6. Receivables Held for Sale

As discussed in prior filings, we have been engaged in an on-going evaluation of the optimal size of our balance sheet taking into consideration our liquidity, capital and funding requirements as well as capital requirements of HSBC. As part of this on-going evaluation, we identified a pool of real estate secured receivables for which we no longer had the intent to hold for the foreseeable future and, as a result, transferred this pool of real estate secured receivables to receivables held for sale during the second quarter of 2012. We anticipate the receivables will be sold in multiple transactions generally over the next two years or, if the foreclosure process is completed prior to sale, the underlying properties acquired in satisfaction of the receivables will be classified as real estate owned (“REO”) and sold. As we continue to work with borrowers, we may also agree to a short sale whereby the property is sold by the borrower at a price which has been pre-negotiated with us and the borrower is released from further obligation. This pool of receivables includes a substantial majority of our real estate receivables which had been written down to the lower of amortized cost or fair value of the collateral less cost to sell as of June 30, 2012 in accordance with our existing charge-off policies as we considered the collateral as the sole source for repayment. However, as we now plan to sell these receivables to a third party investor, fair value represents the price we believe a third party investor would pay to acquire the receivable portfolios. A third party investor would incorporate a number of assumptions in predicting future cash flows, such as differing loss estimates and/or differing times to collect outstanding balances than we as the servicer of these receivables believe would be the case. A third party investor’s valuation process would also reflect these differences in overall cost of capital assumptions as well as the potential volatility in the underlying cash flow assumptions, the combination of which results in a lower estimate of fair value for the cash flows associated with the receivables. Real estate secured receivables written down to the lower of amortized cost or fair value of the collateral less cost to sell in accordance with our existing charge-off policies subsequent to June 30, 2012 will continue to be held for investment.

Based on the projected timing of loan sales and the anticipated flow of foreclosure volume into REO over the next two years, a portion of the real estate secured receivables classified as held for sale during the second quarter of 2012 will ultimately become REO. Upon classification of the underlying properties acquired in satisfaction of these loans as REO, the properties will be recorded at the fair value of the collateral less cost to sell which we expect will represent a higher value than the price a third party investor would have paid to acquire the receivables as explained above. As a result, a portion of the fair value adjustment on receivables held for sale will be recorded in earnings over time, which could be in the region of 20 percent of the fair value adjustment. This estimate is highly dependent upon the timing and size of future receivable sales as well as the volume and timelines associated with foreclosure activity. During the third quarter of 2012, we transferred a portion of our real estate secured receivable portfolio held for sale with a carrying value of $79 million to REO after obtaining title to the underlying collateral and reversed a portion of the lower of amortized cost or fair value adjustment previously recorded totaling $26 million during the three months ended September 30, 2012. Additionally, during the third quarter of 2012, we completed short sales on real estate secured receivables with a carrying value of $46 million. As a result of these short sales, we reversed a portion of the lower of amortized cost or fair value adjustment previously recorded totaling $9 million during the three months ended September 30, 2012 as the settlement price was higher than the carrying value.

In addition to the real estate secured receivables discussed above, we also determined we no longer had the intent to hold our portfolio of personal non-credit card receivables for the foreseeable future and anticipate these receivables will be sold in the near term. As a result, our personal non-credit card receivable portfolio, which was previously held for investment purposes, was transferred to held for sale during the second quarter of 2012. The personal non-credit card receivable portfolio will not be reported as discontinued operations as they do not qualify as a component of our business as the cash flows and operations related to our personal non-credit card receivable portfolio are not clearly distinguishable from the cash flows and operations of our real estate secured receivable portfolio.

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


	September 30, 2012		December 31, 2011
	(in millions)
First lien real estate secured receivables	$	3,181	$	-
Personal non-credit card		3,180		-

Total receivables held for sale	$	6,361	$	-

The table below summarizes the activity in receivables held for sale during 2012:


	Total
	(in millions)
Receivables held for sale – December 31, 2011	$	-
Transfers into receivables held for sale at the lower of amortized cost or fair value:
Real estate secured		3,287
Personal non-credit card		3,469
Additional lower of amortized cost or fair value adjustment subsequent to transfer to receivables held for sale		(50	)
Carrying value of real estate secured receivables held for sale settled through short sale or transfer to REO		(125	)
Change in receivable balance		(220	)

Receivables held for sale – September 30, 2012	$	6,361	⁽¹⁾

⁽¹⁾	Net of a valuation allowance of approximately $1.5 billion.

The following table summarizes the components of the cumulative lower of amortized cost or fair value adjustment recorded during the three and nine months ended September 30, 2012 related to receivables held for sale:


	Lower of amortized cost or fair value adjustments associated with
	Fair Value			REO			Short Sales			Total

	(in millions)
Three Months Ended September 30, 2012:
Lower of amortized cost or fair value adjustment recorded as a component of:
Other revenues⁽²⁾	$	85	⁽³⁾	$	(26	)	$	(9	)	$	50

Total lower of amortized cost or fair value adjustment	$	85		$	(26	)	$	(9	)	$	50

Nine Months Ended September 30, 2012:
Lower of amortized cost or fair value adjustment recorded as a component of:
Provision for credit losses⁽¹⁾	$	112		$	-		$	-		$	112
Other revenues⁽²⁾		1,632			(26	)		(9	)		1,597

Lower of amortized cost or fair value adjustment	$	1,744		$	(26	)	$	(9	)	$	1,709

⁽¹⁾

A portion of the lower of amortized cost or fair value adjustment attributable to credit for personal non-credit card receivables was recorded as a provision for credit losses. This was determined by giving consideration to the impact of over-the-life credit loss estimates as compared to the existing credit loss reserves prior to our decision to transfer to receivables held for sale. There was no lower of cost or fair value adjustment allocated to credit for the real estate secured receivables as these receivables were previously carried at the lower of amortized cost or fair value of the collateral less cost to sell prior to the transfer of the loans to held for sale.

⁽²⁾	Reflects the impact on value caused by current marketplace conditions including changes in interest rates and illiquidity and is recorded as a component of total other revenues in the consolidated statement of income (loss).

⁽³⁾	Reflects the change in fair value of receivables held for sale at September 30, 2012 net of reversals associated with liquidations other than REO and short sales.