILUTED BASIC Diluted Basic Diluted Basic - ---------------------------------------------------------------------------------------------- Earnings available to common shareholders: As Reported $923.4 $923.4 $797.8 $797.8 $572.2 $572.2 Pro Forma 902.9 902.9 789.6 789.6 569.6 569.6 Earnings per share: As Reported $ 1.93 $ 1.97 $ 1.73 $ 1.76 $ 1.24 $ 1.26 Pro Forma 1.88 1.92 1.71 1.74 1.23 1.25 - ----------------------------------------------------------------------------------------------
The compensation expense recognized in pro forma net income for 1997, 1996 and 1995 may not be representative of the effects on pro forma net income for future years. 64 65 The fair value of each option granted was estimated as of the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for 1997, 1996 and 1995 grants:
1997 1996 1995 - -------------------------------------------------------------------------------- Risk free interest rate 5.86% 6.03% 6.77% Expected dividend yield 1.45 1.55 1.59 Expected life 5 YEARS 5 years 5 years Expected volatility 23.9% 28.2% 27.8% - --------------------------------------------------------------------------------
The Black-Scholes model uses different assumptions that can significantly effect the fair value of the options. As a result, the derived fair value estimates cannot be substantiated by comparison to independent markets. - -------------------------------------------------------------------------------- 16. EMPLOYEE BENEFIT PLANS The combined company is now in the process of reviewing its pension and postretirement benefit plans with a view to providing uniform benefits. Completion and approval is expected sometime in 1999. The combined company sponsors several defined benefit pension plans covering substantially all of its employees. Plan benefits are based primarily on years of service. Plan assets primarily consist of common and preferred stocks including those of foreign issuers and corporate and government obligations. At December 31, 1997, plan assets included an investment in 1,258,807 shares of the company's common stock with a fair value of $160.7 million.
In millions Year ended December 31, 1997 1996 1995 - -------------------------------------------------------------------------------- Service cost - benefits earned during the period $(21.1) $(20.5) $(21.2) Interest cost on projected benefit obligation (38.1) (38.6) (40.1) Actual return on assets 98.4 106.9 128.7 Net amortization and deferral (15.3) (28.5) (47.8) - -------------------------------------------------------------------------------- Pension income $ 23.9 $ 19.3 $ 19.6 ================================================================================
The funded status of the combined defined benefit pension plans was as follows:
In millions. At December 31 1997 1996 - -------------------------------------------------------------------------------- Actuarial present value of: Vested benefits obligation $402.5 $393.1 Nonvested benefits obligation 64.7 59.9 - -------------------------------------------------------------------------------- Accumulated benefit obligation 467.2 453.0 Effects of anticipated future compensation levels 79.5 71.4 - -------------------------------------------------------------------------------- Projected benefit obligation 546.7 524.4 Plan assets at fair value 826.7 769.7 - -------------------------------------------------------------------------------- Plan assets in excess of projected benefit obligation $280.0 $245.3 ================================================================================
Each plan was separately valued based on the individual plan's underlying terms and asset mix. The range of assumptions used in determining the projected benefit obligation and pension income of the domestic defined benefit plans at December 31 are as follows:
1997 1996 1995 - -------------------------------------------------------------------------------- Discount rate 7.0% - 7.5% 7.5% 7.3% Salary increase assumption 4.0% - 4.5% 4.0% - 4.5% 3.8% - 4.5% Expected long-term rate of return on plan assets 9.0% -10.0% 9.0% - 10.0% 9.0% - 10.0% - --------------------------------------------------------------------------------
65 66 The projected benefit obligation of the foreign benefit plans totaled $51.3 and $45.8 million at December 31, 1997 and 1996, respectively. Plan assets in excess of the projected benefit obligation for these plans totaled $4.0 and $5.6 million at December 31, 1997 and 1996, respectively. The excess of plan assets over the projected benefit obligation included the following components:
In millions. At December 31 1997 1996 - -------------------------------------------------------------------------------- Unamortized prior service cost $ (1.9) $(2.6) Net unrecognized loss from past experience different from assumed and effects of changes in assumptions (48.3) (62.3) Unamortized assets 13.8 27.2 Prepaid pension cost 316.4 283.0 - -------------------------------------------------------------------------------- Plan assets in excess of projected benefit obligation $280.0 $245.3 ================================================================================
The straight-line method of amortization is used for prior service costs and unrecognized gains and losses. The company maintains various 401(k) savings plans and profit sharing plans for employees meeting certain eligibility requirements. Under the existing Household International plan, each participant's contribution is matched by the company up to a maximum of 6 percent of the participant's compensation. The existing Beneficial 401(k) savings plans provide for annual employer contributions up to 2.5% of each eligible employee's annual compensation. For 1997, 1996 and 1995, total expense for these plans was $23.9, $22.1 and $21.8 million, respectively. The company has several plans which provide medical, dental and life insurance benefits to retirees and eligible dependents. These plans are funded on a pay-as-you-go basis and cover substantially all employees who meet certain age and vested service requirements. The company has instituted dollar limits on its payments under the plans to control the cost of future medical benefits. The company recognizes the expected postretirement costs on an accrual basis, similar to pension accounting. The expected cost of postretirement benefits is required to be recognized over the employees' years of service with the company instead of the period in which the benefits are paid. Under the existing Household International plans, the transition obligation is being recognized over a period of 20 years. The transition obligation represents the unfunded and unrecognized accumulated postretirement benefit obligation. Under the existing Beneficial plan, the transition obligation was recognized up front at the time Statements of Financial Accounting Standards No. 106 was adopted. The net postretirement benefit cost included the following:
In millions. Year ended December 31, 1997 1996 1995 - -------------------------------------------------------------------------------- Service cost-benefits earned during the period $ (4.8) $ (4.8) $ (4.6) Interest cost on accumulated postretirement benefit obligation (12.1) (11.5) (14.7) Net amortization and deferral (2.8) (3.0) (4.7) - -------------------------------------------------------------------------------- Net periodic postretirement benefit cost $(19.7) $(19.3) $(24.0) ================================================================================
66 67 The actuarial and recorded liabilities for postretirement benefit plans, none of which have been funded, were:
In millions. At December 31 1997 1996 - -------------------------------------------------------------------------------- Actuarial present value of postretirement obligation for: Retirees $120.7 $106.8 Fully eligible active participants 21.0 19.9 Other active participants 42.2 39.3 - -------------------------------------------------------------------------------- Accumulated postretirement benefit obligation 183.9 166.0 Net unrecognized gain from past experience different from assumed and effects of changes in assumptions 45.6 49.2 Unamortized liability (94.3) (100.6) - -------------------------------------------------------------------------------- Accrued postretirement benefit obligation $135.2 $114.6 ================================================================================
Each plan was separately valued based on the individual plan's underlying terms. The range of assumptions used in determining the projected benefit obligation and pension cost of such plans at December 31 are as follows:
1997 1996 1995 - -------------------------------------------------------------------------------- Discount rate 7.0% - 7.5% 7.5% 7.3% - --------------------------------------------------------------------------------
The existing Household International plans assumed an annual compensation increase of 4.0 percent. A 10.0 and 11.0 percent annual rate of increase in the gross cost of covered health care benefits was assumed for 1998 and 1997, respectively. This rate of increase is assumed to decline by 1 percent in each year after 1998. Under the existing Beneficial plans, a 10.2 percent pre-65 trend rate was used for 1997 and 1996, with an ultimate rate of 5.0 percent in 2013. In addition, a 9.7 percent post-64 trend rate was used for 1997 and 1996 with an ultimate rate of 5.0 percent in 2018. A one percentage point increase in the health care trend rate would have increased the 1997 and 1996 accumulated postretirement benefit obligation by $10.0 and $13.2 million, respectively, and the net periodic postretirement benefit cost for 1997 and 1996 by $1.2 and $1.6 million, respectively. - -------------------------------------------------------------------------------- 17. INCOME TAXES Total income taxes were allocated as follows:
In millions. Year ended December 31 1997 1996 1995 - -------------------------------------------------------------------------------- Provision for income taxes related to operations $462.2 $461.2 $420.4 Income taxes related to adjustments included in common shareholders' equity: Unrealized gain (loss) on investments, net 10.0 (63.5) 119.9 Foreign currency translation adjustments 19.7 (23.8) (7.7) Exercise of stock options (21.1) (14.3) (10.3) - -------------------------------------------------------------------------------- Total $470.8 $359.6 $522.3 ================================================================================
67 68 Provisions for income taxes related to operations were:
In millions. Year ended December 31 1997 1996 1995 - -------------------------------------------------------------------------------- CURRENT United States $326.3 $522.4 $406.9 Foreign 60.0 54.9 51.0 - -------------------------------------------------------------------------------- Total current 386.3 577.3 457.9 - -------------------------------------------------------------------------------- DEFERRED United States 66.8 (114.4) (26.3) Foreign 9.1 (1.7) (11.2) - -------------------------------------------------------------------------------- Total deferred 75.9 (116.1) (37.5) - -------------------------------------------------------------------------------- Total income taxes $462.2 $461.2 $420.4 ================================================================================
The significant components of deferred income tax provisions attributable to income from operations were:
In millions. Year ended December 31 1997 1996 1995 - -------------------------------------------------------------------------------- Deferred income tax provision $ 67.9 $(90.3) $(19.9) Adjustment of valuation allowance (4.7) (19.5) (19.2) Change in operating loss carryforwards 12.7 (6.3) 1.6 - -------------------------------------------------------------------------------- Deferred income tax provision $75.9 $(116.1) $(37.5) ================================================================================
Income before income taxes from foreign operations was $143.2, $166.3 and $99.6 million in 1997, 1996 and 1995, respectively. Effective tax rates are analyzed as follows:
Year ended December 31 1997 1996 1995 - -------------------------------------------------------------------------------- Statutory federal income tax rate 35.0% 35.0% 35.0% Increase (decrease) in rate resulting from: State and local taxes, net of federal benefit 2.3 2.0 2.2 Capital losses - Germany (2.0) - - Leveraged lease tax benefits (1.9) (1.1) (1.4) Recapture of life insurance policyholders' surplus account balance - - 2.9 Other (.4) .1 2.4 - -------------------------------------------------------------------------------- Effective tax rate 33.0% 36.0% 41.1% ================================================================================
Provision for U.S. income taxes had not been made at December 31, 1997 and 1996 on $160.7 and $181.5 million, respectively, of undistributed earnings of foreign subsidiaries. Determination of the amount of unrecognized deferred tax liability related to investments in foreign subsidiaries is not practicable. In addition, provision for U.S. income taxes had not been made at December 31, 1997 and 1996 on $77.8 million of undistributed earnings of life insurance subsidiaries accumulated as policyholders' surplus under tax laws in effect prior to 1984. If this amount was distributed, the additional income tax payable would be approximately $27.2 million. The company's U.S. savings and loan subsidiary has credit loss reserves for tax purposes that arose in years beginning before December 31, 1987 in the amount of $55.3 million. The amount of deferred tax liability on the aforementioned credit loss reserves not recognized totaled $20.4 million at December 31, 1997. Because this amount would become taxable only in the event of certain circumstances which the company does not expect to occur within the foreseeable future, no deferred tax liability has been established for this item. At December 31, 1997 the company had net operating loss carryforwards for tax purposes of $45.7 million, of which $8.0 million expire in 2000; $11.3 million expire in 2001; $12.7 million expire in 2002; $6.8 million expire in 2003; and $6.9 million expire in 2004. 68 69 Temporary differences which gave rise to a significant portion of deferred tax assets and liabilities were as follows:
In millions. At December 31 1997 1996 - --------------------------------------------------------------------------------- DEFERRED TAX LIABILITIES Receivables sold $ 456.6 $ 261.3 Leveraged lease transactions, net 312.7 383.3 Pension plan assets 123.1 111.0 Other 269.5 175.3 - --------------------------------------------------------------------------------- Total deferred tax liabilities $1,161.9 $ 930.9 ================================================================================= DEFERRED TAX ASSETS Credit loss reserves $ 864.0 $ 700.0 Other 368.5 371.5 - --------------------------------------------------------------------------------- Total deferred tax assets 1,232.5 1,071.5 Valuation allowance (3.3) (8.0) - --------------------------------------------------------------------------------- Total deferred tax assets net of valuation allowance 1,229.2 1,063.5 - --------------------------------------------------------------------------------- Net deferred tax asset at end of year $ 67.3 $ 132.6 =================================================================================
- -------------------------------------------------------------------------------- 18. EARNINGS PER COMMON SHARE In December 1997, the company adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("FAS No. 128"), which supersedes APB Opinion No. 15 "Earnings Per Share" and simplifies the standards for computing and presenting earnings per share ("EPS"). Under the new standards, the presentation of primary EPS has been replaced with a presentation of basic EPS. Basic EPS is computed excluding dilution caused by common stock equivalents such as stock options. The presentation of fully diluted EPS has been replaced with a presentation of diluted EPS, which is calculated in a similar fashion to how fully diluted EPS had been computed. Previously reported EPS has been restated to conform to the new rules.
In millions, except per share data. 1997 1996 1995 --------------- --------------- --------------- Year ended December 31 DILUTED BASIC Diluted Basic Diluted Basic - -------------------------------------------------------------------------------- EARNINGS Net income $940.3 $940.3 $819.6 $819.6 $603.7 $603.7 Preferred dividends (17.0) (17.0) (21.9) (21.9) (31.6) (31.6) - -------------------------------------------------------------------------------- Earnings available to common shareholders $923.3 $923.3 $797.7 $797.7 $572.1 $572.1 ================================================================================ AVERAGE SHARES Common 470.2 470.2 454.6 454.6 454.0 454.0 Common equivalents 8.9 - 7.7 - 8.0 - - -------------------------------------------------------------------------------- Total 479.1 470.2 462.3 454.6 462.0 454.0 ================================================================================ Earnings per common share $ 1.93 $ 1.97 $ 1.73 $ 1.76 $ 1.24 $ 1.26 ================================================================================
- -------------------------------------------------------------------------------- 19. COMMITMENTS AND CONTINGENT LIABILITIES In 1992, the Internal Revenue Service ("IRS") completed its examination of Beneficial's federal income tax returns for 1984 through 1987. The IRS proposed $142.0 million in adjustments that relate principally to activities of a former subsidiary, American Centennial Insurance Company ("ACIC"), prior to its sale in 1987. In order to limit the further accrual of interest on the proposed adjustments, Beneficial paid $105.5 million of tax and interest during the third quarter of 1992. 69 70 The issues were not resolved during the administrative appeals process, and the IRS issued a statutory Notice of Deficiency asserting the unresolved adjustments and increased the disallowance to $195.0 million in the third quarter of 1996. Beneficial has initiated litigation in the United States Tax Court to oppose the disallowance. While the conclusion of this matter in its entirety cannot be predicted with certainty, management does not anticipate the ultimate resolution to differ materially from amounts accrued. The company and subsidiaries are involved in various other legal proceedings in the normal course of business. Management believes the aggregate liabilities, if any, resulting from such actions would not have a material adverse effect on the consolidated financial position of the company. However, as the ultimate resolution of these proceedings is influenced by factors that are outside of the company's control, it is reasonably possible the company's estimated liability under these proceedings may change. See Note 14 for discussion of lease commitments. - -------------------------------------------------------------------------------- 20. GEOGRAPHIC DATA The following is a summary of assets, revenues and operating profit of the company by country:
Identifiable Assets Revenues Operating Profit ------------------------------- ---------------------------- ---------------------------- In millions. 1997 1996 1995 1997 1996 1995 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------------ United States $40,144.9 $39,736.2 $39,263.2 $7,279.2 $6,789.0 $6,475.4 $1,278.0 $1,138.5 $936.4 United Kingdom 5,071.3 4,086.5 3,084.1 774.8 640.5 591.9 146.2 108.8 93.3 Canada 2,142.6 2,163.5 2,090.6 339.8 328.1 403.2 39.2 39.0 21.7 Germany 401.0 413.7 455.1 31.2 55.2 67.4 (65.5) (2.0) (26.2) Ireland 69.0 37.6 10.5 33.8 17.9 4.7 4.6 (3.5) (1.1) - ------------------------------------------------------------------------------------------------------------------------------------ Total $47,828.8 $46,437.5 $44,903.5 $8,458.8 $7,830.7 $7,542.6 $1,402.5 $1,280.8 $1,024.1 ====================================================================================================================================
70 71 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders of Household International, Inc. We have audited the accompanying supplemental consolidated balance sheets of Household International, Inc.(a Delaware corporation) and subsidiaries as of December 31, 1997 and 1996, and the related supplemental consolidated statements of income, changes in preferred stock and common shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. The supplemental consolidated statements give retroactive effect to the merger of Household International, Inc. and Beneficial Corporation on June 30, 1998, which has been accounted for as a pooling of interests as described in Note 2. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the supplemental consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Household International, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, after giving retroactive effect to the merger of Household International Inc. and Beneficial Corporation as described in Note 2, all in conformity with generally accepted accounting principles. Arthur Andersen LLP Chicago, Illinois June 30, 1998 71 EX-99.2 7 SUPPLEMENTAL QUARTERLY FINANCIAL INFORMATION 1 EXHIBIT 99.2 HOUSEHOLD INTERNATIONAL, INC. AND SUBSIDIARIES Index to Supplemental Quarterly Financial Information
Page ---- Supplemental Interim Condensed Consolidated Financial Statements Supplemental Condensed Consolidated Statements of Income (Unaudited) - Three Months Ended March 31, 1998 and 1997 ..................................... 2 Supplemental Condensed Consolidated Balance Sheets - March 31, 1998 (Unaudited) and December 31, 1997 .................. 3 Supplemental Condensed Consolidated Statements of Cash Flows (Unaudited) - Three Months Ended March 31, 1998 and 1997 ........................................... 4 Supplemental Financial Highlights ................................. 5 Notes to Supplemental Interim Condensed Consolidated Financial Statements (Unaudited) .................................. 6
1 2 SUPPLEMENTAL QUARTERLY FINANCIAL INFORMATION SUPPLEMENTAL FINANCIAL STATEMENTS Household International, Inc. and Subsidiaries SUPPLEMENTAL CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) - -------------------------------------------------------------------- All amounts, except per share data, are stated in millions. - ------------------------------------------------------------------------------
Three months ended March 31 1998 1997 - ------------------------------------------------------------------------------ Finance income $1,334.1 $1,287.0 Other interest income 15.3 11.2 Interest expense 612.2 579.8 -------- -------- Net interest margin 737.2 718.4 Provision for credit losses on owned receivables 401.3 386.5 -------- -------- Net interest margin after provision for credit losses 335.9 331.9 -------- -------- Securitization income 419.3 366.2 Insurance revenues 119.5 111.3 Investment income 39.9 45.2 Fee income 151.3 121.4 Gain on Canadian disposal 189.4 - Other income 87.7 166.0 -------- -------- Total other revenues 1,007.1 810.1 -------- -------- Salaries and fringe benefits 276.2 252.7 Occupancy and equipment expense 85.1 84.7 Other marketing expenses 103.0 114.8 Other servicing and administrative expenses 206.4 220.2 Amortization of acquired intangibles and goodwill 42.4 36.8 Policyholders' benefits 63.6 69.8 -------- -------- Total costs and expenses 776.7 779.0 -------- -------- Income before income taxes 566.3 363.0 Income taxes 208.5 130.8 -------- -------- Net income $ 357.8 $ 232.2 ======== ======== Earnings per common share: Net income $ 357.8 $ 232.2 Preferred dividends (4.2) (4.5) -------- -------- Earnings available to common shareholders $ 353.6 $ 227.7 ======== ======== Average common shares 485.5 456.0 -------- -------- Average common and common equivalent shares 497.0 465.5 -------- -------- Basic earnings per common share $ .73 $ .50 -------- -------- Diluted earnings per common share $ .71 $ .49 -------- -------- Dividends declared per common share .15 .13 ======== ========
See notes to supplemental interim condensed consolidated financial statements. 2 3 Household International, Inc. and Subsidiaries SUPPLEMENTAL CONDENSED CONSOLIDATED BALANCE SHEETS - ---------------------------------------------- In millions, except share data. - -----------------------------------------------------------------------
March 31, December 31, 1998 1997 - ------------------------------------------------------------------------ ASSETS (Unaudited) - ------ Cash $ 419.7 $ 534.3 Investment securities 3,259.4 2,898.6 Receivables, net 39,915.7 38,561.5 Acquired intangibles and goodwill, net 1,945.3 1,798.4 Properties and equipment, net 512.6 538.7 Real estate owned 214.7 212.8 Other assets 2,925.5 2,496.6 ----------- ------------ Total assets $ 49,192.9 $ 47,040.9 =========== ============ LIABILITIES AND SHAREHOLDERS' EQUITY - ------------------------------------ Debt: Deposits $ 2,391.3 $ 2,344.2 Commercial paper, bank and other borrowings 10,704.6 10,666.1 Senior and senior subordinated debt (with original maturities over one year) 24,959.8 23,736.2 ----------- ------------ Total debt 38,055.7 36,746.5 Insurance policy and claim reserves 1,498.3 1,606.5 Other liabilities 2,428.6 2,074.4 ----------- ------------ Total liabilities 41,982.6 40,427.4 ----------- ------------ Company obligated mandatorily redeemable preferred securities of subsidiary trusts* 375.0 175.0 ----------- ------------ Preferred stock 264.5 264.5 ----------- ------------ Common shareholders' equity: Common stock, $1.00 par value, 750,000,000 shares authorized (increased as of May 13, 1998); 540,272,396 and 536,870,946 shares issued at March 31, 1998 and December 31, 1997, respectively 540.3 536.9 Additional paid-in capital 1,520.6 1,423.5 Retained earnings 5,252.7 4,978.6 Foreign currency translation adjustments (156.5) (176.5) Unrealized gain on investments, net 12.7 8.8 Less common stock in treasury, 51,039,714 and 51,519,429 shares at March 31, 1998 and December 31, 1997, respectively, at cost (599.0) (597.3) ----------- ------------ Total common shareholders' equity 6,570.8 6,174.0 ----------- ------------ Total liabilities and shareholders' equity $ 49,192.9 $ 47,040.9 =========== ============
* As described in note 8 to the financial statements, the sole assets of the three trusts are Junior Subordinated Deferrable Interest Notes issued by Household International, Inc. in March 1998, June 1996 and June 1995, bearing interest at 7.25, 8.70 and 8.25 percent, respectively, with principal balances of $206.2, $103.1 and $77.3 million, respectively, and due December 31, 2037, June 30, 2036 and June 30, 2025, respectively. See notes to supplemental interim condensed consolidated financial statements. 3 4 Household International, Inc. and Subsidiaries SUPPLEMENTAL CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - -----------------------------------------------------------------------
In millions. - ----------------------------------------------------------------------------- Three months ended March 31 1998 1997 - ----------------------------------------------------------------------------- CASH PROVIDED BY OPERATIONS Net income $ 357.8 $ 232.2 Adjustments to reconcile net income to cash provided by operations: Provision for credit losses on owned receivables 401.3 386.5 Insurance policy and claim reserves (108.0) 20.7 Depreciation and amortization 76.3 75.3 Net realized (gains) losses from sales of assets - (55.0) Other, net 81.0 185.2 --------- --------- Cash provided by operations 808.4 844.9 --------- --------- INVESTMENTS IN OPERATIONS Investment securities: Purchased (420.3) (517.8) Matured 98.8 120.5 Sold 209.6 278.7 Short-term investment securities, net change (231.1) (19.6) Receivables: Originations, net (7,042.4) (5,969.9) Purchases and related premiums (2,210.8) (278.6) Sold 7,359.1 7,305.1 Properties and equipment purchased (11.6) (15.5) Properties and equipment sold 20.4 4.9 --------- --------- Cash increase (decrease) from investments in operations (2,228.3) 907.8 --------- --------- FINANCING AND CAPITAL TRANSACTIONS Short-term debt and demand deposits, net change (57.8) (1,165.6) Time certificates, net change 91.8 (111.5) Senior and senior subordinated debt issued 3,148.8 1,854.1 Senior and senior subordinated debt retired (1,966.1) (2,233.5) Policyholders' benefits paid (27.4) (38.4) Cash received from policyholders 26.6 69.9 Shareholders' dividends (52.4) (42.4) Shareholders' dividends - pooled affiliate (31.3) (28.5) Treasury stock activity - pooled affiliate (11.0) (15.1) Redemption of preferred stock - (55.0) Purchase of treasury stock (9.8) - Issuance of common stock 1.9 9.2 Issuance of company obligated mandatorily redeemable preferred securities of subsidiary trusts 200.0 - --------- --------- Cash increase (decrease) from financing and capital transactions 1,313.3 (1,756.8) --------- --------- Effect of exchange rate changes on cash (8.0) 28.5 --------- --------- Increase (decrease) in cash (114.6) 24.4 Cash at January 1 534.3 518.8 --------- --------- Cash at March 31 $ 419.7 $ 543.2 ========= ========= Supplemental Cash Flow Information: Interest paid $ 524.6 $ 470.9 --------- --------- Income taxes paid (19.6) 11.0 --------- ---------
See notes to supplemental interim condensed consolidated financial statements. 4 5 Household International, Inc. and Subsidiaries SUPPLEMENTAL FINANCIAL HIGHLIGHTS - --------------------------------- All dollar amounts are stated in millions. - ------------------------------------------------------------------
Three months ended March 31 1998 1997 - --------------------------------------------------------------------------- Net income $ 357.8 $ 232.2 -------- -------- Net interest margin and other revenues (1) 1,680.7 1,458.7 -------- -------- Return on average common shareholders' equity (2) 22.2 19.8% -------- -------- Return on average owned assets (2) 2.95 2.03 -------- -------- Managed basis efficiency ratio, normalized (3) 40.6 42.8 -------- -------- All dollar amounts are stated in millions. - ---------------------------------------------------------------------------- March 31, December 31, 1998 1997 - ---------------------------------------------------------------------------- Total assets: Owned $ 49,192.9 $ 47,040.9 Managed 72,519.1 71,519.4 ---------- ------------ Receivables: Owned $ 40,048.3 $ 38,682.0 Serviced with limited recourse 23,326.2 24,478.5 ---------- ------------ Managed $ 63,374.5 $ 63,160.5 ========== ============ Total shareholders' equity as a percent of owned assets (4) 14.66% 14.06% ---------- ------------ Total shareholders' equity as a percent of managed assets (4) 9.94% 9.25% ---------- ------------
(1) Policyholders' benefits have been netted against other revenues. (2) Annualized. (3) Ratio of normalized operating expenses to managed net interest margin and other revenues less policyholders' benefits. (4) Total shareholders' equity at March 31, 1998 and December 31, 1997 includes common shareholders' equity, preferred stock and company obligated mandatorily redeemable preferred securities of subsidiary trusts. See notes to supplemental interim condensed consolidated financial statements. 5 6 Household International, Inc. and Subsidiaries NOTES TO SUPPLEMENTAL INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION --------------------- The accompanying unaudited supplemental condensed consolidated financial statements of Household International, Inc. ("Household") and its subsidiaries have been prepared in accordance with generally accepted accounting principles for interim financial information. Additionally, these financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. They do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Certain prior period amounts have been reclassified to conform with the current period's presentation. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. All per share information has been adjusted for Household's three-for-one stock split effected in the form of a stock dividend and paid on June 1, 1998. Operating results for the three months ended March 31, 1998 should not be considered indicative of the results for any future quarters or the year ending December 31, 1998. Household and its subsidiaries may also be referred to in these supplemental interim condensed financial statements as "we," "us" or "our." These financial statements should be read in conjunction with the supplemental consolidated financial statements for the year ended December 31, 1997. See Exhibit 99.1 of this Form 8-K. On March 10, 1998, the Board of Directors approved a three-for-one split of the company's common stock, effected in the form of a dividend, issued on June 1, 1998, to shareholders of record as of May 14, 1998. The split was subject to shareholder approval to increase authorized shares which was received on May 13, 1998. Accordingly, all common share and per common share data in these supplemental interim condensed consolidated financial statements includes the effect of the Company's stock split. 2. BUSINESS DIVESTITURES - ------------------------- On March 2, 1998, the company completed the sale of certain of Beneficial's Canadian operations. An after tax gain of $118.5 million was recorded upon consummation of the transaction. On April 28, 1998, the company completed the sale of its German operations. The company recorded an after tax loss of $27.8 million in the fourth quarter of 1997 and no additional losses were realized in 1998 as a result of the sale. 6 7 3. INVESTMENT SECURITIES - ------------------------- Investment securities consisted of the following: - ------------------------------------------------------------------------------
In millions. March 31, 1998 December 31, 1997 - ------------------------------------------------------------------------------ Amortized Fair Amortized Fair Cost Value Cost Value - ------------------------------------------------------------------------------ AVAILABLE-FOR-SALE INVESTMENTS Marketable equity securities $ 128.4 $ 130.5 $ 129.0 $ 132.5 Corporate debt securities 1,547.5 1,563.4 1,581.8 1,600.5 U.S. government and federal agency debt securities 384.1 384.5 390.3 380.5 Other 1,139.0 1,140.2 745.8 746.5 --------- -------- --------- --------- Subtotal 3,199.0 3,218.6 2,846.9 2,860.0 Accrued investment income 40.8 40.8 38.6 38.6 --------- -------- --------- --------- Total investment securities $ 3,239.8 $3,259.4 $ 2,885.5 $ 2,898.6 ========= ======== ========= =========
4. RECEIVABLES - --------------- Receivables consisted of the following: - -------------------------------------------------------------------
March 31, December 31, In millions. 1998 1997 - ------------------------------------------------------------------- First mortgage $ 357.6 $ 396.6 Home equity 14,701.1 13,786.2 Auto finance 654.4 487.5 MasterCard/Visa 7,420.0 6,874.7 Private label 8,849.3 9,356.9 Other unsecured 7,199.2 6,823.1 Commercial 866.7 957.0 --------- ------------ Total owned receivables 40,048.3 38,682.0 Accrued finance charges 535.3 536.7 Credit loss reserve for owned receivables (1,725.6) (1,642.1) Unearned credit insurance premiums and claims reserves (233.2) (228.4) Amounts due and deferred from receivables sales 2,138.3 2,094.2 Reserve for receivables serviced with limited recourse (847.4) (880.9) --------- ------------ Total owned receivables, net 39,915.7 38,561.5 Receivables serviced with limited recourse 23,326.2 24,478.5 --------- ------------ Total managed receivables, net $63,241.9 $ 63,040.0 ========= ============
At December 31, 1997, net receivables relating to the disposed Canadian and German operations were $775.1 million and $271.1 million, respectively. 7 8 The outstanding balance of receivables serviced with limited recourse consisted of the following: - -------------------------------------------------------------
March 31, December 31, In millions. 1998 1997 - ------------------------------------------------------------- Home equity $ 5,455.2 $ 6,038.6 Auto finance 348.0 395.9 MasterCard/Visa 11,819.6 12,337.0 Private label 986.2 1,025.0 Other unsecured 4,717.2 4,682.0 --------- ------------ Total $23,326.2 $ 24,478.5 ========= ============
The combination of receivables owned and receivables serviced with limited recourse, which we consider our managed portfolio, is shown below: - --------------------------------------------------------------
March 31, December 31, In millions. 1998 1997 - -------------------------------------------------------------- First mortgage $ 357.6 $ 396.6 Home equity 20,156.3 19,824.8 Auto finance 1,002.4 883.4 MasterCard/Visa 19,239.6 19,211.7 Private label 9,835.5 10,381.9 Other unsecured 11,916.4 11,505.1 Commercial 866.7 957.0 --------- ------------ Total $63,374.5 $ 63,160.5 ========= ============
The amounts due and deferred from receivables sales were $2,138.3 million at March 31, 1998 and $2,094.2 million at December 31, 1997. The amounts due and deferred included unamortized securitization assets and funds set up under the recourse requirements for certain sales totaling $1,856.1 million at March 31, 1998 and $1,819.0 million at December 31, 1997. It also included customer payments not yet sent to us by the securitization trustee of $202.9 million at March 31, 1998 and $226.1 million at December 31, 1997. In addition, we have subordinated interests in certain transactions, which were recorded as receivables, of $1,107.8 million at March 31, 1998 and $1,098.1 million at December 31, 1997. We have agreements with a "AAA"-rated third party who will insure us for up to $21.2 million in losses relating to certain securitization transactions. We maintain credit loss reserves under the recourse requirements for receivables serviced with limited recourse which are based on estimated probable losses under those requirements. The reserves totaled $847.4 million at March 31, 1998 and $880.9 million at December 31, 1997 and represents our best estimate of probable losses on receivables serviced with limited recourse. 8 9 5. CREDIT LOSS RESERVES - ------------------------ An analysis of credit loss reserves for the three months ended March 31 was as follows:
- ----------------------------------------------------------------------- In millions. 1998 1997 - ----------------------------------------------------------------------- Credit loss reserves for owned receivables at January 1 $1,642.1 $1,398.4 Provision for credit losses 401.3 386.5 Chargeoffs (414.5) (369.3) Recoveries 42.6 40.6 Portfolio acquisitions, net 54.1 (17.8) -------- -------- TOTAL CREDIT LOSS RESERVES FOR OWNED RECEIVABLES AT MARCH 31 1,725.6 1,438.4 -------- -------- Credit loss reserves for receivables serviced with limited recourse at January 1 880.9 710.6 Provision for credit losses 261.5 249.1 Chargeoffs (314.4) (204.6) Recoveries 18.8 9.9 Other, net .6 2.6 -------- -------- TOTAL CREDIT LOSS RESERVES FOR RECEIVABLES SERVICED WITH LIMITED RECOURSE AT MARCH 31 847.4 767.6 -------- -------- TOTAL CREDIT LOSS RESERVES FOR MANAGED RECEIVABLES AT MARCH 31 $2,573.0 $2,206.0 ======== ========
6. INCOME TAXES - ---------------- The effective tax rate was 36.8 percent for the three months ended March 31, 1998 and 36.0 percent in the year-ago period. The effective tax rate differs from the statutory federal income tax rate in these years primarily because of the effects of (a) state and local income taxes, (b) capital losses from the sale of German operations (c) leveraged lease tax benefits. 9 10 7. EARNINGS PER COMMON SHARE - ----------------------------- Computations of earnings per common share for the three months ended March 31 were as follows:
- ---------------------------------------------------------------------------- 1998 1997 ------------------ ------------------ In millions, except per share data. Diluted Basic Diluted Basic - ------------------------------------ -------- -------- -------- -------- Earnings: Net income $ 357.8 $ 357.8 $ 232.2 $ 232.2 Preferred dividends (4.2) (4.2) (4.5) (4.5) -------- -------- -------- -------- Earnings available to common shareholders $ 353.6 $ 353.6 $ 227.7 $ 227.7 ======== ======== ======== ======== Average shares: Common 486.1 486.1 456.6 456.6 Common equivalents 10.9 - 8.9 - -------- -------- -------- -------- Total 497.0 486.1 465.5 456.6 ======== ======== ======== ======== Earnings per common share $ .71 $ .73 $ .49 $ .50 ======== ======== ======== ========
8. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUSTS - ------------------------------------------------------------------------------ In March 1998 Household Capital Trust IV ("HCT IV"), a wholly-owned subsidiary of Household, issued 8 million 7.25 percent Trust Preferred Securities ("preferred securities") at $25 per preferred security. The sole asset of HCT IV is $206.2 million of 7.25 percent Junior Subordinated Deferrable Interest Notes issued by Household. The junior subordinated notes held by HCT IV mature on December 31, 2037 and are redeemable by Household in whole or in part beginning on March 19, 2003, at which time the HCT IV preferred securities are callable at par of $25 per preferred security plus accrued and unpaid dividends. Net proceeds from the issuance of preferred securities were used for general corporate purposes. In June 1996 Household Capital Trust II ("HCT II"), a wholly-owned subsidiary of Household, issued 4 million 8.70 percent preferred securities at $25 per preferred security. The sole asset of HCT II is $103.1 million of 8.70 percent Junior Subordinated Deferrable Interest Notes issued by Household. The junior subordinated notes held by HCT II mature on June 30, 2036 and are redeemable by Household in whole or in part beginning on June 30, 2001, at which time the HCT II preferred securities are callable at par value of $25 per preferred security plus accrued and unpaid dividends. In 1995 Household Capital Trust I ("HCT I"), a wholly-owned subsidiary of Household, issued 3 million 8.25 percent preferred securities at $25 per preferred security. The sole asset of HCT I is $77.3 million of 8.25 percent Junior Subordinated Deferrable Interest Notes issued by Household. The junior subordinated notes held by HCT I mature on June 30, 2025 and are redeemable by Household in whole or in part beginning June 30, 2000, at which time the HCT I preferred securities are callable at par value of $25 per preferred security plus accrued and unpaid dividends. HCT I may elect to extend the maturity of its preferred securities to June 30, 2044. 10 11 The obligations of Household with respect to the junior subordinated notes, when considered together with certain undertakings of Household with respect to HCT I, HCT II and HCT IV, constitute full and unconditional guarantees by Household of HCT I's, HCT II's and HCT IV's obligations under the respective preferred securities. The preferred securities are classified in our balance sheets as company obligated mandatorily redeemable preferred securities of subsidiary trusts (representing the minority interest in the trusts) at their face and redemption amount of $375 million at March 31, 1998 and $175 million at December 31, 1997. The preferred securities have a liquidation value of $25 per preferred security. Dividends on the preferred securities are cumulative, payable quarterly in arrears, and are deferrable at Household's option for up to five years from date of issuance. Household cannot pay dividends on its preferred and common stocks during such deferments. 9. COMPREHENSIVE INCOME - --------------------------- In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS No. 130"), effective for fiscal years beginning after December 15, 1997. This statement establishes standards for the reporting and presentation of comprehensive income. Comprehensive income, in addition to traditional net income, includes the mark-to-market adjustments on available-for-sale securities, cumulative translation adjustments and other items which represent a change in equity from "nonowner" sources. FAS No. 130 does not change existing requirements for certain items to be reported as a separate component of shareholders' equity. In accordance with the interim reporting guidelines of FAS No. 130, comprehensive income was $381.7 million for the quarter ended March 31, 1998 and $198.7 million for the quarter ended March 31, 1997. 11 EX-99.3 8 PRESS RELEASE 1 NEWS RELEASE Household International, Inc. 2700 Sanders Road Prospect Heights, IL 60070 FOR IMMEDIATE RELEASE Contacts: Craig A. Streem Vice President-Investors Relations 847.564.6053 or Celeste Murphy Director-Investor Relations 847.564.7568 HOUSEHOLD INTERNATIONAL COMPLETES ACQUISITION OF BENEFICIAL CORPORATION Prospect Heights, IL, June 30, 1998 -- Household International (NYSE:HI) announced today the completion of its previously-announced acquisition of Beneficial Corporation. "We are delighted to have completed this acquisition significantly ahead of our original timetable," William F. Aldinger, chairman and chief executive officer of Household. "The accelerated closing reflects a real spirit of cooperation that was evident throughout the Beneficial organization as well as Household's commitment to execution. "The merger of Household and Beneficial brings together the two most widely recognized brands in consumer finance, creating a combined enterprise that will be a leader in virtually every one of its businesses," Aldinger continued. "It provides a solid platform for sustained profitable growth as we improve efficiency and deliver a broader array of lending and insurance products through a significantly expanded branch network. The transaction is expected to be accretive to Household's earnings in 1999 and beyond." In early July, beneficial stockholders will receive letters of transmittal and instructions to follow in order to exchange their Beneficial stock certificates for Household stock certificates. Harris Trust Company of New York is acting as Exchange Agent in connection with the merger. Household International, through its subsidiaries, is a leading provider of consumer finance and credit card products in the United States, Canada and the United Kingdom. One of Household's primary businesses is HFC, the nation's oldest consumer finance company. Household is also one of the nation's largest issuers of private-label and general purpose credit cards. Its principal cards include the GM Card and the AFL-CIO's Union Privilege Card. ### EX-99.4 9 FINANCIAL STATEMENTS 1 EXHIBIT 99.3 INDEPENDENT AUDITORS' REPORT TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF BENEFICIAL CORPORATION: We have audited the accompanying consolidated balance sheets of Beneficial Corporation and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income and retained earnings and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on the financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Beneficial Corporation and Subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. /s/ DELOITTE & TOUCHE LLP DELOITTE & TOUCHE LLP Parsippany, New Jersey January 28, 1998 2 BENEFICIAL CORPORATION AND SUBSIDIARIES BALANCE SHEET
Years Ended December 31 1997 1996 ----------- ----------- (in millions) ASSETS Cash Equivalents............................. $ 253.9 $ 279.6 Finance Receivables (Note 5)................. 15,030.2 14,536.2 Allowance for Credit Losses (Note 6)...... (559.9) (498.2) ---------- ---------- Net Finance Receivables...................... 14,470.3 14,038.0 Investment Securities (Note 7)............... 866.2 686.1 Property and Equipment....................... 229.3 204.9 Other Assets (Note 8)........................ 1,825.4 1,722.6 ---------- ---------- TOTAL ASSETS.............................. $ 17,645.1 $ 16,931.2 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Short-Term Debt (Note 10).................... $ 4,585.1 $ 4,169.3 Deposits Payable............................. 555.3 635.0 Long-Term Debt (Note 11)..................... 8,887.2 8,631.1 ---------- ---------- Total Interest-Bearing Debt............... 14,027.6 13,435.4 Accounts Payable and Accrued Liabilities (Note 9)...................... 708.0 534.0 Insurance Policy and Claim Reserves.......... 1,137.2 1,267.0 ---------- ---------- Total Liabilities......................... $ 15,872.8 $ 15,236.4 ========== ========== Shareholders' Equity: Preferred Stock (Note 12)................... 114.8 114.8 Common Stock (160.0 shares authorized; 53.3 and 54.0 shares outstanding) (Note 12)... 53.3 54.0 Additional Capital (Note 13)................ 250.7 305.3 Net Unrealized Gain on Investment Securities (Note 7)................................. 5.2 2.6 Accumulated Foreign Currency Translation Adjustments.............................. (48.2) (45.4) Retained Earnings........................... 1,396.5 1,263.5 ---------- ---------- Total Shareholders' Equity.............. 1,772.3 1,694.8 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY. $ 17,645.1 $ 16,931.2 ========== ==========
See Notes to Financial Statements. 3 BENEFICIAL CORPORATION AND SUBSIDIARIES STATEMENT OF INCOME AND RETAINED EARNINGS
Years Ended December 31 1997 1996 1995 (in millions, except per share amounts) REVENUE Finance Charges and Fees.......... $2,317.1 $2,143.5 $2,014.6 Interest Expense.................. 855.0 812.8 816.2 -------- -------- -------- Lending Spread................. 1,462.1 1,330.7 1,198.4 Insurance Premiums................ 177.8 168.7 152.7 Other (Note 18)................... 460.8 459.7 230.9 -------- -------- -------- Total.......................... 2,100.7 1,959.1 1,582.0 -------- -------- -------- OPERATING EXPENSES Salaries and Employee Benefits.... 434.9 412.6 384.6 Insurance Benefits................ 71.1 82.8 80.4 Provision for Credit Losses....... 485.3 398.8 280.2 Provision for Loss on German Disposal (Note 3).................... 58.8 -- -- Provision for Credit Losses on German Liquidating Loan Portfolio (Note 3). -- -- 15.0 Provision for Restructuring (Note 4)... -- -- 9.8 Other (Note 19)........................ 677.3 606.4 541.6 -------- -------- -------- Total............................... 1,727.4 1,500.6 1,311.6 -------- -------- -------- Income Before Income Taxes............. 373.3 458.5 270.4 Provision for Income Taxes (Note 17)... 119.6 177.5 119.9 -------- -------- -------- NET INCOME............................. 253.7 281.0 150.5 Retained Earnings, Beginning of Period. 1,263.5 1,093.0 1,042.2 Dividends Paid (Note 21)............... 120.7 110.5 99.7 -------- -------- -------- RETAINED EARNINGS, END OF PERIOD....... $1,396.5 $1,263.5 $1,093.0 ======== ======== ======== BASIC EARNINGS PER COMMON SHARE (Note 23)...................... $ 4.68 $ 5.19 $ 2.77 ======== ======== ======== DILUTED EARNINGS PER COMMON SHARE (Note 23)........................... $ 4.54 $ 5.05 $ 2.71 ======== ======== ======== DIVIDENDS PER COMMON SHARE............. $ 2.18 $ 1.98 $ 1.80 ======== ======== ======== AVERAGE COMMON SHARES OUTSTANDING (Note 23)........................... 54.7 54.6 53.7 ======== ======== ========
See Notes to Financial Statements. 4 BENEFICIAL CORPORATION AND SUBSIDIARIES STATEMENT OF CASH FLOWS
Years Ended December 31 1997 1996 1995 (in millions) CASH FLOWS FROM OPERATING ACTIVITIES Net Income.............................. $ 253.7 $ 281.0 $ 150.5 Reconciliation of Net Income to Net Cash Provided by Operating Activities: Provision for Credit Losses........ 485.3 398.8 280.2 Provision for Loss on German Disposal....................... 58.8 -- -- Gain on Securitized Receivables.... (73.5) (55.3) (15.4) Provision for Credit Losses on German Liquidating Loan Portfolio.................. -- -- 15.0 Provision for Restructuring........ -- -- 9.8 Provision for Deferred Income Taxes........................... (71.5) (32.5) (35.0) Depreciation and Amortization...... 46.8 49.6 48.8 Insurance Policy and Claim Reserves........................ (129.8) 1.5 180.8 Accounts Payable and Accrued Liabilities..................... 108.2 24.1 50.2 ---------- ---------- ---------- Net Cash Provided by Operating Activities................. 678.0 667.2 684.9 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES Receivables Originated or Acquired.... (13,898.9) (12,341.8) (9,860.3) Receivables Collected................. 11,505.2 8,954.0 7,443.3 Receivables Securitized............... 1,607.8 1,919.3 1,103.8 Available-For-Sale Investments Purchased........................ (463.3) (492.8) (313.9) Held-To-Maturity Investments Purchased (7.4) (13.0) (78.2) Available-For-Sale Investments Sold... 347.8 1,058.5 97.5 Available-For-Sale Investments Matured 61.6 372.9 154.5 Held-To-Maturity Investments Matured.. 16.2 5.3 21.1 Property and Equipment Purchased...... (62.6) (62.6) (37.2) Deposit from Reinsurers............... 120.4 (908.3) -- Interest in Residual Certificates..... (127.4) (10.8) (34.1) Other................................. (43.6) 72.5 34.1 ---------- ---------- ---------- Net Cash Used in Investing Activities.............. (944.2) (1,446.8) (1,469.4) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES Short-Term Debt, Net Change.......... 190.8 88.9 556.4 Deposits Payable, Net Change......... (28.7) 9.2 (29.4) Long-Term Debt Issued................ 2,829.5 2,782.3 3,102.1 Long-Term Debt Repaid................ (2,550.4) (1,983.8) (2,661.3) Dividends Paid....................... (120.7) (110.5) (99.7) Common Stock Repurchased............. (80.0) -- -- ---------- ---------- ---------- Net Cash Provided by Financing Activities.............. 240.5 786.1 868.1 ---------- ---------- ---------- NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS.......................... (25.7) 6.5 83.6 Cash and Equivalents at Beginning of Period............................... 279.6 273.1 189.5 ---------- ---------- ---------- CASH AND EQUIVALENTS AT END OF PERIOD... $ 253.9 $ 279.6 $ 273.1 ========== ========== ========== SUPPLEMENTAL CASH FLOW INFORMATION Interest Paid........................ $ 847.8 $ 816.2 $ 823.4 Income Taxes Paid.................... 181.5 222.9 154.8
See Notes to Financial Statements. 5 BENEFICIAL CORPORATION AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (in millions, except per share amounts) 1. NATURE OF OPERATIONS Beneficial Corporation (Company) is a holding company, subsidiaries of which provide financial services through their various consumer finance, banking and insurance operations located throughout the United States, Canada, Germany, Ireland and the United Kingdom. The Beneficial consumer finance loan office network includes more than 1,200 offices, offering both real estate secured loans and unsecured loans, as well as credit-related insurance products. Additionally, other subsidiaries offer credit card products (largely private-label), tax refund anticipation loans and selected non-credit-related insurance products. Approximately 40% of loans owned outstanding are secured by real estate. The majority of net income is derived from the consumer finance operations and credit insurance products related to the consumer finance business. Operations in any one country outside the United States are not significant in relation to the Company's overall operations. 2. SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES AND PRACTICES a) Basis of Consolidation. The consolidated financial statements include the accounts of the Company and its subsidiaries, after elimination of all significant intercompany accounts and transactions, and have been prepared in accordance with generally accepted accounting principles. Certain prior-period amounts have been reclassified to conform with the 1997 presentation. b) Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. c) Finance Operations. The financial statements are prepared on the accrual basis. Finance charges are recognized as income using the interest method or methods that produce similar results. The net amount of loan origination fees and direct loan origination costs are deferred and amortized into interest income over the estimated lives of the related loans. Direct origination costs for credit cards are deferred and amortized over 12 months. Income accrual is generally suspended after 30 days on delinquent loans. Premiums paid on receivables purchased are amortized using straight-line and accelerated methods generally over the estimated life of the loans. Provisions for credit losses are charged to income in amounts sufficient to maintain the allowance for credit losses at a level considered adequate to cover the losses of principal and interest in the finance receivables portfolio. Delinquent real estate secured receivables are reviewed individually by management, and accounts known to be uncollectible are charged off. In general, other receivables are automatically charged off after no payment has been made for six months. For all types of loans, collection efforts are generally continued. 6 Real estate properties acquired through foreclosure are carried at the lower of cost or estimated fair market value, minus estimated costs to sell, determined on an individual asset basis. Valuations are periodically performed by management, and an allowance for possible losses is established if the book value exceeds the estimated fair market value minus estimated costs to sell. Residual gains or losses on disposition are recorded in expense as incurred. Certain real estate secured loans are accounted for as foreclosed property (in-substance foreclosure) even though the actual foreclosure has not occurred. Such loans continue to be reported in finance receivables. These loans are carried at the lower of cost or estimated fair market value when the borrower has little or no equity in the collateral at its current estimated fair market value and it appears unlikely that the borrower will repay the loan other than through liquidation of the property. d) Receivables Sold with Servicing Retained. Periodically, subsidiaries of the Company sell home equity loans to trusts created as real estate mortgage investment conduits and retain the servicing. At the date of such securitizations, the Company allocates the total cost of the home equity loans to mortgage servicing rights and the loans based on their relative fair values. Fair values are determined based on present valuing the expected future cash flows using a discount rate commensurate with the risks involved, adjusted for prepayments and bad debts. On January 1, 1997, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." For each servicing contract in existence before January 1, 1997, previously recognized excess servicing assets that do not exceed contractually specified servicing fees were combined and recognized as a servicing asset. Previously recognized servicing assets that exceed contractually specified servicing fees were reclassified as interest-only strips and are carried at fair value. Both the servicing assets and the interest-only strips are included in other assets on the balance sheet. The servicing assets are amortized in proportion to, and over the period of, estimated net future servicing fee income. The servicing assets are periodically reviewed for valuation impairment. This review is performed on a disaggregated basis for the predominate risk characteristics of the underlying loans which are loan type, term, interest rate, prepayment rate and loss rate. The fair value of the servicing assets and interest-only strips are determined by present valuing the estimated net future cash flows. The weighted-average assumptions used in the fair value calculations include: discount rate - 15%, prepayment rate - 34%, loss rate - 1.3%, and servicing fees - 1.0%. e) Insurance Operations. The Company's insurance subsidiaries are engaged in writing credit life, credit accident and health insurance, credit property, credit involuntary unemployment insurance and ordinary life insurance. Premiums on credit life insurance are taken into income using the sum-of-the-months or actuarial methods, except in the case of level-term contracts, which are taken into income using the straight-line method over the lives of the policies. Premiums on credit accident and health insurance are generally taken into income using an average of the sum-of-the-digits and the straight-line methods. Premiums for credit property and credit involuntary unemployment insurance are generally taken into income using the sum-of-the-months method or on a pro rata basis. Premiums for ordinary life insurance are included in income when due. Premiums collected on annuity contracts are included as a liability in insurance policy and claim reserves. Policy reserves for credit life, credit accident and health insurance, credit property, and credit involuntary unemployment insurance are equal to related unearned premiums. Additionally, claim reserves for credit life, credit accident and health insurance, credit property, and credit involuntary unemployment insurance are adjusted to reflect claim experience. Liabilities for future life insurance policy benefits associated with ordinary life contracts are accrued when premium revenue is recognized and are computed on the basis of assumptions as to investment yields, mortality, morbidity and withdrawals. 7 f) Valuation of Investment Securities. Investments are owned principally by the insurance subsidiaries and consist primarily of debt securities. Investments in debt securities that the subsidiaries have both the ability and the intention of holding until maturity are classified as held-to-maturity securities and reported at amortized cost (remaining principal net of unamortized premiums or discounts). Investments that may be sold prior to maturity to support the subsidiaries' investment strategy, such as in response to changes in interest rates or tax deductibility of interest, are considered as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders' equity. Gains and losses from trading securities are included in income from operations. The cost of investments sold is determined on the specific cost identification basis. g) Translation of Foreign Currencies. Operations outside the United States are conducted through subsidiaries located in Canada, Germany, Ireland and the United Kingdom. Assets and liabilities of these subsidiaries are translated at the rates of exchange at the balance sheet dates, while income and expense items are translated at the average exchange rates for each period covered by the statement of income and retained earnings. The resulting translation adjustments are included in accumulated foreign currency translation adjustments, a separate component of shareholders' equity. h) Derivative Financial Instruments. To hedge its investment in foreign subsidiaries and to moderate its exposure to interest-rate fluctuations, the Company enters into various transactions involving off-balance-sheet financial instruments. These transactions include options, currency swaps and forwards for foreign currency risk management and interest-rate swaps and forward-rate agreements for interest rate exposure management. Gains or losses on foreign currency instruments designated as hedges of the Company's net investments in foreign subsidiaries are included with translation adjustments in shareholders' equity. Gains or losses on these instruments in excess of the amount needed to offset net investment losses or gains are included in income. The net amount of interest income and interest expense on agreements used to hedge interest-rate exposure is recognized in interest expense over the lives of the instruments. The indices on derivatives used to hedge interest-rate exposure match an index corresponding to either a specific long-term debt instrument or to a pool of short-term debt. The Company does not terminate these derivatives prior to maturity. In the unlikely event of termination, gain or loss would be reflected in the income statement, or deferred and recognized over the remaining life of the hedged instrument. The Company does not serve as a financial intermediary to make markets in any off-balance-sheet financial instruments nor does it hold or issue derivative financial instruments for trading purposes. i) Amortization of Intangible Assets. Excess cost applicable to acquisitions is generally amortized on a straight-line basis over 20 years. j) Earnings per Common Share. Basic earnings per common share are computed by deducting dividend requirements on preferred stock of the Company from net income and dividing the remainder by weighted-average common shares outstanding. Diluted earnings per common share are computed by deducting dividend requirements on non-convertible preferred stocks of the Company from net income and dividing the remainder by weighted-average common shares outstanding adjusted for all dilutive potential common shares that were outstanding during the period. k) Cash Equivalents. The Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. 8 l) Computer Software Costs. The Company capitalizes costs of purchased software or software developed internally when the project is in the application development stage. Costs of developed software that is considered to be in the preliminary project stage or the post-implementation stage are expensed as incurred. Costs incurred in conjunction with Year 2000 remediation are expensed as incurred. 3. DIVESTITURE OF CANADA AND GERMANY As part of a number of strategic initiatives to enhance growth and build shareholder value, the Company recently announced its intent to sell its Canadian consumer finance subsidiary and its German consumer banking subsidiary. On February 10, 1998, the Company entered into a definitive agreement for the sale of its Canadian operations and on March 2nd closed the transaction. The sale generated a net aftertax gain in excess of $100. The Company anticipates the sale of its German subsidiary to occur in the near term. The sale is expected to result in a loss of $27.8 after consideration of a $31.0 tax benefit, primarily generated by the expected utilization of capital losses, and has been accrued at December 31, 1997. As of December 31, 1997, the net assets subject to sale totaled $137.2 and were comprised of the following:
Canada Germany Total Net Finance Receivables..... $775.1 $ 271.6 $ 1,046.7 Other Assets................ 14.7 129.5 144.2 ------ ------- --------- Total Assets............. 789.8 401.1 1,190.9 ------ ------- --------- Short-Term Debt............ 344.2 -- 344.2 Long-Term Debt............. 308.8 32.5 341.3 Deposits................... -- 277.6 277.6 Other Liabilities.......... 15.3 75.3 90.6 ------ ------- --------- Total Liabilities.......... 668.3 385.4 1,053.7 ------ ------- --------- Net Assets................... $121.5 $ 15.7 $ 137.2 ====== ======= =========
In 1997, the Canadian operations reported pretax earnings of $21.2 while the German operating pretax loss was $6.7. The Company had previously announced its intent, in December of 1994, to sell its German subsidiary. However, in December of 1995, the Company announced the decision to retain the operation because no acceptable offers were received. Since negotiations and other efforts did not progress as anticipated in the original loss estimates, the Company recorded a $15.0, or $0.28 per share, charge in 1995 for additional potential losses relating to a significant liquidating loan portfolio. 4. PROVISION FOR RESTRUCTURING In the fourth quarter of 1995, the Company implemented an expense-reduction program, principally within its headquarters operations. The resulting restructuring charge reduced net income by $5.9, or $0.11 per share, and was largely related to early retirement and severance expenses corresponding to workforce reductions of 225. 9 5. FINANCE RECEIVABLES Finance receivables at December 31 consisted of the following:
1997 1996 ---- ---- Receivables Owned: Real Estate Secured............... $ 5,905.3 $ 5,931.7 Personal Unsecured................ 3,262.4 2,982.9 Credit Cards...................... 4,685.4 4,595.8 Sales Finance Contracts........... 994.3 926.3 Commercial........................ 182.8 99.5 --------- --------- Total Owned..................... 15,030.2 14,536.2 Receivables Sold with Servicing Retained (all real estate secured)...... 2,912.7 2,324.8 --------- --------- Total Managed........................ $17,942.9 $16,861.0 ========= =========
Includes receivables of $1,084.2 and $1,103.0 in 1997 and 1996, respectively, relating to the Company's German and Canadian subsidiaries. Average receivables during the years ended December 31 were as follows:
1997 1996 ---- ---- Average Receivables Owned............ $14,459.6 $13,520.8 Average Receivables Sold With Servicing Retained............... 2,600.4 1,798.1 --------- --------- Average Managed...................... $17,060.0 $15,318.9 ========= =========
From time to time, subsidiaries of the Company have sold home equity loans through securitizations and have retained collection and administrative responsibilities as servicer for the trust holding the home equity loans. Scheduled contractual maturities of finance receivables owned to be received after December 31, 1997, are as follows:
1998 1999 2000 2001 Beyond ---- ---- ---- ---- ------ Real Estate Secured...... 18% 12% 12% 13% 45% Personal Unsecured....... 43 32 17 4 4 Credit Cards............. 43 7 7 6 37 Sales Finance Contracts.. 72 20 6 1 1 Commercial............... 25 20 13 8 34 Overall.................. 35% 16% 11% 8% 30%
While the statutes of several states place no maximum limit on the contractual term of closed-end loans secured by real estate, the consumer finance subsidiaries generally limit loans of this type to periods ranging from 60 to 180 months. Terms of closed-end unsecured loans and sales finance contracts generally do not exceed 60 months. It is the Company's experience that a substantial portion of all consumer receivables is renewed or repaid prior to contractual maturity dates. Accordingly, the previous tabulation should not be viewed as a forecast of future cash collections. During the years ended December 31, 1997 and 1996, cash collections totaled $11,505.2 and $8,954.0, respectively. The monthly collections of cash principal as a percentage of average receivables were 6.66% in 1997 and 5.51% in 1996. 10 6. ALLOWANCE FOR CREDIT LOSSES Changes in the allowance for credit losses were as follows:
1997 1996 ---- ---- Balance at Beginning of Year.................. $ 498.2 $ 406.1 Accounts Charged Off.......................... (468.2) (363.3) Recoveries on Accounts Previously Charged Off. 56.0 46.4 Provision for Credit Losses................... 485.3 398.8 Other......................................... (11.4) 10.2 ------- ------- Balance at End of Year......................... $ 559.9 $ 498.2 ======= =======
Year-end balances include $37.5 and $57.3 in 1997 and 1996, respectively, relating to the Company's German and Canadian subsidiaries. 7. INVESTMENT SECURITIES In the fourth quarter of 1995, the Company decided to exit its annuity business. The actual disposition of the annuity business and the capital gain from the sale of corresponding investments increased net income by $8.4, or $0.16 per share, in March 1996. As of December 31, 1997, shareholders' equity included a net unrealized gain of $5.2, consisting of an $8.0 net gain on the Available-For-Sale portfolio, offset by $2.8 of applicable income taxes. Investments at December 31 were as follows:
Gross Gross Est. Amortized Unrealized Unrealized Market 1997 Cost Gains Losses Value ---- --------- ---------- ---------- ------ Available-For-Sale Debt Securities: Corporate............... $294.7 $6.5 $1.1 $300.1 Mortgage-backed......... 29.8 .9 -- 30.7 Municipal............... 5.2 .1 -- 5.3 U.S. Government......... 115.8 1.0 -- 116.8 Foreign Government...... 59.8 .7 -- 60.5 Other................... 5.6 .1 -- 5.5 ------ ----- ----- ----- 510.9 9.2 1.2 518.9 Equity Securities.......... .6 -- -- .6 ------ ----- ----- ----- Total................... $511.5 $9.2 $1.2 $519.5 ====== ==== ==== ====== Held-To-Maturity Debt Securities: Corporate............... $48.8 $ .4 $ .1 $49.1 Mortgage-backed......... 2.2 -- -- 2.2 Municipal............... 10.8 .3 -- 11.1 U.S. Government......... 10.4 -- .1 10.3 Foreign Government...... 1.1 -- .1 1.0 Other................... 10.2 -- -- 10.2 ----- ---- --- ---- Total............. $83.5 $ .7 $ .3 $83.9 ===== ==== ==== =====
11
Gross Gross Est. Amortized Unrealized Unrealized Market 1996 Cost Gains Losses Value ---- --------- ----------- ---------- ------ Available-For-Sale Debt Securities Corporate......... $273.6 $5.3 $3.4 $275.5 Mortgage-backed... 35.1 1.2 .2 36.1 Municipal......... 7.3 .1 .1 7.3 U.S. Government... 93.9 .6 .2 94.3 Foreign Government. 42.4 .5 -- 42.9 ---- ---- ---- ---- 452.3 7.7 3.9 456.1 Equity Securities.... .6 -- -- .6 ---- ---- ---- ---- Total............. $452.9 $7.7 $3.9 $456.7 ====== ==== ==== ====== Held-To-Maturity Debt Securities: Corporate.......... $48.9 $ .1 $ .7 $48.3 Mortgage-backed.... 2.6 -- .1 2.5 Municipal.......... 8.5 .2 -- 8.7 U.S. Government.... 14.4 -- .2 14.2 Foreign Government. 1.1 -- -- 1.1 Other.............. 18.1 -- -- 18.1 ---- --- --- ---- Total........ $93.6 $ .3 $1.0 $92.9 ===== ==== ==== =====
Included in investments is $263.2 and $135.8, in 1997 and 1996, respectively, classified as trading securities. These amounts represent residual interests in securitized receivables resulting from the early payment of principal to certificate holders. The contractual maturities of debt securities at December 31, 1997, are shown in the table that follows. Actual maturities may differ from contractual maturities because some borrowers may have the right to prepay obligations, with or without prepayment penalties.
Amortized Estimated Cost Market Value 1997 Available-For-Sale Due within one year............... $ 29.1 $ 29.1 Due one through five years........ 156.1 158.4 Due five through ten years........ 317.4 322.9 Due after ten years............... 8.3 8.5 ------ ------ Total.......................... $510.9 $518.9 ------ ------ Held-To-Maturity Due within one year.............. $ 7.3 $ 7.3 Due one through five years....... 47.3 47.5 Due five through ten years....... 17.1 17.3 Due after ten years.............. 11.8 11.8 ------- ------- Total......................... $ 83.5 $ 83.9 ======= =======
Proceeds from sales of Available-For-Sale securities totaled $347.8 in 1997, compared with $1,508.5 in 1996. Gross gains of $6.8 in 1997 and $27.5 in 1996, and gross losses of $0.4 in 1997 and $1.6 in 1996, were realized on those sales. 12 8. OTHER ASSETS
At December 31 1997 1996 -------------- ---- ---- Annuity Deposits...................... $ 787.9 $ 908.3 Deferred Income Tax Benefits.......... 302.7 232.3 Excess Cost of Net Assets Acquired.... 43.7 14.6 Interest-Only Residual................ 72.8 46.9 Investments in and Advances to Discontinued Operations.......................... 6.5 15.0 Miscellaneous Accounts and Notes Receivable.......................... 75.7 70.1 Prepaid Expenses...................... 178.9 130.7 Property Acquired by Foreclosure...... 85.5 100.2 Recoverable Income Taxes.............. 43.4 44.6 Servicing Asset....................... 11.4 8.0 Unamortized Insurance Policy Acquisition Costs.................... 33.2 36.0 Other................................. 183.7 115.9 -------- -------- Total.............................. $1,825.4 $1,722.6 ======== ========
The activity in the servicing asset is summarized as follows: balance January 1, 1997 - $8.0, recognized during the period - $6.9, amortization - $3.5, balance at December 31, 1997 - $11.4. 9. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
At December 31........................ 1997 1996 -------------- ---- ---- Accounts Payable...................... $347.3 $191.5 Accrued and Deferred Compensation..... 76.4 72.1 Accrued Interest...................... 81.0 69.5 Accrued Postretirement Benefits....... 72.2 61.1 Accrued Pension Cost.................. 16.8 18.4 Income Taxes Payable.................. 46.1 42.0 Insurance Premiums Payable............ 27.7 32.2 Other................................. 40.5 47.2 ------ ------ Total.............................. $708.0 $534.0 ====== ======
10. SHORT-TERM DEBT Short-term debt, includes $1,277.4. and $916.9 relating to foreign subsidiaries at year-end 1997 and 1996, respectively, of which $344.2 and $228.4 at year-end 1997 and 1996, respectively, relate to the German and Canadian subsidiaries. Short-term debt consisted of the following:
At December 31........................ 1997 1996 -------------- ---- ---- Commercial Paper...................... $3,770.5 $3,695.4 Bank Borrowings....................... 814.6 473.9 -------- -------- Total.............................. $4,585.1 $4,169.3 ======== ========
13 Selected details of short-term borrowings are as follows:
1997 1996 1995 ---- ---- ---- Highest Aggregate at Any Month-End. $4,585.1 $4,571.3 $4,023.9 Daily Average Amount............... 3,977.1 3,846.2 3,366.3 Weighted Average Interest Rates: At Year-End: Commercial Paper............. 5.74% 5.38% 5.85% Bank Borrowings.............. 7.48 6.17 6.71 Overall................... 6.09 5.49 5.98 Paid During Year*: Commercial Paper............. 5.52 5.52 6.24 Bank Borrowings.............. 6.89 6.46 7.19 Overall................... 5.68% 5.63% 6.37%
*Weighted average interest rates paid during the year have been determined by relating short-term interest costs (including the costs of maintaining lines of credit) for each year to the daily average dollar amounts outstanding. The Company maintains committed revolving credit agreements in support of its outstanding commercial paper. At December 31, 1997, the Company had lines of credit of $4,307.5, of which $3,850.7 was unused. The most significant of these credit agreements has a net-worth test of $1,000. Annual commitment fee requirements to support availability of credit agreements at the end of 1997, 1996 and 1995 totaled $3.9, $4.1 and $5.8, respectively. The impact of interest rate hedging activities on the Company's weighted average short-term borrowing rates and on the reported short-term interest expense were increases as follows: .08% and $3.1 in 1997; .13% and $5.1 in 1996; and .05% and $1.7 in 1995. 11. LONG-TERM DEBT
At December 31 1997 1996 -------------- ---- ---- United States.............. $7,814.8 $7,832.2 Canada..................... 308.8 338.6 Germany.................... 32.5 31.6 United Kingdom............. 731.1 428.7 -------- -------- Total................... $8,887.2 $8,631.1 ======== ========
Long-term debt, including weighted average interest rates by year of maturity on debt outstanding at December 31, 1997, is shown below in the earliest year it could become payable:
Average Rates Maturity 1997 1997 1996 -------- ------------- ---- ---- 1997................. $2,610.1 1998................. 7.13% $2,246.1 1,982.0 1999................. 6.73 1,990.7 1,669.7 2000................. 6.71 1,254.1 554.9 2001.................. 7.05 946.3 632.4 2002.................. 6.82 1,293.4 558.3 2003-2007............. 6.77 959.3 426.4 2008-2023............. 7.85 197.3 197.3 --------- --------- Total.............. 6.90% $8,887.2 $8,631.1 ======== ========
14 The weighted average annual interest rates on debt outstanding at year-end were 6.90%, 6.84% and 7.24% for 1997, 1996 and 1995, respectively. Weighted average interest rates (including issuance costs) paid during the year on average long-term debt outstanding were 6.92%, 7.07% and 7.56% for years ended December 31, 1997, 1996 and 1995, respectively. Long-term debt outstanding at December 31, 1997 and 1996, includes $4,174.6 and $3,815.7, respectively, of variable-rate debt that reprices based on various indices. Such variable-rate debt generally has an original maturity of one to two years. The impact of interest rate hedging activities on the Company's weighted average long-term borrowing rates and on the reported long-term interest expense were increases as follows: .02% and $2.0 in 1997; .06% and $4.8 in 1996; and .05% and $3.7 in 1995. 12. CAPITAL STOCK Shares of capital stock outstanding were as follows:
At December 31....................... 1997 1996 1995 -------------- ---- ---- ---- 5% Cumulative Preferred - $50 par value. Authorized, 585,730.............. 407,718(a 407,718(a 407,718(a $5.50 Dividend Cumulative Convertible Preferred - no par value - $20 stated value (each share convertible into nine shares of Common; maximum liquidation value, $1,653,800, $1,845,700, and $2,031,000). Authorized, 1,164,077 Outstanding Shares Beginning of Year................... 18,457 20,310 22,362 Conversion into Common..... (1,919) (1,853) (2,052) -------- -------- -------- Outstanding Shares End of Year 16,538 18,457 20,310 -------- -------- -------- $4.50 Dividend Cumulative Preferred - $100 par value. Authorized, 103,976............. 103,976 103,976 103,976 -------- -------- ------- $4.30 Dividend Cumulative Preferred - no par value - $100 stated value. Authorized, 1,069,204........... 836,585 836,585 836,585 -------- ------- ------- Common - $1 par value. Authorized 160,000,000 Outstanding Shares Beginning of Year.................... 54,041,214 53,197,422 52,509,728 Conversion of $5.50 Preferred into Common............... 17,271 16,677 18,468 Exercise of Stock Options.. 453,363 827,115 669,903 Tendered Shares............ (29,510) -- -- Repurchased Shares......... (1,205,000) -- -- Direct Investment Plan..... 13,271 -- -- Transfer into Treasury from Treasury Shares Held as an Asset.. -- -- (677) Outstanding Shares End of Year................. 53,290,609(b 54,041,214(b 53,197,422(b ---------- ---------- ---------- After deducting treasury shares: a) 5% Cumulative Preferred........ 178,012 178,012 178,012 b) Common............. 3,581,451 2,800,304 3,627,419
15 In addition, the Company is authorized to issue 500,000 shares of preferred stock (no par value) and 2,500,000 shares of preferred stock ($1.00 par value). Included within such shares are 570,000 shares of Series A Participating Preferred Stock ($1.00 par value) that the Company is authorized to issue in connection with Preferred Stock Purchase Rights (see Note 14). None of these authorized preferred shares are issued or outstanding. At December 31, 1997, a total of 148,842 shares of common stock was reserved for conversion of $5.50 Dividend Cumulative Convertible Preferred Stock. During the year, 17,271 shares of common stock were issued upon conversion of the $5.50 Dividend Cumulative Convertible Preferred Stock, and 453,363 common stock treasury shares were reissued in connection with the exercise of stock options. 13. ADDITIONAL CAPITAL Additional capital decreased by $54.6 in 1997 and increased by $35.3 in 1996. The decrease in 1997 resulted from common stock repurchases of $78.8 offset by issuances in connection with various employee stock plans, primarily the non-qualified stock option plan described in Note 20. The increase in 1996 resulted from stock issuances in connection with various employee stock plans. 14. PREFERRED STOCK PURCHASE RIGHTS On August 22, 1996, the Board of Directors of the Company adopted a Renewed Rights Agreement which became effective November 23, 1997. One new Preferred Stock Purchase Right (Right) was issued for each share of common stock, par value $1.00 per share, of the Company outstanding on November 23, 1997, and a Right will be issued for each share of common stock issued thereafter. Under certain circumstances, each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of the Company's Series A Participating Preferred Stock at a price of $235, subject to adjustment. Until the Rights become exercisable, expire or are redeemed, they will automatically trade with the common stock but will at no time have voting power. The Rights will be exercisable under circumstances generally involving certain acquisitions of, or tender offers for, the common stock, or if a 10% stockholder is declared an "Adverse Person" by the Board of Directors. If, at any time after the Rights become exercisable, but before they expire or are redeemed, the Company is acquired in a merger or other business combination or sells 50% or more of its assets or earning power, the holder of a Right will be entitled to buy, at the exercise price, a number of shares of Common Stock of the acquiring or surviving company having a market value of twice the exercise price of each Right. Generally, the Rights may be redeemed by the Company for $.01 per Right at any time prior to the expiration of the Rights on August 22, 2006, and the Company may alter the exercise price of the Rights and extend the duration of the Renewed Rights Agreement beyond its 10-year term. The Renewed Rights Agreement, which became effective on November 23, 1997, replaced the original Rights Agreement adopted in 1987. The original Rights Agreement was substantially identical to the Renewed Rights Agreement, except that (i) the exercise price per Preferred Stock Purchase Right was $87.50 per share, subject to adjustment; (ii) the redemption price was $.025 per Right; (iii) each Right entitled the registered holder to purchase from the Company one two-hundredth of a share of the Company's Series A Participating Preferred Stock; and (iv) the amendment provision did not permit the Company to alter the exercise price of the Rights or to extend the original Rights agreement beyond its 10-year term. 16 15. EMPLOYEE RETIREMENT PLANS The Company has a non-contributory defined benefit pension plan (Plan) covering substantially all employees of the Company and its subsidiaries in the United States. The benefits provided are based on the employee's age, years of service and average compensation during the highest three consecutive years of earnings. The Company has made annual contributions at least equal to the amounts accrued for retirement expense. Plan assets are invested primarily in equity securities and corporate bonds. The Company also has a supplemental retirement plan to restore those benefits which have been earned under the Plan but which are not payable to participants because of the limits imposed by the Internal Revenue Code on qualified plan benefit distributions. Employees of subsidiaries outside the United States generally receive retirement benefits from Company-sponsored plans or from statutory plans administered by governmental agencies in other countries. In addition, the Company funds two 401(k) savings plans, which collectively cover substantially all employees of the Company and its subsidiaries in the United States, under which basic contributions are made annually up to 2.5% of each eligible employee's annual compensation up to $0.15. Related costs charged to income for the years ended December 31, 1997, 1996 and 1995, were $5.4, $4.8 and $4.6, respectively. The Plan's funded status and amounts recognized in the Company's balance sheet are as follows:
At December 31 1997 1996 -------------- ---- ---- Actuarial Present Value of Benefit Obligation: Vested Benefits............................ $ 51.5 $ 45.4 Non-Vested Benefits........................ 12.5 15.0 ------- ------- Accumulated Benefit Obligation................ 64.0 60.4 Effect of Future Salary Increases............. 48.8 43.5 ------- ------- Projected Benefit Obligation.................. 112.8 103.9 Less Plan Assets at Fair Value................ 78.9 65.0 ------- ------- Projected Benefit Obligation in Excess of Plan Assets..................... 33.9 38.9 Less Unrecognized Net Loss.................... 17.1 20.5 ------- ------- Accrued Pension Cost Included in Accounts Payable and Accrued Liabilities...................... $ 16.8 $ 18.4 ====== ======
For 1997, the projected benefit obligation was determined using an assumed discount rate of 7.00% (compared with 7.50% in 1996), an assumed long-term rate of return on assets of 9.00%, and an assumed long-term rate of increase in future compensation levels of 4.50%. The following table details the components of net pension expense for the Plan:
1997 1996 1995 ---- ---- ---- Service Cost - Benefits Earned During Period...$ 5.5 $ 5.4 $ 4.4 Interest Cost on Projected Benefit Obligation.. 7.3 7.6 7.6 Actual Return on Plan Assets...................(13.3) (7.1) (12.3) Net Amortization and Deferral.................. 7.9 1.6 7.1 ----- ----- ----- Net Periodic Pension Cost..................... $ 7.4 $ 7.5 $ 6.8 ===== ===== =====
Pension expense related to the Company's supplemental pension plan was $1.3, $1.3 and $1.2 in 1997, 1996 and 1995, respectively. Pension expense for the Company's subsidiaries outside the United States was $2.8, $2.7 and $2.6 for 1997, 1996 and 1995, respectively. 17 16. POSTRETIREMENT BENEFITS The Company provides postretirement health and dental care benefits to eligible employees in the United States, along with their spouses and eligible dependents. Employees become eligible for these benefits if they meet minimum age and service requirements and if they agree to contribute a portion of the cost. The associated plans are unfunded, and approved claims are paid from Company funds. Under the terms of the plans, the Company reserves the right to modify or terminate the plans. Most employees outside the United States are covered by government health care programs. The cost of such programs is not significant to the Company. The cost to the Company of postretirement benefits consisted of the following components:
At December 31 1997 1996 1995 -------------- ---- ---- ---- Postretirement Benefit Cost: Service Cost - benefits attributable to service during the year.............. $2.0 $2.0 $1.5 Interest Cost on Accumulated Benefit Obligation............ 4.2 4.1 4.2 Amortization of Deferred Gain.. (0.8) (0.3) (0.8) ---- ---- ---- Total....................... $5.4 $5.8 $4.9 ==== ==== ====
The actuarial and recorded liabilities for these benefits were as follows:
At December 31 1997 1996 -------------- ---- ---- Accumulated Postretirement Benefit Obligation: Retirees.................................... $45.1 $38.8 Fully Eligible Active Plan Participants..... 12.4 10.3 Other Active Plan Participants.............. 14.7 12.0 ----- ----- Total.................................... $72.2 $61.1 ===== =====
For measurement purposes, a 10.2% pre-65 trend rate was used for 1997 and 1996, with an ultimate rate of 5.0% in 2013. In addition, a 9.7% post-64 trend rate was used for 1997 and 1996, with an ultimate rate of 5.0% in 2018. For dental costs, a trend rate of 6.0% was used for 1997 and 1996, with an ultimate rate of 4.0% in 2001. The discount rate was 7.00% at December 31, 1997, and 7.50% at December 31, 1996. A one-percentage-point increase in the health care trend rate would have increased the accumulated postretirement benefit obligation by $3.9 at year-end 1997 and would have added $.6 to the benefit cost for the year. 17. INCOME TAXES The provision for income taxes consisted of the following:
1997 1996 1995 ---- ---- ---- Federal: Current: U.S..................... $153.5 $177.0 $124.1 Foreign................. 17.4 16.0 18.4 ------ ------ ------ Total................ 170.9 193.0 142.5 ------ ------ ------ Deferred: U.S..................... (71.3) (32.8) (34.2) Foreign................. (0.2) 0.3 (0.8) ------ ------ ------ Total................ (71.5) (32.5) (35.0) State and Local............... 20.2 17.0 12.4 ------ ------ ------ Total Provision for Income Taxes......... $119.6 $177.5 $119.9 ====== ====== ======
18 Temporary differences that gave rise to deferred tax assets and liabilities were as follows:
At December 31 1997 1996 -------------- ---- ---- Deferred Tax Assets: Allowance for Credit Losses............ $187.2 $163.9 Capital Losses - Germany............... 33.0 -- Retiree Benefit Plans.................. 31.5 29.8 Accrued and Deferred Compensation...... 19.4 19.2 Deferred Commission Income............. 12.8 10.4 Insurance Reserves..................... 10.1 3.3 Foreign Tax Credits*................... 1.3 8.0 All Other............................... 73.0 64.2 ------ ------ Subtotal............................. 368.3 298.8 ====== ====== Deferred Tax Liabilities: Real Estate Partnership Losses.......... 27.4 23.7 Deferred Acquisition Costs.............. 17.8 15.7 All Other............................... 17.1 19.1 ------ ------ Subtotal............................. 62.3 58.5 ------ ------ Valuation Allowance*....................... (3.3) (8.0) ------ ------ Net Deferred Taxes.................... $302.7 $232.3 ====== ======
*Foreign Tax Credits are fully offset by valuation allowances because utilization is uncertain. The tax credits expire over the next five years. A reconciliation of the differences between income taxes computed at the statutory U.S. income tax rate and the consolidated tax provisions is as follows:
1997 1996 1995 ---- ---- ---- Statutory U.S. Tax Rate................... 35.0% 35.0% 35.0% Increase (Decrease): Differential Due to Operations Outside U.S............................... (.8) (1.4) 4.0* State and Local Income Taxes........... 3.5 2.4 3.0 Capital Losses - Germany............... (7.7) -- -- Other.................................. 2.0 2.7 2.3 ---- ---- ---- Effective Tax Rate..................... 32.0% 38.7% 44.3% ==== ==== ====
*Includes 3.2% in 1995 resulting from the non-deductibility of credit losses at the German banking subsidiary. The foreign tax credit utilization resulted from the Company's election to modify the limitation calculation. U.S. income taxes were not provided at December 31, 1997, on $19.0 of undistributed earnings of foreign subsidiaries, which are expected to be permanently invested in foreign countries, and on $77.8 of undistributed earnings of life insurance subsidiaries accumulated as policyholders' surplus under tax laws in effect prior to 1984. Should these amounts be distributed, the additional income taxes payable would be approximately $1.0 and $27.2, respectively. 18. OTHER REVENUE
1997 1996 1995 ---- ---- ---- Investment Income................$ 56.6 $ 80.2 $ 67.8 Net Tax Service (RAL) Revenue.... 105.7 140.9 (14.9) Securitization Revenue........... 237.8 192.3 123.6 Other............................ 60.7 46.3 54.4 ---- ---- ---- Total.......................... $460.8 $459.7 $230.9 ====== ====== ======
19. OTHER EXPENSES
1997 1996 1995 ---- ---- ---- Collection Expense................. $ 27.4 $ 20.4 $ 16.4 Data Processing Costs.............. 57.8 42.1 35.6 Depreciation....................... 38.8 40.8 40.0 Insurance Commissions.............. 19.9 18.5 21.7 Licenses and Taxes................. 20.9 17.6 17.0 Losses on Real Estate Foreclosures. 26.1 38.1 45.9 Marketing.......................... 111.9 77.1 58.2 Occupancy.......................... 80.7 78.1 75.8 Origination Costs.................. 18.0 29.1 26.7 Postage............................ 35.8 32.3 26.6 Premium Amortization............... 33.4 35.2 25.3 Printing........................... 23.3 27.6 22.6 Professional Services.............. 46.0 29.9 26.6 Telecommunications................. 32.8 32.6 30.6 Travel............................. 23.0 21.4 20.3 Other.............................. 81.5 65.6 52.3 ------ ------ ------ Total........................... $677.3 $606.4 $541.6 ====== ====== ======
20. STOCK OPTIONS The Company has a non-qualified stock option plan (Non-Qualified Plan), adopted in 1990, which provides for grants of options to officers, directors and key employees of the Company and its participating subsidiaries. Under the Non-Qualified Plan, the option price shall not be less than 100% of fair market value on the date the option is granted. Options generally become exercisable in cumulative annual increments of 25% each year, commencing one year after date of grant and expiring after 10 years. The aggregate number of options for any calendar year may not exceed 1.75% of the total issued and outstanding common stock of the Company as measured on the first day of any such calendar year. If during any such calendar year the total number of authorized options is not granted, the remainder will be available for granting during any succeeding year during the term of the Non-Qualified Plan. Shares of common stock to be issued upon exercise of options may be treasury shares reacquired by the Company or authorized and unissued common shares or a combination of both. The Company adopted an equity participation plan (Plan) in 1997, that provides for grants of options to each eligible employee. It is the intent of the Plan that there be no overlap in eligibility between the Plan and the Non-Qualified Plan. Under the Plan, the option price shall be 120% of the fair market value on the date the option is granted. Options are fully exercisable when granted and expire after 10 years. 19 The Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." Accordingly, no compensation cost has been recognized for the Non-Qualified Plan or the Plan. Had compensation cost for the Non-Qualified Plan or the Plan been determined based on the fair value at the grant date of awards in 1997, 1996 and 1995 consistent with the provisions of SFAS No. 123, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below:
1997 1996 1995 ---- ---- ---- Net Income - Reported.................. $253.7 $281.0 $150.5 Net Income - Pro Forma................. 248.9 278.8 150.3 Basic Earnings per share: Reported............................ 4.68 5.19 2.77 Pro Forma........................... 4.59 5.15 2.77 Diluted Earnings per share: Reported............................ 4.54 5.05 2.71 Pro Forma........................... 4.45 5.01 2.71
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted- average assumptions used for grants in 1997, 1996 and 1995, respectively: dividend yield of 3.07%,3.54% and 4.00%; risk-free interest rate of 5.82%, 5.95% and 5.77%; expected volatility of 26.3% and expected lives of 5.5 for all years. The pro forma effect on net income for 1997, 1996 and 1995 is not representative of the pro forma effect on net income in future years because it does not take into consideration pro forma compensation expense related to grants made prior to 1995. The weighted average fair value at the date of grant for options granted during 1997, 1996 and 1995 was $16.06, $16.21 and $13.10 per option, respectively. The following table summarizes the activity relating to the Plan:
Weighted-Average Number Exercise Price Shares Under Option Options Outstanding December 31, 1994.. 3,634,566 $33.05 Options Exercised................... (669,903) 28.82 Options Canceled.................... (132,425) 35.26 Options Granted..................... 955,130 49.19 ---------- ------- Options Outstanding December 31, 1995.. 3,787,368 37.79 ========= ======= Options Exercised................... (827,115) 32.79 Options Canceled.................... (68,056) 40.38 Options Granted..................... 1,042,350 64.32 --------- ------- Options Outstanding December 31, 1996.. 3,934,547 45.82 ========= ======= Options Exercised................... (453,363) 38.52 Options Canceled.................... (485,088) 72.10 Options Granted..................... 3,031,800 82.53 --------- ------ Options Outstanding December 31, 1997.. 6,027,896 $62.72 ========= ====== Options Exercisable December 31, 1997.. 3,605,679 $60.92 ========= ======
20 The following table summarizes information about stock options outstanding at December 31, 1997:
Options Outstanding Options Exercisable ------------------------------------------------------------------------------- Weighted- Average Weighted- Weighted- Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Price Outstanding Life Price Exercisable Price -------------- ----------- ------------ --------- ----------- --------- $21.75 - $22.44 42,477 3 years $22.04 42,477 $22.04 29.16 - 31.13 519,727 4.6 years 29.95 519,727 29.95 37.44 - 38.78 1,053,375 6.5 years 37.70 862,737 37.76 49.19 - 49.25 752,414 8 years 49.19 331,814 49.19 61.81 - 64.44 965,313 9 years 64.32 254,834 63.98 75.44 - 79.44 1,100,500 10 years 77.04 - - 81.00 - 90.53 1,594,090 9.6 years 86.54 1,594,090 86.54 --------------- --------- --------- ----- --------- ----- $21.75 - $90.53 6,027,896 8.4 years $62.72 3,605,679 $60.92 =============== ========= ========= ====== ========= ======
21. DIVIDENDS PAID
1997 1996 1995 ---- ---- ---- Preferred Stock: 5%............................. $ 1.0 $ 1.0 $ 1.0 $5.50 Convertible.............. .1 .1 .1 $4.50.......................... .5 .5 .5 $4.30.......................... 3.6 3.6 3.6 --- --- --- 5.2 5.2 5.2 Common Stock...................... 115.5 105.3 94.5 ----- ----- ---- Total Dividends.............. $120.7 $110.5 $99.7 ====== ====== =====
22. GEOGRAPHIC INFORMATION Data by geographic area for the years ended December 31 are shown in the following table:
Inter- United Company States Foreign Eliminations Total 1997 Revenue.......................$ 2,507.8 $ 462.2 $(14.3) $ 2,955.7 Income before Income Taxes.... 389.9 (16.6) -- 373.3 Net Assets.................... 1,380.5 391.8 -- 1,772.3 Total Assets.................. 14,339.9 3,396.9 (91.7) 17,645.1 1996 Revenue....................... 2,371.2 409.6 (8.9) 2,771.9 Income before Income Taxes.... 423.9 34.6 -- 458.5 Net Assets.................... 1,398.6 296.2 -- 1,694.8 Total Assets.................. 14,410.0 2,589.7 (68.5) 16,931.2 1995 Revenue....................... 2,018.5 389.0 (9.3) 2,398.2 Income before Income Taxes.... 251.7 18.7 -- 270.4 Net Assets.................... 1,250.0 253.0 -- 1,503.0 Total Assets.................. 13,572.3 2,219.2 (54.2) 15,737.3
23. EARNINGS PER SHARE
Per Share Income Shares Amount 1997 Net Income........................... $253.7 Less: Preferred stock dividends.. (5.2) -------- Basic Earnings per Share: Income available to common stockholders.................... 248.5 53.0 $4.68 ----- ---- ----- Convertible preferred stock....... 0.1 0.2 Options........................... -- 1.2 Employee stock purchase plan...... -- 0.3 Diluted Earnings per Share: Income available to common stockholders and assumed conversions.................. $248.6 54.7 $4.54 ====== ==== ===== 1996 Net Income........................... $281.0 Less: Preferred stock dividends.. (5.2) -------- Basic Earnings per Share: Income available to common stockholders.................... 275.8 53.1 $5.19 ----- ---- ----- Convertible preferred stock....... 0.1 0.2 Options........................... -- 1.0 Employee stock purchase plan...... -- 0.3 Diluted Earnings per Share: Income available to common stockholders and assumed conversions.................. $275.9 54.6 $5.05 ====== ==== ===== 1995 Net Income........................... $150.5 Less: Preferred stock dividends.. (5.2) --------- Basic Earnings per Share: Income available to common stockholders.................... 145.3 52.5 $2.77 ----- ---- ----- Convertible preferred stock....... 0.1 0.2 Options........................... -- 0.7 Employee stock purchase plan...... -- 0.3 Diluted Earnings per Share: Income available to common stockholders and assumed conversions.................. $145.4 53.7 $2.71 ====== ==== =====
24. DERIVATIVE FINANCIAL INSTRUMENTS The Company enters into foreign exchange forward agreements, options and currency swaps to hedge its net investment in foreign subsidiaries. The forward agreements do not subject the Company to risk caused by exchange-rate movements because gains and losses on these agreements offset losses and gains on the assets and liabilities being hedged. The forward agreements generally have maturities that do not exceed six months. 21 Outstanding forward agreements as of December 31, 1997, consisted of a sale of (pound)46.0 in exchange for US$71.6 and a net forward purchase of DM17.0 in exchange for US$9.6. This compares to forward sales of (pound)46.0 and DM38.0 in exchange for US$71.6 and US$24.7, respectively, at December 31, 1996. The Company sells at-the-money (spot) call options and buys out-of-the-money (spot) put options on British pounds. The strike rate of each call option is set at the then-current exchange rate, and the strike rate of each put option purchased is set at a rate whereby the premium received on the related call option exactly offsets the premium paid for such put option, resulting in no out-of-the-pocket cost. With the exception of the strike rates, all terms of the call and put are identical. The notional amount of each option is an amount that will generally produce offsetting gains or losses (on an aftertax basis) to the gains or losses produced by the underlying net investment. Further, the combination of these instruments (a so-called "no cost collar") is effectively a partial hedge, as hedging gains or losses occur only when the spot rates fluctuate outside the range of the respective strike rates. These option transactions generally have a maturity of three to six months. At December 31, 1997, the Company had purchased options to deliver British pounds in exchange for US$386.3, as compared with December 31, 1996, when the Company owned the right to deliver British pounds for US$166.0. Concurrently, the Company had sold options to buy British pounds for US$391.2 at December 31, 1997, as compared with sales of call options on British pounds for US$166.3 at year-end 1996. Through the use of currency swaps, the Company exchanges principal denominated in U.S. dollars for principal denominated in a foreign currency at the then-current exchange rate and agrees to make the opposite exchanges on the swaps' termination date. Semi-annual interest payments are made on the notional amounts over the life of the agreements. Currency swaps outstanding at year-end obligate the Company to pay DM47.0 in exchange for US$31.1 in September 1998, to pay C$165.0 in exchange for US$120.4 in July 1999 and to pay C$100.0 in exchange for US$74.5 in November 2000. There has been no change in currency swaps outstanding since December 31, 1996. The Company recorded unrealized pretax gains of $6.0 at December 31, 1997, and unrealized pretax losses of $18.5 at December 31, 1996, on open hedges. These gains and losses represent a mark to spot on all open hedges and are recognized in a separate component of equity. There were no gains or losses recognized in net income attributable to the above hedging programs during the three years ended December 31, 1997. Gains and losses in excess of the amount needed to offset gains or losses on investments in foreign subsidiaries due to currency fluctuations are not expected given the above hedging strategy. The Company and its subsidiaries utilize interest rate swaps to manage interest rate risk. The agreements effectively changed interest rates on certain medium-term notes and other indebtedness issued by the Company and its subsidiaries to variable commercial paper or LIBOR indices or fixed rate, with interest received exactly offsetting interest paid on such medium-term notes or other indebtedness. The risks inherent in interest rate swaps are the potential inability of a counterparty to meet the terms of each contract. These agreements to exchange fixed and floating, or floating versus floating, interest rate payments are with major international financial institutions that are expected to fully perform under the terms of the agreements, thereby mitigating credit risk from the transactions. 22 The amounts to be paid or received under the agreements are accrued in interest expense consistent with the terms of the agreements. At December 31, 1997, accrued interest payable related to these interest rate swaps totaled $12.0, which is offset by $12.8 of accrued interest receivable. The impacts of the interest rate hedging activities on the Company's weighted average borrowing rates and on the reported interest expense were increases as follows: .04% and $5.1 in 1997; .08% and $9.9 in 1996; and .05% and $5.4 in 1995. The following table summarizes the interest-rate swaps outstanding at December 31, 1997:
Weighted Average Weighted Notional Interest Rates Average Amount Pay Receive Maturity* Pay fixed-rate - receive floating-rate $ 732.5 7.40% 7.37% 2.6 Pay floating-rate - receive fixed-rate Denominated in: US$ 153.0 6.13 6.51 8.4 British pounds 141.0 7.89 7.94 1.5 Pay floating-rate - receive floating-rate 853.2 6.09 5.75 1.4 -------- ---- ---- --- Total $1,879.7 6.74% 6.61% 2.5 ======== ==== ==== ===
*Remaining term in years. 25. CONCENTRATIONS OF CREDIT RISK Concentrations of credit risk with respect to finance receivables are limited because the Company's subsidiaries primarily lend to consumers across many different geographic areas. The highest percentage of owned receivables in any geographic area is in California (16%), with no other state or country having more than 13%. About 65% of receivables in California are real estate secured, compared with 39% for the Company in total. Second mortgage loans are generally limited to 75% of the appraised value of the home as determined by certified, independent appraisers. In the case of first mortgages, the lending cap is 80%. In addition, a rigorous discipline of credit approval is enforced regarding borrower debt-to-income ratios and overall consumer credit quality. In meeting the financing needs of its customers, subsidiaries of the Company issue commitments to extend additional credit to customers under revolving real estate (including loans securitized), credit cards and sales finance contracts as long as there is no violation of any conditions established in the contract. The commitments generally have fixed expiration dates or other termination clauses and generally require payment of a fee. The Company uses the same credit procedures when entering into such commitments as it does for traditional lending products. At December 31, 1997, committed lines totaled $20,627.2, compared with $18,598.1 at year-end 1996, of which 56% at the end of 1997 was available for further loans. A large majority of these commitments expire without being exercised. As a result, total contractual commitments do not represent future credit exposure or liquidity requirements. 23 26. LEASES The consumer finance system operates from premises under leases generally having an original term of five years with a renewal option for a like term. The Company leases its headquarters in Wilmington, Delaware, under a lease expiring in 2010. Also, a subsidiary leases an office complex in Peapack, New Jersey, with a primary term expiring in 2010 and renewal options totaling 47 years. Data processing equipment lease terms range from one to four years and are generally renewable. The minimum rental commitments under noncancelable operating leases at December 31, 1997, were as follows:
1998......................................................... $ 72.8 1999......................................................... 64.2 2000......................................................... 53.9 2001......................................................... 45.8 2002......................................................... 41.3 2003-2007.................................................... 177.7 2008-2021.................................................... 88.2 ------ Total..................................................... $543.9 ======
27. FAIR VALUE OF FINANCIAL INSTRUMENTS The information provided below is required by SFAS No. 107, "Disclosures About Fair Value of Financial Instruments." These amounts represent estimates of fair value of financial instruments at a point in time. Significant estimates using available market information and appropriate valuation methodologies were used for the purposes of this disclosure. The estimates are not necessarily indicative of the amounts the Company could realize in a current market exchange, and the use of different market assumptions or methodologies could have a material effect on the estimated fair value amounts.
1997 1996 ---- ---- Carrying Estimated Carrying Estimated At December 31 Value Fair Value Value Fair Value -------------- ---------- ---------- --------- ---------- Assets ------ Cash and Equivalents.. $ 253.9 $ 253.9 $ 279.6 $ 279.6 Investment Securities. 866.2 866.6 686.1 685.4 Finance Receivables, Net............ 14,470.3 15,646.2 14,038.0 15,090.9 Servicing Asset....... 11.4 11.4 8.0 8.0 Interest-Only Residual. 72.8 72.8 46.9 46.9 Liabilities ----------- Short-Term Debt........ 4,585.1 4,585.1 4,169.3 4,169.3 Deposits............... 555.3 555.3 635.0 635.0 Long-Term Debt......... 8,887.2 9,033.2 8,631.1 8,812.6 Accounts Payable....... 708.0 708.0 534.0 534.0 December 31 1997 1996 Net Unrealized Gain (Loss) on Derivative Financial Instruments.............. $10.1 $(33.9)
The fair value of investment securities is based on quoted market prices. The fair market value of real estate secured and personal unsecured loans was estimated by discounting the future cash flows over the estimated remaining term, based on past cash collection experience. For credit cards and sales finance products, the carrying amount is a reasonable estimate of fair value. The discount factor was determined by taking into consideration current funding costs, chargeoff experience and premiums paid on acquisitions of receivables with similar characteristics. Demand deposits are shown at their face values. For short-term and long-term debt, the fair values are estimated, using the interest rates currently offered for debt with similar terms and remaining maturities. The estimated fair value of accounts payable approximates their carrying value. The fair value of interest-rate swap agreements, forward exchange contracts and foreign exchange options is the estimated amount the Company would receive or pay to terminate the agreements at the balance sheet date, taking into account current interest rates, foreign exchange rates and the creditworthiness of the counterparties. The fair value estimates presented were based on information available to the Company at December 31, 1997 and 1996. While management is not aware of any significant factors that would affect the year-end 1997 estimate since that date, current estimates of fair value could differ significantly from the amounts disclosed. 28. CONTINGENT LIABILITIES In July 1992, the Internal Revenue Service (IRS) completed its examination of the Company's federal income tax returns for 1984 through 1987. The IRS proposed $142.0 in adjustments relating to 1986 and 1987 additions to the loss reserves of the Company's former subsidiary, American Centennial Insurance Company (ACIC), prior to the Company's sale of its entire interest in ACIC in May 1987. In order to limit the further accrual of interest on the proposed adjustments, the Company paid $105.5 of tax and interest during the third quarter of 1992. The issues were not resolved during the administrative appeals process, and the IRS issued a statutory Notice of Deficiency asserting the unresolved adjustments and increased the disallowance to $195.0 in the third quarter of 1996. The Company has initiated litigation in the United States Tax Court to oppose the disallowance. While the conclusion of this matter cannot be predicted with certainty, management does not anticipate the ultimate resolution to differ materially from amounts accrued. Complete resolution is not expected to occur within one year. The Company and subsidiaries are involved in various other claims and lawsuits incidental to the business. In the opinion of management, these claims and suits in the aggregate will not have a material adverse effect on the Company's consolidated financial statements. 24
BENEFICIAL CORPORATION AND SUBSIDIARIES SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (in millions, except per share amounts) Quarter Ended 3/31 6/30 9/30 12/31 - --------------- ---- ---- ---- ----- 1997 Gross Revenue................ $772.6 $734.0 $744.3 $704.8 Income (Loss) before Income Taxes...................... 162.4 133.4 120.6 (43.1) Net Income (Loss)........... 100.7 88.3 77.5 (12.8) Diluted Earnings (Loss) per Common Share............... 1.80 1.59 1.40 (.25) Dividends per Common Share.. .52 .52 .57 .57 1996 Gross Revenue............... $751.1 $682.4 $678.8 $659.6 Income before Income Taxes.. 184.7 139.6 109.5 24.7 Net Income.................. 107.4 82.4 67.9 23.3 Diluted Earnings per Common Share...................... 1.96 1.48 1.22 .39 Dividends per Common Share.. .47 .47 .52 .52
25 (ii) QUARTER ENDED MARCH 31, 1998 BENEFICIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (in millions)
March 31, December 31, 1998 1997 ---------- --------- (Unaudited) ASSETS Cash and Equivalents . . . . . . . . . . . .$ 224.6 $ 253.9 Finance Receivables (Note 3). . . . . . . . . . 14,550.8 15,030.2 Allowance for Credit Losses (Note 4) . . . . . . (554.3) (559.9) --------- --------- Net Finance Receivables. . . . . . . . . . 13,996.5 14,470.3 Investment Securities (Note 5) . . . . . . . . . 903.4 866.2 Property and Equipment. . . . . . . . . . . . 233.0 229.3 Other Assets . . . . . . . . . . . . . . . 1,260.5 1,825.4 -------- --------- TOTAL ASSETS . . . . . . . . . . . . .$16,618.0 $17,645.1 ======== ========= LIABILITIES AND SHAREHOLDERS' EQUITY Short-Term Debt (Note 7) . . . . . . . . . . .$ 3,935.6 $ 4,585.1 Deposits Payable. . . . . . . . . . . . . . 509.7 555.3 Long-Term Debt (Note 8) . . . . . . . . . . . 8,662.7 8,887.2 -------- --------- Total Interest-Bearing Debt . . . . . . . . . 13,108.0 14,027.6 Accounts Payable and Accrued Liabilities. . . . . . 892.8 708.0 Insurance Policy and Claim Reserves . . . . . . . 569.2 1,137.2 -------- --------- Total Liabilities. . . . . . . . . . . . . 14,570.0 15,872.8 -------- --------- Shareholders' Equity: Preferred Stock . . . . . . . . . . . . . 114.8 114.8 Common Stock . . . . . . . . . . . . . . 54.4 53.3 Additional Capital . . . . . . . . . . . . 349.7 250.7 Accumulated Other Comprehensive Income (Note 11) . . (22.3) (43.0) Retained Earnings. . . . . . . . . . . . . 1,551.4 1,396.5 -------- -------- Total Shareholders' Equity . . . . . . . . . 2,048.0 1,772.3 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY . . .$16,618.0 $17,645.1 ========= =========
See Notes to Financial Statements. 26 BENEFICIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (UNAUDITED) (in millions, except per share amounts)
Three Months Ended March 31, 1998 1997 REVENUE Finance Charges and Fees . . . . . . . . . $614.6 $579.4 Interest Expense. . . . . . . . . . . . 223.6 214.7 ------ ------ Lending Spread. . . . . . . . . . . . 391.0 364.7 Insurance Premiums . . . . . . . . . . . 45.0 45.9 Other (Note 2) . . . . . . . . . . . . 317.1 147.3 ------ ------ Total . . . . . . . . . . . . . . 753.1 557.9 ------ ------ OPERATING EXPENSES Salaries and Employee Benefits . . . . . . . 111.0 105.1 Insurance Benefits . . . . . . . . . . . 15.9 22.8 Provision for Credit Losses . . . . . . . . 139.8 93.1 Other . . . . . . . . . . . . . . . 173.1 174.5 ------ ------ Total . . . . . . . . . . . . . 439.8 395.5 ------ ------ Income Before Income Taxes . . . . . . . . . 313.3 162.4 Provision for Income Taxes . . . . . . . . . 125.8 61.7 ------ ------ NET INCOME . . . . . . . . . . . . . . 187.5 100.7 Other Comprehensive Income (Note 11). . . . . . 20.7 (7.6) COMPREHENSIVE INCOME . . . . . . . . . . . ------ ------ $208.2 $ 93.1 ====== ====== BASIC EARNINGS PER COMMON SHARE (Note 10) . . . . $ 3.49 $ 1.85 ====== ====== DILUTED EARNINGS PER COMMON SHARE (Note 10) . . . $ 3.34 $ 1.80 ====== ====== DIVIDENDS PER COMMON SHARE . . . . . . . . . $ .57 $ .52 ====== ======
See Notes to Financial Statements. 27 BENEFICIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (in millions)
Three Months Ended March 31, 1998 1997 CASH FLOWS FROM OPERATING ACTIVITIES Net Income . . . . . . . . . . . . . . $ 187.5 $ 100.7 Reconciliation of Net Income to Net Cash Provided by Operating Activities: Provision for Credit Losses . . . . . . . . 139.8 93.1 Provision for Deferred Income Taxes . . . . . (3.8) (10.8) Depreciation and Amortization . . . . . . . 10.4 12.9 Insurance Policy & Claim Reserves . . . . . . (568.0) (.9) Accounts Payable & Accrued Liabilities . . . . 184.8 161.5 -------- -------- Net Cash (Used in) Provided by Operating Activities (49.3) 356.5 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Receivables Originated or Acquired . . . . . . (3,517.9) (3,170.3) Receivables Collected. . . . . . . . . . . 3,080.2 2,921.5 Canadian Receivables Sold . . . . . . . . . 804.0 -- Investment Securities Purchased . . . . . . . (92.4) (110.0) Investment Securities Sold . . . . . . . . . 42.0 68.1 Investment Securities Matured . . . . . . . . 31.7 26.2 Deposit from Reinsurer . . . . . . . . . . 576.5 -- Other . . . . . . . . . . . . . . . . 81.6 (27.3) -------- -------- Net Cash Provided by (Used in) Investing Activities 1,005.7 (291.8) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Short-Term Debt, Net Change. . . . . . . . . (665.2) (196.4) Deposits Payable, Net Change . . . . . . . . (39.2) (30.6) Long-Term Debt Issued. . . . . . . . . . . 703.0 1,081.8 Long-Term Debt Repaid. . . . . . . . . . . (940.7) (905.1) Dividends Paid . . . . . . . . . . . . . (32.6) (29.8) Common Stock Repurchased. . . . . . . . . . (11.0) (15.1) ------- -------- Net Cash Used in Financing Activities . . . . (985.7) (95.2) ------- -------- NET DECREASE IN CASH AND EQUIVALENTS . . . . . . (29.3) (30.5) Cash and Equivalents at Beginning of Period. . . . 253.9 279.6 ------- -------- CASH AND EQUIVALENTS AT END OF PERIOD. . . . . . $ 224.6 $ 249.1 ======= ======== SUPPLEMENTAL CASH FLOW INFORMATION Interest Paid . . . . . . . . . . . . . $ 165.1 $ 135.1 Income Taxes Paid . . . . . . . . . . . . (25.7) .4
See Notes to Financial Statements. 28 BENEFICIAL CORPORATION AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (in millions, except per share amounts) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Accounting policies used in the preparation of the unaudited quarterly financial statements are consistent with accounting policies described in the notes to financial statements contained in the Beneficial Corporation (the Company) Annual Report on Form 10-K for the fiscal year-ended December 31, 1997. In the opinion of management, all adjustments, consisting of a normal recurring nature, necessary for a fair presentation have been reflected. Certain prior period amounts have been reclassified to conform with the 1998 presentation. Interim results are not necessarily indicative of results for a full year. 2. SALE OF CANADIAN SUBSIDIARY On March 2, 1998, the Company sold its Canadian subsidiary, Beneficial Canada Holdings Inc., to Associates Capital Corporation of Canada, a subsidiary of Associates First Capital Corporation, resulting in a net aftertax gain of $118.5 million, which is included in other income. 3. FINANCE RECEIVABLES Finance receivables consisted of the following:
March 31, December 31, 1998 1997 Receivables Owned: Real Estate Secured. . . . . . $ 6,124.5 $ 5,905.3 Personal Unsecured . . . . . . 3,080.8 3,262.4 Credit Cards . . . . . . . . 4,200.6 4,685.4 Sales Finance Contracts . . . . 962.0 994.3 Commercial. . . . . . . . . 182.9 182.8 --------- --------- Total Owned. . . . . . . . 14,550.8 15,030.2 Receivables Sold with Servicing Retained (all real estate secured). . . 2,629.8 2,912.7 --------- --------- Total Managed Receivables . . . . $17,180.6 $17,942.9 ========= =========
4. ALLOWANCE FOR CREDIT LOSSES An analysis of the allowance for credit losses follows:
1998 Balance at January 1 . . . . . . . . . . . . . $ 559.9 Accounts Charged Off . . . . . . . . . . . . . (135.4) Recoveries on Accounts Previously Charged Off . . . . . 13.6 Provision for Credit Losses . . . . . . . . . . . 139.8 Sale of Canada . . . . . . . . . . . . . . . (25.7) Other . . . . . . . . . . . . . . . . . . 2.1 -------- Balance at March 31. . . . . . . . . . . . . . $ 554.3 ========
29 5. INVESTMENT SECURITIES Investment securities were as follows:
March 31, 1998 December 31, 1997 -------------- ----------------- Carrying Market Carrying Market Value Value Value Value AVAILABLE-FOR-SALE Debt Securities: Corporate $314.0 $314.0 $300.1 $300.1 Mortgage-backed 33.5 33.5 30.7 30.7 Municipal 5.1 5.1 5.3 5.3 U.S. Government 132.4 132.4 116.8 116.8 Foreign Government 54.2 54.2 60.5 60.5 Other 5.4 5.4 5.5 5.5 ------ ------ ------ ------ 544.6 544.6 518.9 518.9 Equity Securities .6 .6 .6 .6 ------ ------ ------ ------ Total $545.2 $545.2 $519.5 $519.5 ====== ====== ====== ====== HELD-TO-MATURITY Debt Securities: Corporate $ 44.8 $ 45.1 $ 48.8 $ 49.1 Mortgage-backed 1.8 1.8 2.2 2.2 Municipal 10.8 11.1 10.8 11.1 U.S. Government 8.4 8.3 10.4 10.3 Foreign Government 1.1 1.0 1.1 1.0 Other 10.2 10.2 10.2 10.2 ------ ------ ------ ------ Total $ 77.1 $ 77.5 $ 83.5 $ 83.9 ====== ====== ====== ======
Included in total investment securities is $281.1 and $263.2 at March 31, 1998 and December 31, 1997, respectively, classified as trading securities. There were no investments transferred from Held-To-Maturity to Available-For-Sale, nor were there any sales of Held-To-Maturity investments during the three-month period ended March 31, 1998. 6. SERVICING ASSET AND INTEREST-ONLY STRIPS The activity in the servicing asset is summarized as follows:
1998 Balance at January 1 . . . . . . . . . . . . $11.4 Amortization . . . . . . . . . . . . . . . (1.1) ----- Balance at March 31. . . . . . . . . . . . . $10.3 =====
30 Previously recognized servicing assets that exceed contractually specified servicing fees were reclassified as interest-only strips and are carried at fair value which amounted to $66.3 at March 31, 1998. Both the servicing assets and the interest-only strips are included in other assets on the balance sheet. The servicing assets and interest-only strips are amortized in proportion to and over the period of estimated net future servicing fee income. The servicing assets and interest-only strips are periodically reviewed for valuation impairment. This review is performed on a disaggregated basis for the predominate risk characteristics of the underlying loans which are loan type, term, interest rate, prepayment rate and loss rate. The fair value of the servicing assets and interest-only strips are determined by present valuing the estimated net future cash flows. The weighted-average assumptions used in the fair value calculations include: discount rate - 15%, prepayment rate - 34%, loss rate - 1.4%, and servicing fees - 1.0%. As of March 31, 1998, fair value approximates carrying value and therefore no valuation allowance is required. 7. SHORT-TERM DEBT Short-term debt outstanding consisted of the following:
March 31, December 31, 1998 1997 Commercial Paper. . . . . . . . . . $3,471.7 $3,770.5 Bank Borrowings . . . . . . . . . . 463.9 814.6 -------- -------- Total . . . . . . . . . . . $3,935.6 $4,585.1 ======== ========
The weighted average interest rates (including the costs of maintaining lines of credit) on short-term borrowings during the three months ended March 31 were as follows:
1998 1997 -------- ------ U.S. Dollar Borrowings. . . . . . . . 5.70% 5.47% Other Currency Borrowings. . . . . . . 7.22 5.63 Overall. . . . . . . . . . . . . 6.02% 5.49%
The impact of interest rate hedging activities on the Company's weighted average short-term borrowing rates and on the reported short-term interest expense for the three months ended March 31 was a decrease of .04% (annualized) and $0.5 in 1998 and an increase of .13% (annualized) and $1.4 in 1997. 8. LONG-TERM DEBT Long-term debt is shown below in the earliest year it could become payable:
Weighted Average Interest Rates at March 31, December 31, Maturity March 31, 1998 1998 1997 -------- ----------------- ----------- --------- 1998 6.75% $1,529.2 $2,246.1 1999 6.69 1,912.6 1,990.7 2000 6.68 1,174.2 1,254.1 2001 7.00 934.1 946.3 2002 6.77 1,259.3 1,293.4 2003-2007 6.78 1,634.0 959.3 2008-2023 7.49 219.3 197.3 -------- -------- Total 6.78% $8,662.7 $8,887.2 ======== ========
31 The weighted average interest rates (including issuance costs) on the Company's long-term debt during the three months ended March 31 were as follows:
1998 1997 ------ ----- U.S. Dollar Borrowings. . . . . . . . 6.82% 6.87% Other Currency Borrowings. . . . . . . 7.56 6.89 Overall. . . . . . . . . . . . . 6.91% 6.87%
Long-term debt outstanding at March 31, 1998, and December 31, 1997, includes $4,198.3 and $4,174.6, respectively, of variable-rate debt that reprices based on various indices. Such variable-rate debt generally has an original maturity of one-to-three years. The impact of interest rate hedging activities on the Company's weighted average long-term borrowing rates and on the reported long-term interest expense for the three months ended March 31 was an increase of .05% (annualized) and $1.2 in 1998 and .01% (annualized) and $0.3 in 1997. 9. DERIVATIVE FINANCIAL INSTRUMENTS The Company enters into foreign exchange forward agreements, options and currency swaps to hedge its net investment in foreign subsidiaries. At March 31, 1998, the Company had purchased options to deliver British pounds in exchange for US$475.6, as compared to December 31, 1997, when the Company owned the right to deliver British pounds for US$386.3. Concurrently, the Company had sold options to buy British pounds for US$483.0 at March 31, 1998, as compared with sales of call options on British pounds for US$391.2 at year-end 1997. The Company's outstanding forward agreements as of March 31, 1998, consisted of forward sales of (pound)61.1 in exchange for US$101.0 and a forward purchase of DM18.0 in exchange for US$9.8. This compared to a forward sale of (pound)46.0 in exchange for US$71.6 and a net forward purchase of DM17.0 in exchange for US$9.6 at December 31, 1997. Currency swaps outstanding at year-end were terminated during the period based on market prices at the time of termination. The Company accrued pretax losses of $9.3 at March 31, 1998, and pretax gains of $6.0 at December 31, 1997 on open hedges. These gains and losses represent a mark to spot on all open hedges and are recognized in a separate component of equity. There were no gains or losses recognized in net income attributable to the above hedging programs. The Company and its subsidiaries utilize interest-rate swaps to allow it to match fund its variable- and fixed-rate receivables and to manage basis risk. The amounts to be paid or received under the agreements are accrued in interest expense consistent with the terms of the agreements. At March 31, 1998, accrued interest payable related to these interest-rate swaps totaled $13.5, which is largely offset by $12.3 of accrued interest receivable. The impact of interest rate hedging activities on the Company's weighted average borrowing rates and on the reported interest expense for the three months ended March 31, was an increase of .02% (annualized) and $0.7 in 1998 and .05% (annualized) and $1.6 in 1997. 32 The following table summarizes the interest-rate swaps outstanding at March 31, 1998:
Weighted Average Weighted Notional Interest Rates Average Amount Pay Receive Maturity* Pay fixed-rate - receive floating-rate $ 741.8 7.40% 7.40% 2.6 Pay floating-rate - receive fixed-rate Denominated in: US$ 153.0 5.83 6.51 8.2 British pounds 143.0 8.06 7.94 1.3 Pay floating-rate - receive floating-rate 724.6 5.98 5.57 1.5 -------- Total $1,762.4 6.73% 6.61% 2.5 ========
*Remaining term in years. 10. EARNINGS PER COMMON SHARE Computations of basic and diluted earnings per common share are as follows:
Per Share Income Shares Amount March 31, 1998 Net Income. . . . . . . . . . . . . . $187.5 Less: Preferred stock dividends . . . . . . (1.3) Basic Earnings per Share: Income available to common stockholders . . . 186.2 53.4 $3.49 ------ ---- ----- Convertible preferred stock . . . . . . . -- 0.1 Options . . . . . . . . . . . . . . -- 1.9 Employee stock purchase plan . . . . . . . -- 0.3 Diluted Earnings per Share: Income available to common stockholders and assumed conversions . . . . . . . . . $186.2 55.7 $3.34 ====== ==== ===== March 31, 1997 Net Income. . . . . . . . . . . . . . $100.7 Less: Preferred stock dividends . . . . . . (1.3) Basic Earnings per Share: Income available to common stockholders . . . 99.4 53.6 $1.85 ------ ---- ----- Convertible preferred stock . . . . . . . -- 0.2 Options . . . . . . . . . . . . . . -- 1.2 Employee stock purchase plan . . . . . . . -- 0.3 Diluted Earnings per Share: Income available to common stockholders and assumed conversions . . . . . . . . . $ 99.4 55.3 $1.80 ====== ==== =====
33 11. COMPREHENSIVE INCOME Statement of Financial Accounting Standards No. 130 was adopted by the Company effective January 1, 1998. As a result, the income statement includes an amount for other comprehensive income, as well as total comprehensive income. Other comprehensive income includes revenues, expenses, gain and losses that have affected shareholders' equity but not net income, such as foreign currency translation adjustments and unrealized gains and losses on the available-for-sale investment portfolio. Other comprehensive income of $20.7 million for the three months ended March 31, 1998 resulted from $20.8 of aftertax foreign currency translation adjustments, primarily as a result of a $20.4 million reclassification adjustment for the sale of the Canadian operations, and $.1 million related to unrealized losses on available-for-sale investments, compared to a loss of $7.6 million for the three months ended March 31, 1997. On the balance sheet, accumulated other comprehensive income totaled ($22.3) at March 31, 1998 compared to ($43.0) at December 31, 1997. These amounts are net of accumulated foreign currency translation adjustments of ($27.4) and ($48.2) and net unrealized gain on investment securities of $5.1 and $5.2 at March 31, 1998 and December 31, 1997, respectively. 12. RATIO OF EARNINGS TO FIXED CHARGES
Three Months Ended March 31, 1998 1997 Net Income. . . . . . . . . . . $187.5 $100.7 Add Provision for Income Taxes . . . . 125.8 61.7 ------ ------ Earnings Before Income Taxes . . . 313.3 162.4 ------ ------ Fixed Charges: Interest and Debt Expense . . . . . 223.6 214.7 Interest Factor Portion of Rentals . . 7.9 6.2 ------ ------ Total Fixed Charges . . . . . . 231.5 220.9 ------ ------ Earnings Before Income Taxes and Fixed Charges $544.8 $383.3 ====== ====== Ratio of Earnings to Fixed Charges . . . 2.35 1.74 ====== ====== Preferred Dividend Requirements . . . . $ 2.2 $ 2.1 ====== ====== Ratio of Earnings to Fixed Charges and Preferred Dividend Requirements . . . . . . . 2.33 1.72 ====== ======
In computing the ratio of earnings to fixed charges, earnings consist of net income to which has been added income taxes and fixed charges. Fixed charges consist principally of interest on all indebtedness and that portion of rentals considered to represent an appropriate interest factor. Preferred dividend requirements are grossed up to their pretax equivalent. 34 13. CONTINGENT LIABILITIES In July 1992, the Internal Revenue Service (IRS) completed its examination of the Company's federal income tax returns for 1984 through 1987. The IRS proposed $142.0 in adjustments relating to 1986 and 1987 additions to the loss reserves of the Company's former subsidiary, American Centennial Insurance Company (ACIC), prior to the Company's sale of its entire interest in ACIC in May 1987. In order to limit the further accrual of interest on the proposed adjustments, the Company paid $105.5 of tax and interest during the third quarter 1992. The issues were not resolved during the administrative appeals process, and the IRS issued a statutory Notice of Deficiency asserting the unresolved adjustments and increased the disallowance to $195.0 in the third quarter of 1996. The Company has initiated litigation in the United States Tax Court to oppose the disallowance. While the conclusion of this matter cannot be predicted with certainty, management does not anticipate the ultimate resolution to differ materially from amounts accrued. The Company and subsidiaries are involved in various other claims and lawsuits incidental to the business. In the opinion of management, these claims and suits in the aggregate will not have a material adverse effect on the Company's consolidated financial statements. -----END PRIVACY-ENHANCED MESSAGE-----