SECURITIES AND EXCHANGE COMMISSION
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
[NO FEE REQUIRED]
For the fiscal year endedMarch 31, 20052007 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[NO FEE REQUIRED]For the transition period from _______ to _______
Commission file number1-9961
1-9961TOYOTA MOTOR CREDIT CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization) |
Identification No.) |
| |
(Address of principal executive offices) |
(Zip Code) |
Registrant's telephone number, including area code:
| (310) 468-1310
|
Registrant's telephone number, including area code: (310) 468-1310
Securities registered pursuant to
sectionSection 12(b) of the Act:
Title of each class | Name of each exchange on which registered |
| |
Three Month LIBOR Minus 0.03%4.40% Fixed Rate Medium-Term Notes, Due December 22, 2005Series B due October 1, 2008
| New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act:
(Title of class)
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
2.80% Fixed Rate Notes due 2006Yes x No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer __ Accelerated filer __ Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Securities Exchange
Act of 1934)Act).
Yes __ No x
As of April 30,
2005,2007, the number of outstanding shares of capital stock, par value $10,000 per share, of the registrant was 91,500, all of which shares were held by Toyota Financial Services Americas Corporation.
Documents incorporated by reference:None
NoneReduced Disclosure Format
The registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore filing this Form 10-K with the reduced disclosure format.
TOYOTA MOTOR CREDIT CORPORATION
For the fiscal year ended March 31,
20052007
ITEM 1.
| Business
| 3
|
ITEM 2. 1. BUSINESS | Properties
| 15
4 |
ITEM 3. 1A. RISK FACTORS | Legal Proceedings
| 16
14 |
ITEM 4. 1B. UNRESOLVED STAFF COMMENTS | Submission of Matters to a Vote of Security Holders
| 17
18 |
| ITEM 2. PROPERTIES | | | | |
ITEM 5.
| Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases
18 |
| ITEM 3. LEGAL PROCEEDINGS | of Equity Securities
| 17
| 19 |
ITEM 6. 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS | Selected Financial Data
| 18
| 19 |
ITEM 7.
PART II | Management's Discussion and Analysis
| | |
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES | 19 |
| ITEM 6. SELECTED FINANCIAL DATA | 20 |
| ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS | 22 |
ITEM 7A. Quantitative and Qualitative Disclosures About Market RiskQUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 63
| 58 |
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA | Financial Statements and Supplementary Data
| 66
| 61 |
| REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM | Report of Independent Registered Public Accounting Firm
| 66
| 61 |
| CONSOLIDATED BALANCE SHEET | Consolidated Balance Sheet
| 67
| 62 |
| CONSOLIDATED STATEMENT OF INCOME | Consolidated Statement of Income
| 68
| 63 |
| CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY | Consolidated Statement of Shareholder's Equity
| 69
| 64 |
| CONSOLIDATED STATEMENT OF CASH FLOWS | Consolidated Statement of Cash Flows
| 70
| 65 |
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE | Notes to Consolidated Financial Statements
| 71
| 102 |
ITEM 9. Changes in and Disagreements with Accountants 9A. CONTROLS AND PROCEDURES | 107
| 102 |
ITEM 9A. Controls and Procedures 9B. OTHER INFORMATION | 107
| 102 |
ITEM 9B. Other Information
PART III | | |
| | | | | | | | |
ITEM 10. Directors and Executive Officers of the Registrant DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE | 112
103 |
ITEM 11. Executive Compensation EXECUTIVE COMPENSATION | 115
|
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related
| Stockholder Matters
| 120
| 105 |
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS | 105 |
ITEM 13. Certain Relationships and Related TransactionsCERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE | 121
105 |
ITEM 14. Principal Accounting Fees and Services PRINCIPAL ACCOUNTING FEES AND SERVICES | 122
106 |
| | | | |
ITEM 15. Exhibits, Financial Statement Schedules EXHIBITS, FINANCIAL STATEMENT SCHEDULES | 122
106 |
Signatures
SIGNATURES | 123
107 |
Exhibit Index | 124
108 |
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Toyota Motor Credit Corporation
(“TMCC”) was incorporated in California in 1982 and commenced operations in 1983.
TMCCReferences herein to “TMCC” denote Toyota Motor Credit Corporation, and references herein to “we”, “our”, and “us” denote Toyota Motor Credit Corporation and its consolidated
subsidiaries, collectively referred to herein as the “Company”,subsidiaries. We are
wholly ownedwholly-owned by Toyota Financial Services Americas Corporation (“TFSA”), a California corporation, which is a
wholly ownedwholly-owned subsidiary of Toyota Financial Services Corporation (“TFSC”), a Japanese corporation. TFSC, in turn, is a
wholly ownedwholly-owned subsidiary of Toyota Motor Corporation (“TMC”), a Japanese corporation. TFSC manages TMC’s worldwide
financefinancial services operations. TMCC is marketed under the brands of Toyota Financial Services and Lexus Financial Services.
The Company provides
We provide a variety of finance and insurance products to authorized Toyota and Lexus vehicle dealers and, to a lesser extent, other domestic and import franchise dealers (collectively referred to as “vehicle dealers”) and their
customers. The Companycustomers in the United States (excluding Hawaii) (the “U.S.”) and Puerto Rico. We also
providesprovide finance products to commercial and industrial equipment dealers (“industrial equipment dealers”) and their customers.
The Company’sOur products fall primarily into the following finance and insurance product categories:
•
| § | Finance - The Company providesWe provide a broad range of finance products including retail financing, leasing, and dealer financing to vehicle and industrial equipment dealers and their customers. |
•
| § | Insurance - Through a wholly ownedwholly-owned subsidiary, the Company provideswe provide marketing, underwriting, and claims administration related to covering certain risks of vehicle dealers and their customers. The CompanyWe also providesprovide coverage and related administrative services to certain affiliates. |
The Company supports
We support growth in earning assets through funding obtained in the capital markets as well as funds provided by operating activities. Refer to the “Liquidity and Capital Resources” section of Item 7.,
“Management“Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”) for a detailed discussion of
the Company’sour funding activities. A more detailed description of the products and services offered by
the Companyus is contained within this Business section. Refer to Note
1617 – Segment Information of the Notes to Consolidated Financial Statements for financial information including assets, revenues, and net income generated by these segments.
The Company
We primarily
acquiresacquire and
servicesservice finance, lease, and insurance contracts from vehicle dealers through 30 dealer sales and services offices (“DSSOs”)
located throughout the U.S. and three
regional customer service centers (“CSCs”) and from industrial equipment dealers through a corporate department located at
the Company’sour headquarters in Torrance, California. The DSSOs primarily support vehicle dealer financing needs by providing services such as acquiring finance and lease contracts from vehicle dealers, financing inventories, and financing other dealer activities and requirements such as business acquisitions, facilities refurbishment, real estate purchases, and working capital requirements. The DSSOs also provide
information and support for
the Company’s finance andour insurance products sold in the
United States (excluding Hawaii) (“U.S.
”) The CSCs support customer account servicing functions such as collections, lease terminations, and administration of retail and lease customer accounts. The Central region CSC also supports insurance operations by
acquiring insurance contracts, providing customer service and handling claims processing. Refer to
“ItemItem 2.,
Properties”“Properties” for information on the geographical location of the DSSOs and CSCs.
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Public FilingsThe Company’s
Our filings with the Securities and Exchange Commission (“SEC”) may be read and copied at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
The Company’sOur filings may also be found by accessing the SEC website (http://www.sec.gov). The SEC website contains reports, registration statements, proxy and information statements, and other information regarding issuers that file electronically with the SEC. A link to the SEC website is also contained on
the Company’sour website (http://www.toyotafinancial.com) under
“About TFS” under “Investor Relations”.
The CompanyWe will make available, without charge, electronic or paper copies of
itsour filings upon written request to:
Toyota Motor Credit Corporation
19001 South Western Avenue
Attention: Corporate Communications
TMC files periodic reports and other information with the SEC, which can be read and copied at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. TMC’s filings may also be found at http://www.toyota.com under “About Toyota” under “Shareholder Information”.
Revenues generated by receivables
owned by the Companywe own are generally not subject to seasonal variations. Although
contractfinancing volume is subject to a certain degree of seasonality, this seasonality does not have a significant impact on revenues as collections, generally in the form of fixed payments, occur over the course of several years. The automotive finance industry
and therefore the Company, is subject to seasonal variations in credit losses, which are typically higher in the first and fourth calendar quarters of the year.
Geographic Distribution of OperationsThe Company’s primary finance and insurance operations are located in the U.S. and the Commonwealth of Puerto Rico with earning assets principally sourced through Toyota and Lexus vehicle dealers. Prior to fiscal 2005, the Company also conducted business in Mexico and Venezuela through wholly owned subsidiaries and held a minority interest in a TFSC majority-owned subsidiary in Brazil. On April 1, 2004, the Company transferred substantially all of its interests in the Mexican and Venezuelan subsidiaries and its holdings in the Brazilian subsidiary to TFSA. Refer to Note 1 for further discussion of the terms and conditions of the transfer. The combined assets, liabilities and net losses of the Company’s international subsidiaries totaled less than 1% of each of the consolidated assets, liabilities and net income of the Company as of and for fiscal 2004 and 2003. The Company also holds minority interests of less than $1 million in Toyota Credit Argentina S.A. and Toyota Compania Financiera de Argentina S.A., both TFSA majority-owned subsidiaries in Argentina.
As of March 31,
2005,2007, approximately
23%23 percent of managed vehicle retail and lease assets were located in California,
8%9 percent in Texas,
7%7 percent in New York, and
5%6 percent in New Jersey.
The concentration of the remaining vehicle retail and lease assets is spread throughout the other 45 serviced states. Any material adverse changes to California’s, Texas’, New York’s, or New Jersey’s
economyeconomies or applicable laws could have an adverse effect on
the Company’sour financial condition and results of operations.
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Risk FactorsThe Company is exposed to certain risks and uncertainties that could have a material adverse impact to the Company’s financial condition and operating results:
Residual Value Risk
Residual value risk is the risk that the estimated residual value at lease origination will not be recoverable. When the market value of a leased vehicle at contract maturity is less than its contractual residual value, there is a higher probability that the vehicle will be returned to the Company. A higher rate of vehicle returns exposes the Company to greater risk of loss at lease termination. Refer to the “Results of Operations - Residual Value Risk” section of the MD&A for further discussion regarding the Company’s exposure to this risk.
Credit Risk
Credit risk is the risk of loss arising from the failure of a customer or dealer to meet the terms of any contract with the Company or otherwise fail to perform as agreed. Refer to the “Results of Operations - Credit Risk” section of the MD&A for further discussion regarding the Company’s exposure to this risk.
Liquidity Risk
Liquidity risk is the risk arising from the inability of the Company to meet obligations when they come due in a timely manner. The Company’s liquidity strategy is to maintain the capacity to fund the acquisition of assets and repay liabilities in a timely and cost-effective manner under adverse market conditions. Refer to the “Liquidity and Capital Resources” section of the MD&A for further discussion regarding the Company’s exposure to this risk.
Market Risk
Market risk is the risk that changes in market interest rates or prices will negatively impact the Company’s income, capital, and market value. Policies governing market risk exposure are established and periodically reviewed by the Company’s senior management as conditions warrant. The Company uses derivative instruments, along with other tools and strategies, to manage its market risk. The Company has established procedures to ensure that the Company’s risk management, including its use of derivatives, is in accordance with the Company’s policy framework. Refer to Item 7A., “Quantitative and Qualitative Disclosures About Market Risk” for further discussion regarding the Company’s exposure to this risk.
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Operational Risk
Operational risk is the risk of loss resulting from, among other factors, inadequate or failed processes, systems or internal controls, theft, fraud, or natural disaster. Operational risk can occur in many forms including, but not limited to, errors, business interruptions, failure of controls, inappropriate behavior of or misconduct by the Company’s employees or those contracted to perform services for the Company, and vendors that do not perform in accordance with their contractual agreements. These events can potentially result in financial losses or other damages to the Company, including damage to the Company’s reputation.
The Company relies on internal and external information and technological systems to manage the Company’s operations and is exposed to risk of loss resulting from breaches in the security or other failures of these systems. Additionally, the replacement of the Company’s major legacy transaction systems and the migration of the Company’s data center as part of the technology initiative discussed in the “Results of Operations – Operating and Administrative Expenses” section of the MD&A could have a significant impact on the Company’s ability to conduct its core business operations and increase the Company’s risk of loss resulting from disruptions of normal operating processes and procedures that may occur during the implementation of new information and transaction systems.
In order to monitor and manage operational risk, the Company maintains a framework of internal controls designed to provide a sound and well-controlled operational environment. However, as discussed more fully in Item 9A., “Controls and Procedures”, during fiscal 2005, the Company discovered certain material weaknesses in its internal controls that resulted in the restatement of the Company’s financial statements in the second quarter of fiscal 2005 and a cumulative adjustment in the third quarter of fiscal 2005. These matters are more fully discussed in the Company’s quarterly reports on Form 10-Q for the periods ended September 30, 2004 and December 31, 2004, respectively. The Company’s remediation efforts with respect to these material weaknesses are described in Item 9A., “Controls and Procedures”. The Company will continue to evaluate the effectiveness of its internal controls over financial reporting on an ongoing basis. However, due to the complexity of the Company’s business, the existence of material weaknesses along with the final determination regarding the effectiveness of steps taken to remediate material weaknesses in its internal controls and procedures, and the challenges inherent in implementing control structures across global organizations, new problems could be identified in the future, and management can provide no assurance that these problems will not have a material effect on the Company’s operations.
The Company strives to maintain appropriate levels of operational risk relative to its business strategies, competitive and regulatory environment, and markets in which it operates. The Company also maintains appropriate levels of insurance coverage for those operating risks that can be mitigated through the purchase of insurance. Notwithstanding these control measures and insurance coverages, the Company remains exposed to operational risk. However, while the Company’s approach to operational risk management is intended to mitigate such losses, management can provide no assurance that these problems will not have a material effect on the Company’s operations.
Regulatory Risk
Regulatory risk is the risk arising from the failure to comply with applicable regulatory requirements and the risk of liability and other costs imposed under various laws and regulations, including changes in legislation and new regulatory requirements. Refer to the "Regulatory Environment" section of this Business section for further discussion of the Company's exposure to this risk.
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Counterparty Credit Risk
Counterparty credit risk is the risk that a counterparty may fail to perform on its contractual obligations in a derivatives contract. Refer to Item 7.A, “Quantitative and Qualitative Disclosures About Market Risk” for further discussion regarding the Company’s exposure to this risk.
Sales of Toyota and Lexus Vehicles
The Company's business is substantially dependent upon the sale of Toyota and Lexus vehicles and its ability to offer competitive financing in the U.S. Toyota Motor Sales, U.S.A., Inc. (“TMS”), an affiliate of the Company, is the primary distributor of Toyota and Lexus vehicles in the U.S. TMS also sponsors special rate retail financing and lease (“subvention”) programs offered by the Company in the U.S. on certain new and used Toyota and Lexus vehicles. The level of subvention varies based on TMS’s marketing strategies, economic conditions, and volume of vehicle sales. Changes in the volume of sales of such vehicles resulting from governmental action, changes in consumer demand, changes in the level of TMS sponsored subvention programs, increased competition, or changes in pricing of imported units due to currency fluctuations or other events could impact the level of finance and insurance operations of the Company. To date, the level of sales of Toyota and Lexus vehicles has not restricted the Company’s operations. Refer to the “Relationships with Affiliates” section in this Business section and Note 15 – Related Party Transactions of the Notes to Consolidated Financial Statements for further discussion regarding the Company’s relationship with TMS.
Factors Affecting Earnings Growth
The Company’s ability to continue to maintain its earnings growth is subject to a variety of factors, including changes in the overall market for retail financing, leasing or dealer financing, changes in the level of sales of Toyota and Lexus vehicles in the U.S., rates of growth in the number and average balance of customer accounts, the U.S. regulatory environment, competition, rates of default by its customers, changes in the U.S. and international funding markets, the used vehicle market, levels of operating and administrative expenses, including, but not limited to, personnel costs and technology costs, general economic conditions in the U.S. and other factors.Refer to “Competition” and “Regulatory Environment” in this Business section for discussion regarding the Company’s exposure to risk of loss resulting from the competitive and regulatory environments. Refer to the MD&A for discussion of the Company’s exposure to credit risk and expectations regarding operating and administrative expenses. Refer to Item 7A., “Quantitative and Qualitative Disclosures About Market Risk” for further discussion regarding the Company’s exposure to market risk.
Competition
The Company operates in a highly competitive environment. Increases in competitive pressures could have an adverse impact on the Company’s contract volume, market share, revenues, and margins. Refer to the “Competition” section of this Business section for further discussion of the competitive factors affecting the Company's business.
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Concentration of Customer Risk
The Company is exposed to customer concentration risk in certain states, as well as in the aggregation of the outstanding receivable balances of its 25 largest customers. Factors adversely affecting the economy in these states or any of its large vehicle and industrial equipment dealer receivables could have an adverse effect on the Company’s consolidated financial position or results of operations. Refer to “Geographic Distribution of Operations” and “Finance Operations-Dealer Financing-Customer Concentration” in this Business section for further discussion regarding the Company’s exposure to this risk.
Credit Support
The Company’s credit ratings depend, in part, on the existence of the credit support arrangements discussed in the “Liquidity and Capital Resources-Credit Support Agreements” section of the MD&A and on the financial condition and operating results of TMC. Should the Company for any reason not have the benefit of these arrangements (or replacement arrangements acceptable to the rating agencies), the Company would expect that its credit ratings would be lower than its current ratings, leading to higher borrowing costs. However, the Company believes that the credit support arrangements will continue to be available.
Insurance Reserves
The Company’s insurance subsidiary is subject to the risk of loss if its reserves for unearned premium and service revenues on unexpired policies and contracts in-force are not sufficient. The risk associated with using historical loss experience as a basis for establishing earnings factors used to recognize revenue over the term of the contract or policy is that the timing of revenue recognition will materially vary from the actual loss development. The Company’s insurance subsidiary is also subject to the risk of loss if its reserves for reported losses, losses incurred but not reported and loss adjustment expenses are not sufficient. The risk associated with the projection of future loss payments is the assumption that historical loss development patterns will reasonably predict loss development patterns on existing agreements in force. Management mitigates the risks associated with the use of such estimates by using credentialed actuaries to evaluate the adequacy of its reserves, by periodically reviewing the methods used for making such estimates and by having experienced claims personnel actively manage the claim settlement process. Because the reserve establishment process is an estimate, actual losses may vary from amounts established in earlier periods. Refer to Note 2 of the Notes to Consolidated Financial Statements for further description of the reserve setting process.
Reinsurance Risk
Reinsurance risk is the risk that a reinsurer providing excess of loss reinsurance coverage to the Company’s insurance subsidiary will be unable to meet its obligations under the agreement. The Company mitigates this risk by holding letters of credit on behalf of the reinsurers which are available to the Company as collateral for reinsurance balances. In addition, the Company monitors the financial condition of its reinsurers and does not believe that it is exposed to any material credit risk.
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FINANCE OPERATIONS
The Company provides
We provide retail financing, leasing, wholesale financing, and certain other financial products and services to authorized Toyota and Lexus vehicle dealers and, to a lesser extent, other domestic and import franchised dealers and their customers in the U.S. and the Commonwealth of Puerto
Rico as described under Item 1., “Business-General-Geographic Distribution of Operations”. The CompanyRico. We also
offersoffer financing for various industrial and commercial products such as forklifts, light and medium-duty trucks, and electric vehicles. Gross revenues related to transactions with industrial equipment dealers contributed
4%, 4%3 percent, 4 percent, and
5%4 percent to total gross revenues
forin fiscal
2007, 2006, and 2005,
2004 and 2003, respectively.
The table below summarizes
the Company’sour financing revenues,
net of depreciation by primary product.
| Years Ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
Percentage of total financing revenues: | | | | | |
Leasing1 | 57% | | 61% | | 64% |
Retail financing | 37% | | 34% | | 31% |
Dealer financing | 6% | | 5% | | 5% |
|
| |
| |
|
Total financing revenues | 100% | | 100% | | 100% |
|
| |
| |
|
1
| Leasing revenues are shown gross of depreciation on operating leases. Leasing revenues net of depreciation on operating leases represent 29%, 34%,
| | Years Ended March 31, | | | 2007 | | 2006 | | 2005 | Percentage of financing revenues, net of depreciation: | | | | | | | Operating Leases (net of depreciation) | 24% | | 22% | | 22% | Retail financing1 | 62% | | 65% | | 67% | | Dealer financing | 14% | | 13% | | 11% | | Financing revenues, net of depreciation | 100% | | 100% | | 100% |
1 Includes direct finance lease revenues.
Retail and 40%, of total financing revenues net of depreciation on operating leases for fiscal 2005, 2004, and 2003, respectively. |
Lease Financing
The Company acquires
Underwriting
We acquire new and used vehicle and industrial equipment finance and lease contracts originated primarily throughfrom Toyota and Lexus vehicle dealers and industrial equipment dealers. LeaseDealers transmit customer applications electronically to our online system for contract acquisition. Applications that meet certain income, credit, and other requirements are approved by the system, and other applications are further analyzed by credit analysts. We use a proprietary credit scoring system for decisioning credit applications. If approved, we acquire the retail finance contracts to be acquired are evaluated againstand a security interest in the Company’s credit standardsvehicle or industrial equipment that is financed under the contract and if approved, the Company acquireswe acquire the lease contracts and concurrently assumesassume ownership of the leased vehicles or industrial equipment. The Company views itsWe view our lease arrangements, including itsour operating leases, as financing transactions as it doeswe do not seek to re-lease the vehicles or equipment upon either default or at lease termination.
We utilize a tiered pricing program for retail and lease contracts. The Companyprogram matches customer risk with contract rates charged to allow for a range of risk levels. Generally, each approved application is responsible for contractassigned a credit tier. We review and adjust rates regularly based on competitive and economic factors. Rates vary based on credit tier, term, and collateral (if applicable), including whether a new or used vehicle is being financed. Special rates may apply as a result of promotional efforts through subvention programs.
We regularly review and analyze our retail and lease portfolio to evaluate the effectiveness of our underwriting guidelines and purchasing criteria.
Servicing
We also service our retail and lease contracts. Each of our CSCs service the vehicle retail and lease contracts using the same servicing system and procedures, except that centralized tracking units monitor bankruptcy administration, post-charge-off, and recovery. Our industrial equipment retail and lease contracts are serviced at a centralized facility. The collection duringdepartment manages the liquidation of each retail and lease period. The Company usescontract. We consider a customer to be past due if less than 90% of a regularly scheduled payment is received by the due date.
We use a behavioral-based collection strategy to minimize risk of loss and employsemploy various collection methods. The Company is permitted to take possessionUpon commencement of the contracts, we perfect our security interests through state Department of Motor Vehicles (or equivalent) Certificate of Title filings in the retail vehicles orfinanced and through Uniform Commercial Code (“UCC”) filings in the industrial equipment upon lessee defaultfinanced and hashave the right to repossess the assets if customers fail to meet contractual obligations and the right to enforce collection actions against the lessee. Upon default,obligors under the Company sellscontracts.
We generally determine whether to commence repossession efforts before an account is 60 days past due. Repossessed vehicles are held in inventory to comply with statutory requirements and then sold at private auctions, unless public auctions are required by applicable law. Any unpaid amounts remaining after sale or after full charge off are pursued by us to the extent practical and legally permitted. Collections of deficiencies are administered at a centralized facility. Our policy is to charge off a retail or lease contract as soon as disposition of the vehicle has been effected and sales proceeds have been received, but may in some circumstances charge-off a retail or lease contract prior to repossession. When repossession and disposition of the collateral has not been effected, our policy is to charge off as soon as we determine that the vehicle cannot be recovered, but not later than when the contract is 150 days contractually delinquent. Bankrupt accounts may be charged off after 150 days. We sell the vehicles or industrial equipment through vehicle or industrial equipment dealers or physical auctions. Repossessed vehicles are sold through a variety of distribution channels, similar to the sale of vehicles returned at lease end. Refer to the “Residual Value Risk” section of the MD&A for further discussion of our remarketing activities.
We may, in accordance with our customary servicing procedures, waive any prepayment charge, late payment charge, or any other fees that may be collected in the ordinary course of servicing the retail and lease account.
Substantially all of our retail and operating lease receivables are non-recourse to the vehicle and industrial equipment dealers, which relieves the vehicle and industrial equipment dealers from financial responsibility in the event of repossession.
We may experience a higher risk of loss if customers fail to maintain required insurance coverage. The terms of our retail financing programs require customers to maintain physical damage insurance covering loss or
auctions.The Company isdamage to the financed vehicle or industrial equipment in an amount not less than the full value of the vehicle or equipment. TMCC currently does not monitor ongoing insurance compliance as part of its customary servicing procedures for retail accounts.
Our vehicle lease contracts require lessees to maintain minimum liability insurance and physical damage insurance covering loss or damage to the leased vehicle in an amount not less than the full value of the vehicle. TMCC monitors ongoing insurance compliance only in certain vicarious liability states for lease contracts. Refer to the “Regulatory Environment” section of this Business section for further discussion of this issue.
We are also responsible for the residual value of the leased asset if the lessee, vehicle dealer, or industrial equipment dealer does not purchase the asset at lease maturity. At the end of the lease term, lease customers have the option to purchase the leased asset at the contractual residual value or return the leased asset to the vehicle or industrial equipment dealer. If the leased asset is returned to the vehicle or industrial equipment dealer, the vehicle or industrial equipment dealer has the option of purchasing the leased asset or returning it to
the Company.us. In an effort to minimize losses incurred at lease maturity,
the Company haswe have developed remarketing strategies to maximize proceeds and minimize disposition costs on used vehicles and industrial equipment sold at lease termination.
The Company usesWe use various channels to sell vehicles returned at lease maturity. Refer to the
“Results of Operations - Residual“Residual Value Risk” section of the MD&A for further discussion of
the Company’sour remarketing activities. Industrial equipment returned by the lessee or industrial equipment dealer is sold through authorized Toyota industrial equipment dealers or wholesalers using a bidding process.
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The Company may experience a higher risk of loss if customers fail to maintain required insurance coverage. The Company’s vehicle lease contracts require lessees to maintain minimum liability and physical damage insurance covering loss or damage to the leased vehicle in an amount not less than the full value of the vehicle. TMCC monitors ongoing insurance compliance only in vicarious liability states. Refer to the “Regulatory Environment” section of this Business section for further discussion of this issue.
Toyota Lease Trust, a Delaware business trust (the “Titling Trust”), acts as lessor and holds title to leased vehicles in specified states. This arrangement was established to facilitate a previously utilized lease securitization program. Lease contracts acquired by the Titling Trust from Toyota and Lexus vehicle dealers are serviced by TMCC in the same manner as lease contracts owned directly by
the Company. The Company holdsus. We hold an undivided trust interest in lease contracts owned by the Titling Trust, and these lease contracts are included in
the Company’sour lease assets unless and until such time as the interests in the contracts are transferred in a securitization transaction.
The Company doesWe do not presently have an active lease securitization program.
Retail FinancingThe Company acquires new and used vehicle and industrial equipment finance contracts primarily from Toyota, Lexus and, to a lesser extent, other domestic and import franchised dealers and industrial equipment dealers. Finance contracts to be acquired are evaluated against the Company’s credit standards and, if approved, the Company acquires the finance contracts and a security interest in the vehicle or industrial equipment that is financed under the contract. Thereafter, the Company has responsibility for contract administration and collection. The Company uses a behavioral-based collection strategy to minimize risk of loss and employs various collection methods. Upon commencement of the contracts, the Company perfects its security interests through Uniform Commercial Code (“UCC”) filings in the vehicles or industrial equipment financed and has the right to repossess the assets if customers fail to meet contractual obligations and the right to enforce collection actions against the obligors under the contracts. Upon default, the Company sells the vehicles or industrial equipment through vehicle or industrial equipment dealers or physical auctions. Repossessed vehicles are sold through a variety of distribution channels, similar to the sale of vehicles returned at lease end. Refer to the “Results of Operations - Residual Value Risk” section of the MD&A for further discussion of the Company’s remarketing activities.
Substantially all of the Company's retail finance receivables are non-recourse to the vehicle and industrial equipment dealers, which relieves the vehicle and industrial equipment dealers from financial responsibility in the event of repossession.
The Company may experience a higher risk of loss if customers fail to maintain required insurance coverage. The terms of the Company’s retail financing programs require customers to maintain physical damage insurance covering loss or damage to the financed vehicle or industrial equipment in an amount not less than the full value of the vehicle or equipment. TMCC currently does not monitor ongoing insurance compliance as part of its customary servicing procedures for retail accounts.
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Dealer Financing
Dealer financing is comprised of wholesale financing and other
financing options designed to meet dealer
loans.business needs.
Wholesale FinancingThe Company provides
We provide wholesale financing, also referred to as floorplan financing, to vehicle and equipment dealers for inventories of new and used Toyota, Lexus, and other vehicles and industrial equipment.
The Company acquiresWe acquire a security interest in vehicles financed at wholesale, which
the Company perfectswe perfect through UCC filings, and these financings may be backed by corporate or individual guarantees from, or on behalf of, participating vehicle and industrial equipment dealers, dealer groups, or dealer principals. In the event of vehicle or industrial equipment dealer default under a wholesale loan arrangement,
the Company haswe have the right to liquidate assets in which
it haswe have a perfected security interest and seek legal remedies pursuant to the wholesale loan agreement and any applicable guarantees.
TMCC and
TMSToyota Motor Sales, U.S.A., Inc. (“TMS”), our affiliate, have entered into an Amended and Restated Repurchase Agreement. This agreement states that TMS will arrange for the repurchase of new Toyota and Lexus vehicles at the aggregate cost financed by TMCC in the event of vehicle dealer default under floorplan financing.
The CompanyTMCC also entered into similar agreements with Toyota Material Handling, U.S.A., Inc. (“TMHU”)
, Hino Motor Sales, U.S.A., Inc. (“HINO”), and other domestic and import manufacturers. TMHU is the primary distributor of Toyota lift trucks in the U.S.
, and HINO is the exclusive U.S. distributor of commercial trucks manufactured by Hino Motors Ltd. of Japan.
Other Dealer FinancingThe Company extends
We extend term loans and revolving lines of credit to vehicle and industrial equipment dealers for business acquisitions, facilities refurbishment, real estate purchases, and working capital requirements. These loans are typically secured with liens on real estate, vehicle inventory, and/or other dealership assets, as appropriate, and usually are guaranteed by the personal or corporate guarantees of the dealer principals or dealerships.
The CompanyWe also
providesprovide financing to various multi-franchise dealer organizations, referred to as dealer groups, often as part of a lending consortium, for wholesale, working capital, real estate, and business acquisitions. These loans are typically collateralized with liens on real estate, vehicle inventory, and/or other dealership assets, as appropriate.
The Company obtainsWe obtain a personal guarantee from the vehicle or industrial equipment dealer or corporate guarantee from the dealership when deemed prudent. Although the loans are typically collateralized or guaranteed, the value of the underlying collateral or guarantees may not be sufficient to cover
the Company’sour exposure under such agreements.
The Company pricesWe price the credit facilities according to the risks assumed in entering into the credit
facility.Customer Concentration
At March 31, 2005, the 25 largest aggregate outstanding vehiclefacility and industrial equipment dealer receivables totaled $2,724 million, or 6% of net earning assets. Additionally, at March 31, 2005, the Company was committed to another $1,493 million under various funding facilities to these 25 largest vehicle and industrial equipment dealers or dealer groups, which, if entirely funded, would represent an additional 4% of net earning assets. All of these receivables were current as of March 31, 2005. Adverse changes in the business or financial condition of a vehicle or industrial equipment dealer or dealer group to whom the Company has extended a substantial amount of financing or commitments, in particular when the financing is unsecured or not secured by realizable assets, could result in a material adverse effect on the Company’s financial condition and results of operations.
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competitive factors.
TMCC markets its insurance products through Toyota Motor Insurance Services, Inc. (“TMIS”), a
wholly ownedwholly-owned subsidiary.
The principal activities of TMIS and its
wholly ownedwholly-owned insurance company
subsidiariessubsidiaries’ principal activities include marketing, underwriting, and claims administration related to covering certain risks of Toyota, Lexus, and other domestic and import franchise dealers and their customers.
TheTMIS’ primary business
of TMIS consists of issuing vehicle service and maintenance contracts and guaranteed auto protection (“GAP”) agreements sold to customers by or through Toyota and Lexus vehicle dealers, and certain other domestic or import vehicle
dealers.dealers in the U.S. TMIS obtains a significant portion of vehicle service contract business by providing supplemental coverage to the basic factory warranty coverage on certified Toyota and Lexus pre-owned vehicles. TMIS also provides coverage and related administrative services to certain
affiliates of
the Company.Substantially all of the business conducted by TMIS is in connection with the sale of vehicles by related Toyota and Lexus vehicle dealers and certain other domestic or import vehicle dealers in the U.S. In addition, TMIS obtains a significant portion of vehicles service and maintenance contract business by providing limited warranty coverage to TMS on certain pre-owned vehicles. our affiliates.
Changes in the volume of vehicle sales, changes in vehicle dealers’ utilization of programs offered by TMIS, or changes in the level of coverage purchased by TMS could materially impact the level of TMIS operations. Gross revenues from insurance operations
contributed 7%, 6%comprised 7 percent, 6 percent, and
5% to7 percent of total gross revenues for fiscal
2007, 2006, and 2005,
2004 and 2003, respectively.
Vehicle Service Agreements (“VSA”), Certified Pre-owned, and GAP
Vehicle service
contractsagreements offer vehicle owners and lessees mechanical breakdown protection for new and used vehicles secondary to the manufacturer’s new vehicle warranty. VSA coverage is available on Toyota and Lexus vehicles and other domestic and import vehicles. Certified pre-owned contracts offer coverage on Toyota and Lexus vehicles only. GAP insurance, or debt cancellation agreements, provides coverage for a lease or retail contract deficiency balance in the event of a total loss of the covered vehicle.
TMIS,
through its wholly-owned subsidiary, provides insurance to TMCC covering Toyota, Lexus, and certain other domestic and import vehicle dealers’ inventory financed by TMCC. TMIS has obtained reinsurance on the inventory insurance policy covering the excess of certain dollar maximums per occurrence and in the aggregate. Through reinsurance, TMIS limits its exposure to losses by obtaining the right to reimbursement from the assuming company for the reinsured portion of losses.
Other Products and Administrative Services
TMIS administers various other products and programs including prepaid maintenance programs covering Toyota, Lexus and certain other domestic and import vehicles. TMIS,
alsothrough its wholly-owned subsidiary, provides
administrative servicesumbrella liability insurance to
TMS and affiliates covering certain
affiliatesdollar value layers of risk above various primary or self-insured retentions. On all layers in which TMIS has provided coverage, 99 percent of the
Company as discussed in Item 1., “Business - Relationships with Affiliates”.- 12 -
risk has been ceded to various reinsurers.RELATIONSHIPS WITH AFFILIATESThe Company's
Our business is substantially dependent upon the sale of Toyota and Lexus vehicles and
itsour ability to offer competitive financing in the U.S. TMS is the primary distributor of Toyota and Lexus vehicles in the U.S. Automobiles and light trucks sold by TMS during fiscal
2007, 2006, and 2005
2004 and 2003 totaled
2.12.6 million units,
1.92.3 million units, and
1.82.1 million units, respectively. During fiscal
2005, 2004,2007, 2006, and
2003,2005, Toyota and Lexus vehicles accounted for approximately
12.5%, 11.4%,16 percent, 13 percent, and
10.4%,13 percent, respectively, of all retail automobile and light
duty truck unit sales volume in the U.S.
Certain lease and retail financing programs
we have offered
by the Company on vehicles and industrial equipment are subvened by
affiliates of the Company or other entities.our affiliates. TMS sponsors subvention programs on certain new and used Toyota and Lexus vehicles that result in reduced monthly payments to qualified retail and lease customers. Reduced monthly payments on certain Toyota industrial equipment to qualified lease and retail financing customers are subvened by various
affiliates or other entities.affiliates.
Subvention amounts received in connection with these programs typically approximate the amounts required by TMCC to maintain yields at
a levellevels consistent with standard program levels. The level of subvention program activity varies based on
the Company’sour and
itsour affiliates’ marketing strategies, economic conditions, and level of vehicle sales. Subvention amounts received vary based on the mix of Toyota and Lexus vehicles and timing of programs and are earned over expected retail receivable and lease contract terms.
TMCC and TMS are parties to a Shared Services Agreement which
coverscover certain technological and administrative services, such as information systems support, facilities, insurance coverage, and corporate services provided by each entity to the other. TMCC and TMS are also parties to an Amended and Restated Repurchase Agreement, which provides that TMS will arrange for the repurchase of new Toyota and Lexus vehicles at the aggregate cost financed by TMCC in the event of vehicle dealer default under floorplan financing.
The CompanyTMCC is also a party to similar agreements with TMHU,
HINO, and other domestic and import manufacturers.
TMHU is the primary distributor of Toyota lift trucks in the U.S. TMCC and Toyota Financial Savings Bank, a Nevada thrift company owned by TFSA (“TFSB”), are parties to a Master Services Agreement under which TMCC
provides a number of administrative and
otherTFSB provide certain services to
TFSB in exchange for TFSB’s willingness to make available certain financial products and services to TMCC’s customers and dealers. In June 2005, the
Master Services Agreement between TMCC and TFSB was amended and restated to include a number of additional services to be provided to TFSB by TMCC and certain limited services to be provided to TMCC by TFSB.other. These agreements are further discussed in Note
1516 – Related Party Transactions of the Notes to Consolidated Financial Statements.
Employees of TMCC, Toyota Credit de Puerto Rico
Corp,Corp. (“TCPR”), and TMCC’s insurance subsidiaries are generally eligible to participate in the TMS pension plan, the Toyota Savings Plan sponsored by TMS, and various health and life and other post-retirement benefits sponsored by TMS, as discussed further in Note
1213 – Pension and Other Benefit Plans of the Notes to Consolidated Financial Statements.
Credit support agreements
were establishedexist between
the Companyus and TFSC and TFSC and TMC. These agreements are further discussed in the “Liquidity and Capital Resources” section of the MD&A
and Note
1516 – Related Party Transactions of the Notes to Consolidated Financial
Statements, and Item 13., Certain Relationships and Related Transactions.Statements.
TMIS provides administrative services to TMS which are discussed in Note
1516 – Related Party Transactions of the Notes to Consolidated Financial Statements. In addition, TMIS provides various levels and types of insurance coverage to TMS, including the
warranty coverage for TMS’ certified pre-owned
program and variousvehicle program. TMIS, through its wholly-owned subsidiary, provides umbrella liability
policies. Substantiallyinsurance to TMS and affiliates covering certain dollar value layers of risk above various primary or self-insured retentions. On all
layers in which TMIS has provided coverage, 99 percent of the
premiums received from TMS arerisk has been ceded to various reinsurers.
- 13 -
COMPETITION
COMPETITIONThe Company operatesWe operate in a highly competitive environment and competescompete with other financial institutions including national and regional commercial banks, credit unions, savings and loan associations, and finance companies. In particular, we face intensified competition from credit unions finance companies and, tothat offer competitive interest rates for retail financing. To a lesser extent, we compete with other automobile manufacturers’ affiliated finance companies that actively seek to purchase retail consumer contracts through Toyota and Lexus dealers for retail financing and leasing. The Company competesWe compete with national and regional commercial banks and other automobile manufacturers’ affiliated finance companies for dealer financing. No single competitor is dominant in the industry. The Company competesWe compete primarily through service quality, itsour relationship with TMS, and financing rates. The Company seeksWe seek to provide exceptional customer service and competitive financing programs to itsour vehicle and industrial equipment dealers and to their customers.The Company’sOur relationship with TMS is an advantage in providing Toyota and Lexus financing for purchases or leases of Toyota and Lexus vehicles.
Competition for the principal products and services provided through
theour insurance operations is primarily from national and regional independent service contract providers.
The Company competesWe compete primarily through service quality,
itsour relationship with TMS, and pricing.
The Company seeksWe seek to offer
itsour vehicle dealers competitively priced products and excellent customer service.
The Company'sOur relationship with TMS provides an advantage in selling
itsour products and services.
REGULATORY ENVIRONMENTThe
Our finance and insurance operations
of the Company are regulated under both federal and state law.
The Company isWe are governed by, among other federal laws, the Equal Credit Opportunity Act, the Truth-in Lending Act, the Fair Credit Reporting Act, and the consumer data privacy and security provisions of the Gramm-Leach Bliley Act. A majority of states (as well as the Commonwealth of Puerto Rico) have enacted legislation establishing licensing requirements to conduct retail and other finance and insurance activities. Most states also impose limits on the maximum rate of finance charges. In certain states, the margin between the present statutory maximum interest rates and borrowing costs is sufficiently narrow that, in periods of rapidly increasing or high interest rates, there could be an adverse effect on
the Company'sour operations in these states if
the Companywe were unable to pass on increased interest costs to
itsour customers. State laws also impose requirements and restrictions on
the Companyus with respect to, among other matters, required credit application and finance and lease disclosures, late and other fees and charges, the right to repossess a vehicle for failure to pay or other defaults under the finance or lease contract, other rights and remedies
the Companywe may exercise in the event of a default under the finance or lease contract, privacy matters, and other consumer protection matters. In addition, state laws differ as to whether anyone suffering injury to person or property involving a leased vehicle may bring an action against the owner of the vehicle merely by virtue of that ownership. To the extent that applicable state law permits such an action,
the Companywe may be subject to liability to such an injured party. However, the laws of most states either do not permit such suits or limit the lessor’s liability to the amount of any liability insurance that the lessee was required under applicable law to maintain (or, in some states, the lessor was permitted to maintain), but failed to maintain.
The Company’sOur lease contracts in the U.S. contain provisions requiring the lessees to maintain levels of insurance satisfying applicable state law, and
the Company maintainswe maintain certain levels of contingent liability insurance for protection from catastrophic claims. TMCC monitors ongoing lease insurance compliance only in certain vicarious liability states.
The Company encountersDue to recently-enacted federal law, states are no longer permitted to impose unlimited vicarious liability on lessors of leased vehicles. TMCC continues to monitor the impact of the repeal of unlimited vicarious liability. At this time, TMCC has not modified its insurance compliance monitoring programs as a result of this law. We encounter higher risk of loss if the customers fail to maintain the required insurance coverage.
- 14 -
Our insurance operations are subject to state insurance regulations and licensing requirements. State laws vary with respect to which products are regulated and what types of corporate licenses are required to offer certain products and services. Insurance company subsidiaries must be appropriately licensed in certain states in which they conduct business and must maintain minimum capital requirements as determined by their state of domicile. Failure to comply with these state requirements could have an adverse effect on insurance operations in a particular state.
The CompanyWe actively
monitorsmonitor applicable laws and regulations in each state in order to maintain compliance.
The Company
We continually
reviews itsreview our operations for compliance with applicable laws. Future administrative rulings, judicial decisions, and legislation may require modification of
the Company'sour business practices and documentation.
As a registrant with the SEC under the Securities Exchange Act of 1934, as amended,
the Company iswe are subject to various federal securities laws and regulations including, but not limited to, the Sarbanes-Oxley Act of 2002.
The Company isWe are also subject to similar laws and regulations in the foreign countries in which
it obtainswe obtain debt funding.
The Company maintainsWe maintain policies and procedures to ensure compliance with applicable laws and regulations.
At April 30, 2005, the Company2007, we had approximately 2,9003,054 full-time employees, an increase of 100 employees over the prior year. The Company considers itsemployees. We consider our employee relations to be satisfactory. The Company isWe are not subject to any collective bargaining agreements with our employees.
ITEM 1A. RISK FACTORS
We are exposed to certain risks and uncertainties that could have a material adverse impact to our financial condition and operating results.
Sales of Toyota and Lexus Vehicles
Our business is substantially dependent upon the sale of Toyota and Lexus vehicles and our ability to offer competitive financing in the U.S. TMS is the primary distributor of Toyota and Lexus vehicles in the U.S. TMS also sponsors special rate retail financing and lease (“subvention”) programs offered by us in the U.S. on certain new and used Toyota and Lexus vehicles. The level of subvention varies based on TMS’ marketing strategies, economic conditions, and volume of vehicle sales. Changes in the volume of sales of such vehicles resulting from governmental action, changes in consumer demand, changes in the level of TMS sponsored subvention programs, increased competition, or changes in pricing of imported units due to currency fluctuations or other events could impact the level of our finance and insurance operations. To date, the level of sales of Toyota and Lexus vehicles has not restricted our operations. Refer to Item 1., “Business – Relationships with Affiliates” and Note 16 – Related Party Transactions of the Notes to Consolidated Financial Statements for further discussion regarding our relationship with TMS.
Credit Support
Our credit ratings depend, in part, on the existence of the credit support arrangements discussed in the “Liquidity and Capital Resources – Credit Support Agreements” section of the MD&A and on the financial condition and operating results of TMC. Should we for any reason not have the benefit of these arrangements (or replacement arrangements acceptable to the rating agencies), or should the credit ratings of the credit support providers identified in such arrangements be lowered, we would expect that our credit ratings would be lower than our current ratings, leading to higher borrowing costs. However, we believe that the credit support arrangements will continue to be available.
Residual Value Risk
We are exposed to risk of loss on the disposition of leased vehicles and industrial equipment to the extent that sales proceeds realized upon the sale of returned lease assets are not sufficient to cover the residual value that was estimated at lease inception. Residual value represents an estimate of the end of term market value of a leased asset. When the market value of a leased asset at contract maturity is less than its
employees.contractual residual value, there is a higher probability that the leased asset will be returned to us. A higher rate of returns exposes us to greater risk of loss at lease termination. Refer to the “Residual Value Risk” section of the MD&A for further discussion regarding our exposure to this risk.
Credit risk is the risk of loss arising from the failure of a customer or dealer to meet the terms of any contract with us or otherwise fail to perform as agreed. Refer to the “Credit Risk” section of the MD&A for further discussion regarding our exposure to this risk.
Liquidity Risk
Liquidity risk is the risk arising from our inability to meet obligations when they come due in a timely manner. Our liquidity strategy is to maintain the capacity to fund assets and repay liabilities in a timely and cost-effective manner even in the event of adverse market conditions. Refer to the “Liquidity and Capital Resources” section of the MD&A for further discussion regarding our exposure to this risk.
Market Risk
Market risk is the risk that changes in market interest rates or prices will negatively impact our income, capital, and market value. Policies governing market risk exposure are established and periodically reviewed by our senior management as conditions warrant. We use derivative instruments, along with other tools and strategies, to manage our market risk. We have established procedures to ensure that our risk management, including our use of derivatives, is in accordance with our policy framework. Refer to Item 7A., “Quantitative and Qualitative Disclosures About Market Risk” for further discussion regarding our exposure to this risk.
Operational Risk
Operational risk is the risk of loss resulting from, among other factors, inadequate or failed processes, systems or internal controls, theft, fraud, or natural disaster. Operational risk can occur in many forms including, but not limited to, errors, business interruptions, failure of controls, inappropriate behavior of or misconduct by our employees or those contracted to perform services for us, and vendors that do not perform in accordance with their contractual agreements. These events can potentially result in financial losses or other damages to us, including damage to our reputation.
We rely on internal and external information and technological systems to manage our operations and are exposed to risk of loss resulting from breaches in the security or other failures of these systems. Additionally, the replacement of our major legacy transaction systems as part of the technology initiative discussed in the “Operating and Administrative Expenses” section of the MD&A could have a significant impact on our ability to conduct our core business operations and increase our risk of loss resulting from disruptions of normal operating processes and procedures that may occur during the implementation of new information and transaction systems.
In order to monitor and manage operational risk, we maintain a framework of internal controls designed to provide a sound and well-controlled operational environment. However, due to the complexity of our business and the challenges inherent in implementing control structures across global organizations, problems could be identified in the future, and management can provide no assurance that these problems will not have a material effect on our operations.
We strive to maintain appropriate levels of operational risk relative to our business strategies, competitive and regulatory environment, and markets in which we operate. We also maintain appropriate levels of insurance coverage for those operating risks that can be mitigated through the purchase of insurance. Notwithstanding these control measures and insurance coverages, we remain exposed to operational risk. However, while our approach to operational risk management is intended to mitigate such losses, our management can provide no assurance that these problems will not have a material effect on our operations.
Regulatory Risk
Regulatory risk is the risk arising from the failure to comply with applicable regulatory requirements and the risk of liability and other costs imposed under various laws and regulations, including changes in legislation and new regulatory requirements. Refer to the "Regulatory Environment" section of this Business section for further discussion of our exposure to this risk.
Counterparty Credit Risk
Counterparty credit risk is the risk that a counterparty may fail to perform on its contractual obligations in a derivatives contract. Refer to Item 7A., “Quantitative and Qualitative Disclosures About Market Risk” for further discussion regarding our exposure to this risk.
Factors Affecting Earnings
Our earnings are affected by a variety of factors, including changes in the overall market for retail financing, leasing or dealer financing, changes in the level of sales of Toyota and Lexus vehicles in the U.S., rates of growth in the number and average balance of customer accounts, the U.S. regulatory environment, competition, rates of default by our customers, changes in the U.S. and international funding markets, the used vehicle market, levels of operating and administrative expenses, including, but not limited to, personnel costs and technology costs, general economic conditions in the U.S., and other factors. Refer to “Competition” and “Regulatory Environment” in Item 1., “Business” for discussion regarding our exposure to risk of loss resulting from the competitive and regulatory environments. Refer to the MD&A for discussion of our exposure to credit risk and residual value risk. Refer to Item 7A., “Quantitative and Qualitative Disclosures About Market Risk” for further discussion regarding our exposure to market risk.
Competition
We operate in a highly competitive environment. Increases in competitive pressures could have an adverse impact on our contract volume, market share, revenues, and margins. Refer to Item 1., “Business – Competition” for further discussion of the competitive factors affecting our business.
Risk of Catastrophes
Our business is exposed to the risk of catastrophes, including natural events, such as
hurricanes, tornados, earthquakes and fires, and other events, such as explosions, terrorist attacks, and
riots. The incidence and severity of catastrophes and severe weather conditions are inherently
unpredictable. These events may affect consumer spending in the vicinity of the disasters in the U.S. and may otherwise adversely affect our business, earnings, or financial condition.
Concentration of Customer Risk
We are exposed to customer concentration risk in certain states. Factors adversely affecting the economies and applicable laws in these states could have an adverse effect on our consolidated financial position or results of operations. Refer to “Geographic Distribution of Operations” in Item 1., “Business” for further discussion regarding our exposure to this risk.
Insurance Reserves
Our insurance subsidiary is subject to the risk of loss if our reserves for unearned premium and service revenues on unexpired policies and agreements in force are not sufficient. The risk associated with using historical loss experience as a basis for establishing earnings factors used to recognize revenue over the term of the contract or policy is that the timing of revenue recognition will materially vary from the actual loss development. Our insurance subsidiary is also subject to the risk of loss if our reserves for reported losses, losses incurred but not reported, and loss adjustment expenses are not sufficient. The risk associated with the projection of future loss payments is the assumption that historical loss development patterns will reasonably predict loss development patterns on existing agreements in force. Our management mitigates the risks associated with the use of such estimates by using credentialed actuaries to evaluate the adequacy of our reserves, by periodically reviewing the methods used for making such estimates, and by having experienced claims personnel actively manage the claim settlement process. Because the reserve establishment process is an estimate, actual losses may vary from amounts established in earlier periods. Refer to Note 2 – Summary of Accounting Policies of the Notes to Consolidated Financial Statements for further description of the reserve setting process.
Reinsurance Credit Risk
Reinsurance credit risk is the risk that a reinsurer providing reinsurance coverage to our insurance subsidiary will be unable to meet its obligations under the agreement. We mitigate this risk by holding letters of credit on behalf of certain reinsurers which are available to us as collateral for reinsurance balances. In addition, we monitor the financial condition of our reinsurers and do not believe that we are exposed to any material credit risk.
ITEM 1B. UNRESOLVED STAFF COMMENTS
There are no unresolved SEC staff comments to report.
ITEM 2. PROPERTIESThe Company relocated its
Our finance and insurance headquarters operations
to a new location within the TMS headquarters complexare located in Torrance,
California, in fiscal year 2004.During fiscal 2003, the Company completed the physical restructuring of its field operations in the U.S. The fieldCalifornia.
Field operations for both finance and insurance are
now located in three regional customer service centers (“CSC”), three regional management offices, and 30 dealer sales and service offices (“DSSO”) in cities throughout the U.S. Two of the DSSOs share premises with the regional customer services centers. All three of the regional management offices share premises with DSSO offices. The Central region CSC is located in Cedar Rapids, Iowa, and is leased from TMS. The Western region CSC is located in Chandler, Arizona. The Eastern region CSC is located in Owings Mills, Maryland.
The CompanyWe also
hashave offices in the Commonwealth of Puerto Rico. All premises are occupied under lease.
As discussed in Item 1., “Business – General - Geographic Distribution of Operations”, during fiscal 2005, the Mexico and Venezuela operations were transferred to TFSA.The Company believes
We believe that
itsour properties are suitable to meet the requirements of
itsour business.
- 15 -
Various legal actions, governmental proceedings and other claims are pending or may be instituted or asserted in the future against
the Companyus with respect to matters arising in the ordinary course of business. Certain of these actions are or purport to be class action suits, seeking sizeable damages and/or changes in
the Company’sour business operations, policies and practices. Certain of these actions are similar to suits that have been filed against other financial institutions and captive finance companies.
ManagementOur management and internal and external counsel perform periodic reviews of pending claims and actions to determine the probability of adverse verdicts and resulting amounts of liability.
The Company establishesWe establish reserves for legal claims when payments associated with the claims become probable and the costs can be reasonably estimated. The actual costs of resolving legal claims and associated costs of defense may be substantially higher or lower than the amounts reserved for these claims. However, based on information currently available, the advice of counsel, and established reserves,
in the opinion ofour management
expects that the ultimate liability resulting therefrom will not have a material adverse effect on
the Company'sour consolidated financial statements.
The foregoing is a forward looking statement withinWe caution that the
meaning of Section 27A of the Securities Act of 1933, as amended,eventual development, outcome and
Section 21E of the Securities Act of 1934, as amended, which represents the Company’s expectations and beliefs concerning future events. The Company cautions that its discussioncost of legal proceedings
is further qualifiedare by
importanttheir nature uncertain and subject to many factors,
that could cause actual results to differ materially from those in the forward looking statement, including but not limited to, the discovery of facts not presently known to
the Companyus or determinations by judges, juries or other finders of fact which do not accord with
the Company’sour evaluation of the possible liability from existing litigation.
Fair Lending Class ActionsAn alleged class action in the U.S. District Court – Central District of California,Baltimore v. Toyota Motor Credit Corporation filed in November 2000 claims that the Company’s pricing practices discriminate against African-Americans. Two additional cases pending in the state courts in California, (Herra v. Toyota Motor Credit CorporationandGonzales v. Toyota Motor Credit Corporation) filed in the Superior Court of California Alameda County in April 2003 and in the Superior Court of the State of California in August 2003, respectively, contain similar allegations claiming discrimination against minorities. The cases have been brought by various individuals. Injunctive relief is being sought in all three cases and the cases also include a claim for actual damages in an unspecified amount. The parties have conducted a series of mediation sessions and have reached agreement on the principal terms of a settlement. However, continued settlement discussions are ongoing and a final resolution is subject to execution of a settlement agreement. The Company believes it has strong defenses to these claims.
New Jersey Consumer Fraud Action
An action in the New Jersey Superior Court,Jorge v Toyota Motor Insurance Services (“TMIS”), filed in November 2002 claims that the TMIS Gold Plan Vehicle Service Agreement (“VSA”) is unconscionable on its face and violates the New Jersey Consumer Fraud Act. In September 2004, the case was certified as a class action consisting of all New Jersey consumers who purchased a VSA. The plaintiffs are seeking injunctive relief as well as actual damages and treble damages in an unspecified amount. In May 2005, the New Jersey Supreme Court issued a ruling granting TMIS' motion for leave to appeal the trial court's denial of TMIS' motion for summary judgment. The case has been remanded to the Appellate Division for reconsideration on the merits. The Company believes it has strong defenses to these claims.
Litigation is subject to many uncertainties and the outcome is not predictable. It is possible that the matters described above could be decided unfavorably to the Company. Although the amount of liability as of the date of this filing with respect to these matters cannot be ascertained, management believes that any resulting liability will not materially affect the Company’s consolidated financial statements.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
TMCC has omitted this section pursuant to General Instruction I(2) of Form 10-K.
TMCC is a
wholly ownedwholly-owned subsidiary of TFSA and, accordingly, all shares of
the Company'sTMCC’s stock are owned by TFSA. There is no market for TMCC's stock.
Dividends are declared and paid by
the CompanyTMCC as determined by its Board of Directors.
DuringTMCC’s Board of Directors declared and paid cash dividends of $130 million and $115 million to TFSA during fiscal
20052007 and
2004, nofiscal 2006, respectively. No dividends were declared or
paid.- 17 -
paid in fiscal 2005.ITEM 6. SELECTED FINANCIAL DATA | Year Ended March 31, | | Six Months Ended March 31, | | Year Ended September 30, |
|
| |
| |
|
| 2005 | | 2004 | | 2003 | | 2002 | | 20011 | | 2000 |
|
| |
| |
| |
| |
| |
|
| (Dollars in millions) |
INCOME STATEMENT DATA2 | | | | | | | | | | | |
Financing revenues: | | | | | | | | | | | |
Operating lease | $2,141 | | $2,049 | | $1,993 | | $1,870 | | $968 | | $2,007 |
Direct finance lease | 169 | | 291 | | 409 | | 512 | | 269 | | 396 |
Retail financing | 1,506 | | 1,284 | | 1,172 | | 958 | | 398 | | 776 |
Dealer financing | 270 | | 198 | | 181 | | 193 | | 128 | | 189 |
|
| |
| |
| |
| |
| |
|
Total financing revenues | 4,086 | | 3,822 | | 3,755 | | 3,533 | | 1,763 | | 3,368 |
| | | | | | | | | | | |
Depreciation on operating leases | 1,579 | | 1,561 | | 1,502 | | 1,480 | | 747 | | 1,440 |
Interest expense | 670 | | 578 | | 1,249 | | 1,014 | | 760 | | 1,311 |
|
| |
| |
| |
| |
| |
|
Net financing revenues | 1,837 | | 1,683 | | 1,004 | | 1,039 | | 256 | | 617 |
| | | | | | | | | | | |
Insurance premiums earned and contract revenues | 251 | | 212 | | 186 | | 175 | | 80 | | 153 |
Investment and other income | 139 | | 196 | | 182 | | 100 | | 92 | | 30 |
|
| |
| |
| |
| |
| |
|
Net financing revenues and other revenues | 2,227 | | 2,091 | | 1,372 | | 1,314 | | 428 | | 800 |
|
| |
| |
| |
| |
| |
|
Provision for credit losses | 230 | | 351 | | 604 | | 263 | | 89 | | 135 |
Expenses: | | | | | | | | | | | |
Operating and administrative | 650 | | 583 | | 537 | | 527 | | 242 | | 414 |
Insurance losses and loss adjustment expenses | 104 | | 98 | | 87 | | 76 | | 35 | | 81 |
|
| |
| |
| |
| |
| |
|
Total provision for credit losses and expenses | 984 | | 1,032 | | 1,228 | | 866 | | 366 | | 630 |
|
| |
| |
| |
| |
| |
|
Income before equity in net loss of subsidiary, provision for income taxes and cumulative effect of change in accounting principle | 1,243 | | 1,059 | | 144 | | 448 | | 62 | | 170 |
Equity in net loss of subsidiary | - | | - | | - | | - | | - | | (1) |
Provision for income taxes | 481 | | 418 | | 54 | | 177 | | 23 | | 65 |
|
| |
| |
| |
| |
| |
|
Income before cumulative effect of change in accounting principle | 762 | | 641 | | 90 | | 271 | | 39 | | 104 |
Cumulative effect of change in accounting principle, net of tax benefits | - | | - | | - | | - | | (2) | | - |
|
| |
| |
| |
| |
| |
|
Net income | $762 | | $641 | | $90 | | $271 | | $37 | | $104 |
|
| |
| |
| |
| |
| |
|
1
| In June 2000, the Executive Committee of the Board of Directors of the Company approved a change in the Company’s fiscal year-end from September 30 to March 31. This change resulted in a six-month transition period from October 1, 2000 through March 31, 2001.
|
2
| Certain prior period amounts have been reclassified to conform to the current period presentation.
|
- 18 -
| | Years Ended March 31, |
| | | | | | | | | | |
| | 2007 | | 2006 | | 2005 | | 2004 | | 2003 |
| | (Dollars in millions) |
| INCOME STATEMENT DATA | | | | | | | | | |
| Financing revenues: | | | | | | | | | |
| Operating lease | $3,624 | | $2,726 | | $2,141 | | $2,049 | | $1,993 |
| Direct finance lease | 108 | | 138 | | 169 | | 291 | | 409 |
| Retail financing | 2,431 | | 1,915 | | 1,506 | | 1,284 | | 1,172 |
| Dealer financing | 547 | | 402 | | 270 | | 198 | | 181 |
| Total financing revenues | 6,710 | | 5,181 | | 4,086 | | 3,822 | | 3,755 |
| | | | | | | | | | |
| Depreciation on operating leases | 2,673 | | 2,027 | | 1,579 | | 1,561 | | 1,502 |
| Interest expense | 2,666 | | 1,502 | | 670 | | 578 | | 1,249 |
| Net financing revenues | 1,371 | | 1,652 | | 1,837 | | 1,683 | | 1,004 |
| | | | | | | | | | |
Insurance earned premiums and contract revenues | 334 | | 288 | | 251 | | 212 | | 186 |
| Investment and other income | 252 | | 116 | | 139 | | 196 | | 182 |
| Net financing revenues and other revenues | 1,957 | | 2,056 | | 2,227 | | 2,091 | | 1,372 |
| | | | | | | | | | |
| Provision for credit losses | 410 | | 305 | | 230 | | 351 | | 604 |
| Expenses: | | | | | | | | | |
| Operating and administrative | 758 | | 712 | | 650 | | 583 | | 537 |
| Insurance losses and loss adjustment expenses | 126 | | 115 | | 104 | | 98 | | 87 |
| Total provision for credit losses and expenses | 1,294 | | 1,132 | | 984 | | 1,032 | | 1,228 |
| Income before provision for income taxes | 663 | | 924 | | 1,243 | | 1,059 | | 144 |
| Provision for income taxes | 231 | | 344 | | 481 | | 418 | | 54 |
| Net income | $432 | | $580 | | $762 | | $641 | | $90 |
-20-
| March 31, | | September 30, |
|
| |
|
| 2005 | | 2004 | | 2003 | | 2002 | | 2001 | | 2000 |
|
| |
| |
| |
| |
| |
|
| (Dollars in millions) |
BALANCE SHEET DATA1 | | | | | | | | | | | |
Finance receivables, net | $37,608 | | $32,318 | | $26,328 | | $23,309 | | $19,081 | | $18,060 |
Investments in operating leases, net | $9,341 | | $7,609 | | $7,946 | | $7,593 | | $7,368 | | $7,923 |
Total assets | $50,676 | | $44,634 | | $39,001 | | $ 33,942 | | $ 28,914 | | $27,880 |
Debt | $41,757 | | $36,854 | | $32,156 | | $27,020 | | $22,189 | | $22,330 |
Capital stock | $915 | | $915 | | $915 | | $915 | | $915 | | $915 |
Retained earnings2 | $3,283 | | $2,604 | | $1,963 | | $1,873 | | $1,606 | | $1,570 |
Total shareholder's equity | $4,244 | | $3,563 | | $2,895 | | $ 2,802 | | $ 2,537 | | $ 2,503 |
1
| Certain prior period amounts have been reclassified to conform to the current period presentation.
|
2
| During fiscal 2002, the Company's Board of Directors declared and paid a cash dividend of $4 million to TFSA. No dividends were declared or paid in any other period presented.
|
| As of/for the |
|
|
| Year Ended March 31, | | Six Months Ended
March 31, | | Year Ended September 30, |
|
| |
| |
|
| 2005 | | 2004 | | 2003 | | 2002 | | 2001 | | 2000 |
|
| |
| |
| |
| |
| |
|
| (Dollars in millions) |
KEY FINANCIAL DATA1 | | | | | | | | | | | |
| | | | | | | | | | | |
Ratio of earnings to fixed charges | 2.84 | | 2.81 | | 1.11 | | 1.44 | | 1.08 | | 1.13 |
Debt to equity | 9.84 | | 10.34 | | 11.11 | | 9.64 | | 8.75 | | 8.92 |
Return on assets2 | 1.60% | | 1.53% | | 0.25% | | 0.86% | | 0.26% | | 0.40% |
Allowance for credit losses as a percentage of gross earning assets | 1.06% | | 1.29% | | 1.33% | | 0.88% | | 0.80% | | 0.83% |
Net credit losses as a percentage of average earning assets2 | 0.56% | | 0.74% | | 1.12% | | 0.63% | | 0.50% | | 0.40% |
Over-60 day delinquencies as a percentage of gross earning assets | 0.28% | | 0.34% | | 0.57% | | 0.72% | | 0.26% | | 0.25% |
1
| Certain prior period amounts have been reclassified to conform to the current period presentation.
|
2
| Ratio for the six months ended March 31, 2001 has been annualized using six-month results.
|
- 19 -
| | March 31, |
| | 2007 | | 2006 | | 2005 | | 2004 | | 2003 | |
| | (Dollars in millions) |
| BALANCE SHEET DATA | | | | | | | | | | |
| | | | | | | | | | | |
| Finance receivables, net | $47,862 | | $42,022 | | $37,608 | | $32,318 | | $26,328 | |
| Investments in operating leases, net | 16,493 | | 12,869 | | 9,341 | | 7,609 | | 7,946 | |
| Total assets | 69,368 | | 58,261 | | 50,676 | | 44,634 | | 39,001 | |
| Debt | 58,529 | | 48,708 | | 41,757 | | 36,854 | | 32,156 | |
| Capital stock | 915 | | 915 | | 915 | | 915 | | 915 | |
Retained earnings1 | 4,098 | | 3,820 | | 3,283 | | 2,604 | | 1,963 | |
| Total shareholder's equity | 5,065 | | 4,795 | | 4,244 | | 3,563 | | 2,895 | |
1 Our Board of Directors declared and paid cash dividends of $130 million and $115 million to TFSA during fiscal 2007 and fiscal 2006,
respectively. No dividends were declared or paid in any other period presented.
| As of/for the Years Ended March 31, |
| | 2007 | | 2006 | | 2005 | | 2004 | | 2003 | |
| | |
| KEY FINANCIAL DATA | | | | | | | | | | |
| | | | | | | | | | | |
Ratio of earnings to fixed charges | 1.25 | | 1.61 | | 2.84 | | 2.81 | | 1.11 | |
Debt to equity | 11.56 | | 10.16 | | 9.84 | | 10.34 | | 11.11 | |
Return on assets | 0.68% | | 1.06% | | 1.60% | | 1.53% | | 0.25% | |
Allowance for credit losses as a percentage of gross earning assets | 0.85% | | 0.96% | | 1.06% | | 1.29% | | 1.33% | |
Net charge-offs as a percentage of average gross earning assets | 0.64% | | 0.54% | | 0.56% | | 0.74% | | 1.12% | |
Over-60 day delinquencies as a percentage of gross earning assets | 0.46% | | 0.43% | | 0.28% | | 0.34% | | 0.57% | |
Toyota Motor Credit Corporation (“TMCC”) and its consolidated subsidiaries, collectively referred to herein as
the “Company”“we”, “our”, and “us”, is
wholly ownedwholly-owned by Toyota Financial Services Americas Corporation (“TFSA”), a California corporation which is a
wholly ownedwholly-owned subsidiary of Toyota Financial Services Corporation (“TFSC”), a Japanese corporation.
The Company generates TFSC, in turn, is a wholly-owned subsidiary of Toyota Motor Corporation (“TMC”), a Japanese corporation. TFSC manages TMC’s worldwide financial services operations. TMCC is marketed under the brands of Toyota Financial Services and Lexus Financial Services.
We generate revenue, income, and cash flows by providing retail financing, leasing, wholesale financing, and certain other financial products and services to vehicle and industrial equipment dealers and their customers.
The CompanyWe also
generatesgenerate revenue through marketing, underwriting, and administering claims related to covering certain risks of vehicle dealers and their customers.
The Company supportsWe support growth in earning assets through funding obtained in the capital markets as well as funds provided by investing and operating activities.
The Company’s
Our financial results are affected by a variety of economic and industry factors, including but not limited to, new and used vehicle markets, new vehicle incentives, consumer behavior, employment growth,
the Company’sour ability to respond to changes in interest rates with respect to both contract pricing and funding, and the level of competitive pressure. Changes in these factors can influence the demand for new and used vehicles, the number of contracts that default and the loss per occurrence, the realizability of residual values on
the Company’sour lease earning assets, and
the Company’sour gross margins on
new contractfinancing volume. Additionally,
the Company’sour funding programs and related costs are influenced by changes in the capital markets and prevailing interest rates, which may affect
the Company’sour ability to obtain cost effective funding to support earning asset growth.
The Company measures
We measure the performance of
itsour finance operations
onusing the
basis of new contractfollowing metrics: financing volume,
and market share
of financingrelated to Toyota and Lexus vehicle sales, return on assets, financial leverage, financing margins,
operating efficiency, and
operating efficiency. The Company measuresloss metrics. We measure the performance of
itsour insurance operations on the basis of agreement volume, the number of agreements in force,
investment portfolio return, and loss ratio.
The Company’s
Our primary competitors are other financial institutions including national and regional commercial banks, credit unions, savings and loan associations, finance companies and, to a lesser extent, other automobile manufacturers’ affiliated finance companies that actively seek to purchase retail consumer contracts through Toyota and Lexus independent dealerships (“dealerships”).
During fiscal 2005, the Company experienced increased competition in the U.S. automotive sector. To compete effectively in this sector, the Company strivesWe strive to achieve, among others, the following goals:
Exceptional Customer Service:The Company’s relationshipsOur relationship with its Toyota and Lexus vehicle dealers and industrial equipment dealers and their customers continue to beoffer a competitive advantage for the Company. The Company seeksus. We seek to provide exceptional service to dealers and their customers by focusing itsour dealer sales and services offices (“DSSOs”) network and resources on encouraging the dealerships to continuously improve the quality of service provided by their finance and insurance representatives, and to increase customer loyalty to their dealerships and the Toyota and Lexus brands. By providing consistent and reliable support, training, and resources to itsour dealer network, the Company continueswe continue to develop itsour dealer relationships. The Company also worksWe work closely with Toyota Motor Sales, U.S.A., Inc. (“TMS”) and, Toyota Material Handling, U.S.A., Inc. (“TMHU”), and Hino Motor Sales, U.S.A., Inc. (“HINO”) to offer special retail, lease, dealer financing, and insurance programs, in addition to marketing programs targeted towards the retention of repeat customers. The CompanyWe also focusesfocus on improving the quality of service provided to existing vehicle retail, lease, and leaseinsurance customers through itsour customer service centers (“CSCs”).- 20 -
Enhanced Risk Based Pricing: The Company prices We price and structures itsstructure our retail and lease contracts to compensate for the credit risk it assumes.we assume. The goal of this strategy is to maximize profitability and better match contract rates with a widerbroad range of risk levels. To achieve this goal, the Company evaluates itswe evaluate our existing portfolio to identify key opportunities to target and expand additional volume. The Company deliversWe deliver timely information to DSSOs and dealerships to assist them in benefiting from market opportunities. The Company seeksWe constantly strive to further refine itsour strategy and methodology for risk based pricing.
Efficient Funding: The Company’sLiquidity Strategy: Our liquidity strategy is to maintain the capacity to fund assets and repay liabilities in a timely and cost-effective manner undereven in the event of adverse market conditions. This capacity primarily arises from the Company’sour high credit rating, our ability to raise funds in the global capital markets, as well as itsand our ability to generate liquidity from itsour balance sheet. This strategy has led the Companyus to develop a borrowing base that is diversified by market and geographic distribution and type of security, among other factors, as well as programs to prepare assets for sale and securitization.
Fiscal 20052007 Operating SummaryThe Company
Our consolidated net income was $432 million and $580 million during fiscal 2007 and fiscal 2006, respectively. Our results in fiscal 2007 were primarily affected by an increase in interest expense due to higher market interest rates, our higher outstanding debt portfolio, and the impact of our derivatives portfolio. This was partially offset by the impact of record financing volume of 1.3 million units on our retail and lease contracts and a record number of agreements issued on our insurance products of 1.4 million units which resulted in increased revenues. We also realized a higher level of gains on our investment portfolio.
Our financing operations reported net income of $762$317 million and $524 million during fiscal 2005, compared with2007 and fiscal 2006, respectively. The decrease in net income resulted from continued margin pressure due to the interest rate environment, and to a lesser extent, higher provisions for credit losses as a result of our growth in earning assets and broader range of credit quality within the retail portfolio.
Our insurance operations reported net income of $641$115 million and $56 million during fiscal 2007 and fiscal 2006, respectively. Our results in fiscal 2004. Fiscal 2005 financial results2007 were influencedprimarily affected by a numberhigher level of factors including volume growthrealized gains on our investment portfolio and improvements in customer delinquenciesincreased contract revenues and related credit losses,earned premiums. This was partially offset by higher operatingthe increase in insurance losses and loss adjustment expenses. Insurance losses and loss adjustment expenses increased primarily due to the increase in the number of agreements in force.
We continue our progress on our multi-year initiative to replace our major legacy transaction systems (“technology initiative”). The purpose of the technology initiative is to implement simplified, streamlined technology solutions that improve service delivery to our customers, enhance the quality and speed of information management, and support our future business. Our management believes we have properly aligned our resources internally for the technology initiative.
Overall, we have increased our capital position by $270 million bringing total equity to $5.1 billion at March 31, 2007. Our debt-to-equity positions were 11.56 and 10.16 at March 31, 2007 and 2006, respectively.
FINANCING OPERATIONS
Results of Operations
Fiscal 2007 compared to Fiscal 2006
| | Percentage change |
| Fiscal 2007 versus Fiscal 2006 | | Fiscal 2006 versus Fiscal 2005 |
| Financing Revenues: | | | |
| Operating lease | 33% | | 27% |
| Direct finance lease | (22%) | | (18%) |
| Retail financing | 27% | | 27% |
| Dealer financing | 36% | | 49% |
| Total financing revenues | 30% | | 27% |
| | | |
| Depreciation on operating leases | 32% | | 28% |
| Interest expense | 77% | | 124% |
| Net financing revenues | (17%) | | (10%) |
Net financing revenues decreased 17 percent during fiscal 2007 compared to fiscal 2006. Our net financing revenues were affected by the increase in interest expense resulting fromdue to higher market interest rates, andour higher outstanding debt balances. Duringportfolio, and the impact of our derivatives portfolio. This was partially offset by the increase in finance receivables and higher portfolio yields on our finance receivables. Refer to the “Interest Expense” section within this MD&A for further discussion regarding interest expense. Our financing revenues were influenced as follows:
| · | Our operating lease revenues and direct finance lease revenues on a combined basis were up 30 percent during fiscal 2007 versus fiscal 2006. This increase was primarily driven by our higher investments in operating leases due to higher leasing volume, partially offset by the decrease in direct finance leases as a substantial number of our new vehicle leases are classified as operating leases. |
| · | Our retail financing revenues increased 27 percent during fiscal 2007 versus fiscal 2006. This was due to an increase in retail finance receivables with a corresponding increase in our portfolio yield. |
| · | Dealer financing revenues increased 36 percent during fiscal 2007 versus fiscal 2006 primarily due to an increase in the yield on dealer financing and an increase in the number of dealers serviced which led to a higher average outstanding balance on dealer financing earning assets. The yield on dealer financing receivables increased as the majority of the dealer financing portfolio bears interest at variable rates which re-price with changes in market rates. |
Our total finance receivables portfolio yield was 6.9 percent and 6.1 percent during fiscal 2005,2007 and fiscal 2006, respectively.
Depreciation expense on operating leases increased 32 percent during fiscal 2007 versus fiscal 2006. This increase is consistent with the Company increased itsincrease in the average number of operating lease units outstanding during fiscal 2007 versus fiscal 2006. Refer to the “Residual Value Risk” section within this MD&A for further discussion.
Net Earning Assets and Vehicle Financing Volume
The composition of our net earning assets is summarized below (dollars in millions):
| | March 31, | | % Change |
| | 2007 | | 2006 | | 2005 | | 2007 to 2006 | | 2006 to 2005 |
Net earning assets | |
| Finance receivables, net | |
| Retail finance receivables, net | $38,329 | | $33,621 | | $28,771 | | 14% | | 17% |
| Direct finance leases, net | 704 | | 1,127 | | 1,917 | | (38%) | | (41%) |
| Dealer financing, net | 8,829 | | 7,274 | | 6,920 | | 21% | | 5% |
| Total finance receivables, net | 47,862 | | 42,022 | | 37,608 | | 14% | | 12% |
| Investments in operating leases, net | 16,493 | | 12,869 | | 9,341 | | 28% | | 38% |
| Net earning assets | $64,355 | | $54,891 | | $46,949 | | 17% | | 17% |
| | | | | | | | | | |
Average original contract terms: | | | | | | | | | |
Leasing1 | 43 months | | 44 months | | 47 months | | | | |
Retail financing2 | 61 months | | 60 months | | 58 months | | | | |
| | | | | | | | | | |
Dealer financing | | | | | | | | | |
(Number of dealers serviced) | | | | | | | | | |
Toyota and Lexus Dealers 3 | 787 | | 728 | | 685 | | 8% | | 6% |
Vehicle dealers outside of the Toyota/Lexus dealer network | 409 | | 374 | | 374 | | 9% | | - |
Total number of dealers receiving vehicle wholesale financing | 1,196 | | 1,102 | | 1,059 | | 9% | | 4% |
| | | | | | | | | | |
| Dealer inventory financed (units) | 220,000 | | 170,000 | | 165,000 | | 29% | | 3% |
1 Terms range from 24 months to 60 months.
2 Terms range from 24 months to 72 months.
3 Includes wholesale and other loan arrangements in which we participate as part of a syndicate of lenders.
The composition of our vehicle financing volume and market share is summarized below:
| | Years ended March 31, | | % Change |
| | 2007 | | 2006 | | 2005 | | 2007 to 2006 | | 2006 to 2005 |
Vehicle financing volume (units): | | | | | | | | | |
| New retail | 749,000 | | 618,000 | | 626,000 | | 21% | | (1%) |
| Used retail | 299,000 | | 267,000 | | 240,000 | | 12% | | 11% |
| Lease | 253,000 | | 235,000 | | 155,000 | | 8% | | 52% |
| Total | 1,301,000 | | 1,120,000 | | 1,021,000 | | 16% | | 10% |
| | | | | | | | | | |
TMS subvened vehicle financing volume (units included in the above table): | |
| New retail | 212,000 | | 205,000 | | 243,000 | | 3% | | (16%) |
| Used retail | 40,000 | | 42,000 | | 41,000 | | (5%) | | 2% |
| Lease | 130,000 | | 157,000 | | 77,000 | | (17%) | | 104% |
| Total | 382,000 | | 404,000 | | 361,000 | | (5%) | | 12% |
| | | | | | | | | | |
Market share1: | | | | | | | | | |
| Retail | 35.4% | | 32.9% | | 36.4% | | | | |
| Lease | 12.2% | | 12.7% | | 9.1% | | | | |
| Total | 47.6% | | 45.6% | | 45.5% | | | | |
1 Represents the percentage of total domestic TMS sales of new contractsToyota and Lexus vehicles financed by us, excluding sales
under dealer rental car and commercial fleet programs and sales of a private Toyota distributor.
Our higher retail and lease financing volume during fiscal 2007 compared to fiscal 2006 resulted in increases in earning assets. Our financing volume, acquired primarily from Toyota and Lexus vehicle dealers,
from 951,000 contracts inwas up 16 percent during fiscal
20042007 compared to
1,021,000 contracts in fiscal
2005.2006. Much of this growth in volume resulted from increased sales levels of Toyota and Lexus vehicles in the
U.S.United States. TMS sold
2.12.6 million units during fiscal
20052007, compared to
1.92.3 million units in fiscal
2004. The Company’s consumer2006. TMS’ increased sales in fiscal 2007 were largely due to strong sales of redesigned models. Our total retail and lease
finance market share of new Toyota and Lexus vehicles
excluding fleet sales and sales of an independent distributor, remained level at 45.5%. Earning assets increased
$7,022 million, or 18%, to $46,949 million due to new vehicle contract volume exceeding liquidations during fiscal 2005, as well as the effect of a reduction in securitization activity during the prior and current fiscal years. The Company did not execute any securitization transactions during fiscal 2005, compared to one such transaction during fiscal 2004.Current year net financing revenues increased $154 million, or 9%, over the prior year to $1,837 million due to the increase in earning assets partially offset by a general decline in the overall portfolio yield of the Company’s earning assets. The liquidation of older, higher yielding assets which in recent fiscal years have been replaced by lower yielding assets has resulted in a reduction of the overall portfolio yield. The lower yields have been driven by the declining interest rate environment experienced over the last several fiscal years as well as the competitive environment.
Overall interest expense increased $92 million or 16% due to higher market interest rates and outstanding debt balances. The increase in interest expense on debt was partially offset by favorable fair market value adjustments on derivatives primarily due to an increase in short-term interest rates, particularly three-month LIBOR.
The Company continued to improve the operational efficiency and effectiveness of its CSCs in fiscal 2005. These efforts have resulted in improvements in customer and vehicle dealer satisfaction and reductions in customer delinquency and net charge-offs2007 when compared to fiscal 2004. Additionally, the Company benefited from favorable economic conditions as evidenced by improvements in the unemployment rate2006.
Retail Finance Receivables and industry charge-off and delinquency rates. As a result, the allowance for credit losses as a percentage of gross earning assets declined from 1.29% to 1.06%.- 21 -
Financing Volume
Overall, the Company increased its capital position by $681 million bringing total equity to $4,244 million at March 31, 2005. The Company’s debt-to-equity position improved from 10.34 to 9.84 at March 31, 2004 and 2005, respectively.
During fiscal 2004 the Company launched a multi-year initiative to replace its major legacy transaction systems (“technology initiative”). The purpose of the initiative is to implement simplified, streamlined technology solutions to improve service delivery to its customers, enhance the quality and speed of information management, and support continued profitable growth. Refer to the “Results of Operations – Operating and Administrative Expenses” section of this MD&A for further discussion regarding actual and expected costs to be incurred under this initiative.
Fiscal 2006 Business Outlook
The following is a summary of the Company’s business outlook for fiscal 2006 and should be read in conjunction with the related current year discussions in the “Financial Condition” and “Results of Operations” sections of this MD&A.
The Company anticipates increased new vehicle retail and lease contract volume and continued availability of TMS subvention programs, particularly targeted towards driving incremental lease volume. The Company also anticipates continued growth in dealer financing, which historically has positively influenced vehicle financing volume.
The Company’s financial results depend on its ability to maintain gross margin in a highly competitive market and rising interest rate environment. The Company expects the level of competitive pricing pressure to continue, increasing the risk of margin compression. As discussed in prior periods, the Company intends to take a balanced approach to matching changes in financing rates to changes in costs of funds. The Company expects operating and administrative costs to increase as a result of costs incurred related to its technology initiative and general business growth; although, as a percentage of earning assets, expenses are expected to be consistent with fiscal 2005. In prior periods, the Company’s operating results have been favorably impacted by declines in the provision for credit losses. The Company does not expect this to continue to the same extent in the next fiscal year.
Contract Volume Outlook
In light of recent economic trends indicating potential improvements in the vehicle lease market, including the strengthened used vehicle market and rising market interest rates, and in line with industry trends, the Company has placed new emphasis on increasing lease contract volume. The Company expects lease contract volume and market share to continue to increase in the next fiscal year as a result of these factors and through the increased availability of subvention programs. Competitive pricing pressure adversely affected the Company’s retail market share of TMS sales throughout fiscal 2005, and this trend is expected to continue in the next fiscal year. The Company expects retail contract volume to continue to move in line with Toyota and Lexus vehicle sales trends.
- 22 -
Residual Value Risk Outlook
After several years of declining used vehicle prices resulting from increased industry-wide use of incentives on new vehicles and a slowdown of the U.S. economy, the used vehicle market strengthened during fiscal 2005. Although some uncertainty around the used vehicle market remains, particularly in light of the continuing use of incentives and the variability in fuel prices, management expects the number of leased vehicles returned at maturity to continue to decline in the next fiscal year. The Company continues to refine its process for projecting market values and return rates. These enhancements, along with a strengthened used vehicle market, have resulted in carrying values more closely approximating actual end of term values. Management believes that these recent trends will continue, thus supporting its strategy to increase lease volume. Additionally, management expects the increased focus on leasing volume to result in higher depreciation expense on operating leases in the next fiscal year, as well as an increase in the number of returned vehicles in the years following fiscal 2006.
Credit Risk Outlook
The Company’s vehicle retail and lease delinquency and credit losses trended favorably throughout fiscal 2005. This improvement resulted from current favorable economic trends and the continued benefits of operational and technological efficiencies and processes implemented during fiscal 2004 discussed in the “Results of Operations – Credit Risk” section of this MD&A. However, the Company’s recent and anticipated future mix of business reflects growth in longer term retail contracts, as well as growth in retail receivables with a broader range of credit quality. These factors increase the level of credit risk assumed by the Company. Additionally, the number of vehicle dealers receiving dealer financing increased from March 31, 2004 compared to March 31, 2005. This growth in dealer financing, as well as a higher concentration of credit risk in the form of higher lending exposure to some dealers with a greater mix of non-Toyota/Lexus collateral have also increased the level of credit risk assumed by the Company. To date these changes have not had a material effect on delinquencies or credit losses related to the Company’s retail and dealer financing portfolio. Management anticipates that the fiscal 2006 levels of delinquencies and credit losses as a percentage of the earning assets portfolio will be consistent with fiscal 2005. However, economic developments, including rising U.S. interest rates could cause an adverse trend in delinquencies and credit losses.
The foregoing information may contain “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward looking statements may include estimates, projections and statements of the Company’s beliefs concerning future events, business plans, objectives, expected operating results, and the assumptions upon which those statements are based. Refer to the “Cautionary Statement for Purposes of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995” section of this MD&A for a detailed discussion regarding words used to identify such statements and factors that could cause actual results to differ materially from those expressed or implied by such statements.
- 23 -
Fiscal 2005 Compared to Fiscal 2004
FINANCIAL CONDITION
Net Earning Assets
The composition of the Company’s net earning assets is summarized below:
| March 31, | | % Change |
|
| |
|
| 2005 | | 2004 | | 2003 | | 2005 to 2004 | | 2004 to 2003 |
|
| |
| |
| | |
| (Dollars in millions) | | |
| | |
| |
|
Net Earning Assets1 | | | | | |
Finance receivables, net | | | | | |
Retail finance receivables, net | $28,779 | | $22,182 | | $15,737 | | 30% | | 41% |
Direct finance leases, net | 1,917 | | 3,584 | | 5,000 | | (47%) | | (28%) |
Dealer financing, net | 6,912 | | 6,552 | | 5,591 | | 5% | | 17% |
|
| |
| |
| | | | |
Total finance receivables, net | 37,608 | | 32,318 | | 26,328 | | 16% | | 23% |
Investments in operating leases, net | 9,341 | | 7,609 | | 7,946 | | 23% | | (4%) |
|
| |
| |
| | | | |
Net earning assets | $46,949 | | $39,927 | | $34,274 | | 18% | | 16% |
|
| |
| |
| | | | |
| | | | | | | | | |
Average Original Contract Terms: | | | | | | | | | |
Leasing2 | 47 months | | 48 months | | 47 months | | | | |
Retail financing3 | 58 months | | 58 months | | 57 months | | | | |
| | | | | | | | | |
Dealer Financing (Number of dealers serviced) | | | | | | | | | |
Toyota and Lexus Dealers4 | 685 | | 633 | | 576 | | | | |
Vehicle dealers outside of the Toyota/Lexus dealer network | 374 | | 373 | | 251 | | | | |
|
| |
| |
| | | | |
Total number of dealers receiving vehicle wholesale financing | 1,059 | | 1,006 | | 827 | | | | |
|
| |
| |
| | | | |
Dealer inventory financed (units) | 165,000 | | 166,000 | | 147,000 | | | | |
1
| Certain prior period amounts have been reclassified to conform to the current period presentation.
| |
2
| Terms range from 24 months to 60 months.
| |
3
| Terms range from 24 months to 72 months.
| |
4
| Includes wholesale and other loan arrangements in which the Company participates as part of a syndicate of lenders.
|
| | | |
- 24 -
The increase in net earning assets was driven by the continued growth in retail
Retail finance receivables and
dealervehicle retail financing
and the recent growth in investments in operating leases, partially offset by reductions in direct finance leases.Retail finance receivables increased as the new volume of vehicles financed exceeded existing portfolio liquidations. This growth was generated in large part by higher Toyota and Lexus vehicle sales levels, which increased 9% from fiscal 2004 to fiscal 2005. The increase in retail finance receivables was also influenced by the effect of a reduction in securitization activity. The Company entered into one securitization transaction totaling approximately $1,884 million that qualified for sale accounting during fiscal 2004, and did not execute any securitization transactions during fiscal 2005. Refer to the “Financial Condition – Contract Volume” section of this MD&A for further discussion regarding the Company’s retail programs.
Dealer financing increased primarily due to the Company’s continued emphasis on developing dealer relationships. Many of the Toyota and Lexus dealerships serviced by the Company share common ownership, or are otherwise affiliated, with non-Toyota/Lexus dealerships. The Company believes that providing single-source financing for affiliated dealers with multiple franchises both within and outside of the Toyota and Lexus dealer franchise network will increase its retail and lease penetration, supporting continued growth in its retail finance and lease portfolios. This strategy also exposes the Company to a greater concentration of credit risk in the form of higher lending exposure to some dealers with a greater mix of non-Toyota/Lexus collateral. Refer to the “Results of Operations – Credit Risk” section of this MD&A for further discussion regarding the Company’s allowance for credit losses on dealer financing.
The increase in investments in operating leases and the related decrease in direct finance leases resulted primarily from the classification of new vehicle leases as operating leases. As with all other significant estimates, the Company periodically reviews lease classification criteria. In particular, the Company monitors the trends in the economic useful life of its vehicles subject to lease as it relates to lease classification criteria. During the latter half of fiscal 2004, the Company determined that the lease terms offered on vehicles under new leases no longer met the criteria required for accounting treatment as direct finance leases. Accordingly, substantially all new leases are classified as operating leases rather than as direct finance leases.
Total lease earning assets remained relatively consistent during fiscal 2005. The level of direct finance leases will continue to decline as the direct finance lease portfolio liquidates. However, the level of operating leases has increased primarily due to the classification of new vehicle leases as operating leases discussed above. Management expects total lease earning assets to increase in the future due to the Company’s increased emphasis on leasing. Refer to the “Financial Condition – Contract Volume” section of this MD&A for further discussion regarding changes in the Company’s emphasis on leasing.
- 25 -
Contract Volume
The composition of the Company’s contract volume and market share is summarized below:
| Years Ended March 31, | | % Change |
|
| |
|
| 2005 | | 2004 | | 2003 | | 2005 to 2004 | | 2004 to 2003 |
|
| |
| |
| | |
Contract Volume: | | | | | | | |
| | | | | | |
| |
|
New vehicle retail contracts | 626,000 | | 595,000 | | 476,000 | | 5% | | 25% |
Used vehicle retail contracts | 240,000 | | 238,000 | | 214,000 | | 1% | | 11% |
|
| |
| |
| | | | |
Total vehicle retail contract volume | 866,000 | | 833,000 | | 690,000 | | 4% | | 21% |
| | | | | | | | | |
New vehicle leases | 154,000 | | 116,000 | | 164,000 | | 33% | | (29%) |
Used vehicle leases | 1,000 | | 2,000 | | 3,000 | | (50%) | | (33%) |
|
| |
| |
| | | | |
Total vehicle lease contract volume | 155,000 | | 118,000 | | 167,000 | | 31% | | (29%) |
|
| |
| |
| | | | |
Total contract volume | 1,021,000 | | 951,000 | | 857,000 | | 7% | | 11% |
|
| |
| |
| | | | |
| | | | | | | | | |
TMS subvened contract volume (included in the above table): | | | | | | | | | | |
New vehicle retail contracts | 243,000 | | 263,000 | | 198,000 | | (8%) | | 33% |
Used vehicle retail contracts | 41,000 | | 45,000 | | 32,000 | | (9%) | | 41% |
New vehicle leases | 77,000 | | 34,000 | | 43,000 | | 126% | | (21%) |
|
| |
| |
| | | | |
Total | 361,000 | | 342,000 | | 273,000 | | 6% | | 25% |
|
| |
| |
| | | | |
| | | | | | | | | |
TMS subvention rates1: | | | | | | | | | |
Vehicle retail | 33% | | 37% | | 33% | | | | |
Vehicle lease | 50% | | 29% | | 26% | | | | |
| | | | | | | | | |
Market share2: | | | | | | | | | |
Vehicle retail contracts | 36.4% | | 37.9% | | 33.3% | | | | |
Vehicle leases | 9.1% | | 7.6% | | 11.7% | | | | |
|
| |
| |
| | | | |
Total | 45.5% | | 45.5% | | 45.0% | | | | |
|
| |
| |
| | | | |
| | | | | | | | | | | | | | | | | | |
1
| TMS subvention rates represent subvened new and used contract volume as a percentage of total contract volume for vehicle retail contracts and vehicle lease contracts.
|
2
| Market share represents the percentage of total domestic TMS sales of new Toyota and Lexus vehicles financed by TMCC, excluding fleet sales and sales of a private Toyota distributor.
|
Total contract volume increased due to the combined effects of higher Toyota and Lexus vehicle sales, incremental volume from the increased number of wholesale dealers serviced by TMCC, and continued availability of TMS subvention. The Company’s overall market share of TMS sales remained level as the Company’s contract volume and TMS vehicle sales increased at a similar pace.
- 26 -
Vehicle lease contract volume and market share both increased due to higher Toyota and Lexus vehicle sales and higher lease subvention contract volume, in line with the Company’s new emphasis on leasing. In light of recent economic trends indicating potential improvements in the vehicle lease market, including the strengthened used vehicle market and rising market interest rates, and in line with industry trends, the Company has placed new emphasis on increasing lease contract volume. The Company expects lease contract volume and market share to continue to increase in the the next fiscal year as a result of these factors and through an increased availability of subvention programs.
Vehicle retail contract volume increased due to higher Toyota and Lexus vehicle sales while vehicle retail market share decreased due to higher competitive pricing pressurecombined with our emphasis on developing dealer relationships and lower retail subvention contract volume. Competitive pricing pressure adversely affected the Company’spurchasing a broader range of credit quality. Our retail market share of TMS new vehicle sales throughoutincreased in fiscal 2005, and this trend is expected2007 compared to continuefiscal 2006. This was primarily due to the increase in the next fiscal year.number of vehicle dealers receiving wholesale financing. We generally experience a higher level of retail financing volume as a result of these relationships. The Company expectscontinued availability of TMS retail contractsubvention also contributed to the increase.
Lease Earning Assets and Financing Volume
Total lease earning assets are comprised of investments in operating leases and direct finance leases. Our vehicle lease financing volume
to continue to move in line withis impacted by the level of Toyota and Lexus vehicle sales,
trends.- 27 -
RESULTS OF OPERATIONS
Total Financing Revenues
| Years Ended March 31, | | % Change |
|
| |
|
| 2005 | | 2004 | | 2003 | | 2005 to 2004 | | 2004 to 2003 |
|
| |
| |
| | |
| (Dollars in millions) | | |
| | |
| | |
Financing revenues: | | | | | | | | | |
Operating lease1 | $2,141 | | $2,049 | | $1,993 | | 4% | | 3% |
Direct finance lease | 169 | | 291 | | 409 | | (42%) | | (29%) |
Retail financing | 1,506 | | 1,284 | | 1,172 | | 17% | | 10% |
Dealer financing | 270 | | 198 | | 181 | | 36% | | 9% |
|
| |
| |
| | | | |
Total financing revenues | $4,086 | | $3,822 | | $3,755 | | 7% | | 2% |
|
| |
| |
| | | | |
| | | | | | | | | |
Finance receivables portfolio yield2 | 5.48% | | 5.98% | | 6.90% | | | | |
| | | | | | | | | |
1
| Gross of depreciation on operating leases of $1,579 million, $1,561 million, and $1,502 million for fiscal 2005, 2004, and 2003, respectively.
|
2
| Represents the combined yield on direct finance leases, retail finance receivables, and dealer financing. Excludes return on assets on investments in operating leases, net.
|
Totalthe availability of subvention programs, and changes in the interest rate environment. Leasing generally becomes more attractive to customers in a rising interest rate environment because the difference between monthly payments under a lease contract and a retail installment contract typically widens as interest rates rise. Our vehicle lease financing revenuesvolume increased in fiscal 2007 compared to fiscal 2006 due to increases in retail financing, dealer financing, and operating lease revenues, partially offset by a decline in direct finance lease revenue.
Operating lease revenues increased and direct finance lease revenues decreased primarily as a result of the classification ofhigher TMS new vehicle leases as operating leases describedsales. Our lease market share of TMS new vehicle sales decreased slightly in the “Financial Condition” section of this MD&A. Operating lease revenues were also affected by the decline in corresponding contract ratesfiscal 2007 compared to fiscal 2006. This was primarily due to the liquidation of older lease earning assets with higher contract rates, which in recent fiscal years have been replaced by lease earning assets with lower contract rates.
Retail financing revenues increased as a result of the continued growth in vehicle retail finance receivables, partially offset by reductions in corresponding portfolio yield. The yield on retail finance receivables declined due to the liquidation of older, higher yielding retail finance receivables, which in recent fiscal years have been replaced by lower yielding assets.
Dealer financing revenues increased due to the growth in outstanding dealer financing, combined with an increase in corresponding yield. In contrast to the decrease in the yield on retail finance receivables, the yield on dealeravailability of TMS lease subvention.
Dealer Financing Earning Assets
Dealer financing increased
because a majority of the dealer financing portfolio bears interest at variable rates which reprice with rising market rates.The declineprimarily due to continued growth in the overall finance receivables portfolio yield resulted from the continuing liquidationnumber of higher yielding earning assets, which in recent fiscal years have been replaced by lower yielding assets, as well as the impact of competitive pricing pressure.
- 28 -
vehicle dealers receiving wholesale financing and our emphasis on developing dealer relationships.
Residual Value RiskThe Company is
We are exposed to risk of loss on the disposition of leased vehicles and industrial equipment to the extent that sales proceeds
realized upon the sale of returned lease assets are not sufficient to cover the
carryingresidual value
of the leased assetthat was estimated at
termination.lease inception. Substantially all of
the Company’sour residual value risk relates to
itsour vehicle lease portfolio. To date,
the Company haswe have not incurred material
residual value losses related to
declines in contractual residual values on itsour industrial equipment portfolios.
Management periodically reviews the estimated realizable value of leased assets to assess the appropriateness of the carrying value of the lease residuals. For operating leases, the impact of estimated declines in contractual residual values is recorded over time in depreciation expense in the Consolidated Statement of Income and is discussed in the “Results of Operations – Depreciation on Operating Leases” section of this MD&A. For direct finance leases, the impact of estimated declines in contractual residual values is recorded at the time of assessment as a reduction of direct finance lease revenues in the Consolidated Statement of Income.
Factors Affecting Exposure to Residual Value Risk
Residual value represents an estimate of the end of term market value of a leased asset. The primary factors affecting
the Company’sour exposure to residual value risk are the levels at which
contractual residual values are established at lease inception, projected market values, and the resulting impact on vehicle lease return rates and loss severity. The evaluation of these factors involves significant assumptions, complex analysis, and management judgment. Refer to the “Critical Accounting Estimates” section of this MD&A for further discussion of the estimates involved in the determination of residual values.
Contractual Residual Values at Lease InceptionThe contractual residual value established at lease inception represents an estimate of the end of term market value of a leased vehicle. Contractual residual
Residual values are
determinedestimated at lease inception by examining external industry data and
the Company’sour own
historical residual experience. Factors considered in this evaluation include, but are not limited to,
expected economic conditions, new vehicle pricing, new vehicle incentive programs, new vehicle sales, product attributes of popular vehicles, the mix of used vehicle supply, the level of current used vehicle values, and fuel prices. These factors are evaluated in the context of their historical
trends.trends to anticipate potential changes in the relationship among those factors in the future.
End of Term Market Values
Our management periodically reviews the estimated end of term market values of leased vehicles to assess the appropriateness of its carrying values. To the extent the estimated end of term market value of a leased vehicle
declines fromis lower than the
contractual residual value established at lease inception, the residual value of the leased vehicle is adjusted downward so that the carrying value at lease end will approximate the estimated end of term market value. These adjustments are made over time for operating leases
andby recording depreciation expense in the Consolidated Statement of Income. Refer to the “Depreciation on Operating Leases” section of this MD&A for further discussion. For direct finance leases, the impact of the estimated decline in end of term market values is recorded at the time of assessment
foras a reduction of direct finance
leases.lease revenues in the Consolidated Statement of Income. Factors considered in this assessment are
the same assimilar to those considered in the evaluation of
contractual residual values at lease inception discussed above.
- 29 -
Vehicle Lease Return Rate
The vehicle lease return rate represents the number of end of term leased vehicles returned to
the Companyus for sale as a percentage of lease contracts that were originally scheduled to mature in the same period. When the market value of a leased vehicle at contract maturity is less than its contractual residual value
(i.e., the price at which the lease customer may purchase the leased vehicle), there is a higher probability that the vehicle will be returned to
us. In addition, a higher market supply of certain models of used vehicles generally results in a lower relative level of demand for those vehicles, resulting in a higher probability that the
Company.vehicle will be returned to us. A higher rate of vehicle returns exposes
the Companyus to greater risk of loss at lease termination.
Loss severity is the extent to which the end of term market value of a
leaseleased vehicle is less than
its carrying value at lease end.the estimated residual value. Although
the Company makes every effortwe employ a rigorous process to
establish accurate contractual residualestimate end of term market values,
at lease inception and adjusts the residual value downward throughout the life of the lease as conditions warrant, the Companywe may
still incur losses to the extent the end of term market value of a
leaseleased vehicle is less than
its carrying value at lease end.the estimated residual value.
At the end of the lease contract, lease customers have the option to purchase the vehicle at the contractual residual value or return the vehicle to the vehicle dealer. If the vehicle is returned to the vehicle dealer, the vehicle dealer has the option of purchasing the vehicle or returning it to
the Company. The Company hasus. We have developed remarketing strategies to maximize proceeds and minimize disposition costs on used vehicles sold at lease termination.
The Company usesWe use various channels to sell vehicles returned at lease end, including the following:
The
Company introducedgoal of the Dealer Direct program (“Dealer Direct”)
in fiscal 2004. The goal of Dealer Direct is to increase vehicle dealer purchases of off-lease vehicles thereby reducing the disposition costs of such vehicles. Through Dealer Direct, the vehicle dealer accepting the lease return (the “grounding vehicle dealer”) has the option to purchase the vehicle at the contractual residual value, purchase the vehicle at an assessed market value, or return the vehicle to
the Company.us. During fiscal
2005, 28%2007, 35 percent of returned vehicles
waswere sold to the grounding vehicle dealer, compared to
13%31 percent sold during fiscal
2004.2006. Vehicles not purchased by the grounding vehicle dealer are made available to all Toyota and Lexus vehicle dealers through the Dealer Direct online auction. During fiscal
2005, 12%2007, 12 percent of returned vehicles
waswere sold through the Dealer Direct online auction to franchise vehicle dealers, compared to
7%10 percent sold during fiscal
2004.2006. The disposition costs of vehicles sold through the Dealer Direct online auction are lower than the costs of those sold through auction sites. The average holding period of a vehicle sold through Dealer Direct was approximately
seven6 days, as compared to approximately
thirty25 days for
all off-lease vehicles
sold through other means. Management expects the total percentage of returned vehicles sold through the Dealer Direct program to remain consistent during the next fiscal year.sold.
Vehicles not purchased through
the Dealer Direct
program are sold
through fourteenat physical vehicle auction sites throughout the country. During fiscal
2005,2007, approximately
60%53 percent of returned vehicles
waswere sold through
physical auction, compared to approximately
80%59 percent of returned vehicles sold during fiscal
2004.2006. Where necessary,
the Company reconditionswe recondition used vehicles prior to sale in order to enhance the
vehicle values
of the vehicles at auction. Additionally,
the Company redistributeswe redistribute vehicles geographically
should certain model concentrations potentially affect sales prices at auction.- 30 -
to minimize oversupply in any location.
The following table summarizes the Company’sour scheduled maturities related to our leased vehicle portfolio and related vehicle sales at lease termination by period:
| | Years Ended March 31, |
| | 2007 | | 2006 | | 2005 |
| Scheduled maturities (units) | 171,000 | | 166,000 | | 179,000 |
Vehicles sold at lease termination (units)1 | 39,000 | | 49,000 | | 76,000 |
1 Includes vehicles sold at physical auction, Dealer Direct online auction, and dealer purchases at a price other than the
contractual residual value.
Scheduled maturities remained fairly constant in fiscal 2007 compared to fiscal 2006. The number of vehicles sold at lease termination decreased in fiscal 2007 compared to fiscal 2006 due to lower return rates. Lower return rates
by period: | Years Ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
Scheduled maturities (units) | 179,000 | | 185,000 | | 211,000 |
Vehicle lease return rates1 | 41% | | 48% | | 51% |
1
| The vehicle lease return rate represents end of term leased vehicles returned to the Company for sale as a percentage of lease contracts that were originally scheduled to mature in the same period.
|
The decrease in scheduled maturities resulted from lower levels of lease originations in prior yearswere primarily due to the Company’s emphasis on retail financing programs during those periods. The decrease infavorability of used vehicle lease return rates resulted from a narrowing spread betweenmarket values relative to contractual residual values and end of lease market values, a decreaseon certain vehicles in scheduled lease maturities, and a higher percentage of longer-term lease contract maturities. A decrease in scheduled lease maturities affects return rate in that a lower market supply of certain makes of used vehicles generally results in a higher relative level of demand for those vehicles, which provides an incentive for lessees and vehicle dealers to purchase them at the end of lease term. Longer term lease contracts typically have a lower return rate.
Refer to the “Results of Operations – Depreciation on Operating Leases” section of this MD&A for further discussion of the impact of return rates on depreciation expense.
fiscal 2007.
Depreciation on Operating Leases
The following table
sets forth the items included in the Company’sprovides information related to our depreciation on operating leases:
| Years Ended | | % Change |
|
| |
|
| 2005 | | 2004 | | 2003 | | 2005 to 2004 | | 2004 to 2003 |
|
| |
| |
| | |
| | | |
| |
| |
|
| | | | |
Depreciation on operating leases (in millions) | $1,579 | | $1,561 | | $1,502 | | 1% | | 4% |
| | | | | | | | | |
Average capitalized cost per vehicle | $32,508 | | $31,821 | | $30,445 | | 2% | | 5% |
(Less) Average depreciable basis per vehicle | 15,415 | | 14,612 | | 13,455 | | 5% | | 9% |
|
| |
| |
| | | | |
Average residual values per vehicle | $17,093 | | $17,209 | | $16,990 | | (1%) | | 1% |
|
| |
| |
| | | | |
Average depreciable basis percentage | 47.4% | | 45.9% | | 44.2% | | | | |
Average operating lease units outstanding | 320,000 | | 311,000 | | 317,000 | | | | |
| | | | | | | | | | |
The Company records
| | Years Ended March 31, | | % Change |
| | 2007 | | 2006 | | 2005 | | 2007 to 2006 | | 2006 to 2005 |
| Depreciation on operating leases (in millions) | $2,673 | | $2,027 | | $1,579 | | 32% | | 28% |
| Average operating lease units outstanding | 554,000 | | 420,000 | | 320,000 | | 32% | | 31% |
We record depreciation expense on the portion of
itsour lease portfolio classified as operating leases. Depreciation expense is recorded over the
original contract lifelease term and is based upon the depreciable basis of the leased
vehicle (“depreciable basis”).vehicle. Depreciable basis is the difference between a leased vehicle’s original
bookacquisition value
(“capitalized cost”) and its
contractual residual value established at lease inception.
Adjustments to depreciationDepreciation expense
areis recorded on a straight-line basis over the remaining life of the lease when the end of term market value is estimated to be less than the carrying value. Refer to the
“Results of Operations – Residual“Residual Value Risk” section of this MD&A for a discussion regarding
the Company’sour exposure to residual value risk on
itsour lease portfolio. Refer to the “Critical Accounting Estimates” section of this MD&A for a further discussion of the estimates involved in the determination of residual values.
- 31 -
Depreciation expense on operating leases
remained relatively consistent as increasesincreased during fiscal 2007 compared to fiscal 2006 due to an increase in the average
number of operating lease
units outstanding andvehicles outstanding. Depreciation expense is also affected by changes in the
average depreciable basis were offset byused vehicle market because used vehicle market trends are a
decreasesignificant factor in
adjustments to depreciation expense recorded to bring contractual residual values in line with projectedestimating end of term market values.
The recent strengthening of the used vehicle market and the enhancements made by the Company to refine its process for projecting end of term market values and return rates were both key drivers in reducing the level of adjustments made to depreciation expense. The strengthening ofDuring fiscal 2007, the used vehicle market was
evidenced bystable and did not materially contribute to the
improvement in the Manheim Used Vehicle Value Index, a statistical index based on historical auction sales data, which increased from approximately 106.6 (as a percentage of January 1995 used car prices) at March 2004 to approximately 112.2 at March 2005. In prior years, the Company recorded larger adjustments to depreciation expense in response to rapid declines in forecasted end of term values.Outlook
After several years of declining used vehicle prices resulting from increased industry-wide use of incentives on new vehicles and a slowdown of the U.S. economy, the used vehicle market strengthened during fiscal 2005. Although some uncertainty around the used vehicle market remains, particularly in light of the continuing use of incentives and the variability in fuel prices, management expects the number of leased vehicles returned at maturity to continue to decline in the next fiscal year. The Company continues to refine its process for projecting market values and return rates. These enhancements, along with a strengthened used vehicle market, have resulted in carrying values more closely approximating actual end of term values. Management believes that these recent trends will continue, thus supporting its strategy to increase lease volume. Additionally, management expects the increased focus on leasing volume to result in higher depreciation expense on operating leases in the next fiscal year, as well as an increase in the number of returned vehicles in the years following fiscal 2006. Refer to the “Financial Condition – Contract Volume” section of this MD&A for further discussion regarding changes in the Company’s emphasis on leasing.
depreciation expense.
Credit RiskThe Company is
We are exposed to credit risk on
itsour earning assets. Credit risk is the risk of loss arising from the failure
by theof a customer or dealer to meet the terms of any contract with
the Companyus or otherwise fail to perform as agreed.
The Company’sOur level of credit risk on
itsour retail and lease portfolio is influenced primarily by two factors: the total number of contracts that default (“frequency of occurrence”) and the amount of loss per occurrence
net of recoveries (“loss severity”), which in turn are influenced by various economic factors, the used vehicle market, purchase quality mix, contract term length, and operational changes (as discussed below).
The Company’sOur level of credit risk on
itsour dealer financing portfolio is influenced primarily by the financial strength of dealers within
itsour portfolio, dealer concentration, collateral quality, and economic factors.
In the past, most of the Company’s credit losses were related to its retail finance receivables and lease earning assets. The Company is exposed to credit losses on its dealer financing portfolio, but default rates for those receivables have been substantially lower than those for retail finance receivables and lease earning assets. To date, the Company haswe have not incurred material credit losses on itsour dealer financing portfolio.
- 32 -
Factors Affecting Retail and Lease Portfolio Credit Risk
General economic conditions such as unemployment rates, bankruptcy rates, consumer debt levels,
fuel prices, consumer credit performance, interest rates, and inflation can influence both the frequency of occurrence and loss severity.
Changes in used vehicle prices directly affect the proceeds from sales of repossessed vehicles and, accordingly, the level of loss severity
experienced by the Company.we have experienced. The supply of and demand for used vehicles, interest rates, inflation, the level of manufacturer incentives on new vehicles, and general economic outlook are some of the factors affecting the used vehicle market.
A change in the mix of contracts acquired at various risk levels may
potentially increasechange the amount of credit risk
the Company assumes.we assume. An increase in the number of contracts acquired with lower credit quality (as measured by scores that establish a consumer’s creditworthiness based on present financial condition, experience, and past credit history) can increase the amount of credit risk. Conversely, an increase in the number of contracts with higher credit quality acquired can lower credit risk. An increase in the mix of contracts with lower credit quality can also increase operational risk unless appropriate controls and procedures are established.
The Company strivesWe strive to price contracts
according to their risk in order to achieve
a reasonablean appropriate risk adjusted return on investment.
The average original contract term of retail and lease vehicle contracts influences credit losses. Longer term contracts (those having original terms of 48, 60, or 72 months) generally experience a higher rate of default and thus affect the frequency of occurrence and loss severity.
Operational changes
such as theand ongoing implementation of new information and transaction systems are designed to have a positive effect on
the Company’sour operations, including customer service improvements in the management of delinquencies and credit losses, through the implementation of processes and tools that create greater operational efficiency and effectiveness.
However, such changes have the potentialWe continue to
adversely affect delinquenciesmake improvements in our service operations and credit
losses by disrupting the Company’s normal operations during the operational change process.loss management methods.
Factors Affecting Dealer Financing Portfolio Credit Risk
The financial strength of dealers to which the Company extendswe extend credit directly influences credit risk. Lending to dealers with lower quality credit characteristics increases the risk of loss assumed by the Company.we assume. Extending a substantial amount of financing or commitments to a specific dealer or group of dealers creates a concentration of credit risk, particularly when the financing is unsecured or not fully secured by realizable assets. Collateral quality influences credit risk in that lower quality collateral increases the risk that, in the event of dealer default, the value of the collateral will be less than the amount owed to us.
Credit Loss Experience
The level of credit losses is influenced primarily by two factors: frequency of occurrence and loss severity. Frequency of occurrence as a percentage of average outstanding contracts remained constant at 1.8% for fiscal 2006 and fiscal 2007. Loss severity increased by 7.9% from fiscal 2006 to fiscal 2007 primarily due to the
Company.- 33 -
broader range of credit quality within the retail portfolio.
We experienced an increase in net charge-offs as a percentage of average gross earning assets from fiscal 2006 to fiscal 2007. The increase in net charge-offs as a percentage of average gross earning assets was primarily due to an increase in longer term contracts and a broader range of credit quality in our retail portfolio since fiscal 2005. Refer to Item 1., “Business” for discussion of our charge-off policy.
We experienced an increase in 60-day delinquencies on the overall portfolio primarily due to the higher credit risk within the retail portfolio as described above.
| | Years Ended March 31, |
| | 2007 | | 2006 | | 2005 |
| Net charge-offs as a percentage of average gross earning assets | | | | | |
| Finance receivables | 0.76% | | 0.64% | | 0.63% |
| Operating leases | 0.26% | | 0.17% | | 0.27% |
| Total | 0.64% | | 0.54% | | 0.56% |
| | | | | | |
Aggregate balances 60 or more days past due as a percentage of gross earning assets1 | | | | | |
Finance receivables2 | 0.53% | | 0.47% | | 0.30% |
Operating leases2 | 0.24% | | 0.29% | | 0.19% |
| Total | 0.46% | | 0.43% | | 0.28% |
1 Substantially all retail, direct finance lease, and operating lease receivables do not involve recourse to the dealer in the event of
customer default.
2 Includes accounts in bankruptcy and excludes accounts for which vehicles have been repossessed.
Allowance for Credit Losses and Credit Loss ExperienceThe Company maintains
We maintain an allowance for credit losses to cover probable losses resulting from the non-performance of itsour customers. The determination of the allowance involves significant assumptions, complex analysis, and management judgment. Refer to the “Critical Accounting Estimates” section of this MD&A for further discussion of the estimates involved in determining the allowance. The following tables provide information related to the Company’sour allowance for credit losses (dollars in millions):
| | Years Ended March 31, |
| | 2007 | | 2006 | | 2005 |
| Allowance for credit losses at beginning of period | $530 | | $503 | | $520 |
| Provision for credit losses | 410 | | 305 | | 230 |
Charge-offs, net of recoveries (“net charge-offs”)1 | (386) | | (278) | | (243) |
| Distribution of net assets to TFSA | - | | - | | (4) |
| Allowance for credit losses at end of period | $554 | | $530 | | $503 |
1 Net of recoveries of $82 million, $79 million, and $69 million in years ended March 31, 2007, 2006, and 2005, respectively.
| | Years Ended March 31, |
| | 2007 | | 2006 | | 2005 |
Allowance for credit losses as a percentage of gross earning assets | | | | | |
| Finance receivables | 1.03% | | 1.17% | | 1.16% |
| Operating leases | 0.37% | | 0.26% | | 0.65% |
| Total | 0.85% | | 0.96% | | 1.06% |
Our management reviews periodically the differences between expected and actual incurred credit
loss experience: | Years Ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
| (Dollars in millions) |
| | | | | |
Allowance for credit losses at beginning of period | $520 | | $462 | | $273 |
Provision for credit losses | 230 | | 351 | | 604 |
Charge-offs, net of recoveries (“net charge-offs”)1 | (243) | | (276) | | (370) |
Sale of receivables | - | | (17) | | (45) |
Distribution of net assets to TFSA | (4) | | - | | - |
|
| |
| |
|
Allowance for credit losses at end of period | $503 | | $520 | | $462 |
|
| |
| |
|
1
| Netlosses. In fiscal 2007, the methodology for calculating the portion of recoveries of $69 million, $59 million and $35 million in years ended March 31, 2005, 2004, and 2003, respectively.
|
| Years Ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
| (Dollars in millions) |
Aggregate balances 60 or more days past due | | | | | |
Finance receivables | $115 | | $115 | | $160 |
Operating leases | 17 | | 23 | | 38 |
|
| |
| |
|
Total | $132 | | $138 | | $198 |
|
| |
| |
|
| | | | | |
Aggregate balances 60 or more days past due as a percentage of gross earning assets | | | | | |
Finance receivables | 0.30% | | 0.35% | | 0.60% |
Operating leases | 0.19% | | 0.30% | | 0.47% |
Total | 0.28% | | 0.34% | | 0.57% |
| | | | | |
Allowance for credit losses as a percentage of gross earning assets | | | | | |
Finance receivables | 1.16% | | 1.17% | | 1.22% |
Operating leases | 0.65% | | 1.79% | | 1.69% |
Total | 1.06% | | 1.29% | | 1.33% |
| | | | | |
Net charge-offs as a percentage of average gross earning assets | | | | | |
Finance receivables | 0.63% | | 0.81% | | 1.23% |
Operating leases | 0.27% | | 0.47% | | 0.73% |
Total | 0.56% | | 0.74% | | 1.12% |
- 34 -
As part of management’s quarterly evaluation, the overall allowance for credit losses was adjusted to reflect reductions in total net charge-offs resulting from decreases in both frequency of occurrence and loss severity, as well as an increase in the recovery of previously recorded charge-offs . Frequency of occurrence as a percentage of average outstanding contracts decreased from 3.03% during the year ended March 31, 2004 to 2.28% during the year ended March 31, 2005. Loss severity decreased by 5% from the year ended March 31, 2004 comparedrelating to the year ended March 31, 2005.
The improvement indealer products was refined to better utilize external credit lossesdata and charge-offs resulted, in large part, from favorable economic conditions (as evidencedto introduce a framework to quantify portfolio level risk factors (such as concentration risk) not addressed by improvements in the unemployment rate, lower industry delinquency and charge-off rates, and the strengthened used vehicle market), and the continued benefits of operational and technological initiatives implemented during fiscal 2004. These initiatives included the implementation of new tools and technology to measure and monitor performance, the strategic outsourcing of certain functions, the development of enhanced training for CSC field associates, and technology initiatives and strategies that enhanced collections productivity. Loss severity was also positively influenced by the recent strengthening of the used vehicle market discussed in the “Results of Operations – Residual Value Risk” section within this MD&A.
The overall decrease in theexternal credit data.
Our allowance for credit losses
was comprised of a decrease in the allowance for credit losses related to the operating lease portfolio, partially offset by increases in the allowance for credit losses on the retail and dealer financing portfolios, respectively. With respect to the operating lease portfolio, management expects the levels in delinquencies and credit losses to remain favorable as a significant portion of new lease volume has resulted from an increased
level of subvention programs. Subvened leases typically exhibit stronger credit quality characteristics when compared to those of non-subvened leases as TMS subvention programs typically involve higher quality credit customers. Accordingly, management reduced the allowance for credit losses related to the operating lease portfolio.The increases in the allowance for credit losses related to the retail and dealer financing portfolios were recorded in responseprimarily due to the growth in the corresponding portfolios, as well asour earning assets and the broader range of credit quality within the portfolio. Refer to the “Financial Condition – Contract Volume” section within this MD&A for further discussion regarding the changesretail portfolio, partially offset by continued improvements in Company’s emphasis on leasingour service operations and credit loss management methods, and the “Financial Condition – Net Earning Assets” section within this MD&Arefinement of our methodology for further discussion regardingcalculating the growth inportion of the dealer financing portfolio.
Outlook
The Company’s vehicle retail and lease delinquency andallowance for credit losses trended favorably throughout fiscal 2005. This improvement resulted from current favorable economic trends andrelating to dealer products.
INSURANCE OPERATIONS
The following table summarizes the
continued benefitsresults of
operational and technological efficiencies and processes implemented during fiscal 2004 discussed above. However, the Company’s recent and anticipated future mix of business reflects growth in longer term retail contracts, as well as growth in retail receivables with a broader range of credit quality. These factors increase the level of credit risk assumed by the Company. Additionally, the number of vehicle dealers receiving dealer financing increased from March 31, 2004 compared to March 31, 2005. This growth in dealer financing, as well as a higher concentration of credit risk in the form of higher lending exposure to some dealers with a greater mix of non-Toyota/Lexus collateral have also increased the level of credit risk assumed by the Company. To date these changes have not had a material effect on delinquencies or credit losses related to the Company’s retail and dealer financing portfolio. Management anticipates that the fiscal 2006 levels of delinquencies and credit losses as a percentage of the earning assets portfolio will be consistent with fiscal 2005. However, economic developments, including rising U.S. interest rates, could cause an adverse trend in delinquencies and credit losses.- 35 -
Selectedour Insurance Operations Results
The general financial condition and operating expenses of the insurance segment are included(dollars in the foregoing discussion of the overall financial condition and results of operations of the Company. Certainmillions):
| | | Years Ended March 31, | | % Change |
| | | 2007 | | 2006 | | 2005 | | 2007 to 2006 | | 2006 to 2005 |
| Contract revenues and earned premiums | | $285 | | $244 | | $214 | | 17% | | 14% |
| Commissions and fees | | 49 | | 44 | | 37 | | 11% | | 19% |
| Insurance earned premiums and contract revenues | | $334 | | $288 | | $251 | | 16% | | 15% |
| | | | | | | | | | | |
| Insurance losses and loss adjustment expenses | | $126 | | $115 | | $104 | | 10% | | 11% |
| | | | | | | | | | | |
| Agreements issued (units) | | 1,407,000 | | 1,254,000 | | 1,136,000 | | 12% | | 10% |
| Agreements in force (units) | | 4,428,000 | | 3,895,000 | | 3,438,000 | | 14% | | 13% |
Contract revenues and
expenses specific to the Company’s insurance operations are discussed below. | | Years Ended March 31, | | % Change |
| |
| |
|
| | 2005 | | 2004 | | 2003 | | 2005 to 2004 | | 2004 to 2003 |
| |
| |
| |
| | |
| | (Dollars in millions) | | |
| | | |
| |
|
Contract revenues and earned premiums | | $214 | | $181 | | $161 | | 18% | | 12% |
Commissions and fees | | 37 | | 31 | | 25 | | 19% | | 24% |
| |
| |
| |
| | | | |
Insurance premiums earned and contract revenues1 | | $251 | | $212 | | $186 | | 18% | | 14% |
| |
| |
| |
| | | | |
Insurance losses and loss adjustment expenses | | $104 | | $98 | | $87 | | 6% | | 13% |
| | | | | | | | | | |
Agreement volume (units) | | 1,136,000 | | 1,030,000 | | 887,000 | | 10% | | 16% |
Agreements in force (units) | | 3,438,000 | | 3,026,000 | | 2,634,000 | | 14% | | 15% |
1
| Certain prior period amounts have been reclassified to conform to the current period presentation
|
Insurance Premiums Earned and Contract Revenues
Revenueearned premiums from insurance operations isare affected by sales volume as well as the level, age, and mix of agreements in force. Agreements in force represent active insurance policies written and contracts issued. Contract revenues and earned premiums represent revenues from the agreements in force. CommissionCommissions and fee revenuesfees represent revenues from services provided to insurers and insureds, including certain affiliates of the Company.
Contract revenues and earned premiums increased primarily due to increased contract volume and agreements in force and prior year contract rate increases. Commissions and fees increased primarily due to the increases in agreement volume.
Insurance Losses and Loss Adjustment Expenses
our affiliates.
Insurance losses and loss adjustment expenses
represent losses incurred by the Company’s insurance operations. Losses incurred are a function of the number of covered risks, the frequency and severity of claims associated with the agreements in force, and the level of risk retained by
theour insurance operations. Insurance losses
and loss adjustment expenses include amounts paid and accrued for reported losses, estimates of losses incurred but not reported, and any related claim adjustment expenses. Refer to Note 2 – Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements for further discussion regarding
the Company’sour exposure to risks surrounding the reserve estimates.
Insurance losses
Our insurance operations reported $115 million and
loss adjustment expenses$56 million of net income during fiscal 2007 and fiscal 2006, respectively. Contract revenues and earned premiums increased
primarily due to an increase in the number of agreements
issued and agreements in force,
and in the average loss per claim (“claim severity”), partially offset by a decrease in the percentage of risk based contracts in-force incurring a loss (“loss frequency”). Claim severity increased by 10% from fiscal 2004 to fiscal 2005, while average monthly loss frequency decreased from 0.75% in fiscal 2004 to 0.67% in fiscal 2005.- 36 -
Derivative Instruments
Business Use of Derivative Instruments
The Company’s assets consist primarily of U.S. dollar denominated fixed rate receivables. The Company’s liabilities consist primarily of fixed and floating rate debt which is issued in the global capital markets. In order to maintain a conservative liquidity profile, the life of the Company’s debt is typically longer than the life of the Company’s assets. Upon the issuance of fixed rate debt, the Company generally elects to enter into pay floating interest rate swaps. The interest rate risk arising from the mismatch in the re-pricing of assets relative to liabilities is managed via pay fixed swaps and purchased interest rate caps which are executed on a portfolio basis. The currency exposure related to non-U.S. dollar denominated debt is hedged at issuance, using cross currency interest rate swaps, currency basis swaps, or a combination of interest rate swaps coupled with currency basis swaps to convert non-U.S. dollar debt to U.S. dollar denominated payments.
The Company’s use of derivatives is limited to the management of interest rate and foreign exchange risks. The Company is not a derivatives dealer and does not enter into derivatives transactions for trading purposes.
Accounting for Derivative Instruments
All derivative instruments are recorded on the balance sheet at fair value, taking into consideration the effects of legally enforceable master netting agreements that allow the Company to net settle positive and negative positions and offset cash collateral held with the same counterparty on a net basis. Changes in the fair value of the derivatives are recorded in interest expense in the Consolidated Statement of Income.
The Company categorizes derivatives as those designated for hedge accounting (“hedge accounting derivatives”) and those that are not designated for hedge accounting (“non-hedge accounting derivatives”). The Company designates at inception whether the derivative is considered a hedge accounting derivative or a non-hedge accounting derivative. That designation may change based on management’s intentions and changing circumstances.
In order to qualify for hedge accounting, a derivative must be considered highly effective at reducing the risk associated with the exposure being hedged. When the Company designates a derivative in a hedging relationship, the Company documents the risk management objective and strategy. This documentation includes the identification of the hedging instrument, the hedged item and the risk exposure, and how the Company will assess effectiveness prospectively and retrospectively. The Company assesses the extent to which a hedging instrument is effective at achieving offsetting changes in fair value at least quarterly. The Company recognizes changes in the fair value of derivatives designated in fair value hedging relationships (including foreign currency fair value hedging relationships) in interest expense in the Consolidated Statement of Income along with the fair value changes of the hedged item attributable to the hedged risk. For certain types of hedge relationships that meet stringent criteria, the Company applies the shortcut method, which provides an assumption of zero ineffectiveness that results in equal and offsetting changes in fair value in the Consolidated Statement of Income for both the hedged debt and the hedge accounting derivative.
When the shortcut method is not applied, any ineffective portion of the derivative that is designated as a fair value hedge is recognized as a component of interest expense in the Consolidated Statement of Income. If the Company elects not to designate a derivative instrument in a hedging relationship, or the relationship does not qualify for hedge accounting treatment, the full change in the fair value of the derivative instrument is recognized as a component of interest expense in the Consolidated Statement of Income with no offsetting fair value adjustment for the hedged item.
- 37 -
The Company reviews the effectiveness of its hedging relationships quarterly to determine whether the relationships have been and continue to be effective. The Company currently uses regression analysis to assess the effectiveness of its hedges. The Company began using regression analysis to assess hedge effectiveness in the fourth quarter of fiscal 2004. Prior to that date, the Company employed the dollar-offset method. When the Company determines that a hedging relationship has not been effective, hedge accounting is no longer applied. If hedge accounting is discontinued, the Company continues to carry the derivative instrument as a component of other assets or other liabilities in the Consolidated Balance Sheet at its fair value with changes in fair value reported as interest expense in the Consolidated Statement of Income. Additionally, for discontinued fair value hedges, the Company ceases to adjust the hedged item for changes in fair value and amortizes the cumulative fair value adjustments recognized in prior periods over the remaining term of the debt.
The Company will also discontinue the use of hedge accounting if a derivative is sold, terminated or exercised, or if the Company’s management determines that designating a derivative under hedge accounting is no longer appropriate (“de-designated derivatives”). De-designated derivatives are included within the category of non-hedge accounting derivatives.
The Company’s goal is to manage the interest rate risk arising from the differences in timing between the re-pricing of assets relative to liabilities. The Company uses non-hedge accounting derivatives to manage this exposure. The use of non-hedge accounting derivatives to mitigate interest rate risk has resulted in significant earnings volatility. This volatility arises from the accounting treatment of the Company’s non-hedge accounting derivatives, which requires that changes in the fair value of the non-hedge accounting derivatives be reflected in the Consolidated Statement of Income. The Company addresses this earnings volatility by de-designating derivatives (previously treated as hedge accounting derivatives) that have offsetting economic characteristics to the non-hedge accounting derivatives. Volatility is reduced as a result of de-designation because combining the changes in fair value of de-designated derivatives with those of other non-hedge accounting derivatives results in a natural offset in the Statement of Consolidated Income. The hedged item associated with the derivative previously treated as a hedge accounting derivative ceases to be adjusted for changes in fair value upon de-designation. The Company began de-designating these derivatives in the fourth quarter of fiscal 2004.
The Company employs analytical measures such as duration and Value at Risk to identify which hedge accounting derivatives to de-designate. The Company performs similar analyses when entering into new derivative transactions. To the extent the Company can more closely match the accounting treatment to the underlying economics of the derivatives portfolio by not electing hedge accounting, the transaction is identified and treated as a non-hedge accounting derivative.
- 38 -
The following table summarizes the Company’s derivative assets and liabilities, which are included in other assets and other liabilities in the Consolidated Balance Sheet:
| March 31, |
| 2005 | | 2004 |
|
| |
|
| (Dollars in millions) |
| | | |
Derivative assets | $2,440 | | $2,226 |
Less: Collateral held1 | 982 | | 63 |
|
| |
|
Derivative assets, net of collateral | $1,458 | | $2,163 |
|
| |
|
Derivative liabilities | $23 | | $34 |
1
| Represents cash received under reciprocal collateral arrangements that the Company has entered into with certain derivative counterparties as described in Item 7A., “Quantitative and Qualitative Disclosures About Market Risk.”
|
The following table summarizes the composition of the Company’s derivatives portfolio:
| | Notionals: | | | Fair value of : |
| |
| | |
|
| | Hedge accounting derivatives | | Non-hedge accounting derivatives | | Total notionals | | | Derivative assets | | Derivative liabilities |
| |
| |
| |
| | |
| |
|
| | (Dollars in millions) |
March 31, 2005 | | | | | | | | | | | |
Pay-float swaps1 | | $11,532 | | $14,859 | | $26,391 | | | $2,205 | | ($173) |
Pay-fixed swaps | | - | | 30,611 | | 30,611 | | | 383 | | (10) |
Interest rate caps | | - | | 800 | | 800 | | | 12 | | - |
Counterparty netting | | - | | - | | - | | | (160) | | 160 |
| |
| |
| |
| | |
| |
|
Total | | $11,532 | | $46,270 | | $57,802 | | | $2,440 | | ($23) |
| |
| |
| |
| | |
| |
|
March 31, 2004 | | | | | | | | | | | |
Pay-float swaps1 | | $10,785 | | $14,619 | | $25,404 | | | $2,497 | | ($32) |
Pay-fixed swaps | | - | | 18,932 | | 18,932 | | | 1 | | (279) |
Interest rate caps | | - | | 800 | | 800 | | | 5 | | - |
Counterparty netting | | - | | - | | - | | | (277) | | 277 |
| |
| |
| |
| | |
| |
|
Total | | $10,785 | | $34,351 | | $45,136 | | | $2,226 | | ($34) |
| |
| |
| |
| | |
| |
|
1 Includes cross-currency interest rate swaps and currency basis swaps.
- 39 -
Interest Expense
The following table summarizes the components of interest expense:
| Years ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
| (Dollars in millions) |
| | | | | |
Interest expense on debt | $1,167 | | $1,056 | | $1,107 |
Amortization of basis adjustments on debt | (179) | | (60) | | (20) |
Net interest on hedge accounting derivatives | (177) | | (507) | | (539) |
Amortization of debt issue costs | 43 | | 49 | | 52 |
Ineffectiveness related to hedge accounting derivatives | (15) | | (4) | | (12) |
Other | (12) | | - | | - |
|
| |
| |
|
Interest expense excluding non-hedge accounting results | 827 | | 534 | | 588 |
Net result from non-hedge accounting | (157) | | 44 | | 661 |
|
| |
| |
|
Total interest expense | $670 | | $578 | | $1,249 |
|
| |
| |
|
Interest expense on debt primarily represents the interest due on notes and loans payable and commercial paper. The increase was due primarily to increases in market interest rates on unsecured debt and commercial paper issuances and higher outstanding balances.
The increase in the amortization of basis adjustments on debt is primarily due to the recognitionincrease in Toyota and Lexus vehicle sales in the U.S. The increase in commissions and fees is in line with the increase in the number of amortization relatedagreements issued.
Insurance losses and loss adjustment expenses were $126 million and $115 million during fiscal 2007 and fiscal 2006, respectively. The increase in insurance losses and loss adjustment expenses primarily relate to the fair value adjustmentsincreased claims reported on debt for terminated fair value hedging relationships. As discussed in the “Use of Derivative Instruments” section within this MD&A, the de-designation of the hedge accounting derivative results in the termination of the fair value hedging relationships. As a consequence of these terminations, the fair value adjustmentsvehicle service agreements and guaranteed auto protection insurance products due to the hedged items continue to beincreased number of agreements in force and an increase in loss severity.
Our insurance operations reported
as part$134 million and $44 million of
the basis of the debtinvestment income on marketable securities during fiscal 2007 and
are amortized to interest expense over the life of the debt.Net interest on hedge accounting derivatives represents net interest on pay-float swaps. The decreasefiscal 2006, respectively. This increase was primarily due to an increase in short-term interest rates, primarily 3-month LIBOR.
- 40 -
The following table summarizes the components of the net result from non-hedge accounting, which is includedrealized gains on our investment portfolio. In addition, higher investment balances and investment yields during fiscal 2007 resulted in an increase in interest expense.
| Years ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
| (Dollars in millions) |
| (Gain)/Loss |
| | | | | |
Currency basis swaps unrealized gain | ($85) | | ($46) | | $- |
Foreign currency transaction loss | 83 | | 52 | | - |
Net interest on non-hedge accounting derivatives | (71) | | 172 | | 232 |
Unrealized (gain) loss on non-hedge accounting derivatives | | | | | |
Interest rate swaps | (62) | | (161) | | 308 |
Interest rate caps | (6) | | 32 | | 121 |
Other | (16) | | (5) | | - |
|
| |
| |
|
Net result from non-hedge accounting | ($157) | | $44 | | $661 |
|
| |
| |
|
Currency basis swaps are used in combination with interest rate swaps to convert non-U.S. dollar debt to U.S. dollar denominated payments. The Company has elected hedge accounting for certain interest rate swapsincome on fixed income securities.
INVESTMENT AND OTHER INCOME
Our consolidated investment and
related debt, but has elected not to apply hedge accounting for the currency basis swaps. The increase in the fair value of the currency basis swaps was primarily due to the decrease of the U.S. dollar against certain other
currencies.The foreign currency transaction loss relates to foreign currency denominated debt where hedge accounting has been applied only for interest rate risk. The increase was primarily due to the decrease of the U.S. dollar against certain other currencies.
Net interest on non-hedge accounting derivatives represents net interest on pay-fixed and pay-float swaps and interest rate caps. The favorable change in net interest on non-hedge accounting derivatives was primarily due to higher notional balances resulting from the reclassification of $6,133 million in notional balances of hedge accounting derivatives to non-hedge accounting derivatives. This reclassification resulted from the de-designation of derivatives.
The decrease in the unrealized gain on non-hedge accounting derivativesincome is primarily due to the de-designationcomprised of derivatives beginning in the fourth quarterinvestment income on marketable securities, investment income from securitizations, and other income. We reported $252 million, $116 million, and $139 million of investment and other income during fiscal 2004. Rather than electing hedge accounting treatment foryears 2007, 2006, and 2005, respectively. Of these derivatives, the Company allows the changes in the fair valueamounts, $134 million, $44 million, and $35 million of the non-hedge accounting derivatives to partially offset each other. The unrealized gaininvestment income on non-hedge accounting derivatives was also affectedmarketable securities were reported by the increased market interest rates, particularly the twoour insurance operations during fiscal years 2007, 2006, and three-year swap rates.
2005, respectively. Refer to the “Use of Derivative Instruments”“Insurance Operations” section within this MD&A for further discussion of the Company’s use of derivatives.
- 41 -
regarding investment income on marketable securities. We reported $106 million, $42 million, and
Other IncomeThe following table summarizes the Company’s investment and other income:
| Years Ended March 31, | | % Change |
|
| |
|
| 2005 | | 2004 | | 2003 | | 2005 to 2004 | | 2004 to 2003 |
|
| |
| |
| | |
| (Dollars in millions) | | |
| | |
| |
|
| | | | | |
Income from retained interests | $49 | | $72 | | $55 | | (32%) | | 31% |
Servicing fee income | 25 | | 45 | | 38 | | (44%) | | 18% |
Gains from securitization of finance receivables | - | | 30 | | 106 | | (100%) | | (72%) |
Losses on impairment of retained interests | - | | - | | (21) | | - | | 100% |
|
| |
| |
| | | | |
Investment income from securitizations | 74 | | 147 | | 178 | | (50%) | | (17%) |
| | | | | | | | | |
Investment income from marketable securities | 30 | | 25 | | 25 | | 20% | | - |
Realized gains (losses) on marketable securities | 5 | | 10 | | (21) | | (50%) | | - |
Losses related to Argentine investment | - | | - | | (9) | | - | | 100% |
Other income | 30 | | 14 | | 9 | | 114% | | 56% |
|
| |
| |
| | | | |
Investment and other income | $139 | | $196 | | $182 | | (29%) | | 8% |
|
| |
| |
| | | | |
Investment and$30 million of other income decreasedduring fiscal years 2007, 2006, and 2005, respectively. Other income primarily consists of interest income on cash held in excess of our immediate funding needs, which increased from the prior year primarily due to the absencehigher yields earned during fiscal 2007.
We reported $12 million, $30 million, and $74 million of
gains from securitization of finance receivables and declines ininvestment income from
retained interestssecuritizations during fiscal years 2007, 2006, and
servicing fee income, partially offset by an increase in other income.Income from Retained Interests and Servicing Fee Income
Income from retained interests represents investment income earned on interests retained in securitizations, as discussed2005, respectively. The decline is due to a reduction in the “Off-Balance Sheet Arrangements” section within this MD&A. The decrease in income from retained interests is due toaverage outstanding balance of securitization pools as a result of the amortization of the related retained interests. In addition, the Company did not enter into any new securitization transactions during fiscal 2005.
Servicing fee income relates to the contractual servicing fees that the Company receives for servicing its securitized receivables. Servicing fee income decreases as the balance of securitized receivables decreases. The Company did not enter into any new securitization transactions during fiscal 2005, and the balance of securitized receivables continued to liquidate, resulting in a decrease in servicing fee income.
fewer outstanding transactions. The outstanding balance of securitized retail finance receivables serviced by the Companywe service decreased from $4,264to $164 million at March 31, 2004 to $1,9562007 from $533 million at March 31, 2005.
- 42 -
2006. Gains from Securitization of Finance ReceivablesTAXESThe securitization of receivables generally accelerates the recognition of income on retail contracts, net of servicing fees
Our effective tax rate was 35 percent and
other related deferrals, into the period the assets are sold. Numerous factors can affect the timing and amounts of gain recognition, such as the amount of assets sold, market interest rates at the time of the sale, the structure of the sale, and key economic assumptions used as discussed in the “Critical Accounting Estimates” section within this MD&A. Gains from securitization decreased as the Company did not enter into a securitization transaction during 2005 as compared with one securitization transaction totaling approximately $1,884 million37 percent during fiscal
2004.Investment Income from2007 and Realized Gains (Losses) on Marketable Securities
fiscal 2006, respectively. The Company realized lower gains on marketable securities, primarilydecrease in income taxes during fiscal 2007 compared to fiscal 2006 was due to lower net realized gains on debt and equity investments. Realized losses incurreda one time favorable adjustment related to a change in Texas franchise tax law (Texas margin tax (H.B. No. 3)) recorded in fiscal 2005 include $4 million in impairment losses.
Other Income
The increase in other2007 and a federal income represents interest income of $33 million on a tax refund received during fiscal 2005benefit related to the conclusionHybrid vehicle credit. The hybrid tax credit is based on lease volume and amount of the Internal Revenue Service examinationcredit, both of fiscal 1992 through fiscal 1996 tax years, partially offset by net interest expense unrelatedwhich vary from quarter to the Company’s debt portfolio.
quarter.
OperatingOPERATING AND ADMINISTRATIVE EXPENSES
The following table summarizes our operating and
Administrative Expenses | Years Ended March 31, | | % Change |
|
| |
|
| 2005 | | 2004 | | 2003 | | 2005 to 2004 | | 2004 to 2003 |
|
| |
| |
| | |
| (Dollars in millions) | | |
| | |
| |
|
Employee expenses | $286 | | $246 | | $240 | | 16% | | 3% |
Operating expenses | 321 | | 303 | | 270 | | 6% | | 12% |
Insurance dealer incentive expenses | 43 | | 34 | | 27 | | 26% | | 26% |
|
| |
| |
| | | | |
Total operating and administrative expenses | $650 | | $583 | | $537 | | 11% | | 9% |
|
| |
| |
| | | | |
administrative expenses (dollars in millions):
| | Years Ended March 31, | | % Change |
| | 2007 | | 2006 | | 2005 | | 2007 to 2006 | | 2006 to 2005 |
| Employee expenses | $320 | | $304 | | $286 | | 5% | | 6% |
| Operating expenses | 351 | | 340 | | 321 | | 3% | | 6% |
| Insurance dealer back-end program expenses | 87 | | 68 | | 43 | | 28% | | 58% |
| Total operating and administrative expenses | $758 | | $712 | | $650 | | 6% | | 10% |
The increase in operating and administrative expenses
during fiscal 2007 compared to fiscal 2006 was primarily due to an increase in
insurance dealer back-end program expenses,
related to new technology development and additional employee expenses incurred to support overall business
growth. The Company expects operatinggrowth, and
administrative costsexpenses related to
continue to increase as a result of costs incurred under itsnew technology
initiative and general business growth; however, expenses as a percentage of average earning assets are expected to be consistent with fiscal 2005.development. Included in operating and administrative expenses are charges allocated by TMS for certain technological and administrative services provided to TMCC. Refer to Note
1516 – Related Party Transactions of the Notes to Consolidated Financial Statements for further details.
During fiscal 2004 the Company launched a multi-year initiative to replace its major legacy transaction systems. The purpose of the initiative is to implement simplified, streamlined technology solutions to improve service delivery to its customers, enhance the quality and speed of information management, and support continued profitable growth. This technology initiative includes the replacement of the Company’s insurance claims processing module, wholesale transaction system, contract acquisition technology system, retail and lease transaction systems, and commercial finance transaction system, as well as the migration of the Company’s data center to a new facility. The Company completed the replacement of its insurance claims processing module and wholesale transaction system during fiscal 2005. Additional enhancements to these systems are expected to continue in the next fiscal year.
- 43 -
The replacement of the Company’s contract acquisition technology system, its retail and lease transaction systems and its commercial finance transaction system, and the execution of the Company’s data center migration to a new facility are ongoing. The Company has dedicated key resources to the management and execution of these technology projects and expects to incur significant costs related to its technology initiative over the next several fiscal years. Notwithstanding the current level of resources and expenditures the Company has dedicated and plans to dedicate to this initiative, systems implementations of this magnitude typically require additional resource allocation to ensure successful transition and completion. The Company believes it has properly aligned its resources internally and is in a strategic position to address such issues. However, as discussed in Item 1., “Business – Risk Factors – Operational Risk”, the replacement of major legacy transaction systems and the migration of the Company’s data center could increase the Company’s exposure to risk of loss through disruption of normal operating processes and procedures.
Insurance dealer
incentiveback-end program expenses are
based onprimarily driven by insurance volume and underwriting performance. The increase was primarily due to an increase in the number of
enrolledparticipating dealers, higher sales volume and agreements in force, and improved dealer underwriting performance. Refer to the
“Results of Operations – Selected Insurance Results”“Insurance Operations” section of
within this MD&A for further discussion regarding
the Company’sour insurance results.
Fiscal 2004 Compared
We continue our progress on our multi-year initiative to
Fiscal 2003Net earning assets increased primarily due to higher levels of both retail finance receivables and dealer financing, partially offset by a decrease in lease earning assets.replace our major legacy transaction systems (“technology initiative”). The increase in retail finance receivables primarily resulted from the growth in the number of new vehicles financed under the Company’s retail financing programs. This growth was generated in large part by an increased availability of TMS subvention and higher Toyota and Lexus vehicle sales levels. The increase in dealer financing was primarily due to increases in the number of vehicle dealers receiving vehicle wholesale financing and the corresponding increase in the amount of dealer inventory financed by the Company. Total lease earning assets decreased primarily due to the continued emphasis on retail financing programs.
Total contract volume increased due to the combined effects of higher Toyota and Lexus vehicle sales, incremental volume from the increased number of wholesale dealers serviced by TMCC, and continued availability of TMS subvention. Used vehicle retail contract volume increased when compared with the prior year primarily due to increased TMS retail subvention programs for certain used Toyota and Lexus vehicle contracts. In contrast, total vehicle lease contract volume decreased due to the continued emphasis on retail financing programs.
Total financing revenues increased slightly due to retail financing and dealer financing revenue increases, partially offset by a decline in leasing revenues. Leasing revenues declined due to reductions in vehicle lease earning assets. Retail financing revenues increased as a resultpurpose of the continued growth in vehicle retail finance receivables, partially offset by reductions in retail financing portfolio yield. Dealer financing revenues increased duetechnology initiative is to increases inimplement simplified, streamlined technology solutions that improve service delivery to our customers, enhance the related receivables, partially offset by a reduction in dealer financing portfolio yield.
Higher total depreciation expensequality and speed of information management, and support our future business. Our management believes we have properly aligned our resources internally for the technology initiative. Refer to Item 1A., “Risk Factors” for discussion on how the replacement of major legacy transaction systems could increase our exposure to risk of loss through disruption of normal operating leases resulted from an overall increase in the average depreciable basis, partially offset by lower adjustments to depreciation expense recorded to bring contractual residual values in line with projected market values.
Reductions in the provision for credit lossesprocesses and total charge-offs, net of recoveries, as well as in the allowance for credit losses as a percentage of gross earning assets, reflect decreases in both frequency of occurrence and loss severity. This improvement in both the frequency and severity of credit losses resulted, in large part, from several operational initiatives implemented during fiscal 2004 discussed in the “Results of Operations – Credit Risk” section within this MD&A, and from a strengthening of the used vehicle market.
- 44 -
The decrease in interest expense on debt was due primarily to decreases in market interest rates on unsecured debt and commercial paper issuances. The amortization of basis adjustments on debt increased due to the de-designation of derivatives, which the Company initiated during the fourth quarter of fiscal 2004. No such amortization related to de-designation was recognized in fiscal 2003. Net result from non-hedge accounting improved primarily due to the impact of increased market interest rates, particularly the two and three-year swap rates, on the Company’s non-hedge accounting derivatives.
Investment and other income increased primarily due to the positive impact of realized gains on marketable securities and the absence of losses on impairment of retained interests and on the investment in Toyota Credit Argentina S.A., partially offset by lower gains from securitizations of finance receivables.
The increase in operating and administrative expenses reflects increases in personnel expenses related to increased headcount and training activities, expenses related to technology services provided by TMS, expenses related to new technology development, losses on disposal of assets in connection with the Company’s move to the new headquarters location, and additional costs incurred to support growth in the Company’s business.
Insurance premiums earned and contract revenues from insurance operations increased primarily due to increased contract volume and increases in total agreements in force. Insurance losses and loss adjustment expenses increased primarily due to an increased number of agreements in force.
- 45 -
procedures.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity risk is the risk arising from the inability to meet obligations when they come due.
The Company’sOur liquidity strategy is to maintain the capacity to fund assets and repay liabilities in a timely and cost-effective manner
undereven in the event of adverse market conditions. This capacity primarily arises from
the Company’sour ability to raise funds in the global capital markets as well as
itsour ability to generate liquidity from
itsour balance sheet. This strategy has led
the Companyus to develop a borrowing base that is diversified by market and geographic distribution,
and type of security,
and investor type, among other factors, as well as
programs to prepare assets for sale and securitization.a securitization program. Credit support provided by
the Company’sour parent provides an additional source of liquidity to
the Company,us, although it is not relied upon
by the Company in
itsour liquidity planning and capital and risk management.
The following table summarizes the outstanding components of
the Company’sour funding
sources: | March 31, | |
| 2005 | | 2004 |
|
| |
|
| (Dollars in millions) |
| | | |
Commercial paper | $10,397 | | $8,094 |
Unsecured term debt1 | 31,360 | | 28,534 |
On-balance sheet securitization | - | | 226 |
|
| |
|
Total debt | 41,757 | | 36,854 |
Off-balance sheet securitization | 1,867 | | 4,121 |
|
| |
|
Total funding | $43,624 | | $40,975 |
|
| |
|
| | | | |
| | March 31, |
| | 2007 | | 2006 |
| Commercial paper | $14,954 | | $12,162 |
Unsecured term debt1 | 43,575 | | 36,546 |
| Total debt | 58,529 | | 48,708 |
| Off-balance sheet securitization | 156 | | 508 |
| Total funding | $58,685 | | $49,216 |
1
| 1Includes fair marketcarrying value changesadjustments of $1.1 billion and foreign currency transaction adjustments on debt in hedge accounting and non-hedge accounting relationships of $1,981 million and $1,915$457 million at March 31, 20052007 and 2004,2006, respectively, as described in |
| Note 910 - Debt of the Notes to Consolidated Financial Statements. |
The Company does
We do not rely on any single source of funding and may choose to realign
itsour funding activities depending upon market conditions, relative costs, and other factors.
The Company believesWe believe that
itsour funding sources, combined with operating and investing activities,
will provide sufficient liquidity to meet future funding
requirements and business
growth. Our funding volume is based on asset growth
requirements.and debt maturities.
For liquidity purposes,
the Company holdswe hold cash in excess of
itsour immediate funding needs. These excess funds are invested in short-term highly liquid and investment grade money market
instruments. The Companyinstruments, which provide liquidity for our short-term funding needs and flexibility in the use of our other funding sources. We maintained excess funds ranging from
$194$321 million to
$2,394 million$3.2 billion during fiscal
2005,2007, with an average balance of
$991 million.$1.4 billion.
Short-term funding needs are met through the issuance of commercial paper in the
U.S.United States. Commercial paper outstanding under
the Company'sour commercial paper programs ranged from approximately
$8,027 million$10.5 billion to
$13,941 million$17.8 billion during fiscal
2005,2007, with an average outstanding balance of
$10,032 million. The Company’s$14.1 billion. Our commercial paper programs are supported by the liquidity facilities discussed later in this section. As
ana commercial paper issuer rated A-1+ by Standard & Poor’s Ratings Group, a division of The McGraw-Hill Companies, Inc. (“S&P”) and P-1 by Moody’s Investors Service, Inc. (“Moody’s”),
the Company believeswe believe there is ample capacity to meet
itsour short-term
funding requirements.
- 46 -
Term funding requirements are met through the issuance of a variety of debt securities
issued in both the
U.S.United States and international capital markets. To diversify
itsour funding sources,
the Company haswe have issued in a variety of markets, currencies, and maturities,
and to a variety of investors, which allows
itus to broaden
itsour distribution of securities and further enhance liquidity.
The following table summarizes
theour components of
the Company’s unsecured term debt at par
value: | U.S. dollar medium term notes ("MTNs") and domestic bonds | | Euro MTNs ("EMTNs") | | Eurobonds | | Total unsecured term debt |
|
| |
| |
| |
|
| (Dollars in millions) |
| | | | | | | |
Balance at March 31, 20041 | $10,188 | | $13,751 | | $2,428 | | $26,367 |
Issuances during fiscal 2005 | 6,069 | | 2,818 | | 391 | | 9,278 |
Payments during fiscal 2005 | (4,284) | | (2,028) | | - | | (6,312) |
|
| |
| |
| |
|
Balance at March 31, 20051 | $11,973 | | $14,541 | | $2,819 | | $29,333 |
|
| |
| |
| |
|
1
| value (dollars in millions):
| | U.S. medium term notes ("MTNs") and domestic bonds | | Euro MTNs ("EMTNs") | | Eurobonds | | Total unsecured term debt4 | Balance at March 31, 20061 | $16,683 | | $16,069 | | $3,344 | | $36,096 | | Issuances during fiscal 2007 | 8,7562 | | 7,0453 | | 8083 | | 16,609 | | Payments during fiscal 2007 | (7,269) | | (2,613) | | - | | (9,882) | Balance at March 31, 20071 | $18,170 | | $20,501 | | $4,152 | | $42,823 | | | | | | | | | | | Issuances during the one month ended April 30, 2007 | $1,9832 | | $5273 | | - | | $2,510 |
1 Amounts represent par values and as such exclude unamortized premium/discount, foreign currency transaction gains and losses on debt denominated in foreign currencies, fair value adjustments to debt in hedge accounting relationships, and as such exclude basis adjustments, unamortized premium/discount, and foreign currency transaction adjustment. |
During fiscal 2005, the Company issuedunamortized fair value adjustments on the equivalenthedged item for terminated hedge accounting relationships. Par values
of approximately U.S. $2,818 million fixednon-U.S. currency denominated notes are determined using foreign exchange rates applicable as of the issuance dates.
2 MTNs and floating rate notes under the EMTN program. These notes were issued in U.S. dollars, euros, British pounds sterling, and Australian dollars,domestic bonds had terms to maturity ranging from approximately two1 year to 30 years, and had interest rates
at the time of issuance ranging from 0 percent to 8.5 percent.
3 EMTNs were issued in U.S. and non-U.S. currencies, had terms to maturity ranging from approximately ten1 year to 40 years,
and had interest rates at the time of issuance ranging from 1.0 percent to 15.3 percent. Eurobonds were issued in Swiss Francs,
had terms to maturity ranging from approximately 7 to 10 years, and had interest rates at the time of issuance ranging from 2.05%
2.8 percent to
5.41%.All unsecured term2.9 percent. Concurrent with the issuance of non-U.S. currency denominated notes, we entered into cross
currency interest rate swap agreements to convert payments of principal and interest on these notes to U.S. dollars.
4 Consists of fixed and floating rate debt. Upon the issuance of fixed rate debt, was issued with original maturities ranging from greater than one yearwe generally elect to approximately thirty years. The remaining maturitiesenter into pay-float
interest rate swaps. Refer to the “Derivative Instruments” section of
all unsecured term debt outstanding at March 31, 2005 ranged from less than one year to approximately thirty years.The Company maintainsthis MD&A for further discussion.
We maintain a
$15,021 million shelf registration with the Securities and Exchange Commission (“SEC”) to provide for the issuance of debt securities in the U.S. capital markets
to both retail and institutional investors. We qualify as a well-known seasoned issuer under
which approximately $8,573 million was available for issuance at April 30, 2005. UnderSEC rules, and as a result, we may issue under our registration statement an unlimited amount of debt securities during the
Company’sthree year period ending March 2009. Our EMTN program
which provides for the issuance of debt securities in the international capital
markets,markets. In September 2006, the EMTN program was renewed for a one year period, and the maximum aggregate principal amount authorized to be outstanding at any time
is $20,000 millionwas increased from $20 billion to $30 billion, or the equivalent in other currencies, of which
approximately $5,541 million$7.1 billion was available for issuance at April 30,
2005. The U.S. dollar and2007. Our EMTN
programsprogram may be expanded from time to time to allow for the continued use of
these sourcesthis source of funding. In addition,
the Companywe may issue bonds in the international capital markets that are not issued under
itsour U.S.
dollar and EMTN programs.
- 47 -
Debt securities issued under the U.S. shelf registration statement are issued pursuant to the terms of an indenture, and EMTNs are issued pursuant to the terms of an agency agreement, both of which contain customary terms and conditions, including negative pledge and cross-default provisions.
SecuritizationLiquidity Facilities and Letters of Credit
For additional liquidity purposes, we maintain syndicated bank credit facilities with certain banks. During fiscal 2007, TMCC and TCPR entered into two new committed syndicated bank credit facilities.
364 Day Credit Agreement
In March 2007, TMCC, TCPR, and other Toyota affiliates entered into a $4.0 billion 364 day syndicated bank credit facility pursuant to a 364 Day Credit Agreement. The Company’sability to make draws is subject to covenants and conditions customary in a transaction of this nature, including negative pledge and cross default provisions. The 364 Day Credit Agreement may be used for general corporate purposes and was not drawn upon as of March 31, 2007.
Participation in this facility replaces the $2.9 billion 364 day syndicated bank credit facility which was in place at March 31, 2006.
Five Year Credit Agreement
In March 2007, TMCC, TCPR, and other Toyota affiliates entered into an $8.0 billion five year syndicated bank credit facility pursuant to a Five Year Credit Agreement. The ability to make draws is subject to covenants and conditions customary in a transaction of this nature, including negative pledge and cross default provisions. The Five Year Credit Agreement may be used for general corporate purposes and was not drawn upon as of March 31, 2007.
Participation in this facility replaces the $5.8 billion five year syndicated bank credit facility which was in place at March 31, 2006.
Letters of Credit Facilities Agreement
In addition, TMCC has uncommitted letters of credit facilities totaling $55 million at March 31, 2007 and 2006. Of the total credit facilities, $2 million of the uncommitted letters of credit facilities were used at March 31, 2007 and 2006.
Securitization
Our securitization program represents an additional source of
liquidity, as the Company currently owns $28,779 millionliquidity. As of March 31, 2007, we owned approximately $38.3 billion in potentially securitizable retail finance receivables.
The Company currently maintains a shelfWe maintain an effective registration
statement that complies with
Regulation AB, the
SEC relatingSEC’s rule governing the offering of asset backed securities, and can be used to
the issuance ofissue asset backed securities secured by
our retail finance
receivables.contracts. During fiscal
2005, the Company2007, we did not execute any securitization transactions.
As of April 30, 2005, approximately $6,169 million remained available for issuance under the registration statement. In December 2004, the SEC adopted Regulation AB relating to offerings and the on-going reporting of asset-backed securities. The Company intends to comply with the new rules to ensure future ability to utilize securitization as a source of liquidity. Refer to the “Off-Balance Sheet Arrangements” section of this MD&A for further discussion about
the Company’sour securitization program.
Liquidity Facilities and Letters of CreditFor additional liquidity purposes, the Company maintains syndicated bank credit facilities with certain banks. During fiscal 2005, the Company renewed and decreased its 364-day syndicated bank credit facilities from $4,000 million to $2,900 million and renewed and increased its 5-year syndicated bank credit facilities from $1,400 million to $4,200 million.
The following table summarizes the Company’s credit facilities:
| TMCC | | TCPR | | Total |
|
| |
| |
|
| March 31, |
|
|
| 2005 | | 2004 | | 2005 | | 2004 | | 2005 | | 2004 |
|
| |
| |
| |
| |
| |
|
| (Dollars in millions) |
364-day syndicated bank credit facilities – committed | $2,767 | | $3,600 | | $133 | | $400 | | $2,900 | | $4,000 |
5-year syndicated bank credit facility – committed | 3,933 | | 1,400 | | 267 | | - | | 4,200 | | 1,400 |
Letters of credit facilities – uncommitted | 55 | | 55 | | - | | - | | 55 | | 55 |
|
| |
| |
| |
| |
| |
|
Total credit facilities | $6,755 | | $5,055 | | $400 | | $400 | | $7,155 | | $5,455 |
|
| |
| |
| |
| |
| |
|
Of the total credit facilities, $2 million of the uncommitted letters of credit facilities was used at March 31, 2005 and 2004. No amounts were drawn on the committed facilities at March 31, 2005 and 2004.
The syndicated bank credit facilities do not contain any material adverse change clauses or restrictive financial covenants that would limit the ability of the Company or Toyota Credit de Puerto Rico Corp. (“TCPR”) to borrow under their respective facilities.
- 48 -
Credit Support Agreements
Under the terms of a credit support agreement between TMC and TFSC (“TMC Credit Support Agreement”), TMC agreed to: 1) maintain
100%100 percent ownership of TFSC; 2) cause TFSC and its subsidiaries to have a net worth of at least ¥10 million, equivalent to
$93,327$84,868 at March 31,
2005;2007; and 3) make sufficient funds available to TFSC so that TFSC will be able to (i) service the obligations arising out of its own bonds, debentures, notes and other investment securities and commercial paper and (ii) honor its obligations incurred as a result of guarantees or credit support agreements that it has extended. The agreement is not a guarantee by TMC of any securities or obligations of TFSC.
Under the terms of a similar credit support agreement between TFSC and TMCC (“TFSC Credit Support Agreement”), TFSC agreed to: 1) maintain
100%100 percent ownership of TMCC; 2) cause TMCC and its subsidiaries to have a net worth of at least $100,000; and 3) make sufficient funds available to TMCC so that TMCC will be able to service the obligations arising out of its own bonds, debentures, notes and other investment securities and commercial paper (collectively, “TMCC Securities”). The agreement is not a guarantee by TFSC of any TMCC Securities or other obligations of TMCC. The TMC Credit Support Agreement and the TFSC Credit Support Agreement are governed by, and construed in accordance with, the laws of Japan. TMCC Securities do not include the securities issued by securitization trusts in connection with TMCC’s securitization programs.
Holders of TMCC Securities have the right to claim directly against TFSC and TMC to perform their respective obligations under the Credit Support Agreements by making a written claim together with a declaration to the effect that the holder will have recourse to the rights given under the Credit Support Agreement. If TFSC and/or TMC receives such a claim from any holder of TMCC Securities, TFSC and/or TMC shall indemnify, without any further action or formality, the holder against any loss or damage resulting from the failure of TFSC and/or TMC to perform any of their respective obligations under the Credit Support Agreements. The holder of TMCC Securities who made the claim may then enforce the indemnity directly against TFSC and/or TMC.
In connection with the TFSC Credit Support Agreement, TMCC and TFSC are parties to a credit support fee agreement (“Credit Support Fee Agreement”). The Credit Support Fee Agreement requires TMCC to pay to TFSC a semi-annual fee equal to
0.05%0.06 percent per annum of the weighted average outstanding amount of TMCC Securities entitled to credit support.
TCPR is the beneficiary of a credit support agreement with TFSC containing the same provisions as the TFSC Credit Support Agreement described above but pertaining to TCPR and TCPR bonds, debentures, notes and other investment securities and commercial paper (collectively,
"TCPR Securities"“TCPR Securities”). Holders of TCPR Securities have the right to claim directly against TFSC and TMC to perform their respective obligations as described above. This agreement is not a guarantee by TFSC of any securities or other obligations of TCPR. TCPR has agreed to pay TFSC a semi-annual fee equal to
0.05%0.06 percent per annum of the weighted average outstanding amount of TCPR Securities entitled to credit support.
In June 2005, the semi-annual fee TMCC and TCPR are required to pay to TFSC increased from 0.05% to 0.06% per annum of the weighted average outstanding amounts entitled to credit support of TMCC Securities and TCPR Securities, respectively.
TMC files periodic reports and other information with the SEC, which can be read and copied at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. Copies of such material may also be obtained at prescribed rates by mail at the same address. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. TMC’s filings may also be found at http://www.toyota.com under
“About Toyota” under “Shareholder Information”
under “About Toyota”.
- 49 -
As of April 30,
2005,2007, the ratings and outlook established by Moody’s and S&P for TMCC were as follows:
| NRSRO | | Senior Debt | | Commercial Paper | | Outlook |
|
S&P | |
AAA | |
A-1+ | |
Stable |
| Moody’s | | Aaa | | P-1 | | |
| S&P
| | AAA
| | A-1+
| | Stable |
| Moody’s
| | Aaa
| | P-1
| | Stable
|
The cost and availability of unsecured financing is influenced by credit ratings, which are intended to be an indicator of the creditworthiness of a particular company, security or obligation. Lower ratings generally result in higher borrowing costs as well as reduced access to capital markets. Credit ratings are not recommendations to buy, sell, or hold securities and are subject to revision or withdrawal at any time by the assigning nationally recognized statistical rating organization (“NRSRO”). Each NRSRO may have different criteria for evaluating risk, and therefore ratings should be evaluated independently for each NRSRO.
Our credit ratings depend in part on the existence of the credit support agreements of TFSC and TMC. See “Item 1A. Risk Factors - 50 -
Credit Support”.
Derivative Instruments
Business Use of Derivative Instruments
Our assets consist primarily of U.S. dollar denominated fixed rate receivables. Our liabilities consist primarily of fixed and floating rate debt which is issued in the global capital markets. In order to maintain a conservative liquidity profile, the life of our debt is typically longer than that of our assets. Upon the issuance of fixed rate debt, we generally elect to enter into pay-float interest rate swaps. The terms of pay-float swap agreements correspond to the terms of the debt. The interest rate risk arising from the mismatch in the re-pricing of assets relative to liabilities is managed via pay-fixed swaps and purchased interest rate caps which are executed on a portfolio basis. Our pay-fixed swap agreements are primarily two to three years in tenor from origination. The currency exposure related to non-U.S. dollar denominated debt is economically hedged at issuance, using cross currency interest rate swaps, currency basis swaps, or a combination of interest rate swaps coupled with currency basis swaps to convert non-U.S. dollar denominated debt to U.S. dollar denominated payments.
We enter into derivative instruments for risk management purposes. Our use of derivatives is limited to the management of interest rate and foreign exchange risks.
Accounting for Derivative Instruments
All derivative instruments are recorded on the balance sheet at fair value, taking into consideration the effects of legally enforceable master netting agreements that allow us to net settle positive and negative positions and offset cash collateral held with the same counterparty on a net basis. Changes in the fair value of the derivatives are recorded in interest expense in the Consolidated Statement of Income.
We categorize derivatives as those designated for hedge accounting (“hedge accounting derivatives”) and those that are not designated for hedge accounting (“non-hedge accounting derivatives”). We elect at inception whether to designate a derivative as a hedge accounting derivative. That designation may change based on management’s intentions and changing circumstances. Hedge accounting derivatives are comprised of pay-float interest rate swaps and cross currency interest rate swaps. Non-hedge accounting derivatives are comprised of pay-fixed interest rate swaps, de-designated pay-float interest rate swaps, pay-float interest rate swaps for which hedge accounting has not been elected, interest rate caps, and currency basis swaps. De-designation of hedge accounting derivatives is further discussed below.
In order to qualify for hedge accounting, a derivative must be considered highly effective at reducing the risk associated with the exposure being hedged. When we designate a derivative in a hedging relationship, we document the risk management objective and strategy. This documentation includes the identification of the hedging instrument, the hedged item and the risk exposure, and how we will assess effectiveness prospectively and retrospectively. We assess the extent to which a hedging instrument is effective at achieving offsetting changes in fair value at least quarterly. We recognize changes in the fair value of derivatives designated in fair value hedging relationships (including foreign currency fair value hedging relationships) in interest expense in the Consolidated Statement of Income along with the fair value changes of the hedged item attributable to the hedged risk. For certain types of existing hedge relationships that meet stringent criteria, we apply the shortcut method, which provides an assumption of zero ineffectiveness that results in equal and offsetting changes in fair value in the Consolidated Statement of Income for both the hedged debt and the hedge accounting derivative.
When the shortcut method is not applied, any ineffective portion of the derivative that is designated as a fair value hedge is recognized as a component of interest expense in the Consolidated Statement of Income. If we elect not to designate a derivative instrument in a hedging relationship, or the relationship does not qualify for hedge accounting treatment, the full change in the fair value of the derivative instrument is recognized as a component of interest expense in the Consolidated Statement of Income with no offsetting adjustment for the economically hedged item.
We review the effectiveness of our hedging relationships quarterly to determine whether the relationships have been and continue to be effective. We use regression analysis to assess the effectiveness of our hedges. When we determine that a hedging relationship is not or has not been effective, hedge accounting is no longer applied. If hedge accounting is discontinued, we continue to carry the derivative instrument as a component of other assets or other liabilities in the Consolidated Balance Sheet at its fair value with changes in fair value reported as interest expense in the Consolidated Statement of Income. Additionally, for discontinued fair value hedges, we cease to adjust the hedged item for changes in fair value and amortize the cumulative fair value adjustments recognized in prior periods over the remaining term of the debt.
We will also discontinue the use of hedge accounting if a derivative is sold, terminated, or exercised, or if management determines that designating a derivative under hedge accounting is no longer appropriate (“de-designated derivatives”). De-designated derivatives are included within the category of non-hedge accounting derivatives.
We also issue debt whose coupons or repayment terms are linked to the performance of equity securities, commodities, or currencies. The contingent payment components of these obligations may meet the definition in SFAS No. 133 of an “embedded derivative.” These debt instruments are assessed to determine if the embedded derivative requires separate reporting and accounting, and if so, the embedded derivative may be recorded on the balance sheet at fair value or the entire financial instrument may be recorded at fair value under SFAS No. 155. Changes in the fair value of the embedded derivative and associated non-hedge accounting derivative are reported in interest expense in the Consolidated Statement of Income. Separating an embedded derivative from its host contract requires careful analysis, judgment, and an understanding of the terms and conditions of the instrument.
One of our goals is to manage the interest rate risk arising from the differences in timing between the re-pricing of assets relative to liabilities. We use non-hedge accounting derivatives, specifically pay-fixed interest rate swaps and interest rate caps, to manage this exposure. The use of these non-hedge accounting derivatives to mitigate interest rate risk has historically resulted in significant volatility in the net result from non-hedge accounting. This volatility arises from the accounting treatment of these non-hedge accounting derivatives, which requires that changes in their fair value be reflected in the Consolidated Statement of Income. We address this volatility by de-designating certain pay-float interest rate swaps (previously treated as hedge accounting derivatives) that have offsetting economic characteristics to the non-hedge accounting derivatives or by electing not to designate certain pay-float interest rate swaps in a hedging transaction. We employ analytical measures such as duration and Value at Risk to identify whether to de-designate a hedge accounting derivative or to not elect hedge accounting.
De-designating hedge accounting derivatives or not electing hedge accounting typically reduces volatility in the net result from non-hedge accounting because the combined changes in the fair value of these derivatives with those of other non-hedge accounting derivatives result in a natural offset in the Statement of Consolidated Income. The hedged item associated with the derivative previously treated as a hedge accounting derivative ceases to be adjusted for changes in fair value upon de-designation. To the extent we can more closely match the accounting treatment to the underlying economics of the derivatives portfolio by de-designating or by not electing hedge accounting, the transaction is identified and treated as a non-hedge accounting derivative and volatility is typically reduced. There may be interest rate scenarios where volatility may increase as a result of discontinuing hedge accounting. However, we consider the likelihood of such scenarios occurring to be remote.
Our management’s expectation is that the combination of the changes in fair values of de-designated derivatives with those of non-hedge accounting derivatives will continue to reduce volatility on a quarterly basis. Our management does not engage in de-designation with a view as to the favorable or unfavorable impact on the results of operations. De-designation has resulted in lower losses in the net result from non-hedge accounting in certain quarters and in lower gains in the net result from non-hedge accounting in other quarters. These decreases represent reductions in volatility in the net result from non-
hedge accounting. We estimate that the impact of de-designation on the results of operations was a reduction in the volatility in net result from non-hedge accounting of approximately $25 million and $2 million for the quarters ended March 31, 2007 and March 31, 2006, respectively. Our management evaluates the reduction of volatility on a quarterly basis only, and does not aggregate or net these quarterly reductions for the twelve month period.
Derivative Assets and Liabilities
The following table summarizes our derivative assets and liabilities, which are included in other assets and other liabilities in the Consolidated Balance Sheet (dollars in millions):
| | March 31, |
| | 2007 | | 2006 |
| Derivative assets | $1,520 | | $1,152 |
Less: Collateral held1 | 291 | | 251 |
| Derivative assets, net of collateral | $1,229 | | $901 |
| | | | |
| Derivative liabilities | $97 | | $230 |
| 1 Represents cash received under reciprocal collateral arrangements that we have entered into with certain derivative |
| counterparties as described in Item 7A., “Quantitative and Qualitative Disclosures About Market Risk”. |
The following table summarizes the composition of our derivatives portfolio (dollars in millions):
| | | Notionals: | | | Fair value of : |
| | | Hedge accounting derivatives | | Non-hedge accounting derivatives | | Total notionals | | | Derivative assets | | Derivative liabilities |
| March 31, 2007 | | | | | | | | | | | |
Pay-float swaps1 | | $21,036 | | $14,537 | | $35,573 | | | $1,408 | | ($112) |
| Pay-fixed swaps | | - | | 42,126 | | 42,126 | | | 121 | | - |
| Interest rate caps | | - | | 945 | | 945 | | | 6 | | - |
| Counterparty netting | | - | | - | | - | | | (15) | | 15 |
| Total | | $21,036 | | $57,608 | | $78,644 | | | $1,520 | | ($97) |
| | | | | | | | | | | | |
| March 31, 2006 | | | | | | | | | | | |
Pay-float swaps1 | | $14,486 | | $14,264 | | $28,750 | | | $967 | | ($611) |
| Pay-fixed swaps | | - | | 41,575 | | 41,575 | | | 561 | | - |
| Interest rate caps | | - | | 550 | | 550 | | | 5 | | - |
| Counterparty netting | | - | | - | | - | | | (381) | | 381 |
| Total | | $14,486 | | $56,389 | | $70,875 | | | $1,152 | | ($230) |
1 Includes cross-currency interest rate swaps and currency basis swaps.
Interest Expense
The following table summarizes the components of interest expense (dollars in millions):
| | Years ended March 31, |
| | 2007 | | 2006 | | 2005 |
| Interest expense on debt | $2,564 | | $1,792 | | $1,167 |
| Amortization of basis adjustments on debt | (72) | | (128) | | (179) |
| Net interest realized on hedge accounting derivatives | 206 | | (7) | | (177) |
| Amortization of debt issue costs | 57 | | 43 | | 43 |
| Ineffectiveness related to hedge accounting derivatives | 15 | | 4 | | (15) |
| Other | - | | - | | (12) |
| Interest expense excluding non-hedge accounting results | 2,770 | | 1,704 | | 827 |
| Net result from non-hedge accounting | (104) | | (202) | | (157) |
| Total interest expense | $2,666 | | $1,502 | | $670 |
Fiscal 2007 versus Fiscal 2006
Interest expense on debt primarily represents the interest due on notes and loans payable and commercial paper. The increase was primarily due to increases in market interest rates on unsecured debt and commercial paper issuances and higher outstanding balances.
The amortization of basis adjustments on debt is primarily comprised of amortization related to the fair value adjustments on debt for terminated fair value hedging relationships. As discussed in the “Derivative Instruments” section of this MD&A, the de-designation of the hedge accounting derivatives results in the termination of fair value hedging relationships. As a consequence of these terminations, the fair value adjustments to the hedged items continue to be reported as part of the basis of the debt and are amortized to interest expense over the life of the debt. The decrease in amortization for fiscal 2007 as compared to the prior year was due to maturities during fiscal 2006 of debt associated with previously terminated fair value hedging relationships.
Net interest realized on hedge accounting derivatives represents net interest on pay-float swaps for which hedge accounting has been elected. The change for fiscal 2007 when compared with the prior year was due to the rise in short-term interest rates, primarily three-month LIBOR, and higher outstanding debt balances.
The following table summarizes the components of the net result from non-hedge accounting, which is included in interest expense (dollars in millions):
| | Years ended March 31, |
| | 2007 | | 2006 | | 2005 |
| Currency basis swaps unrealized (gain)/loss | ($127) | | $114 | | ($85) |
| Foreign currency transaction loss/(gain) | 127 | | (115) | | 83 |
| Net interest realized on non-hedge accounting derivatives | (344) | | (260) | | (71) |
| Unrealized loss/(gain) on non-hedge accounting derivatives | | | | | |
| Interest rate swaps | 242 | | 51 | | (62) |
| Interest rate caps | (2) | | 7 | | (6) |
| Other | - | | 1 | | (16) |
| Net result from non-hedge accounting | ($104) | | ($202) | | ($157) |
Fiscal 2007 versus Fiscal 2006
Currency basis swaps are used in combination with interest rate swaps to convert non-U.S. dollar denominated debt to U.S. dollar denominated payments. We have elected hedge accounting for the interest rate swaps and debt, but have elected not to apply hedge accounting for the currency basis swaps. The gain in the fair value of the currency basis swaps was primarily due to the weakening of the U.S. dollar relative to certain other currencies.
The foreign currency transaction gain or loss relates to foreign currency denominated debt where hedge accounting has been applied only for interest rate risk. The loss recognized was primarily due to the weakening of the U.S. dollar relative to certain other currencies. Foreign currency transaction gain or loss offset the unrealized gain or loss on the currency basis swaps discussed above.
Net interest realized on non-hedge accounting derivatives represents interest received on pay-fixed swaps offset by interest paid on non-hedge accounting pay-float swaps. The change for fiscal 2007 when compared with the prior year was primarily due to the impact of the rise in the three-month LIBOR, resulting in higher interest payments received on pay-fixed swaps, partially offset by higher interest payments made on pay-float swaps.
The unrealized loss on non-hedge accounting derivatives was primarily due to the passage of time on pay-fixed swaps with less than one year to maturity and the impact of the fall in two- and three- year swap rates on pay-fixed swaps with more than one year to maturity. However, this unrealized loss was primarily offset by unrealized gains on pay-float swaps with more than one year to maturity which resulted from the fall in two- and three-year swap rates.
Refer to the “Derivative Instruments” section of this MD&A for further discussion.
Fiscal 2006 Compared to Fiscal 2005
Our consolidated net income was $580 million and $762 million during fiscal 2006 and fiscal 2005, respectively.
Our results in fiscal 2006 were primarily affected by an increase in interest expense due to higher market interest rates and our higher outstanding debt portfolio. This was partially offset by the impact of higher financing volume of 1.1 million units on our retail and lease contracts and agreements issued on our insurance products of 1.3 million units which resulted in increased revenues.
Our financing operations reported net income of $524 million and $709 million during fiscal 2006 and fiscal 2005, respectively. The decrease in net income resulted from continued margin pressure due to the interest rate environment, and to a lesser extent, higher provisions for credit losses as a result of our growth in earning assets and our broader range of credit quality within the retail portfolio.
Our insurance operations reported net income of $56 million and $53 million during fiscal 2006 and fiscal 2005, respectively. Our results in fiscal 2006 were primarily affected by the impact of increased contract revenues and earned premiums. This was partially offset by the increase in insurance losses and loss adjustment expenses. Insurance losses and loss adjustment expenses increased primarily due to the increase in the number of agreements in force.
We continued our progress on our multi-year initiative to replace our major legacy transaction systems (“technology initiative”). Our management believes it has properly aligned our resources internally for the technology initiative.
Overall, we increased our capital position by $551 million bringing total equity to $4.8 billion at March 31, 2006. Our debt-to-equity positions were 10.16 and 9.84 at March 31, 2006 and 2005, respectively.
OFF-BALANCE SHEET ARRANGEMENTS
Securitization of receivables allows
the Companyus to access a highly liquid and efficient capital market while providing
the Companyus with an alternative source of funding and investor diversification.
The CompanyWe began participating in the asset-backed securitization market in
1993, securitizing both retail and lease finance receivables. The Company’s recent securitization program involves only retail finance receivables.1993. For further discussion of
the Company’sour funding strategy, refer to the “Liquidity and Capital Resources” section
withinof this MD&A.
The Company’s
Our securitization program typically involves a two-step transaction.
The Company sellsWe sell discrete pools of retail finance receivables to a
wholly ownedwholly-owned consolidated bankruptcy remote special purpose entity (“SPE”), which in turn transfers the receivables to a qualified special purpose entity (“QSPE” or “securitization trust”) in exchange for the proceeds from securities issued by the securitization trust. The asset-backed securities are rated by at least two NRSROs and sold in registered public offerings. These securities, usually in the form of
either notes or certificates of various maturities and interest rates, are secured by
collections on the sold
receivables and collections with respect to the receivables. The securities are structured into senior and subordinated classes. Generally, the senior classes have
payment priority over the subordinated
classes in receiving collections from the sold receivables. The Company typically uses an amortizing structure in its securitizations. In most amortizing structures, holders of the asset-backed securities receive monthly payments of principal and interest and therefore the outstanding principal balance of the securities is repaid as the securitization trust receives principal collections on the sold receivables.classes.
The following flow chart diagrams a typical securitization transaction:
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Our use of SPEs in securitizations is consistent with conventional practices in the securitization
markets.industry. The
two-step sale
to the SPEprocess isolates the sold receivables from
otherour general creditors
of the Company for the benefit of securitization
investors and theinvestors. The securitization is accounted for as a sale, assuming accounting requirements are satisfied. Investors in securitizations have no recourse to
the Companyus beyond the
contractual cash flows of the securitized receivables, retained subordinated interests, any cash reserve funds, and any amounts available or funded under the revolving liquidity notes
in the related trust as discussed below. Investors do not have recourse to
our other assets
of the Company for obligor defaults.
The Company doesWe do not guarantee any securities issued by any securitization trust. None of
the Company’sour officers, directors, or employees
holdshold any equity interests or
receivesreceive any direct or indirect compensation from
the Company’sour SPEs. The SPEs do not own
the Company’sour stock or stock of any of
the Company’sour affiliates and there are no contracts to do so. Each SPE has limited purposes and may only be used to purchase and sell the receivables. The individual securitization trusts have a limited duration and generally terminate when investors holding the asset-backed securities have been paid all amounts owed to them.
The SPE retains an interest in each securitization trust. Each retained interest includes subordinated securities issued by the securitization trust and interest-only strips representing the right to receive any excess interest. The retained interests are subordinated and serve as credit enhancements for the more senior securities issued by the securitization trust to help ensure that adequate funds will be available to pay investors. The retained interests are held by the SPE as restricted assets and are not available to satisfy any obligations of the Company.our obligations. The SPE’s ability to realize value on its retained interests depends on actual credit losses and prepayment speeds on the sold receivables. To the extent prepayment speeds are faster or losses are greater than expected, the SPE may be required to recognize an impairment loss on the retained
interests. For accounting purposes, the interests of the SPE are consolidated with
the Company’sour accounts. These retained interests as well as senior securities
we have purchased
by the Company are reflected in the Consolidated Balance Sheet as available for sale investments in marketable securities and other assets. For further discussion of the estimates involved in the valuation of
the Company’sour retained interests, refer to the “Critical Accounting Estimates” section
withinof this MD&A.
Various forms of credit enhancements are provided to reduce the risk of loss for senior classes of securities. These credit enhancements may include the following:
•
| · | Cash reserve funds or restricted cash: Unless a revolving liquidity note as discussed below,(“RLN”) is in place, a portion of the proceeds from the sale of asset-backed securities is held by the securitization trust in segregated reserve funds and may be used to pay principal and interest to investors if collections on the sold receivables are insufficient. In the event a securitization trust experiences charge-offs or delinquencies above specified levels, additional excess amounts from collections on receivables held by the securitization trusts will be added to such reserve funds. |
•
| · | Subordinated securities: Generally, these securities are not repaid until the senior securities are paid in full. |
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•
| Revolving liquidity notes: In certain securitization structures, revolving liquidity notes (“RLN”) are used in lieu of deposits to a cash reserve fund. The securitization trust may draw upon the RLN to cover any shortfall in interest and principal payments to investors. The Company funds any draws, and the terms of the RLN obligate the securitization trust to repay amounts drawn plus accrued interest. Repayments of principal and interest due under the RLN are subordinate to principal and interest payments on the asset-backed securities and, in some circumstances, to deposits into a reserve account. If collections are insufficient to repay amounts outstanding under RLN, the Company will recognize a loss for the outstanding amounts. The Company must fund the entire amount available under the RLN into a reserve account if the Company’s short term unsecured debt ratings are downgraded below P-1 or A-1 by Moody’s or S&P, respectively. Management believes the likelihood of the Company incurring such losses or the Company’s short-term credit rating being downgraded is remote. No amounts were outstanding under the RLN as of March 31, 2005 and 2004. The RLN had no material fair value as of March 31, 2005 and 2004. The Company has not recognized a liability for the RLN because it does not expect to be required to fund any amounts under the RLN.
|
The Company
We may enter into a swap agreement with the securitization trust under which the securitization trust is obligated to pay
the Companyus a fixed rate of interest on payment dates in exchange for receiving amounts equal to the floating rate of interest payable on the asset backed securities.
Income earned from the sale of receivables includes gains or losses on assets sold, servicing fee income, and interest income earned on retained interests. The sale of receivables has the effect of reducing financing revenues in the year the receivables are sold, as well as in future years. The net impact of securitizations on annual earnings will include financing revenue effects in addition to the reported gain or loss on assets sold and will vary depending on the amount and timing of securitizations in the current year, as well as the interest rate environment at the time the finance receivables were originated and securitized. Gains on assets sold are recognized in the period in which the sale occurs and are included in investment and other income in the Consolidated Statement of Income. The recorded gains on assets sold are dependent on the carrying amount and fair value of the assets less the fair value of retained obligations, if any, at the time of the sale. The carrying amount is allocated between the assets sold and the retained interests based on their relative fair values at the date of the sale.
The Company recognizes
We recognize income from the retained interests over the life of the respective underlying retained interest using the effective yield method. The effective yield represents the excess of all forecasted cash flows over the initial amount recorded as the retained interest at the sale date. As adjustments to forecasted cash flows are made,
the Company adjustswe adjust the rate at which income is earned prospectively. If changes in the forecasted cash flows result in an other-than-temporary decline in the fair value of the retained interests, an impairment loss is recognized to the extent that the fair value is less than the carrying amount. Such losses, when incurred, are included in investment and other income in the Consolidated Statement of Income. Otherwise, any difference in the carrying amount and the fair value of the retained interests is recognized as an unrealized gain or loss, net of income taxes, and is included in accumulated other comprehensive income in the Consolidated Balance Sheet.
- 53 -
TMCC continues to service the sold receivables for a servicing
fee. TMCC’sfee, prepares servicing
duties include collecting payments on receivables and submitting them to the appropriate trustee for distribution to the certificate holders. TMCC also prepares monthly investor reports
which include information on the performance of the sold receivables, including collections, delinquencies, credit losses, and amounts distributable to investors, which each trustee uses on behalf ofregarding the securitization
trust to distribute monthly interesttrusts performance and
principal payments to investors. TMCC also performs administrative services for
each securitization trust, including filing periodic reports, preparing notices, and tax reporting. While servicing the sold receivables for the securitization
trusts, TMCC applies the same servicing policies and procedures that are applied to the owned receivables.trusts.
The sale of receivables through securitizations is further discussed in Note 7 – Sale of Receivables of the Notes to Consolidated Financial Statements.
TMCC has guaranteed the payments of principal and interest with respect to the bonds of manufacturing facilities of certain affiliates. TMCC receives an annual fee of $102,000 for guaranteeing such payments. The nature, business purpose, and amounts of these guarantees are described in Note
1415 – Commitments and Contingencies of the Notes to Consolidated Financial Statements. Other than the fee discussed above, there are no corresponding expenses or cash flows arising from
the Company’sour guarantees, nor are any amounts recorded as liabilities on
the Company’sour Consolidated Balance Sheet.
Lending CommitmentsThe Company provides
We provide fixed and variable rate credit facilities to vehicle and industrial equipment dealers. These credit facilities are typically used for business acquisitions, facilities refurbishment, real estate purchases, and working capital requirements. These loans are typically collateralized with liens on real estate, vehicle inventory, and/or other dealership assets, as appropriate.
The Company obtainsWe obtain a personal guarantee from the vehicle or industrial equipment dealer or corporate guarantee from the dealership when deemed prudent. Although the loans are typically collateralized or guaranteed, the value of the underlying collateral or guarantees may not be sufficient to cover
the Company’sour exposure under such agreements.
The Company pricesWe price the credit facilities to reflect the credit risks assumed in entering into the credit
facility. The Companyfacility and competitive factors. We also
providesprovide financing to various multi-franchise dealer organizations, referred to as dealer groups, often as part of a lending consortium, for wholesale, working capital, real estate, and business acquisitions.
The Company has also extended credit facilities to affiliates as described in Note 14 – Commitments and Contingencies of the Notes to Consolidated Financial Statements. While the majority of these credit facilities and financing arrangements are secured, approximately
22%8 percent of the lending commitments at March 31,
20052007 are unsecured.
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Indemnification
In addition to these lending commitments, we have also extended $8.1 billion and $6.6 billion of wholesale financing lines not considered to be contractual commitments at March 31, 2007 and 2006, respectively. We have also extended credit facilities to affiliates as described in Note 15 – Commitments and Contingencies of the ordinary courseNotes to Consolidated Financial Statements.
Indemnification
Refer to Note 15 – Commitments and Contingencies of
business, the
Company enters intoNotes to Consolidated Financial Statements for a detailed description of agreements containing indemnification
provisions standard in the industry related to several types of transactions, including, but not limited to, debt funding, derivatives, securitization transactions, and its vendor and supplier agreements. Performance under these indemnities would occur upon a breach of the representations, warranties or covenants made or given, or a third party claim. In addition, the Company has agreed in certain debt and derivative issuances, and subject to certain exceptions, to gross-up payments due to third parties in the event that withholding tax is imposed on such payments. In addition, certain of the Company’s funding arrangements would require the Company to pay lenders for increased costs due to certain changes in laws or regulations. Due to the difficulty in predicting events which could cause a breach of the indemnification provisions or trigger a gross-up or other payment obligation, the Company is not able to estimate its maximum exposure to future payments that could result from claims made under such provisions.
The Company hasWe have not made any material payments in the past as a result of these provisions, and as of March 31,
2005, the Company does not believe2007, we determined that it is
not probable that
itwe will be required to make any material payments in the future. As
such,of March 31, 2007 and 2006, no amounts have been recorded under these
indemnifications as of March 31, 2005.indemnifications.
Receivable Repurchase ObligationsTMCC makes certain representations and warranties to the SPEs, and the SPEs make corresponding representations and warranties to the securitization trusts, relating to the receivables sold in securitization transactions. TMCC and the SPEs may be required to repurchase any receivable in the event of a breach of a representation and warranty that would materially and adversely affect the interest of the SPEs, or any securitization trust, as applicable. In addition, TMCC, as the servicer of the receivables, may be required to repurchase any receivable in the event of a breach of a covenant by the servicer that would materially and adversely affect the interest of any securitization trust, or if extensions or modifications to a receivable are made, and TMCC, as the servicer, does not elect to make advances to cover any resulting reductions in interest payments. The repurchase price is generally the outstanding principal balance of the receivable plus any accrued interest thereon. These provisions are customary in the securitization industry.No receivables were repurchased under these provisions during fiscal 2005. Receivables repurchased during fiscal 2004 and 2003 totaled $1 million in each year. The Company does not believe it is probable that it will be required to make any material payments in the future and, as such, no amounts have been recorded under these obligations as of March 31, 2005.
Advancing Requirements
As a servicer of receivables sold through securitizations, TMCC is required to advance delinquent amounts contractually owed by an obligor to the applicable securitization trust to the extent it believes the advance will be recovered from future collections of the related receivable. Each securitization trust is required to reimburse the Company for any outstanding advances from collections on all receivables before making other required payments. These provisions are customary in the securitization industry. Advances outstanding at March 31, 2005 and 2004 totaled $5 million and $13 million, respectively.
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CONTRACTUAL OBLIGATIONS AND CREDIT-RELATED COMMITMENTS
The Company has
We have certain obligations to make future payments under contracts and credit-related financial instruments and commitments. Aggregate contractual obligations and credit-related commitments in existence at March 31,
20052007 are summarized as
follows: | | Payments due by period |
| |
|
Contractual Obligations | | Total | | Less than 1 year | | 1-3 years | | 3-5 years | | More than 5 years |
| |
| |
| |
| |
| |
|
| | (Dollars in millions) |
| | |
Debt1 | | $41,757 | | $17,232 | | $13,917 | | $7,672 | | $2,936 |
Lending commitments2 | | 4,118 | | 4,118 | | (2) | | (2) | | (2) |
Premises occupied under lease | | 117 | | 19 | | 30 | | 19 | | 49 |
Revolving liquidity notes3 | | 40 | | 40 | | (3) | | (3) | | (3) |
Purchase obligations4 | | 35 | | 23 | | 12 | | | | |
| |
| |
| |
| |
| |
|
Total | | $46,067 | | $21,432 | | $13,959 | | $7,691 | | $2,985 |
| |
| |
| |
| |
| |
|
1
| Debt includes the effects of fair market value changes and foreign currency transaction adjustments.
|
2
| Lending commitments represent term loans and revolving lines of credit extended by the Company to vehicle and industrial equipment dealers and affiliates as described in the “Off-Balance Sheet Arrangements” section of this MD&A. Of this amount, $2,591 million was outstanding as of March 31, 2005. The above lending commitments have various expiration dates.
|
3
| Certain securitization trusts may draw from TMCC under the RLNs over the life of the related securitization transactions. The terms of the RLNs obligate the securitization trust to repay amounts drawn plus accrued interest. Repayments of principal and interest due under the RLNs are subordinated as described in the “Off-Balance Sheet Arrangements” section of this MD&A. No amounts were outstanding as of March 31, 2005.
|
4
| Purchase obligations represent fixed or minimum payment obligations under the Company’s contracts, $15 million of which relate to contracts with information technology service providers in connection with the technology initiative described in the “Results of Operations - Operating and Administrative Expenses” section of this MD&A. The amounts included herein represent the minimum contractual obligations in certain situations; however, actual amounts incurred may be substantially higher depending on the particular circumstance, including in the case of information technology contracts, the amount of usage once implemented by the Company. Contracts that do not specify fixed payments or provide for a minimum payment are not included. Certain contracts noted herein contain voluntary provisions under which the contract may be terminated for a specified fee, ranging up to $1.6 million, depending upon the contract.
|
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follows (dollars in millions):
| | | Payments due by period |
Contractual Obligations | | Total | | Less than 1 year | | 1-3 years | | 3-5 years | | More than 5 years |
Debt1 | | $58,529 | | $28,064 | | $17,135 | | $8,693 | | $4,637 |
Lending commitments2 | | 4,369 | | 4,369 | | (2) | | (2) | | (2) |
| Premises occupied under lease | | 101 | | 19 | | 27 | | 18 | | 37 |
Revolving liquidity notes3 | | 17 | | 17 | | (3) | | (3) | | (3) |
Purchase obligations4 | | 86 | | 52 | | 31 | | 3 | | - |
| Total | | $63,102 | | $32,521 | | $17,193 | | $8,714 | | $4,674 |
1 Debt includes the effects of fair market value changes and foreign currency transaction adjustments.
2 Lending commitments represent term loans and revolving lines of credit we extended to vehicle and industrial equipment
dealers and affiliates as described in the “Off-Balance Sheet Arrangements” section of this MD&A. Of the amount shown
above, $2.9 billion was outstanding as of March 31, 2007. The amount shown above excludes $8.1 billion of wholesale
financing lines not considered to be contractual commitments at March 31, 2007 of which $5.2 billion was outstanding at
March 31, 2007. The above lending commitments have various expiration dates.
3 Certain securitization trusts may draw from TMCC under the RLNs over the life of the related securitization transactions.
The terms of the RLNs obligate the securitization trust to repay amounts drawn plus accrued interest. Repayments of principal
and interest due under the RLNs are subordinated. No amounts were outstanding under any RLN as of March 31, 2007.
4 Purchase obligations represent fixed or minimum payment obligations under our contracts, $82 million of which relate to
contracts with information technology service providers in connection with the technology initiative described in the “Operating
and Administrative Expenses” section of this MD&A. The amounts included herein represent the minimum contractual
obligations in certain situations; however, actual amounts incurred may be substantially higher depending on the particular
circumstance, including in the case of information technology contracts, the amount of usage once we have implemented it.
Contracts that do not specify fixed payments or provide for a minimum payment are not included. Certain contracts noted
herein contain voluntary provisions under which the contract may be terminated for a specified fee, ranging up to $1 million,
depending upon the contract.
CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995This report contains
Certain statements contained in this Form 10-K or incorporated by reference herein are “forward looking statements” within the meaning of
Section 27A of the Securities
Litigation Reform Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which include estimates, projections and statements of the Company’s beliefs concerning future events, business plans, objectives, expected operating results, and the assumptions upon which those1995. These statements are
based. Forward lookingbased on current expectations and currently available information. However, since these statements
include, without limitation, any statementare based on factors that
involve risks and uncertainties, our performance and results may
predict, forecast, indicatediffer materially from those described or
imply future results, performance or achievements, and are typically identified with wordsimplied by such forward-looking statements. Words such as “believe,” “anticipate,” “expect,” “estimate,” “project,” “should,” “intend,” “will,” “may” or words or phrases of similar
meaning. The Company cautionsmeaning are intended to identify forward looking statements. We caution that the
forward lookingforward-looking statements involve known and unknown risks, uncertainties and other important factors that may cause actual results to differ materially from those in the
forward lookingforward-looking statements, including, without limitation, the
following:•
| changes in demand for Toyota and Lexus products
|
•
| changes in economic conditions
|
•
| a decline in the market acceptability of leasing or retail financing
|
•
| the effect of competitive pricing on interest margins
|
changes in vehicle and component pricing due to the appreciation of the Japanese yen against the U.S. dollar
•
| the effect of governmental actions
| |
•
| changes in tax laws or the Company’s tax position
|
•
| the effect of competitive pressures on the used car market and residual values and the continuation of the other factors causing changes in vehicle returns and losses incurred at lease maturity
|
•
| the continuation of, and if continued, the level and type of subvention programs offered by TMS
|
•
| the ability of the Company to successfully access the U.S. and international capital markets
|
the effect of any NRSRO actions
•
| increases in market interest rates or other changes in costs associated with the Company’s debt funding
|
•
| implementation of new technology systems or failure to successfully implement the Company’s disaster recovery program
|
•
| the effectiveness of the Company’s internal control or financial systems, or a failure of internal control resulting in a loss
|
•
| the effectiveness of the Company’s internal control over financial reporting resulting in an error in the Company’s financial statements or disclosures
|
•
| continuation of factors causing changes in delinquencies and credit losses
|
•
| changes in the fiscal policy of any government agency which increases sovereign risk
|
•
| monetary policies exercised by the European Central Bank and other monetary authorities
|
•
| effect of any military action by or against the U.S., as well as any future terrorist attacks, including any resulting effect on general economic conditions, consumer confidence and general market liquidity
|
•
| with respect to the effect of litigation matters, the discovery of facts not presently known to the Company or determination by judges, juries or other finders of fact which do not accord with the Company’s evaluation of the possible liability from existing litigation
|
•
| with respect to financial reporting disclosure matters, the discovery of facts not presently known to the Company or management that may be discovered in connection with its ongoing review of internal controls over financial reporting
|
•
| inability of a party to the Company’s syndicated credit facilities or credit support agreements to perform when required
|
•
| losses resulting from default by any vehicle or industrial equipment dealers to which the Company has a significant credit exposure
|
default by any counterparty to a derivative contract
- 57 -
•
| performance under any guaranty or comfort letter issued by the Company
|
•
| changes in legislation and new regulatory requirements
|
The risks included here are not exhaustive. New risk factors emerge from time to time and it is not possible for the Company to predict all such risk factors, nor to assess the impact such risk factors might have on the Company’s business or the extent to which any factor or combination of factors may cause actual results to differ materially from those containedset forth in any forward looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward looking statements as a prediction of actual results. The Company“Item 1A. Risk Factors”. We will not update the forward lookingforward-looking statements to reflect actual results or changes in the factors affecting the forward lookingforward-looking statements.
Refer to Note 2 – Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.
CRITICAL ACCOUNTING ESTIMATESThe Company has
We have identified the estimates below as critical to
the Company’sour business operations and the understanding of
the Company’sour results of operations. The impact and any associated risks related to these estimates on
the Company’s business operations are discussed throughout the MD&A where such estimates affect reported and expected financial results. The evaluation of the factors used in determining each of
the Company’sour critical accounting estimates involves significant assumptions, complex analysis, and management judgment. Changes in the evaluation of these factors may significantly impact the consolidated financial statements. Different assumptions or changes in economic circumstances could result in additional changes to the determination of the allowance for credit losses, the determination of residual values, the valuation of
the Company’sour retained interests in securitizations, and
itsour results of operations and financial condition.
The Company’sOur other significant accounting policies are discussed in Note 2
-– Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.
Determination of the Allowance for Credit LossesThe Company maintains
We maintain an allowance for credit losses to cover probable losses on
itsour earning assets resulting from the failure of customers or dealers to make required payments. The level of credit losses is influenced primarily by two factors: frequency of occurrence and loss severity. These and other factors are further discussed in the
“Results of Operations - Credit“Credit Risk” section of this MD&A. For evaluation purposes, exposures to credit losses are segmented into the two primary categories of “consumer” and “dealer”.
The Company’sOur consumer portfolio is further segmented into retail finance receivables and lease earning assets, both of which are characterized by smaller
contract balances and homogenous populations.
The Company’sOur dealer portfolio consists of loans related to dealer financing. The overall allowance is evaluated at least quarterly, considering a variety of assumptions and factors to determine whether reserves are considered adequate to cover probable losses. For further discussion of the accounting treatment of
the Company’sour allowance for credit losses, refer to Note 2 – Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.
Nature of Estimates and Assumptions Required
The evaluation of the appropriateness of the allowance for credit losses and
the Company’sour exposure to credit losses involves estimates and requires significant judgment. The estimate of credit losses is based upon information available at the reporting date.
- 58 -
The consumer portfolio is evaluated using methodologies such as
net flowroll rate analysis, credit risk grade/tier segmentation analysis, time series regression analysis, and vintage analysis. Various techniques are used including the segmenting of retail finance receivables and lease earning assets into pools, identifying risk characteristics, and reviewing historical delinquency and loss trends. Management also reviews and analyzes external factors including, but not limited to, changes in economic conditions, the used vehicle market, and consumer behavior. In addition, internal factors, such as asset growth, purchase quality mix, and contract term length, are also considered in the review. As discussed in the
“Results of Operations – Credit“Credit Risk” section of this MD&A, most of
the Company’sour credit losses are related to
itsour consumer portfolio.
The dealer portfolio is evaluated by first segmenting dealer financing into loan-risk pools, which are determined based on the risk characteristics of the loan (i.e. secured, unsecured, syndicated, etc.). The dealer pools are then analyzed using an internally developed risk rating process or by reference to third party risk rating sources. In addition, field operations management is consulted each quarter to determine if any specific dealer loan is considered to be impaired. If any such loans are identified, specificallocated reserves are established, as appropriate, and the loan is removed from the loan-risk pool for separate monitoring.
As discussed in the “Results of Operations – Credit Risk” section of this MD&A, to date, the Company has not incurred material credit losses on its dealer financing portfolio.Sensitivity Analysis
The assumptions used in evaluating
the Company’sour exposure to credit losses involve estimates and significant judgment. The expected loss severity and frequency of occurrence on the vehicle retail and lease portfolios represent two of the key assumptions involved in determining the allowance for credit losses. Holding other estimates constant, a
10%10 percent increase or decrease in either the estimated loss severity or the estimated frequency of occurrence on the vehicle retail and lease portfolios would have resulted in
an increase or decrease, respectively, of $38 million toa change in the
provisionallowance for credit losses
in fiscal 2005.of $52 million as of March 31, 2007.
Determination of Residual Values
The determination of
contractual residual values on
the Company’sour lease portfolio involves
estimatedestimating end of term market values of leased
vehicles.vehicles and industrial equipment. Establishing these estimates involves various assumptions, complex analysis, and significant judgment. Actual losses incurred at lease termination could be significantly different from expected losses. Substantially all of
the Company’sour residual value risk relates to
itsour vehicle lease
portfolio. To date, the Company has not incurred material losses related to declines in contractual residual values on its industrial equipment portfolio. For further discussion of the accounting treatment of residual values on
the Company’sour lease earning assets, refer to Note 2 – Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.
- 59 -
Nature of Estimates and Assumptions RequiredThe contractual residual
Residual values of lease earning assets are estimated at lease inception by examining external industry data and the Company’sour own historical residual experience. Factors considered in this evaluation include, expected economic conditions, historical trends, and market information on new and used vehicle sales. During the term of the lease, management evaluates the adequacy of its estimate of the residual value and makes downward adjustments to the carrying value to the extent the market value at lease maturity is estimated to be less than the carrying value and when such decline is considered to be other-than-temporary. Factors affecting the estimated market value at lease maturity include, but are not limited to, expected economic conditions, new vehicle pricing, new vehicle incentive programs, new vehicle sales, product attributes of popular vehicles, the mix of used vehicle supply, the level of current used vehicle values, and fuel prices. Our management periodically reviews the estimated end of term market values of leased vehicles to assess the appropriateness of its carrying values. To the extent the estimated end of term market value of a leased vehicle is lower than the residual value established at lease inception, the residual value of the leased vehicle is adjusted downward so that the carrying value at lease end will approximate the estimated end of term market value. Factors affecting the estimated end of term market value are similar to those considered in the evaluation of residual values at lease inception discussed above. These factors are evaluated in the context of their historical trends.trends to anticipate potential changes in the relationship among those factors in the future. For operating leases, adjustments are made on a straight-line basis over the remaining terms of the leases and are included in depreciation on operating leases expense in the Consolidated
Statement of Income. For direct finance leases, adjustments are made at the time of assessment and are
includedrecorded as a reduction
toof direct finance lease revenues in the Consolidated Statement of Income.
Sensitivity AnalysisEstimates used in determining
Estimated return rates and end of term market values
for leased vehicles significantly impact the amount and timing of depreciation expense. Return rate and loss severity represent two of the key assumptions involved in determining the amount
and timing of depreciation expense to be
recorded.recorded in the Consolidated Statement of Income.
The vehicle lease return rate represents the number of end of term leased vehicles returned to
the Companyus for sale as a percentage of lease contracts that were originally scheduled to mature in the same period. When the market value of a leased vehicle at contract maturity is less than its contractual residual value
(i.e., the price at which the lease customer may purchase the leased vehicle), there is a higher probability that the vehicle will be returned to
us. In addition, a higher market supply of certain models of used vehicles generally results in a lower relative level of demand for those vehicles, resulting in a higher probability that the
Company.vehicle will be returned to us. A higher rate of vehicle returns exposes
the Companyus to greater risk of loss at lease termination.
HoldingAt March 31, 2007, holding other estimates constant,
an increase or decrease of 5 percentage points in estimatedif the return rate
for our existing portfolio of leased vehicles were to increase by 1 percent from our present estimates, the effect would
have resultedbe to increase depreciation on these vehicles by approximately $9 million. This increase in
additional before-tax expense or income, respectively,depreciation would be charged to depreciation on operating leases in the Consolidated Statement of
$10 million in fiscal 2005.Income on a straight line basis over the remaining terms of the operating leases.
End of term market values determine the amount of loss severity at lease maturity. Loss severity is the extent to which the end of term market value of a
leaseleased vehicle is less than
its carrying value at lease end.the estimated residual value. Although
the Company makes every effortwe employ a rigorous process to
establish accurate contractual residualestimate end of term market values,
at lease inception and adjusts the residual value downward throughout the life of the lease as conditions warrant, the Companywe may
still incur losses to the extent the end of term market value of a
leaseleased vehicle is less than
its carrying value at lease end. Holdingthe estimated residual value. At March 31, 2007, holding other estimates constant,
anif end of term market values for our existing portfolio of leased vehicles were to decrease by 1 percent from our present estimates, the effect would be to increase
or decreasedepreciation on these vehicles by approximately $45 million. This increase in depreciation would be charged to depreciation on operating leases in the Consolidated Statement of
15% in estimated loss severity would have resulted in additional before-tax expense or income, respectively, of $7 million in fiscal 2005.- 60 -
Sale of Receivables and Valuation of Retained Interests
The Company’s securitization transactions are completed using QSPEs and are usually structured to obtain sale accounting treatment. For further descriptionIncome on a straight line basis over the remaining terms of the securitization structures, refer to the “Off-Balance Sheet Arrangements” section within this MD&A.
The Company is required to recognize a gain or loss on the sale of receivables in the period the sale occurs. The recorded gains or losses on sold receivables depend on the carrying amount and the fair value of such receivables, less the fair value of obligations, if any, at the sale date. The Company retains interests in the securitizations in the form of senior interests, which consist of senior securities purchased by the Company, and subordinated interests, which consist of interest-only strips and subordinated securities. The subordinated retained interests do not have a readily available market value. Therefore, the fair value of the retained interests is calculated by discounting forecasted cash flows using management’s estimates of key economic assumptions discussed below. The Company recognizes income from each retained interest over its life utilizing the effective yield method. The yield represents the excess of all forecasted cash flows over the initial amount recorded as the retained interest at the sale date. As adjustments to forecasted cash flows are made, the Company adjusts the rate at which income is earned prospectively. For further discussion of the accounting treatment of the Company’s securitizations, refer to Note 2 – Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.
operating leases.
Nature of Estimates and Assumptions RequiredDetermination of the gain or loss on each sale of finance receivables, the fair value of retained interests, and the income from such retained interests requires management to make estimates and judgments regarding various assumptions. Such assumptions include expected credit losses over the life of the sold receivables, the risk of payments on sold receivables occurring earlier than scheduled maturities, also referred to as prepayment speed, and discount rates used to calculate the present value of future cash flows. The assumptions used are affected by various internal and external factors, including various portfolio, industry and economic indicators such as changes in economic conditions and consumer behavior that management believes are key to estimating expected credit losses, as well as historical delinquency and loss analysis and trends. Management evaluates these factors on a periodic basis for each securitization transaction and modifies its assumptions as the underlying analyses and the credit environment change.
Sensitivity Analysis
Note 7 – Sale of Receivables of the Notes to Consolidated Financial Statements sets forth the sensitivity of the fair value of retained interests to changes in each of the assumptions discussed above. Any changes in such assumptions will have a similar effect on gains on securitization and income from retained interests recognized during the period.
Derivative Instruments
The Company manages its
We manage our exposure to market risks such as interest rate and foreign exchange risks with derivative instruments. These instruments include interest rate swaps,
cross currency
interest ratebasis swaps, and purchased interest rate caps.
The Company’sOur use of derivatives is limited to the management of interest rate and foreign exchange risks. For further discussion of the accounting treatment of
the Company’sour derivatives, refer to Note 2 – Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.
- 61 -
Nature of Estimates and Assumptions RequiredThe Company’s management
Management determines the application of derivatives accounting through the identification of hedging instruments, hedged items, and the nature of the risk being hedged, as well as the methodology used to assess the hedging instrument's effectiveness.
In some cases, management may elect not to designate a hedge relationship for accounting purposes, or to de-designate a previously designated hedge relationship, in order to moderate the volatility of the derivative portfolio on the Company’s reported interest expense. The fair values of
the Company’sour derivative financial instruments are calculated by applying standard valuation techniques, such as discounted cash flow analysis employing readily available market data, including interest rates, foreign exchange rates, and volatilities. However, considerable judgment is required in interpreting market data to develop estimates of fair value; therefore, the estimates are not necessarily indicative of the amounts that could be realized or would be paid in a current market exchange.
- 62 -
Sale of Receivables and Valuation of Retained Interests
Our securitization transactions are completed using QSPEs and are usually structured to obtain sale accounting treatment. For further description of the securitization structures, refer to the “Off-Balance
Sheet Arrangements” section of this MD&A.
We are required to recognize a gain or loss on the sale of receivables in the period the sale occurs. The recorded gains or losses on sold receivables depend on the carrying amount and the fair value of such receivables, less the fair value of obligations, if any, at the sale date. We retain interests in the securitizations in the form of senior interests, which consist of senior securities we have purchased, and subordinated interests, which consist of interest-only strips and subordinated securities. The subordinated retained interests do not have a readily available market value. Therefore, the fair value of the retained interests is calculated by discounting forecasted cash flows using management’s estimates of key economic assumptions discussed below. We recognize income from each retained interest over its life utilizing the effective yield method. The yield represents the excess of all forecasted cash flows over the initial amount recorded as the retained interest at the sale date. As adjustments to forecasted cash flows are made, we adjust the rate at which income is earned prospectively. For further discussion of the accounting treatment of our securitizations, refer to Note 2 – Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.
Determination of the gain or loss on each sale of finance receivables, the fair value of retained interests, and the income from such retained interests requires management to make estimates and judgments regarding various assumptions. Such assumptions include expected credit losses over the life of the sold receivables, the risk of payments on sold receivables occurring earlier than scheduled maturities, also referred to as prepayment speed, discount rates used to calculate the present value of future cash flows, and weighted average life (in years). The assumptions used are affected by various internal and external factors, including various portfolio, industry and economic indicators such as changes in economic conditions and consumer behavior that management believes are key to estimating expected credit losses, as well as historical delinquency and loss analysis and trends. Our management evaluates these factors on a periodic basis for each securitization transaction and modifies our assumptions as the underlying analyses and the credit environment change.
ITEM7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISKThe Company is
We are exposed to various types of market risks as a result of
itsour normal business activities. Market risk is the sensitivity of
the Company’sour income, market value, and capital to fluctuations in market variables such as foreign exchange rates, interest rates, and market prices.
The Company manages its
We manage our exposure to certain market risks, in part through the use of derivative instruments. Refer to the
“Results of Operations – Use of Derivative“Derivative Instruments” section of the MD&A for further discussion of
the Company’sour use of derivative instruments.
The Company is not a derivatives dealer and does not enter into derivatives transactions for trading purposes.
Currently,
the Company’sour primary market risk exposure is interest rate risk. Interest rate risk results primarily from differences in the re-pricing characteristics of
the Company’sour assets and liabilities. When evaluating interest rate risk management strategies,
the Company considerswe consider a variety of factors, including, but not limited to, management’s risk tolerance and market conditions.
The Company usesWe use various analytical techniques (including the Value at Risk (“VaR”) methodology, gap analysis, and sensitivity analysis) to assess and manage interest rate risk.
The VaR model
used by the Companywe use presents the potential loss in fair value for
the Company’sour portfolio from adverse changes in interest rates for a 30-day holding period within a
95%95 percent confidence interval using
the Monte Carlo simulation
technique.techniques. The VaR methodology is applied to
the Company’s derivative financial instruments,our financial instruments and lease contracts. The methodology uses historical interest rate data to assess the potential future losses from changes in market interest rates while holding other market risks constant. The model assumes that loan prepayments do not depend on the level of interest rates. All options in the debt and derivatives portfolio are included in the VaR calculation, with the exception of
call options
onembedded in debt instruments which are offset by the use of interest rate swaps with
call options mirroring those
embedded in the underlying debt. These matched positions are not included in the VaR calculation as the resulting net exposure is not material.
The VaR of
the Company'sour portfolio as of and for the years ended March 31,
20052007 and
20042006 measured as the potential 30 day loss in fair value from assumed adverse changes in interest rates are as
follows: | As of March 31, 2005 | | Average for the Year Ended March 31, 2005 |
|
| |
|
Mean portfolio value | $9,139 million | | $8,587 million |
VaR | $118 million | | $82 million |
Percentage of the mean portfolio value | 1.29% | | 0.95% |
Confidence level | 95.0% | | 95.0% |
| As of March 31, 2004 | | Average for the Year Ended March 31, 2004 |
|
| |
|
Mean portfolio value | $7,448 million | | $6,237 million |
VaR | $47 million | | $51 million |
Percentage of the mean portfolio value | 0.63% | | 0.82% |
Confidence level | 95.0% | | 95.0% |
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follows (dollars in millions):| | March 31, 2007 | Average for the Year Ended March 31, 2007 |
| Mean portfolio value | $10,651 | $10,285 |
| VaR | $127 | $138 |
| Percentage of the mean portfolio value | 1.19% | 1.34% |
| Confidence level | 95.0% | 95.0% |
| | | |
| | March 31, 2006 | Average for the Year Ended March 31, 2006 |
| Mean portfolio value | $9,603 | $9,555 |
| VaR | $102 | $117 |
| Percentage of the mean portfolio value | 1.06% | 1.22% |
| Confidence level | 95.0% | 95.0% |
Our calculated VaR exposure represents an estimate of reasonably possible net losses that would be recognized on itsour portfolio of financial instruments assuming hypothetical movements in future market rates and is not necessarily indicative of actual results which may occur. It does not represent the maximum possible loss nor any expected loss that may occur, sinceresults. Since actual future gains and losses will differ from those estimated, based upon actual fluctuations in market rates, operating exposures, and the timing thereof, andas well as changes in the composition of the Company’sour portfolio of financial instruments during the year.year, our calculated VaR exposure does not represent the maximum possible loss nor any expected loss. The increase in the mean portfolio value fromVaR at March 31, 20042007 compared to March 31, 2005 is2006 increased primarily theas a result of increased earning assets. The increaseoverall growth in VaR results from an increase in the notional balance and duration of the Company’s fixed rate earning assets combined with a reduction in the duration of the Company’s pay-fixed interest rate swaps.our asset portfolio.
Equity Price RiskThe Company is
We are also exposed to equity price risk related to equity investments included in the investment portfolio of
itsour insurance operations. These investments,
classified as available for sale, consist primarily of passively managed mutual funds that are designed to track the performance of major equity market indices.
These investments are classified as available for sale. Fair market values of the equity investments are determined using quoted market prices.
A summary of the unrealized gains and losses on equity investments included in the Company’sour other comprehensive income assuming a 10%10 percent and 20%20 percent adverse change in market prices is presented below: | March 31, |
| 2005 | | 2004 |
|
| |
|
| (Dollars in millions) |
| | | |
Carrying value | $250 | | $132 |
Fair market value | $306 | | $176 |
Unrealized gain, net of tax | $35 | | $27 |
Estimated 10% adverse change, net of tax | $16 | | $16 |
Estimated 20% adverse change, net of tax | ($3) | | $5 |
below (dollars in millions)1:
| | March 31, 2007 | March 31, 2006 |
| Cost | $523 | $363 |
| Fair market value | 600 | 461 |
| Unrealized gain/(loss), net of tax | 48 | 61 |
| With estimated 10 percent adverse change, net of tax | 11 | 32 |
| With estimated 20 percent adverse change, net of tax | (26) | 4 |
1 Excludes private placement fixed income pooled trusts, which are included in the VaR model described under “Interest Rate
Risk”.
These hypothetical scenarios represent an estimate of reasonably possible net losses that may be recognized as a result of changes in the fair market value of
the Company’sour equity investments assuming hypothetical adverse movements in future market values. These scenarios are not necessarily indicative of actual results that may occur. Additionally, the hypothetical scenarios do not represent the maximum possible loss or any expected loss that may occur, since actual future gains and losses will differ from those estimated, based upon actual fluctuations in market prices.
Foreign Exchange Rate RiskThe Company issues
We issue debt in a variety of
currencies, including, but not limited to, U.S. dollars, euros, British pounds sterling, Swiss francs and Japanese yen.currencies. As a matter of policy, currency exposure related to foreign currency debt is hedged at issuance through the execution of cross currency interest rate swaps or a combination of interest rate swaps coupled with currency basis swaps. Therefore,
the Company believeswe believe that the market risk exposure to changes in currency exchange rates on
itsour debt issuances is not material.
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We are also exposed to foreign exchange risk related to equity,
fixed income pooled trusts, and bond investments included in the investment portfolio of
itsour insurance operations. These investments consist primarily of international equity funds,
international fixed income pooled trusts, and to a lesser extent, bond funds which are incorporated into the overall investment portfolio to provide broader diversification of the investment assets. Substantially all of the market risk exposure to changes in currency exchange rates relates to the investments in international equity
funds.funds and international fixed income pooled trusts. These
equity fundinternational investments, and any related foreign exchange risk, are included in
theour market price risk analysis described above.
COUNTERPARTY CREDIT RISKThe Company enters
We enter into reciprocal collateral arrangements with certain counterparties to mitigate
itsour exposure to the credit risk associated with the respective counterparty. A valuation of
the Company’sour position with the respective counterparty is performed at least
once a month.monthly. If the market value of
the Company’sour net derivatives position with the counterparty exceeds a specified threshold, the counterparty is required to transfer cash collateral in excess of the threshold to
the Company.us. Conversely, if the market value of the counterparty's net derivatives position with
the Companyus exceeds a specified threshold,
the Company iswe are required to transfer cash collateral in excess of the threshold to the counterparty.
The Company’sOur International Swaps and Derivatives Association (“ISDA”) Master Agreements with counterparties contain legal right of offset provisions, and therefore the collateral amounts are netted against derivative assets, which are included in other assets in the Consolidated Balance Sheet. At March 31,
2005, the Company2007 and 2006, we held a net
$982$291 million
and $251 million, respectively, in collateral from counterparties, which is included in cash and cash equivalents in the Consolidated Balance Sheet.
The Company isWe are not required to hold the collateral in a segregated account.
Counterparty credit risk of derivative instruments is represented by the fair value of contracts with a positive fair value at March 31,
2005,2007, reduced by the effects of master netting agreements and collateral. At March 31,
2005,2007, substantially all of
the Company'sour derivative instruments were executed with commercial banks and investment banking firms assigned investment grade ratings of "A" or better by NRSROs.
The Company hasWe have not experienced a counterparty default and
doesdo not currently anticipate non-performance by any of
itsour counterparties, and as such
hashave no reserves related to non-performance as of March 31,
2005.2007. In addition, many of
the Company’sour ISDA Master Agreements with counterparties contain reciprocal ratings triggers providing either party with an option to terminate the agreement and related transactions at market in the event of a ratings downgrade below a specified threshold.
A summary of the net counterparty credit exposure by credit rating
as of March 31, 2007 and 2006 (net of collateral held) is presented
below: | March 31, |
|
|
| 2005 | | 2004 |
|
| |
|
| (Dollars in millions) |
Credit Rating | |
AAA | $493 | | $1,029 |
AA | 887 | | 894 |
A | 78 | | 223 |
Non-rated entities1 | - | | 17 |
|
| |
|
Total net counterparty credit exposure | $1,458 | | $2,163 |
|
| |
|
| | March 31, 2007 | March 31, 2006 |
| Credit Rating | | |
| AAA | $226 | $156 |
| AA | 939 | 655 |
| A | 64 | 90 |
| Total net counterparty credit exposure | $1,229 | $901 |
1
| Exposure to various TMCC securitization trusts where the Company acts as a swap counterparty to the trust.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
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To the Board of Directors and Shareholder of
Toyota Motor Credit Corporation:
In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, shareholder’s equity and cash flows present fairly, in all material respects, the financial position of Toyota Motor Credit Corporation and its subsidiaries at March 31,
20052007 and
2004,2006, and the results of their operations and their cash flows for each of the three years in the period ended March 31,
20052007 in conformity with accounting principles generally accepted in the United States of America. 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 of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/S/ PRICEWATERHOUSECOOPERS LLP
June
21, 2005- 66 -
12, 2007
TOYOTA MOTOR CREDIT CORPORATION
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
| March 31, |
|
|
| 2005 | | 2004 |
|
| |
|
ASSETS | | | |
| | | |
Cash and cash equivalents | $799 | | $818 |
Investments in marketable securities | 927 | | 1,125 |
Finance receivables, net | 37,608 | | 32,318 |
Investments in operating leases, net | 9,341 | | 7,609 |
Other assets | 2,001 | | 2,764 |
|
| |
|
Total assets | $50,676 | | $44,634 |
|
| |
|
LIABILITIES AND SHAREHOLDER'S EQUITY | | | |
| | | |
Debt | $41,757 | | $36,854 |
Deferred income taxes | 2,585 | | 2,225 |
Other liabilities | 2,090 | | 1,992 |
|
| |
|
Total liabilities | 46,432 | | 41,071 |
|
| |
|
Commitments and contingencies (See Note 14) | | | |
| | | |
Shareholder's equity: | | | |
Capital stock, $l0,000 par value (100,000 shares authorized; issued | | | |
and outstanding 91,500 in 2005 and 2004) | 915 | | 915 |
Accumulated other comprehensive income | 46 | | 44 |
Retained earnings | 3,283 | | 2,604 |
|
| |
|
Total shareholder's equity | 4,244 | | 3,563 |
|
| |
|
Total liabilities and shareholder's equity | $50,676 | | $44,634 |
|
| |
|
See Accompanying Notes to Consolidated Financial Statements | | | |
- 67 -
| | March 31, |
| | 2007 | | 2006 |
ASSETS | | | |
| | | | |
| Cash and cash equivalents | $1,329 | | $815 |
| Investments in marketable securities | 1,465 | | 1,176 |
| Finance receivables, net | 47,862 | | 42,022 |
| Investments in operating leases, net | 16,493 | | 12,869 |
| Other assets | 2,219 | | 1,379 |
| Total assets | $69,368 | | $58,261 |
| | | | |
LIABILITIES AND SHAREHOLDER'S EQUITY | | | |
| | | | |
| Debt | $58,529 | | $48,708 |
| Deferred income taxes | 3,153 | | 2,428 |
| Other liabilities | 2,621 | | 2,330 |
| Total liabilities | 64,303 | | 53,466 |
| | | | |
| Commitments and contingencies (See Note 15) | | | |
| | | | |
| Shareholder's equity: | | | |
| Capital stock, $l0,000 par value (100,000 shares authorized; | | | |
| issued and outstanding 91,500 in 2007 and 2006) | 915 | | 915 |
| Accumulated other comprehensive income | 52 | | 60 |
| Retained earnings | 4,098 | | 3,820 |
| Total shareholder's equity | 5,065 | | 4,795 |
| Total liabilities and shareholder's equity | $69,368 | | $58,261 |
| | | | |
| See Accompanying Notes to Consolidated Financial Statements | | | |
TOYOTA MOTOR CREDIT CORPORATION
CONSOLIDATED STATEMENT OF INCOME
(Dollars in millions)
| Fiscal Years |
| Ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
Financing revenues: | | | | | |
Operating lease | $2,141 | | $2,049 | | $1,993 |
Direct finance lease | 169 | | 291 | | 409 |
Retail financing | 1,506 | | 1,284 | | 1,172 |
Dealer financing | 270 | | 198 | | 181 |
|
| |
| |
|
Total financing revenues | 4,086 | | 3,822 | | 3,755 |
| | | | | |
Depreciation on operating leases | 1,579 | | 1,561 | | 1,502 |
Interest expense | 670 | | 578 | | 1,249 |
|
| |
| |
|
Net financing revenues | 1,837 | | 1,683 | | 1,004 |
| | | | | |
Insurance premiums earned and contract revenues | 251 | | 212 | | 186 |
Investment and other income | 139 | | 196 | | 182 |
|
| |
| |
|
Net financing revenues and other revenues | 2,227 | | 2,091 | | 1,372 |
|
| |
| |
|
| | | | | |
Provision for credit losses | 230 | | 351 | | 604 |
Expenses: | | | | | |
Operating and administrative | 650 | | 583 | | 537 |
Insurance losses and loss adjustment expenses | 104 | | 98 | | 87 |
|
| |
| |
|
Total provision for credit losses and expenses | 984 | | 1,032 | | 1,228 |
|
| |
| |
|
| | | | | |
Income before provision for income taxes | 1,243 | | 1,059 | | 144 |
Provision for income taxes | 481 | | 418 | | 54 |
|
| |
| |
|
| | | | | |
Net income | $762 | | $641 | | $90 |
|
| |
| |
|
See Accompanying Notes to Consolidated Financial Statements. | | | | | |
- 68 -
| | Fiscal Years |
| | Ended March 31, |
| | 2007 | | 2006 | | 2005 |
| Financing revenues: | | | | | |
| Operating lease | $3,624 | | $2,726 | | $2,141 |
| Direct finance lease | 108 | | 138 | | 169 |
| Retail financing | 2,431 | | 1,915 | | 1,506 |
| Dealer financing | 547 | | 402 | | 270 |
| Total financing revenues | 6,710 | | 5,181 | | 4,086 |
| | | | | | |
| Depreciation on operating leases | 2,673 | | 2,027 | | 1,579 |
| Interest expense | 2,666 | | 1,502 | | 670 |
| Net financing revenues | 1,371 | | 1,652 | | 1,837 |
| | | | | | |
| Insurance earned premiums and contract revenues | 334 | | 288 | | 251 |
| Investment and other income | 252 | | 116 | | 139 |
| Net financing revenues and other revenues | 1,957 | | 2,056 | | 2,227 |
| | | | | | |
| Provision for credit losses | 410 | | 305 | | 230 |
| Expenses: | | | | | |
| Operating and administrative | 758 | | 712 | | 650 |
| Insurance losses and loss adjustment expenses | 126 | | 115 | | 104 |
| Total provision for credit losses and expenses | 1,294 | | 1,132 | | 984 |
| | | | | | |
| Income before provision for income taxes | 663 | | 924 | | 1,243 |
| Provision for income taxes | 231 | | 344 | | 481 |
| | | | | | |
| Net income | $432 | | $580 | | $762 |
| | | | | | |
| See Accompanying Notes to Consolidated Financial Statements. | | | | | |
TOYOTA MOTOR CREDIT CORPORATION
CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY
(Dollars in millions)
| Capital Stock | | Retained Earnings | | Accumulated Other Comprehensive Income | | Total |
|
| |
| |
| |
|
BALANCE AT MARCH 31, 2002 | $915 | | $1,873 | | $14 | | $2,802 |
| | | | | | | |
Net income for the year ended March 31, 2003 | - | | 90 | | - | | 90 |
Net unrealized loss on available-for-sale marketable securities, net of tax benefit of $6 million | - | | - | | (9) | | (9) |
Reclassification adjustment for net loss included in net income, net of tax benefit of $9 million | - | | - | | 12 | | 12 |
|
| |
| |
| |
|
Total comprehensive income | - | | 90 | | 3 | | 93 |
| | | | | | | |
BALANCE AT MARCH 31, 2003 | $915 | | $1,963 | | $17 | | $2,895 |
| | | | | | | |
Net income for the year ended March 31, 2004 | - | | 641 | | - | | 641 |
Net unrealized gain on available-for-sale marketable securities, net of tax provision of $18 million | - | | - | | 33 | | 33 |
Reclassification adjustment for net gain included in net income, net of tax provision of $4 million | - | | - | | (6) | | (6) |
|
| |
| |
| |
|
Total comprehensive income | - | | 641 | | 27 | | 668 |
| | | | | | | |
BALANCE AT MARCH 31, 2004 | $915 | | $2,604 | | $44 | | $3,563 |
| | | | | | | |
Net income for the year ended March 31, 2005 | - | | 762 | | - | | 762 |
Net unrealized gain on available-for-sale marketable securities, net of tax provision of $1 million | - | | - | | 2 | | 2 |
Reclassification adjustment for net gain included in net income, net of tax provision of $4 million | - | | - | | (6) | | (6) |
|
| |
| |
| |
|
Total comprehensive income | - | | 762 | | (4) | | 758 |
| | | | | | | |
Distribution of net assets to TFSA | - | | (23) | | 6 | | (17) |
Advance to TFSA under credit agreement | - | | (60) | | - | | (60) |
|
| |
| |
| |
|
BALANCE AT MARCH 31, 2005 | $915 | | $3,283 | | $46 | | $4,244 |
|
| |
| |
| |
|
See Accompanying Notes to Consolidated Financial Statements. | | |
- 69 -
| | Capital Stock | | Retained Earnings | | Accumulated Other Comprehensive Income | | Total |
| | | | | | | | |
| BALANCE AT MARCH 31, 2004 | $915 | | $2,604 | | $44 | | $3,563 |
| | | | | | | | |
| Net income for the year ended March 31, 2005 | - | | 762 | | - | | 762 |
| Net unrealized gain on available-for-sale marketable securities, net of tax provision of $1 million | - | | - | | 2 | | 2 |
| Reclassification adjustment for net gain included in net income, net of tax provision of $4 million | - | | - | | (6) | | (6) |
| Total comprehensive income | - | | 762 | | (4) | | 758 |
| | | | | | | | |
| Distribution of net assets to TFSA | - | | (23) | | 6 | | (17) |
| Advances to TFSA | - | | (60) | | - | | (60) |
| | | | | | | | |
| BALANCE AT MARCH 31, 2005 | $915 | | $3,283 | | $46 | | $4,244 |
| | | | | | | | |
| Net income for the year ended March 31, 2006 | - | | 580 | | - | | 580 |
| Net unrealized gain on available-for-sale marketable securities, net of tax provision of $9 million | - | | - | | 18 | | 18 |
| Reclassification adjustment for net gain included in net income, net of tax provision of $2 million | - | | - | | (4) | | (4) |
| Total comprehensive income | - | | 580 | | 14 | | 594 |
| | | | | | | | |
| Advances to TFSA | - | | (24) | | - | | (24) |
| Reclassification to re-establish receivable due from TFSA (See Note 16) | - | | 96 | | - | | 96 |
| Dividends | - | | (115) | | - | | (115) |
| | | | | | | | |
| BALANCE AT MARCH 31, 2006 | $915 | | $3,820 | | $60 | | $4,795 |
| | | | | | | | |
| Net income for the year ended March 31, 2007 | - | | 432 | | - | | 432 |
| Net unrealized gain on available-for-sale marketable securities, net of tax provision of $4 million | - | | - | | 10 | | 10 |
| Reclassification adjustment for net gain included in net income, net of tax provision of $10 million | - | | - | | (18) | | (18) |
| Total comprehensive income | - | | 432 | | (8) | | 424 |
| | | | | | | | |
| Advances to TFSA | - | | (24) | | - | | (24) |
| Dividends | - | | (130) | | - | | (130) |
| | | | | | | | |
| BALANCE AT MARCH 31, 2007 | $915 | | $4,098 | | $52 | | $5,065 |
| | | | | | | | |
| See Accompanying Notes to Consolidated Financial Statements. | | |
TOYOTA MOTOR CREDIT CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
| Fiscal Years Ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
Cash flows from operating activities: | | | | | |
Net income | $762 | | $641 | | $90 |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
Net result from non-hedge accounting | (157) | | 44 | | 661 |
Depreciation and amortization | 1,759 | | 1,827 | | 1,760 |
Recognition of deferred income | (295) | | (265) | | (256) |
Provision for credit losses | 230 | | 351 | | 604 |
Gain from securitization of finance receivables | - | | (30) | | (106) |
Other assets | | | | | |
Decrease (increase) in other assets | 60 | | (190) | | (114) |
Decrease in derivative assets | 919 | | 63 | | - |
Increase in deferred income taxes | 372 | | 336 | | 165 |
Increase in other liabilities | 154 | | 122 | | 22 |
|
| |
| |
|
Net cash provided by operating activities | 3,804 | | 2,899 | | 2,826 |
|
| |
| |
|
| | | | | |
Cash flows from investing activities: | | | | | |
Purchase of investments in marketable securities | (766) | | (1,528) | | (2,144) |
Disposition of investments in marketable securities | 759 | | 1,831 | | 1,513 |
Acquisition of finance receivables | (17,961) | | (16,723) | | (13,287) |
Collection of finance receivables | 11,109 | | 8,039 | | 5,959 |
Acquisition of direct finance leases | (108) | | (1,004) | | (1,443) |
Collection of direct finance leases | 1,728 | | 2,400 | | 2,672 |
Net change in wholesale receivables | (390) | | (612) | | (1,610) |
Acquisition of investments in operating leases | (5,213) | | (3,005) | | (3,852) |
Disposals of investments in operating leases | 2,082 | | 1,782 | | 1,900 |
Proceeds from sale of finance receivables | - | | 1,825 | | 4,502 |
|
| |
| |
|
Net cash used in investing activities | (8,760) | | (6,995) | | (5,790) |
|
| |
| |
|
| | | | | |
Cash flows from financing activities: | | | | | |
Proceeds from issuance of debt | 9,260 | | 8,279 | | 9,787 |
Payments on debt | (6,538) | | (7,617) | | (6,398) |
Net change in commercial paper | 2,289 | | 3,272 | | (192) |
Distribution of net assets to TFSA | (14) | | - | | - |
Advance to TFSA under credit agreement | (60) | | - | | - |
|
| |
| |
|
Net cash provided by financing activities | 4,937 | | 3,934 | | 3,197 |
|
| |
| |
|
| | | | | |
Net (decrease) increase in cash and cash equivalents | (19) | | (162) | | 233 |
| | | | | |
Cash and cash equivalents at the beginning of the period | 818 | | 980 | | 747 |
|
| |
| |
|
Cash and cash equivalents at the end of the period | $799 | | $818 | | $980 |
|
| |
| |
|
| | | | | |
Supplemental disclosures: | | | | | |
Non-cash investing and financing activities in connection with the distribution of net assets to TFSA: | | | | | |
Decrease in assets | $133 | | - | | - |
Decrease in liabilities | $130 | | - | | - |
See Accompanying Notes to Consolidated Financial Statements. | | | | |
- 70 -
| | Fiscal Years Ended March 31, |
| | 2007 | | 2006 | | 2005 |
| Cash flows from operating activities: | | | | | |
| Net income | $432 | | $580 | | $762 |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
| Non-cash impact of hedging activities | 183 | | (66) | | (157) |
| Depreciation and amortization | 3,263 | | 2,484 | | 1,759 |
| Recognition of deferred income | (682) | | (469) | | (295) |
| Provision for credit losses | 410 | | 305 | | 230 |
| (Increase) decrease in other assets | (412) | | 129 | | 60 |
| Increase (decrease) in amounts held under reciprocal collateral arrangements | 40 | | (731) | | 919 |
| Increase (decrease) in deferred income taxes | 730 | | (165) | | 372 |
| Increase in other liabilities | 207 | | 84 | | 154 |
| Net cash provided by operating activities | 4,171 | | 2,151 | | 3,804 |
| | | | | | |
| Cash flows from investing activities: | | | | | |
| Purchase of investments in marketable securities | (1,363) | | (1,632) | | (766) |
| Disposition of investments in marketable securities | 1,114 | | 1,408 | | 759 |
| Acquisition of finance receivables | (22,325) | | (19,713) | | (17,961) |
| Collection of finance receivables | 16,886 | | 14,360 | | 11,109 |
| Acquisition of direct finance leases | (165) | | (135) | | (108) |
| Collection of direct finance leases | 635 | | 954 | | 1,728 |
| Net change in wholesale receivables | (1,220) | | (207) | | (390) |
| Acquisition of investments in operating leases | (8,548) | | (7,809) | | (5,213) |
| Disposals of investments in operating leases | 2,431 | | 2,362 | | 2,082 |
| Net cash used in investing activities | (12,555) | | (10,412) | | (8,760) |
| | | | | | |
| Cash flows from financing activities: | | | | | |
| Proceeds from issuance of debt | 16,286 | | 13,328 | | 9,260 |
| Payments on debt | (9,882) | | (6,601) | | (6,538) |
| Net change in commercial paper | 2,648 | | 1,689 | | 2,289 |
| Advances to TFSA | (24) | | (24) | | (14) |
| Dividends paid | (130) | | (115) | | - |
Distribution of net assets to TFSA1 | - | | - | | (60) |
| Net cash provided by financing activities | 8,898 | | 8,277 | | 4,937 |
| | | | | | |
| Net increase (decrease) in cash and cash equivalents | 514 | | 16 | | (19) |
| | | | | | |
| Cash and cash equivalents at the beginning of the period | 815 | | 799 | | 818 |
| Cash and cash equivalents at the end of the period | $1,329 | | $815 | | $799 |
| | | | | | |
1 Non-cash investing and financing activities in connection with the fiscal 2005 distribution of net assets to TFSA are discussed in further detail
in Note 1 – Nature of Operations.
See Accompanying Notes to Consolidated Financial Statements.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 -– Nature of Operations
Toyota Motor Credit Corporation
(“TMCC”) was incorporated in California in 1982 and commenced operations in 1983.
TMCCReferences herein to “TMCC” denote Toyota Motor Credit Corporation, and references herein to “we”, “our”, and “us” denote Toyota Motor Credit Corporation and its consolidated
subsidiaries, collectively referred to herein as the “Company”,subsidiaries. We are
wholly ownedwholly-owned by Toyota Financial Services Americas Corporation (“TFSA”), a California corporation, which is a
wholly ownedwholly-owned subsidiary of Toyota Financial Services Corporation (“TFSC”), a Japanese corporation. TFSC, in turn, is a
wholly ownedwholly-owned subsidiary of Toyota Motor Corporation (“TMC”), a Japanese corporation. TFSC manages TMC’s worldwide
financefinancial services operations. TMCC is marketed under the brands of Toyota Financial Services and Lexus Financial Services.
The Company's business is substantially dependent upon the sale of Toyota and Lexus vehicles by Toyota Motor Sales, U.S.A., Inc. (“TMS”).The Company provides
We provide a variety of finance and insurance products to authorized Toyota and Lexus vehicle dealers and, to a lesser extent, other domestic and import franchise dealers (collectively referred to as “vehicle dealers”) and their
customers. The Companycustomers in the United States (excluding Hawaii) (the “U.S.”) and Puerto Rico. We also
providesprovide finance products to commercial and industrial equipment dealers (“industrial equipment dealers”) and their customers.
The Company’sOur products fall primarily into the following finance and insurance product categories:
•
| · | Finance - The Company providesWe provide a broad range of finance products including retail financing, leasing, and dealer financing to vehicle and industrial equipment dealers and their customers. |
•
| · | Insurance - Through Toyota Motor Insurance Services, Inc. (“TMIS”), a wholly ownedwholly-owned subsidiary, the Company provideswe provide marketing, underwriting, and claims administration related to covering certain risks of vehicle dealers and their customers. The CompanyWe also providesprovide coverage and related administrative services to certain affiliates. |
The Company’s
Our primary finance and insurance operations are located in the
United States (excluding Hawaii) (“U.S.
”) and
the Commonwealth of Puerto Rico with earning assets principally sourced through Toyota and Lexus vehicle dealers.
The Company also holds minority interests of less than $1 million in Toyota Credit Argentina S.A. and Toyota Compania Financiera de Argentina S.A., both TFSA majority-owned subsidiaries in Argentina.
During fiscal 2005,
the Companywe transferred substantially all of
itsour interests in Toyota Services de Mexico, S.A. de C.V. (“TSM”) and Toyota Services de Venezuela, C.A. (“TSV”), and
itsour minority interest in Banco Toyota do
Brazil,Brasil, S.A. (“BTB”), to TFSA. The transfer of the $17 million carrying value, net of the $6 million cumulative translation adjustment, of
the Company’sour interests in these entities was accounted for as a distribution of assets and, accordingly, a reduction of shareholder’s equity.
Included in the distribution of assets was a net non-cash decrease in our assets and liabilities of $133 million and $130, respectively. Due to the immaterial size of the Mexican and Venezuelan operations and the Brazilian holdings relative to
the Company’sour consolidated financial condition and results of operations, the related assets, liabilities, and results of operations prior to the transfer are included with the results of ongoing operations in the Consolidated Balance Sheet and Consolidated Statement of Income.
As of March 31,
2005,2007, approximately
23%23 percent of managed vehicle retail and lease assets were located in California,
8%9 percent in Texas,
7%7 percent in New York, and
5%6 percent in New Jersey.
The concentration of the remaining vehicle retail and lease assets is spread throughout the other 45 serviced states. In addition, at March 31, 2005, the 25 largest aggregate outstanding vehicle and industrial equipment dealer receivables totaled $2,724 million.- 71 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 -– Summary of Significant Accounting Policies
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 and 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.
Principles of Consolidation
The consolidated financial statements include the accounts of TMCC and its
wholly ownedwholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated.
Cash and Cash Equivalents
Cash equivalents, consisting primarily of money market instruments and debt securities, represent highly liquid investments with original maturities of three months or less.
Investments in Marketable Securities
Investments in marketable securities consist of
debtfixed income and equity securities and interests retained in the sale of receivables.
The Company’sOur accounting policies related to the valuation of interests retained in the sale of receivables are discussed under “Sale of Receivables and Valuation of Retained Interests” within this footnote.
Debt
Fixed income and equity securities are designated as available-for-sale and carried at fair value using quoted market prices
or discounted cash flow analysis with unrealized gains or losses included in accumulated other comprehensive income, net of applicable taxes.
The Company uses��We use the specific identification method to determine realized gains and losses related to
itsour investment portfolio. Realized investment gains and losses are reflected in investment and other income in the Consolidated Statement of Income.
The Company evaluates debt Premiums and discounts on investments are amortized to investment income using the effective interest method.
We utilize a systematic process to evaluate whether unrealized losses related to investments in fixed income and equity securities
forare temporary in nature. Factors considered in determining whether a loss is other-than-temporary
impairment by identifying securities that have declines in fair market value that meet the Company’s predetermined dollar and percentage thresholds. Consideration is given to, among other factors,include the length of time
and extent to which the
securityfair value has
remained below amortizedbeen less than cost, the financial condition and
near-term prospects of the
investee, changesissuer, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in
the investee’s economic or technical environment, and changes in the investee’s debt rating.fair value. If
the decline islosses are considered to be other-than-temporary, the cost basis of the security is written down to fair value and the write down is reflected in investment and other income in the Consolidated Statement of Income.
Declines in fair value below amortized cost experienced for twelve consecutive months are considered other-than-temporary regardless of dollar amount.- 72 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of Significant Accounting Policies (Continued)Retail Receivables and Dealer Financing
Revenues associated with retail receivables and dealer financing are recognized so as to approximate a level rate of return over the contract term. Incremental direct costs incurred in connection with the acquisition of retail receivables and dealer financing, including incentive and rate participation payments made to vehicle dealers, and incremental direct costs, are capitalized and amortized so as to approximate a level rate of return over the term of the related contracts. Retail receivables are reported at their outstanding balance, including
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 – Summary of Significant Accounting Policies (Continued)
accrued interest and incremental direct costs, net of unearned income.
Unearned income includes deferred income on affiliate sponsored special rate program (“subvention”) payments received from affiliates.
The Company intendsWe intend to hold substantially all of
itsour retail receivables to maturity.
At lease inception,
the Company recordswe record the aggregate future minimum lease payments, contractual residual value of the leased vehicle, and unearned income. Unearned income includes deferred subvention payments received from affiliates. Revenue is recognized over the lease term so as to approximate a level rate of return on the outstanding net investment. Incremental direct costs and fees paid or received in connection with the acquisition of direct finance leases, including incentive and rate participation payments made to vehicle dealers
incremental direct costs, and acquisition fees collected from customers, are capitalized and amortized so as to approximate a level rate of return over the term of the related contracts.
Investments in Operating Leases
Investments in operating leases are recorded at cost and depreciated on a straight-line basis over the lease term to the estimated residual value. Operating lease revenue is recorded to income on a straight-line basis over the term of the lease. Incremental direct costs and fees paid or received in connection with the acquisition of vehicle leases, including incentive and rate participation payments made to vehicle dealers
incremental direct costs, and acquisition fees collected from customers, are capitalized and amortized on a straight-line basis over the term of the related contracts. Investments in operating leases are recorded net of deferred subvention payments received from affiliates and deferred acquisition fees collected from customers.
- 73 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary Operating lease revenue is recorded net of Significant Accounting Policies (Continued)
sales taxes collected from customers.
Determination of Residual ValuesThe contractual
Substantially all of our residual
value risk relates to our vehicle lease portfolio. Residual values of lease earning assets are estimated at lease inception by examining external industry data and
the Company’sour own
historical residual experience. Factors considered in this evaluation include,
but are not limited to, expected economic conditions,
historical trends, and market information on new
andvehicle pricing, new vehicle incentive programs, new vehicle sales, product attributes of popular vehicles, the mix of used vehicle
sales. Duringsupply, the
level of current used vehicle values, and fuel prices. Our management periodically reviews the estimated end of term
market values of
leased vehicles to assess the
lease, management evaluates the adequacyappropriateness of its
estimatecarrying values. To the extent the estimated end of
term market value of a leased vehicle is lower than the residual value
and makesestablished at lease inception, the residual value of the leased vehicle is adjusted downward
adjustments toso that the carrying value
toat lease end will approximate the
extentestimated end of term market value. Factors affecting the
estimated end of term market value
are similar to those considered in the evaluation of residual values at lease
maturity is estimatedinception discussed above. These factors are evaluated in the context of their historical trends to
be less thananticipate potential changes in the
carrying value and when such decline is considered to be other-than-temporary.relationship among those factors in the future. For operating leases, adjustments are made on a straight-line basis over the remaining terms of the leases and are included in depreciation on operating leases
expense in the Consolidated Statement of Income. For direct finance leases, adjustments are made at the time of assessment and are
includedrecorded as a reduction
toof direct finance lease revenues in the Consolidated Statement of Income.
In addition,
We periodically evaluate the
Company also periodically evaluates the currentcarrying value of operating leases for impairment.
Operating lease assets are considered impaired whenIf the expected undiscounted future cash flows over the remaining lease
termterms are less than book
value.The Company usesvalue, the operating lease assets are considered to be impaired and a loss is recorded in the current period Consolidated Statement of Income. We use various channels to sell vehicles returned at lease end. The Company doesWe do not
re-lease returned vehicles.
Substantially all
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 – Summary of the Company’s residual value risk relates to its vehicle lease portfolio. To date, the Company has not incurred material losses related to declines in contractual residual values on its industrial equipment portfolio.Significant Accounting Policies (Continued)
Allowance for Credit LossesThe Company maintains
We maintain an allowance for credit losses to cover probable losses on
itsour earning assets resulting from the failure of customers or dealers to make required payments. Management evaluates the allowance at least quarterly, considering a variety of factors and assumptions to determine whether the allowance is considered adequate to cover probable losses. The allowance for credit losses is management’s best estimate of the amount of probable credit losses in
the Company’sour existing portfolio.
Increases to the allowance for credit losses are accompanied by corresponding charges to the provision for credit losses. Except where applicable law requires otherwise, account balances are charged off when payments due are no longer expected to be received or the account is
180150 days contractually delinquent, whichever occurs first. Related collateral, if recoverable, is repossessed and sold. Any shortfalls between proceeds received from the sale of repossessed collateral and the amounts due from customers are charged against the allowance. The allowance related to
the Company’sour earning assets is included in finance receivables, net and investment in operating leases, net in the Consolidated Balance Sheet. The related provision expense is included in the provision for credit losses in the Consolidated Statement of Income. Charge-offs are presented net of amounts recovered on previously charged off accounts.
- 74 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of Significant Accounting Policies (Continued)Derivative Instruments
All derivative instruments are recorded on the balance sheet at fair value, taking into consideration the effects of legally enforceable master netting agreements that allow
the Companyus to net settle positive and negative positions and offset cash collateral held with the same counterparty on a net basis. Changes in the fair value of the derivatives are recorded in interest expense in the Consolidated Statement of Income.
The Company categorizes
We categorize derivatives as those designated for hedge accounting (“hedge accounting derivatives”) and those that are not designated for hedge accounting (“non-hedge accounting derivatives”).
The Company designatesWe elect at inception whether
theto designate a derivative
is consideredas a hedge
accounting derivative or a non-hedge accounting derivative. That designation may change based on management’s intentions and changing circumstances.
Hedge accounting derivatives are comprised of pay-float interest rate swaps and cross currency interest rate swaps. Non-hedge accounting derivatives are comprised of pay-fixed interest rate swaps, de-designated pay-float interest rate swaps, pay-float interest rate swaps for which hedge accounting has not been elected, interest rate caps, and currency basis swaps. De-designation of hedge accounting derivatives is further discussed below.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 – Summary of Significant Accounting Policies (Continued)
In order to qualify for hedge accounting, a derivative must be considered highly effective at reducing the risk associated with the exposure being hedged. When
the Company designateswe designate a derivative in a hedging relationship,
the Company documentswe document the risk management objective and strategy. This documentation includes the identification of the hedging instrument, the hedged item and the risk exposure, and how
the Companywe will assess effectiveness prospectively and retrospectively.
The Company assessesWe assess the extent to which a hedging instrument is effective at achieving offsetting changes in fair value at least quarterly.
The Company recognizesWe recognize changes in the fair value of derivatives designated in fair value hedging relationships (including foreign currency fair value hedging relationships) in interest expense in the Consolidated Statement of Income along with the fair value changes of the hedged item attributable to the hedged risk. For certain types of
existing hedge relationships that meet stringent criteria,
the Company applieswe apply the shortcut method, which provides an assumption of zero ineffectiveness that results in equal and offsetting changes in fair value in the Consolidated Statement of Income for both the hedged debt and the hedge accounting derivative.
When the shortcut method is not applied, any ineffective portion of the derivative that is designated as a fair value hedge is recognized as a component of interest expense in the Consolidated Statement of Income. If
the Company electswe elect not to designate a derivative instrument in a hedging relationship, or the relationship does not qualify for hedge accounting treatment, the full change in the fair value of the derivative instrument is recognized as a component of interest expense in the Consolidated Statement of Income with no offsetting
fair value adjustment for the
economically hedged item.
The Company reviews
We review the effectiveness of
itsour hedging relationships quarterly to determine whether the relationships have been and continue to be effective.
The Company currently usesWe use regression analysis to assess the effectiveness of
itsour hedges.
The Company began using regression analysis to assess hedge effectiveness in the fourth quarter of fiscal 2004. Prior to that date, the Company employed the dollar-offset method. When
the Company determineswe determine that a hedging relationship
is not or has not been effective, hedge accounting is no longer applied. If hedge accounting is discontinued,
the Company continueswe continue to carry the derivative instrument as a component of other assets or other liabilities in the Consolidated Balance Sheet at
itsour fair value with changes in fair value reported as interest expense in the Consolidated Statement of Income. Additionally, for discontinued fair value hedges,
the Company ceaseswe cease to adjust the hedged item for changes in fair value and amortizes the cumulative fair value adjustments recognized in prior periods over the remaining term of the debt.
- 75 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of Significant Accounting Policies (Continued)
The Company
We will also discontinue the use of hedge accounting if a derivative is sold, terminated, or exercised, or if
the Company’s management determines that designating a derivative under hedge accounting is no longer appropriate (“de-designated derivatives”). De-designated derivatives are included within the category of non-hedge accounting derivatives.
The Company’s goal is to manage the interest rate risk arising from the differences in timing between the re-pricing of assets relative to liabilities. The Company uses non-hedge accounting derivatives to manage this exposure. The use of non-hedge accounting derivatives to mitigate interest rate risk has resulted in significant earnings volatility. This volatility arises from the accounting treatment of the Company’s non-hedge accounting derivatives, which requires that changes in the fair value of the non-hedge accounting derivatives be reflected in the Consolidated Statement of Income. The Company addresses this earnings volatility by de-designating derivatives (previously treated as hedge accounting derivatives) that have offsetting economic characteristics to the non-hedge accounting derivatives. Volatility is reduced as a result of de-designation because combining the changes in fair value of de-designated derivatives with those of other non-hedge accounting derivatives results in a natural offset in the Statement of Consolidated Income. The hedged item associated with the derivative previously treated as a hedge accounting derivative ceases to be adjusted for changes in fair value upon de-designation. The Company began de-designating these derivatives in the fourth quarter of fiscal 2004.
The Company employs analytical measures such as duration and Value at Risk to identify which hedge accounting derivatives to de-designate. The Company performs similar analyses when entering into new derivative transactions. To the extent the Company can more closely match the accounting treatment to the underlying economics of the derivatives portfolio by not electing hedge accounting, the transaction is identified and treated as a non-hedge accounting derivative.
Foreign Currency Transactions
Certain transactions
we have entered into,
by the Company, primarily related to debt, are denominated in foreign currencies. These transactions are fully hedged at issuance. During periods when the debt and the related derivatives do not qualify for hedge accounting, these transactions are translated into U.S. dollars using the applicable exchange rate at the transaction date and retranslated at each balance sheet date using the exchange rate in effect at that date. Gains and losses related to foreign currency transactions, primarily debt, are included in interest expense in the Consolidated Statement of Income.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 – Summary of Significant Accounting Policies (Continued)
Insurance Earned Premiums Earned and Contract Revenues
Revenues from providing coverage under various contractual agreements are recognized over the
termsterm of the
agreementscoverage in relation to the timing and level of anticipated
claims and administrative expenses. Revenues from insurance premiums, net of premiums ceded to reinsurers, are earned over the terms of the respective policies in proportion to the estimated loss development. Management relies on historical loss experience as a basis for establishing earnings factors used to recognize revenue over the term of the contract or policy.
The portion of premiums and
servicecontract revenues written applicable to the unexpired terms of the policies is recorded as unearned premiums or unearned
servicecontract revenue. Policies and contracts sold are usually in force from 3 to 84 months. Certain costs of acquiring new business, consisting primarily of commissions and premium taxes, are deferred and amortized over the term of the related policies on the same basis as revenues are earned.
- 76 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of Significant Accounting Policies (Continued)
Commissions and fees from services provided are recognized over the term of the coverage in relation to the timing of services performed. The effect of subsequent cancellations is recorded as an offset to
earnedunearned insurance premiums
and unearned contract
revenues, and commissions and fees, accordingly.revenues.
Insurance Losses and Loss Adjustment Expenses
Insurance losses
and loss adjustment expenses include amounts paid and accrued for loss events that are known and have been recorded as claims, estimates of losses incurred but not reported that are based on actuarial estimates and historical loss development patterns, and loss adjustment expenses that are expected to be incurred in connection with settling and paying these claims.
Accruals for unpaid losses,
and losses incurred but not reported,
and loss adjustment expenses are included in other liabilities in the Consolidated Balance Sheet. Estimated liabilities are reviewed regularly and
the Company recognizeswe recognize any differences in the periods they are determined. If anticipated losses, loss adjustment expenses, unamortized acquisition costs, and maintenance costs exceed the recorded unearned premium,
or deferred income reserve, a premium deficiency is recognized by first charging any unamortized acquisition costs to expense and then by recording a liability for any excess deficiency.
ReinsuranceThe Company purchases
On certain covered risks, we purchase on an annual basis
excess of loss reinsurance to protect
us against the
impact of large, irregularly occurring losses. Reinsurance reduces the magnitude of sudden
unpredictable changes in net income. The amounts recoverable from reinsurers are estimated in a manner consistent with the reinsuredreinsurance policy and include recoverable amounts for paid and unpaid losses. Amounts recoverable from reinsurers on unpaid losses, including incurred but not reported losses, and amounts paid to reinsurers relating to the unexpired portion of reinsurance contracts are included in other assets in the Consolidated Balance Sheet. Ceded insurance-related expenses are recorded as a reduction to insurance losses and loss adjustment expenses in the Consolidated Statement of Income. Amounts recoverable from reinsurers are recorded as a receivable but are not collectible until the losses are paid.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 – Summary of Significant Accounting Policies (Continued)
Income TaxesThe Company uses
We use the liability method of accounting for income taxes under which deferred tax assets and liabilities are adjusted to reflect changes in tax rates and laws in the period such changes are enacted resulting in adjustments to the current fiscal year’s provision for income taxes.
TMCC files a consolidated federal income tax return with its
domestic parentsubsidiaries and
subsidiaries.TFSA. TMCC files either separate or consolidated/combined state income tax returns with Toyota Motor North America (“TMA”)
, TFSA, or
other domestic parent and subsidiaries of TMCC. State income tax expense is generally recognized as if TMCC and its
domestic subsidiaries filed their tax returns on a stand-alone basis. In those states where TMCC and its
domestic subsidiaries join in the filing of consolidated or combined income tax returns, TMCC and its
domestic subsidiaries are allocated their share of the total income tax expense based on combined allocation/apportionment factors and separate company income or loss. Based on the state tax sharing agreement with TMA, TMCC and its
domestic subsidiaries pay for their share of the combined income tax expense and are reimbursed for the benefit of any of their tax losses utilized in the combined state income tax returns.
- 77 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of Significant Accounting Policies (Continued)Sale of Receivables and Valuation of Retained Interests
The Company’s
Our securitization transactions are completed using qualified special purpose entities (“QSPE”), also referred to as securitization trusts, and are usually structured to obtain sale accounting. Sale accounting treatment requires that gains or losses on finance receivables sold are recognized in the period in which the sale occurs. The recorded gains or losses on sold receivables depend on the carrying amount and the fair value of such receivables, less the fair value of retained obligations, if any, at the sale date. The carrying amount is allocated between the sold receivables and the subordinated retained interests described below based on their relative fair values at the sale date. Gains or losses on sold receivables are included in investment and other income in the Consolidated Statement of Income.
The Company retains senior and
We retain subordinated interests in the securitizations, which are included in investments in marketable securities
and other assets in the Consolidated Balance Sheet.
Senior interests in the securitizations represent senior securities purchased by the Company. Subordinated interests include interest only strips and subordinated securities, which provide credit enhancement to the senior securities. These subordinated retained interests are paid after the required distributions are made to senior securities. The subordinated retained interests do not have a readily available market value. Therefore, the fair value of the retained interests is calculated by discounting forecasted cash flows using management’s estimates of key economic assumptions. All key assumptions used in the valuation of the retained interests are periodically reviewed and are revised as deemed appropriate.
The Company recognizes
We recognize income from retained interests over the life of the respective underlying retained interest using the effective yield method. The yield represents the excess of all forecasted cash flows over the initial amount recorded as the retained interest at the sale date. As adjustments to forecasted cash flows are made,
the Company adjustswe adjust the rate at which income is earned prospectively. If changes in the forecasted cash flows result in an other-than-temporary decline in the fair value of the retained interests, then an impairment loss is recognized to the extent that the fair value is less than the carrying amount. Such losses, when incurred, are included in investment and other income in the Consolidated Statement of Income. Otherwise, any difference in the carrying amount and the fair value of the retained interest is recognized as an unrealized gain or loss, net of income taxes, and is included in accumulated other comprehensive income in the Consolidated Balance Sheet.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 – Summary of Significant Accounting Policies (Continued)
In October 2004,February 2006, the Emerging Issues Task ForceFinancial Accounting Standards Board (“EITF”FASB”) ratified its consensus on Issueissued Statement of Financial Accounting Standards (“SFAS”) No. 04-10, “Applying Paragraph 19 of FASB Statement155, “Accounting for Certain Hybrid Instruments” (“SFAS 155”), which permits, but does not require, fair value accounting for any hybrid financial instrument that contains an embedded derivative that would otherwise require bifurcation in accordance with SFAS No. 131, “Disclosure about Segments of an Enterprise133 “Accounting for Derivative Instruments and Related Information,” in Determining Whether to Aggregate Operating Segments That Do Not Meet the Quantitative Thresholds”Hedging Activities” (“EITF 04-10”SFAS 133”). EITF 04-10 clarifiesThe statement also subjects beneficial interests issued by securitization vehicles to the requirements of SFAS 133. We adopted the statement on April 1, 2006 and it did not have a material impact on our consolidated financial statements.
In March 2006, the FASB issued SFAS No. 156, “Accounting for
operating segment aggregation.Servicing of Financial Assets” (“SFAS 156”), which amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, with respect to the accounting for separately recognized servicing assets and servicing liabilities. This statement is effective as of April 1, 2007. The
effective dateadoption of
EITF 04-10 is currently pending. The implementation of EITF 04-10SFAS 156 is not expected to have a material impact on
the Company’sour consolidated financial statements.
- 78 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 - Summary of Significant Accounting Policies (Continued)
In
November 2004,July 2006, the
EITF ratified its consensus on IssueFASB issued FASB Interpretation No.
03-13, “Applying the Conditions48, “Accounting for Uncertainty in
Paragraph 42Income Taxes—an interpretation of FASB Statement No.
144109” (“FIN 48”), which clarifies the accounting for uncertainty in
Determining Whether to Report Discontinued Operations” (“EITF 03-13”). EITF 03-13 relates to components of an enterprisetax positions. This Interpretation requires that
are either disposed of or classified as held for salewe recognize in
fiscal periods beginning after December 15, 2004. EITF 03-13 allows significant events or circumstances that occur after the balance sheet date but before the issuance ofour financial statements,
the impact of a tax position, if that position is more likely than not to be
taken into consideration in the evaluation of whether a component should be presented as discontinued or continuing operations, and modifies assessment period guidance to allow for an assessment period greater than one year. The implementation of EITF 03-13 did not have a material impactsustained on audit, based on the
Company’s consolidated financial statements.In June 2005,technical merits of the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections” (“FAS 154”). FAS 154 replaces APB Opinion No. 20, “Accounting Changes” and FAS No. 3, “Reporting Accounting Changes in Interim Financial Statements”. FAS 154 requires that a voluntary change in accounting principleposition. FIN 48 will be applied retrospectively with all prior period financial statements presented on the new accounting principle. FAS 154 also requires that a change in method of depreciating or amortizing a long-lived nonfinancial asset be accounted for prospectively as a change in estimate, and correction of errors in previously issued financial statements should be termed a “restatement”. FAS 154 is effective for accounting changes and correctionus as of errors made in fiscal years beginning after December 15, 2005.April 1, 2007. The implementationadoption of FAS 154FIN 48 is not expected to have a material impact on the Company’sour consolidated financial statements.
Reclassifications
Certain
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides guidance on how prior period amountsyear misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the financial statements are materially misstated. SAB 108 is effective for our annual financial statements covering the fiscal year ended March 31, 2007. The implementation of SAB 108 did not have been reclassified to conforma material impact on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The standard provides a consistent definition of fair value which focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over specific entity inputs. The standard establishes a three level hierarchy for fair value measurements based on the transparency of inputs to the
current period presentation.- 79 -
valuation of an asset or liability as of the measurement date. SFAS 157 is effective for us as of April 1, 2008. We are currently evaluating the impact of adopting SFAS 157 and are unable to estimate its impact, if any, on our consolidated financial statements. TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2 – Summary of Significant Accounting Policies (Continued)
In September 2006, the FASB issued SFAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (“SFAS 158”). This standard requires employers that sponsor defined benefit plans to recognize the over-funded status of a defined benefit postretirement plan as an asset or a liability in its statement of financial
position and to recognize changes in that funded status in the year in which the changes occur, through comprehensive income. SFAS 158 requires the determination of the fair values of a plan’s assets at a
company’s year-end and recognition of actuarial gains and losses, prior service costs or credits, and transition assets or obligations as a component of Accumulated Other Comprehensive Income. This statement is effective for us as of March 31, 2007. We are a participating employer in certain retirement, postretirement health care and life insurance plans that are sponsored by an affiliate, Toyota Motor Sales, U.S.A., Inc. (“TMS”). We adopted SFAS 158 as of March 31, 2007 and it did not have a material impact on Shareholder’s Equity.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115 (“SFAS 159”), which is effective for us as of April 1, 2008, with earlier adoption permitted. This standard provides an option to irrevocably elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments, and written loan commitments. Under SFAS 159, fair value would be used for both the initial and subsequent measurement of the designated assets, liabilities and commitments, with the changes recognized in earnings. We are currently evaluating the impact of adopting SFAS 159 and are unable to estimate its impact, if any, on our consolidated financial statements.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 -– Investments in Marketable Securities
The amortized cost and estimated fair value of investments in marketable securities
and related unrealized gains and losses are as
follows: | March 31, 2005 |
|
|
| Cost | | Fair Value | | Unrealized Gains | | Unrealized Losses |
|
| |
| |
| |
|
| (Dollars in millions) |
Available-for-sale securities: | | | | | | | |
Subordinated securities | $79 | | $79 | | $- | | $- |
Interest-only strips | 14 | | 30 | | 16 | | - |
Other asset-backed securities | 291 | | 292 | | 2 | | (1) |
Corporate debt securities | 110 | | 111 | | 2 | | (1) |
Equity securities | 288 | | 344 | | 57 | | (1) |
U.S. debt securities | 71 | | 71 | | 1 | | (1) |
|
| |
| |
| |
|
Total marketable securities | $853 | | $927 | | $78 | | ($4) |
|
| |
| |
| |
|
| March 31, 2004 |
|
|
| Cost | | Fair Value | | Unrealized Gains | | Unrealized Losses |
|
| |
| |
| |
|
| (Dollars in millions) |
Available-for-sale securities: | | | | | | | |
Senior securities | $110 | | $110 | | $ - | | $ - |
Subordinated securities | 244 | | 245 | | 1 | | - |
Interest-only strips | 49 | | 75 | | 26 | | - |
Other asset-backed securities | 320 | | 328 | | 8 | | - |
Corporate debt securities | 100 | | 105 | | 5 | | - |
Equity securities | 174 | | 216 | | 44 | | (2) |
U.S. debt securities | 45 | | 46 | | 1 | | - |
|
| |
| |
| |
|
Total marketable securities | 1,042 | | 1,125 | | $85 | | ($2) |
|
| |
| |
| |
|
follows (dollars in millions):
| | March 31, 2007 |
| | Cost | | Fair Value | | Unrealized Gains | | Unrealized Losses |
Available-for-sale securities: | | | | | | | |
| Subordinated securities | $9 | | $9 | | $- | | $- |
| Interest-only strips | - | | 1 | | 1 | | - |
| Asset-backed securities | 28 | | 28 | | - | | - |
| Mortgage-backed securities | 151 | | 152 | | 1 | | - |
| U.S. Treasury and government agency debt securities | 53 | | 53 | | - | | - |
| Municipal debt securities | - | | - | | - | | - |
| Foreign government debt securities | - | | - | | - | | - |
| Corporate debt securities | 128 | | 130 | | 2 | | - |
Equity securities1 | 1,014 | | 1,092 | | 82 | | (4) |
| Other debt securities | - | | - | | - | | - |
| Total marketable securities | $1,383 | | $1,465 | | $86 | | ($4) |
| | March 31, 2006 |
| | Cost | | Fair Value | | Unrealized Gains | | Unrealized Losses |
Available-for-sale securities: | | | | | | | |
| Subordinated Securities | $23 | | $23 | | $- | | $- |
| Interest-only strips | 2 | | 7 | | 5 | | - |
| Asset-backed securities | 15 | | 15 | | - | | - |
| Mortgage-backed securities | 338 | | 334 | | 2 | | (6) |
| U.S. Treasury and government agency debt securities | 67 | | 65 | | - | | (2) |
| Municipal debt securities | 12 | | 12 | | - | | - |
| Foreign government debt securities | 5 | | 5 | | - | | - |
| Corporate debt securities | 148 | | 147 | | 1 | | (2) |
Equity securities1 | 380 | | 478 | | 99 | | (1) |
| Other debt securities | 90 | | 90 | | - | | - |
| Total marketable securities | $1,080 | | $1,176 | | $107 | | ($11) |
1 The balance at March 31, 2007 includes private placement fixed income pooled trusts which had a cost of $491 million and fair
market value of $492 million. The balance at March 31, 2006 includes private placement fixed income pooled trusts which had
a cost and fair market value of $17 million.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 – Investments in Marketable Securities (Continued)
At March 31,
20052007 and
2004,2006, there were no marketable securities in
the Company’sour available-for-sale portfolio with material unrealized losses that have been in an unrealized loss position for more than a year.
- 80 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Proceeds from sales and realized gains and losses on sales from available-for-sale securities are presented below (dollars in millions).
| | Years Ended March 31, |
| | 2007 | | 2006 | | 2005 |
Available-for-sale securities1: | | | | | |
| Proceeds from sales | $936 | | $1,282 | | $610 |
| Realized gains on sales | $82 | | $13 | | $13 |
Realized losses on sales2 | $10 | | $8 | | $8 |
1 The cash flow information presented above relates to our investment portfolio of our insurance operations. Cash flows related
to interests retained in securitization transactions are discussed in Note 3 - Investments7 – Sale of Receivables.
2 Realized losses incurred in Marketable Securities (Continued)fiscal 2007, 2006, and 2005 include $6 million, $3 million and $4 million, respectively, in | Years Ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
| (Dollars in millions) |
Available-for-sale securities1: | | | | | |
Proceeds from sales | $610 | | $658 | | $456 |
Realized gains on sales | $13 | | $13 | | $8 |
Realized losses on sales2 | $8 | | $3 | | $29 |
1
| The cash flow information presented above relates to the Company’s investment portfolio of its insurance operations. Cash flows related to interests retained in securitization transactions are discussed in Note 7 – Sale of Receivables.
|
2
| Realized losses incurred in fiscal 2005 and 2003 include $4 million and $25 million, respectively, in impairment losses. No impairment losses were incurred in fiscal 2004.
|
impairment losses.
The contractual maturities of investments in marketable securities at March 31,
20052007 are
as follows: | Available-for-Sale Securities |
|
|
| Cost | | Fair Value |
|
| |
|
| (Dollars in millions) |
| |
Within one year | $44 | | $48 |
After one year through five years | 233 | | 245 |
After five years through ten years | 98 | | 98 |
After ten years | 190 | | 192 |
Equity securities | 288 | | 344 |
|
| |
|
Total | $853 | | $927 |
|
| |
|
summarized in the following table (dollars in millions). Prepayments may cause actual maturities to differ from scheduled maturities.
| | |
Available-for-Sale Securities: | Cost | | Fair Value |
| Within one year | $25 | | $26 |
| After one year through five years | 102 | | 103 |
| After five years through ten years | 41 | | 41 |
| After ten years | 201 | | 203 |
| Equity securities | 1,014 | | 1,092 |
| Total | $1,383 | | $1,465 |
In accordance with statutory requirements,
the Companywe had on deposit with state insurance authorities U.S. debt securities with amortized cost and fair value of
$5 million and $4 million at March 31,
20052007 and
$5 million at March 31, 2004.- 81 -
2006, respectively.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4 -– Finance Receivables, Net
Finance receivables, net consisted of the
following: | March 31, |
|
|
| 2005 | | 2004 |
|
| |
|
| (Dollars in millions) |
| |
Retail receivables | $29,026 | | $22,377 |
Direct finance leases | 2,208 | | 4,234 |
Dealer financing | 6,967 | | 6,571 |
|
| |
|
| 38,201 | | 33,182 |
Deferred origination costs | 555 | | 484 |
Unearned income | (706) | | (966) |
Allowance for credit losses | (442) | | (382) |
|
| |
|
Finance receivables, net | $37,608 | | $32,318 |
|
| |
|
following (dollars in millions):
| | March 31, |
| | 2007 | | 2006 |
| Retail receivables | $38,785 | | $33,919 |
| Direct finance leases | 778 | | 1,270 |
| Dealer financing | 8,868 | | 7,329 |
| | 48,431 | | 42,518 |
| Deferred origination costs | 684 | | 627 |
| Unearned income | (760) | | (627) |
| Allowance for credit losses | (493) | | (496) |
| Finance receivables, net | $47,862 | | $42,022 |
The net investment in direct finance leases included in finance receivables, net consisted of the
following: | March 31, |
|
|
| 2005 | | 2004 |
|
| |
|
| (Dollars in millions) |
| |
Minimum lease payments to be received | $1,372 | | $2,960 |
Estimated unguaranteed residual values | 836 | | 1,274 |
|
| |
|
Direct finance leases | 2,208 | | 4,234 |
Plus: Deferred origination costs | 15 | | 31 |
Less: Unearned income | (280) | | (616) |
|
| |
|
Investment in direct finance leases, net of unearned income | $1,943 | | $3,649 |
|
| |
|
- 82 -
following (dollars in millions):
| | March 31, |
| | 2007 | | 2006 | |
| Minimum lease payments to be received | $485 | | $719 | |
| Estimated unguaranteed residual values | 293 | | 551 | |
| Direct finance leases | 778 | | 1,270 | |
| Plus: Deferred origination costs | 2 | | 6 | |
| Less: Unearned income | (64) | | (126) | |
| Investment in direct finance leases, net of unearned income | $716 | | $1,150 | |
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4 -– Finance Receivables, Net (Continued)
Minimum lease payments on direct finance leases and contractual maturities on retail receivables and dealer financing are as
follows:Years Ending March 31, | | Direct finance leases | | Retail receivables | | Dealer financing |
| |
| |
| |
|
| | (Dollars in millions) |
| | | | | | |
2006 | | $690 | | $7,821 | | $5,684 |
2007 | | 417 | | 7,338 | | 300 |
2008 | | 213 | | 6,437 | | 263 |
2009 | | 45 | | 4,723 | | 398 |
2010 | | 7 | | 2,254 | | 259 |
Thereafter | | - | | 453 | | 63 |
| |
| |
| |
|
Total | | $1,372 | | $29,026 | | $6,967 |
| |
| |
| |
|
follows (dollars in millions):
| | | Minimum lease payments on | | Contractual Maturities |
| Years Ending March 31, | | Direct finance leases | | Retail receivables | | Dealer financing |
| 2008 | | $235 | | $10,540 | | $7,229 |
| 2009 | | 128 | | 9,827 | | 527 |
| 2010 | | 67 | | 8,274 | | 367 |
| 2011 | | 38 | | 6,072 | | 363 |
| 2012 | | 15 | | 3,259 | | 298 |
| Thereafter | | 2 | | 813 | | 84 |
| Total | | $485 | | $38,785 | | $8,868 |
A
substantialsignificant portion of
the Company’sour finance receivables has historically been repaid prior to contractual maturity dates; contractual maturities as shown above should not be considered as necessarily indicative of future cash collections.
Note 5 -– Investments in Operating Leases, Net
Investments in operating leases, net consisted of the
following: | March 31, |
|
|
| 2005 | | 2004 |
|
| |
|
| (Dollars in millions) |
| | | |
Vehicles | $11,510 | | $9,700 |
Equipment and other | 734 | | 688 |
|
| |
|
| 12,244 | | 10,388 |
Deferred origination fees | (23) | | (18) |
Deferred income | (99) | | (58) |
Accumulated depreciation | (2,720) | | (2,565) |
Allowance for credit losses | (61) | | (138) |
|
| |
|
Investments in operating leases, net | $9,341 | | $7,609 |
|
| |
|
- 83 -
following (dollars in millions):
| | March 31, |
| | 2007 | | 2006 |
| Vehicles | $20,448 | | $15,690 |
| Equipment and other | 844 | | 751 |
| | 21,292 | | 16,441 |
| Deferred origination fees | (47) | | (39) |
| Deferred income | (404) | | (311) |
| Accumulated depreciation | (4,287) | | (3,188) |
| Allowance for credit losses | (61) | | (34) |
| Investments in operating leases, net | $16,493 | | $12,869 |
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 5 -– Investments in Operating Leases, Net (Continued)
Future minimum lease rentals on operating leases are as
follows:Years Ending March 31, | | Future Minimum Rentals on Operating Leases |
| |
|
| | (Dollars in millions) |
| | | | |
2006 | | | $1,796 | |
2007 | | | 1,258 | |
2008 | | | 722 | |
2009 | | | 250 | |
2010 | | | 63 | |
Thereafter | | | - | |
| | |
| |
Total | | | $4,089 | |
| | |
| |
follows (dollars in millions):
| Years Ending March 31, | Future Minimum Rentals on Operating Leases |
| 2008 | $3,239 |
| 2009 | 2,380 |
| 2010 | 1,140 |
| 2011 | 355 |
| 2012 | 70 |
| Thereafter | - |
| Total | $7,184 |
A
substantialsignificant portion of
the Company’sour operating lease contracts has historically been terminated prior to maturity; future minimum rentals as shown above should not be considered as necessarily indicative of future cash collections.
Note 6 -– Allowance for Credit Losses
The following
table providestables provide information related to
the Company’sour allowance for credit losses
and aggregate balances 60 or more days past due on finance receivables and investments in operating
leases: | Years Ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
| (Dollars in millions) |
| | | | | |
Allowance for credit losses at beginning of period | $520 | | $462 | | $273 |
Provision for credit losses | 230 | | 351 | | 604 |
Charge-offs, net of recoveries1 | (243) | | (276) | | (370) |
Sale of receivables | - | | (17) | | (45) |
Distribution of net assets to TFSA | (4) | | - | | - |
|
| |
| |
|
Allowance for credit losses at end of period | $503 | | $520 | | $462 |
|
| |
| |
|
1
| leases (dollars in millions):
| | Years Ended March 31, | | | 2007 | | 2006 | | 2005 | | Allowance for credit losses at beginning of period | $530 | | $503 | | $520 | | Provision for credit losses | 410 | | 305 | | 230 | Charge-offs, net of recoveries1 | (386) | | (278) | | (243) | | Distribution of net assets to TFSA | - | | - | | (4) | | Allowance for credit losses at end of period | $554 | | $530 | | $503 |
1 Net of recoveries of $82 million, $79 million, and $69 million, $59 million and $35 million in years ended March 31, 2005, 2004 and 2003, respectively. |
The aggregate balances of finance receivables 60 or more days past due totaled $115 million at both March 31, 2007, 2006 and 2005, and 2004. respectively.
| | Years Ended March 31, |
| | 2007 | | 2006 | | 2005 |
Aggregate balances 60 or more days past due2 | | | | | |
Finance receivables3 | $258 | | $198 | | $115 |
Operating leases3 | 39 | | 38 | | 17 |
| Total | $297 | | $236 | | $132 |
2 Substantially all retail, and direct finance lease, and operating lease receivables do not involve recourse to the dealer in the event of
customer default. The aggregate balances of investments
3 Includes accounts in operating leases of 60 or more days past due totaled $17 millionbankruptcy and $23 million at March 31, 2005 and 2004, respectively.- 84 -
excludes accounts for which vehicles have been repossessed.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 7 -– Sale of ReceivablesThe Company retains
We retain servicing rights and
earnsearn a contractual servicing fee of
1%1 percent per annum on the total monthly outstanding principal balance of
itsour securitized retail receivables.
Of the servicing fee, 0.25% is considered excess servicing income to the Company and is recognized as a servicing fee asset. In a subordinated capacity,
the Company retainswe retain interest-only strips and subordinated securities in these securitizations. The retained interests are held as restricted assets. Investors in the securitizations have no recourse to
the Companyus beyond
the Company’sour retained subordinated interests, any cash reserve funds, and any amounts drawn on
the revolving liquidity
notes discussed in Note 14 – Commitments and Contingencies. The Company’snotes. Our exposure to these retained interests
existsexist until the associated securities are paid in full. Investors do not have recourse to other assets held by TMCC for failure of obligors on the receivables to pay when due.
Cash Flows from Securitizations
No securitizations were executed during fiscal 2007, 2006 and 2005. The following table summarizes
gains on retail finance receivables sold during fiscal 2004 and 2003 and certain cash flows received from, and paid to, the retail securitization trusts outstanding during fiscal
2007, 2006, and 2005
2004, and 2003. No securitizations were executed during fiscal 2005. | Years Ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
| (Dollars in millions) |
| | | | | |
Gains on assets sold | $- | | $30 | | $106 |
| | | | | |
Cash flow information: | | | | | |
Proceeds from new securitizations, net of purchased and retained securities | $- | | $1,269 | | $3,195 |
Servicing fees received | $32 | | $58 | | $54 |
Excess interest received from interest only strips | $79 | | $175 | | $119 |
Repurchases of receivables1 | ($292) | | ($286) | | ($94) |
Servicing advances | ($2) | | ($7) | | ($9) |
Reimbursement of servicing advances | $8 | | $12 | | $13 |
| | | | | | |
| | Years Ended March 31, |
| | 2007 | | 2006 | | 2005 |
| | | | | | |
Cash flow information: | | | | | |
| Servicing fees received | $4 | | $13 | | $32 |
| Excess interest received from interest only strips | $10 | | $30 | | $79 |
Repurchases of receivables1 | - | | ($442) | | ($292) |
| Servicing advances | ($2) | | ($4) | | ($2) |
| Reimbursement of servicing advances | $2 | | $7 | | $8 |
1
| 1Balance represents optional clean-up calls. We exercised our right to repurchase finance receivables from securitization trusts |
Key Economic Assumptions
Key economic assumptions used in estimating the fair value of retained interests at the sale dates of the securitization transactions completed during fiscal 2005, 2004 and 2003 were as follows:
| Years Ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
| | | | | |
Prepayment speed related to securitizations | - | | 1.50% | | 1.50% |
Weighted average life (in years) | - | | 1.85 | | 1.45-1.85 |
Expected annual credit losses | - | | 0.80% | | 0.75-0.80% |
Residual cash flows discount rate | - | | 5%-10% | | 5%-10% |
- 85 -
| as provided for in the terms of our securitization agreements. |
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 7 -– Sale of Receivables (Continued)Expected cumulative static pool losses over the life of the securitizations are calculated by taking actual life to date losses plus projected losses and dividing the sum by the original balance of each pool of assets at the time of the original sale. At March 31, 2005, expected cumulative static pool credit losses for the retail finance receivables securitized in fiscal 2004 and 2003 were 0.49% and 0.54%, respectively. No securitizations were executed during fiscal 2005.
Sensitivity AnalysisThe key economic assumptions and the sensitivity of the current fair value of the retained interests to an immediate 10% and 20% adverse change in those assumptions at March 31, 2005 are presented below:
| (Dollars in millions)
|
| |
Retained interests included in investments in marketable securities
| $108
|
Retained interests included in other assets
| 1
|
|
|
Total retained interests
| $109
|
|
|
| |
Prepayment speed assumption
| 1.50
|
Impact of 10 percent adverse change
| ($4)
|
Impact of 20 percent adverse change
| ($9)
|
| |
Residual cash flows discount rate (annual rate)
| 5.00 – 12.00%
|
Impact of 10 percent adverse change
| ($1)
|
Impact of 20 percent adverse change
| ($1)
|
| |
Expected credit losses
| 0.34 – 0.97%
|
Impact of 10 percent adverse change
| ($1)
|
Impact of 20 percent adverse change
| ($3)
|
These hypothetical scenarios do not reflect expected market conditions and should not be used as a prediction of future performance. As the figures indicate, changes in the fair value may not be linear. In addition, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption. Actual changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. Actual cash flows may differ from the above analysis.
- 86 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 7 - Sale of Receivables (Continued)
Managed Receivables
Outstanding balances, delinquency amounts and net credit losses for managed receivables, which include both owned and securitized receivables, are summarized as
follows: | March 31, |
|
|
| 2005 | | 2004 |
|
| |
|
| (Dollars in millions) |
| | | |
Retail finance receivables managed | $31,096 | | $26,744 |
Direct finance leases managed | 1,943 | | 3,649 |
Dealer financing managed | 6,967 | | 6,571 |
|
| |
|
Total finance receivables managed | 40,006 | | 36,964 |
| | | |
Less: | | | |
Securitized retail finance receivables | 1,956 | | 4,264 |
Allowance for credit losses | 442 | | 382 |
|
| |
|
Total finance receivables owned | $37,608 | | $32,318 |
|
| |
|
| Amount 60 Days or More Past Due | | Credit Losses Net of Recoveries |
|
| |
|
| March 31, | | March 31, |
|
| |
|
| 2005 | | 2004 | | 2005 | | 2004 |
|
| |
| |
| |
|
| (Dollars in millions) |
| | | | | | | |
Retail finance receivables managed | $108 | | $103 | | $198 | | $198 |
Direct finance leases managed | 14 | | 29 | | 34 | | 68 |
Dealer financing managed | - | | - | | - | | - |
|
| |
| |
| |
|
Total finance receivables managed | $122 | | $132 | | $232 | | $266 |
|
| |
| |
| |
|
- 87 -
follows (dollars in millions):
| | March 31, |
| | 2007 | | 2006 |
| Retail finance receivables managed | $38,935 | | $34,573 |
| Direct finance leases managed | 715 | | 1,150 |
| Dealer financing managed | 8,869 | | 7,329 |
| Total finance receivables managed | $48,519 | | $43,052 |
| | | | |
| Less: | | | |
| Securitized retail finance receivables | 164 | | 533 |
| Allowance for credit losses | 493 | | 497 |
| Total finance receivables owned | $47,862 | | $42,022 |
| | Amount 60 Days or More Past Due | | Credit Losses Net of Recoveries |
| | March 31, | | March 31, |
| | 2007 | | 2006 | | 2007 | | 2006 |
| Retail finance receivables managed | $250 | | $183 | | $335 | | $245 |
| Direct finance leases managed | 6 | | 16 | | 10 | | 13 |
| Dealer financing managed | 2 | | 1 | | - | | - |
| Total finance receivables managed | $258 | | $200 | | $345 | | $258 |
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 8 – Interest Expense and Derivatives and Hedging Activities
The following table summarizes the components of interest
expense: | Years ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
| (Dollars in millions) |
| | | | | |
Interest expense on debt | $1,167 | | $1,056 | | $1,107 |
Amortization of basis adjustments on debt | (179) | | (60) | | (20) |
Net interest on hedge accounting derivatives | (177) | | (507) | | (539) |
Amortization of debt issue costs | 43 | | 49 | | 52 |
Ineffectiveness related to hedge accounting derivatives | (15) | | (4) | | (12) |
Other | (12) | | - | | - |
|
| |
| |
|
Interest expense excluding non-hedge accounting results | 827 | | 534 | | 588 |
Net result from non-hedge accounting | (157) | | 44 | | 661 |
|
| |
| |
|
Total interest expense | $670 | | $578 | | $1,249 |
|
| |
| |
|
expense (dollars in millions):
| | Years ended March 31, |
| | 2007 | | 2006 | | 2005 |
| | |
| Interest expense on debt | $2,564 | | $1,792 | | $1,167 |
| Amortization of basis adjustments on debt | (72) | | (128) | | (179) |
| Net interest realized on hedge accounting derivatives | 206 | | (7) | | (177) |
| Amortization of debt issue costs | 57 | | 43 | | 43 |
| Ineffectiveness related to hedge accounting derivatives | 15 | | 4 | | (15) |
| Other | - | | - | | (12) |
| Interest expense excluding non-hedge accounting results | 2,770 | | 1,704 | | 827 |
| Net result from non-hedge accounting | (104) | | (202) | | (157) |
| Total interest expense | $2,666 | | $1,502 | | $670 |
The following table summarizes the components of the net result from non-hedge accounting, which is included in interest
expense. | Years ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
| (Dollars in millions) |
| (Gain)/Loss |
| | | | | |
Currency basis swaps unrealized gain | ($85) | | ($46) | | $- |
Foreign currency transaction loss | 83 | | 52 | | - |
Net interest on non-hedge accounting derivatives | (71) | | 172 | | 232 |
Unrealized (gain) loss on non-hedge accounting derivatives | | | | | |
Interest rate swaps | (62) | | (161) | | 308 |
Interest rate caps | (6) | | 32 | | 121 |
Other | (16) | | (5) | | - |
|
| |
| |
|
Net result from non-hedge accounting | ($157) | | $44 | | $661 |
|
| |
| |
|
- 88 -
expense (dollars in millions):| | Years ended March 31, |
| | 2007 | | 2006 | | 2005 |
| | |
| Currency basis swaps unrealized (gain)/loss | ($127) | | $114 | | ($85) |
| Foreign currency transaction loss/(gain) | 127 | | (115) | | 83 |
| Net interest realized on non-hedge accounting derivatives | (344) | | (260) | | (71) |
| Unrealized loss/(gain) on non-hedge accounting derivatives | | | | | |
| Interest rate swaps | 242 | | 51 | | (62) |
| Interest rate caps | (2) | | 7 | | (6) |
| Other | - | | 1 | | (16) |
| Net result from non-hedge accounting | ($104) | | ($202) | | ($157) |
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 8 – Interest Expense and Derivatives and Hedging Activities (Continued)
The following table summarizes our derivative assets and liabilities, which are included in other assets and other liabilities in the Consolidated Balance Sheet (dollars in millions):
| | March 31, |
| | 2007 | | 2006 |
| | | | |
| Derivative assets | $1,520 | | $1,152 |
Less: Collateral held1 | 291 | | 251 |
| Derivative assets, net of collateral | $1,229 | | $901 |
| | | | |
| Derivative liabilities | $97 | | $230 |
| 1 Represents cash received under reciprocal collateral arrangements that we have entered into with certain derivative |
| counterparties as described below under “Counterparty Credit Risk”. |
Counterparty Credit RiskThe Company enters
We enter into reciprocal collateral arrangements with certain counterparties to mitigate
itsour exposure to the credit risk associated with the respective counterparty. A valuation of
the Company’sour position with the respective counterparty is performed
at least once a month.monthly. If the market value of
the Company’sour net derivatives position with the counterparty exceeds a specified threshold, the counterparty is required to transfer cash collateral in excess of the threshold to
the Company.us. Conversely, if the market value of the counterparty's net derivatives position with
the Companyus exceeds a specified threshold,
the Company iswe are required to transfer cash collateral in excess of the threshold to the counterparty.
The Company’sOur International Swaps and Derivatives Association (“ISDA”) Master Agreements with counterparties contain legal right of offset provisions, and therefore the collateral amounts are netted against derivative assets, which are included in other assets in the Consolidated Balance Sheet. At March 31,
2005, the Company2007 and 2006, we held a net
$982$291 million
and $251 million, respectively, in collateral from counterparties, which is included in cash and cash equivalents in the Consolidated Balance Sheet.
The Company isWe are not required to hold the collateral in a segregated account.
Counterparty credit risk of derivative instruments is represented by the fair value of contracts with a positive fair value at March 31,
2005,2007, reduced by the effects of master netting agreements and collateral. At March 31,
2005,2007, substantially all of
the Company'sour derivative instruments were executed with commercial banks and investment banking firms assigned investment grade ratings of "A" or better by nationally recognized statistical rating organizations.
The Company hasWe have not experienced a counterparty default and
doesdo not currently anticipate non-performance by any of
itsour counterparties, and as such
hashave no reserves related to non-performance as of March 31,
2005.2007. In addition, many of
the Company’sour ISDA Master Agreements with counterparties contain reciprocal ratings triggers providing either party with an option to terminate the agreement and related transactions at market in the event of a ratings downgrade below a specified threshold.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 8 – Interest Expense and Derivatives and Hedging Activities (Continued)
A summary of the net counterparty credit exposure by credit rating
as of March 31, 2007 and 2006 (net of collateral held) is presented
below: | March 31, |
|
|
| 2005 | | 2004 |
|
| |
|
| (Dollars in millions) |
Credit Rating | |
AAA | $493 | | $1,029 |
AA | 887 | | 894 |
A | 78 | | 223 |
Non-rated entities1 | - | | 17 |
|
| |
|
Total net counterparty credit exposure | $1,458 | | $2,163 |
|
| |
|
| | March 31, |
| | 2007 | | 2006 |
| | |
| Credit Rating | |
| AAA | $226 | | $156 |
| AA | 939 | | 655 |
| A | 64 | | 90 |
| Total net counterparty credit exposure | $1,229 | | $901 |
Note 9 – Other Assets and Other Liabilities
1
| Exposure to various TMCC securitization trusts whereOther assets and other liabilities consisted of the Company acts as a swap counterparty to the trust.
following (dollars in millions): |
- 89 -
| | March 31, |
| | 2007 | | 2006 |
| | |
Other assets: | | | |
| Derivative assets | $1,229 | | $901 |
Used vehicles held for sale1 | 132 | | 160 |
| Deferred charges | 151 | | 108 |
| Income taxes receivable | 342 | | - |
| Other assets | 365 | | 210 |
| Total other assets | $2,219 | | $1,379 |
| | | | |
Other liabilities: | | | |
| Unearned insurance premiums and contract revenues | $1,139 | | $953 |
| Accounts payable and accrued expenses | 935 | | 846 |
| Derivative liabilities | 97 | | 230 |
| Deferred income | 263 | | 186 |
| Other liabilities | 187 | | 115 |
| Total other liabilities | $2,621 | | $2,330 |
1Primarily represents repossessed and off-lease vehicles.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Debt and the related weighted average contractual interest rates are summarized as
follows: | | | Weighted Average Contractual Interest Rates |
| | |
|
| March 31, | | March 31, |
| 2005 | | 2004 | | 2005 | | 2004 |
|
| |
| |
| |
|
| (Dollars in millions) | |
| | | | | |
Commercial paper | $10,397 | | $8,094 | | 2.77% | | 1.03% |
Notes and loans payable | 29,379 | | 26,845 | | 3.71% | | 3.44% |
Carrying value adjustment1 | 1,981 | | 1,915 | | | | |
|
| |
| | | | |
Debt | $41,757 | | $36,854 | | 3.47% | | 2.90% |
|
| |
| | | | |
| | | | Weighted Average Contractual Interest Rates |
| | March 31, | | March 31, |
| | 2007 | | 2006 | | 2007 | | 2006 |
| | | | | | |
Commercial paper1 | $14,954 | | $12,162 | | 5.29% | | 4.67% |
Notes and loans payable1 | 42,440 | | 36,089 | | 4.44% | | 4.09% |
Carrying value adjustment2 | 1,135 | | 457 | | | | |
| Debt | $58,529 | | $48,708 | | 4.67% | | 4.23% |
1
| Comprised
1 Includes unamortized premium/discount. |
| 2 Represents the effects of fair market value change and foreign currency transaction gains and losses on debt denominated in foreign currencies, fair value |
| adjustments to debt in hedge accounting relationships, and non-hedgethe unamortized fair value adjustments on the hedged item for |
| terminated fair value hedge accounting relationships. |
Included in debt are
The carrying value of our notes and loans payable includes unsecured notes denominated in various foreign currencies valued at
$11,182 million$17.0 billion and
$10,494 million$12.5 billion at March 31,
20052007 and
2004,2006, respectively. Concurrent with the issuance of these unsecured notes,
the Companywe entered into cross currency interest rate
swap agreementsswaps or a combination of interest rate swaps coupled with currency basis swaps in the same notional amount to convert non-U.S.
dollarcurrency debt to U.S. dollar denominated payments.
In fiscal 2005,
Additionally, the
Company exercised its option to redeem the remaining outstanding amountcarrying value of
notes payable related to a securitization transaction accounted for as a collateralized borrowing executed in fiscal 2002. No gain or loss was recognized on this transaction. At March 31, 2004, these notes payable totaled $226 million and were collateralized by retail finance receivables of $261 million. The retail finance receivables served as collateral for the payment of the debt and were therefore restricted from TMCC’s creditors.The Company’sour notes and loans payable and carrying value adjustment includes $6,104 million in variableat March 31, 2007 consists of $9.0 billion of unsecured floating rate debt with indexed contractual interest rates at March 31, 2005 ranging from 2.08%0 percent to 4.47%8.4 percent and $25,256 million in$34.6 billion of unsecured fixed rate debt with contractual interest rates ranging from 0.05%0 percent to 7.59% at15.3 percent. Upon issuance of fixed rate debt, we generally elect to enter into interest rate swaps to convert fixed rate debt to floating rate debt.
As of March 31,
2005.Included in debt is2007, our commercial paper withhad an average remaining maturity of forty one days at March 31, 2005. Notes44 days. Our notes and loans payable mature on various dates through fiscal 2036.
- 90 -
2047.
TOYOTA MOTOR CREDIT CORPORATION
-85-
| TOYOTA MOTOR CREDIT CORPORATION |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 9 -10 – Debt (Continued)
Scheduled maturities of
the Company’sour debt portfolio are summarized
below: | | March 31, 2005 | |
| |
| |
| | (Dollars in millions) | |
| | | |
Commercial paper | | $10,397 | | |
Other debt due in the fiscal years ending: | | | | |
2006 | | 6,835 | | |
2007 | | 7,109 | | |
2008 | | 6,808 | | |
2009 | | 4,194 | | |
2010 | | 3,478 | | |
Thereafter | | 2,936 | | |
Total other debt | | | 31,360 | | |
| | |
| | |
Debt | | | $41,757 | | |
| | |
| | |
below (dollars in millions):
| | | March 31, 2007 |
| | | |
| Commercial paper | | $14,954 |
| Other debt due in the fiscal years ending: | | |
| 2008 | | 13,110 |
| 2009 | | 8,722 |
| 2010 | | 8,413 |
| 2011 | | 4,386 |
| 2012 | | 4,307 |
| Thereafter | | 4,637 |
| Total other debt | | 43,575 |
| Debt | | $58,529 |
Interest payments on debt, including net settlements on interest rate swaps, were $842 million, $668 million,$1.6 billion, $1.4 billion, and $750$842 million in fiscal 2007, 2006, and 2005, 2004,respectively.
Note 11 – Liquidity Facilities and 2003, respectively.Note 10 - Liquidity FacilitiesLetters of Credit
During fiscal 2007, TMCC and Letters of Credit |
The following table summarizes TMCC’s and its subsidiary, Toyota Credit de Puerto Rico Corp.’s (“TCPR”) credit facilities:
| TMCC | | TCPR | | Total |
|
| |
| |
|
| March 31, |
|
|
| 2005 | | 2004 | | 2005 | | 2004 | | 2005 | | 2004 |
|
| |
| |
| |
| |
| |
|
| (Dollars in millions) |
364-day syndicated bank credit facilities – committed | $2,767 | | $3,600 | | $133 | | $400 | | $2,900 | | $4,000 |
5-year syndicated bank credit facility – committed | 3,933 | | 1,400 | | 267 | | - | | 4,200 | | 1,400 |
Letters of credit facilities – uncommitted | 55 | | 55 | | - | | - | | 55 | | 55 |
|
| |
| |
| |
| |
| |
|
Total credit facilities | $6,755 | | $5,055 | | $400 | | $400 | | $7,155 | | $5,455 |
|
| |
| |
| |
| |
| |
|
| | | | | | | | | | | | | |
During fiscal 2005, the Company renewed and decreased its 364-dayentered into two new committed syndicated bank credit facilities from $4,000 million to $2,900 millionfacilities.
364 Day Credit Agreement
In March 2007, TMCC, TCPR, and renewed and increased its 5-yearother Toyota affiliates entered into a $4.0 billion 364 day syndicated bank credit facility pursuant to a 364 Day Credit Agreement. The ability to make draws is subject to covenants and conditions customary in a transaction of this nature, including negative pledge and cross default provisions. The 364 Day Credit Agreement may be used for general corporate purposes and was not drawn upon as of March 31, 2007.
Participation in this facility replaces the $2.9 billion 364 day syndicated bank credit facility which was in place at March 31, 2006.
Five Year Credit Agreement
In March 2007, TMCC, TCPR, and other Toyota affiliates entered into an $8.0 billion five year syndicated bank credit facility pursuant to a Five Year Credit Agreement. The ability to make draws is subject to covenants and conditions customary in a transaction of this nature, including negative pledge and cross default provisions. The Five Year Credit Agreement may be used for general corporate purposes and was not drawn upon as of March 31, 2007.
Participation in this facility replaces the $5.8 billion five year syndicated bank credit facility which was in place at March 31, 2006.
Letters of Credit Facilities Agreement
In addition, TMCC has uncommitted letters of credit facilities
from $1,400totaling $55 million
to $4,200 million.at March 31, 2007 and 2006. Of the total credit facilities, $2 million of the uncommitted letters of credit facilities waswere used at March 31, 20052007 and 2004. No amounts were drawn on the committed facilities at March 31, 2005 and 2004.
- 91 -
2006. TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 11 -12 – Fair Value of Financial Instruments
The fair value of financial instruments at March 31,
20052007 and
20042006 was estimated using the valuation methodologies described below. Considerable judgment was employed in interpreting market data to develop estimates of fair value; accordingly, the estimates presented herein are not necessarily indicative of the amounts that could be realized or would be paid in a current market exchange. The use of different market assumptions or valuation methodologies could have a material effect on the estimated fair value amounts.
The carrying amounts and estimated fair values of
the Company'sour financial instruments are as
follows: | March 31, |
|
|
| 2005 | | 2004 |
|
| |
|
| Carrying Amount | | Fair Value | | Carrying Amount | | Fair Value |
|
| |
| |
| |
|
| (Dollars in millions) |
Balance sheet financial instruments: | | | | | | | |
| | | | | | | |
Assets: | | | | | | | |
Cash and cash equivalents | $799 | | $799 | | $818 | | $818 |
Investments in marketable securities | $927 | | $927 | | $1,125 | | $1,125 |
Finance receivables, net | $35,691 | | $35,600 | | $28,734 | | $29,098 |
Derivative assets | $1,458 | | $1,458 | | $2,163 | | $2,163 |
| | | | | | | |
Liabilities: | | | | | | | |
Debt | $41,757 | | $41,465 | | $36,854 | | $36,768 |
Derivative liabilities | $23 | | $23 | | $34 | | $34 |
follows (dollars in millions):
| | March 31, |
| | 2007 | | 2006 |
| | Carrying Amount | | Fair Value | | Carrying Amount | | Fair Value |
| | |
| Balance sheet financial instruments: | | | | | | | |
| | | | | | | | |
Assets: | | | | | | | |
| Cash and cash equivalents | $1,329 | | $1,329 | | $815 | | $815 |
| Investments in marketable securities | $1,465 | | $1,465 | | $1,176 | | $1,176 |
Finance receivables, net 1 | $47,158 | | $46,567 | | $40,896 | | $40,246 |
| Derivative assets | $1,229 | | $1,229 | | $901 | | $901 |
| | | | | | | | |
Liabilities: | | | | | | | |
| Debt | $58,529 | | $58,588 | | $48,708 | | $48,290 |
| Derivative liabilities | $97 | | $97 | | $230 | | $230 |
1 Includes $8.7 billion and $6.8 billion of variable rate finance receivables at March 31, 2007 and 2006, respectively, whose
carrying amounts approximate fair value as these receivables re-price at prevailing market rates. Excludes $704 million and
$1.1 billion of direct finance leases, net at March 31, 2007 and 2006, respectively, which are not considered financial
instruments.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12 – Fair Value of Financial Instruments (Continued)
The fair value estimates presented herein are based on information available as of March 31,
20052007 and
2004.2006. The methods and assumptions used to estimate the fair value of financial instruments are summarized as follows:
Cash and Cash Equivalents
The carrying amount of cash and cash equivalents approximates fair value due to the short maturity of these investments.
Investments in Marketable Securities
The fair value of marketable securities was estimated using quoted market prices or discounted cash flow analysis.
- 92 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 11 - Fair Value of Financial Instruments (Continued)Finance Receivables, Net
The carrying amounts of $6,604 million and $6,289 million of variable rate finance receivables at March 31, 2005 and 2004, respectively, approximate fair value as these receivables re-price at prevailing market rates. The carrying amounts and fair values of finance receivables, net above excludes $1,917 million and $3,584 of direct finance leases, net at March 31, 2005 and 2004, respectively, which are not considered financial instruments.
The fair value of fixed rate finance receivables at March 31,
20052007 and
20042006 was estimated by discounting expected cash flows using the blended rates of finance receivables originated during the quarters ended March 31,
20052007 and
2004,2006, respectively. Although the fair value of finance receivables at March 31,
20052007 was less than the carrying amount, management expects to collect all amounts due according to the contractual terms of the finance receivable agreements, less the related allowance for credit losses, based on
the Company’sour intent to hold the finance receivables to maturity.
Derivative Assets and Liabilities
The estimated fair value of
the Company'sour derivative assets and liabilities was derived by discounting expected cash flows using quoted market exchange rates, quoted market interest rates, or quoted market prices, as of March 31,
20052007 and
20042006 as applicable to each instrument. Derivative assets and liabilities are recorded in other assets and other liabilities, respectively, in the Consolidated Balance Sheet.
The fair value of debt was estimated by discounting expected cash flows using the interest rates at which debt of similar credit quality and maturity would be issued as of March 31,
20052007 and
2004. The Company also utilizes2006. We utilize quoted market exchange rates, quoted market interest rates, or quoted market prices, when appropriate, in developing cash flows. The carrying amount of commercial paper was assumed to approximate fair value due to the short maturity of these instruments.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12 -13 – Pension and Other Benefit Plans
Employees of TMCC, TCPR, and TMCC’s insurance subsidiaries are generally eligible to participate in the TMS pension plan commencing on the first day of the month following
hire.hire and are vested after 5 years of continuous employment. Benefits payable under this non-contributory defined benefit pension plan are based upon the employees' years of credited service, the highest-paid 60 consecutive months' compensation, and the highest average fiscal year bonus over a period of 60 consecutive months, reduced by a percentage of social security benefits.
Employees of TMCC, TCPR, and TMCC’s insurance subsidiaries are also eligible to participate in the Toyota Savings Plan sponsored by TMS. Participants may elect to contribute up to
30%30 percent of their base pay on a pre-tax
basis. The Company matchesbasis, subject to Internal Revenue Code limitations. We match 66-2/3 cents for each dollar the participant contributes, up to
6%6 percent of base pay. Participants are vested
25%25 percent each year with respect to
the Company’sour contributions and are fully vested after four years.
In addition, employees of TMCC, TCPR, and TMCC’s insurance subsidiaries are generally eligible to participate in various health and life and other post-retirement benefits sponsored by TMS. In order to be eligible for these benefits, the employee must retire from the
Companycompany with at least ten years of service and in some cases be at least 55 years of age.
The Company’s
We adopted SFAS 158 as of March 31, 2007 and it did not have a material impact on Shareholder’s Equity.
Our employee benefits expense was $54$63 million, $43$61 million, and $38$54 million for the years
ended March 31,
2007, 2006, and 2005,
2004, and 2003, respectively.
- 93 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 13 -14 – Income Tax Provision for Income Taxes
The provision for income taxes consisted of the
following: | Years Ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
| (Dollars in millions) |
Current | | | | | |
Federal, net of foreign tax credit | $52 | | $43 | | ($98) |
State | 47 | | 32 | | (26) |
Foreign | 11 | | 8 | | 8 |
|
| |
| |
|
Total current | 110 | | 83 | | (116) |
|
| |
| |
|
Deferred | | | | | |
Federal | 349 | | 303 | | 151 |
State | 22 | | 32 | | 19 |
|
| |
| |
|
Total deferred | 371 | | 335 | | 170 |
|
| |
| |
|
Provision for income taxes | $481 | | $418 | | $54 |
|
| |
| |
|
following (dollars in millions):
| | Years Ended March 31, |
| | 2007 | | 2006 | | 2005 |
| | |
| Current | | | | | |
| Federal, net of foreign tax credit | ($440) | | $464 | | $ 52 |
| State | (61) | | 34 | | 47 |
| Foreign | 2 | | 10 | | 11 |
| Total current | (499) | | 508 | | 110 |
| Deferred | | | | | |
| Federal | 636 | | (360) | | 349 |
| State | 94 | | 196 | | 22 |
| Total deferred | 730 | | (164) | | 371 |
| Provision for income taxes | $231 | | $344 | | $481 |
A reconciliation between the U.S. federal statutory tax rate and the effective tax rate
is as follows:
| Years Ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
Provision for income taxes at U.S. federal statutory tax rate | 35.00% | | 35.00% | | 35.00% |
State and local taxes (net of federal tax benefit) | 4.10% | | 4.37% | | 4.69% |
Other, deferred state liability benefit due to reduced effective state rate | (0.45)% | | (0.36)% | | (8.14)% |
Other1 | 0.07% | | 0.50% | | 5.91% |
|
| |
| |
|
Effective tax rate | 38.72% | | 39.51% | | 37.46% |
|
| |
| |
|
| | | | | | |
| | Years Ended March 31, |
| | 2007 | | 2006 | | 2005 |
| | | | | | |
| Provision for income taxes at U.S. federal statutory tax rate | 35.00% | | 35.00% | | 35.00% |
| State and local taxes (net of federal tax benefit) | 3.74% | | 3.84% | | 4.10% |
Other1 | (3.88%) | | (1.64%) | | (0.38%) |
| Effective tax rate | 34.86% | | 37.20% | | 38.72% |
1
| 1Includes deferred tax asset valuation expensebenefit due to reduced effective state tax rate and new hybrid credit for the years ended March 31, 20042007 and 2003.2006. |
- 94 -
-90-
TOYOTA MOTOR CREDIT CORPORATION
| TOYOTA MOTOR CREDIT CORPORATION |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 13 -14 – Income Tax Provision for Income Taxes (Continued)
The deferred federal and state income tax liabilities are as
follows: | March 31, |
|
|
| 2005 | | 2004 |
|
| |
|
| (Dollars in millions) |
| |
Federal | $2,384 | | $2,040 |
State | 201 | | 185 |
|
| |
|
Net deferred income tax liability | $2,585 | | $2,225 |
|
| |
|
The Company'sfollows (dollars in millions):
| | March 31, |
| | 2007 | | 2006 |
| | |
| Federal | $2,793 | | $2,031 |
| State | 360 | | 397 |
| Net deferred income tax liability | $3,153 | | $2,428 |
Our deferred tax liabilities and assets consisted of the
following: | | March 31, |
| |
|
| | 2005 | | 2004 |
| |
| |
|
| | (Dollars in millions) |
Liabilities: | | | |
Lease transactions | $2,737 | | $2,557 |
State taxes | 212 | | 210 |
Mark-to-market | 41 | | - |
Other | 133 | | 123 |
|
| |
|
Deferred tax liabilities | 3,123 | | 2,890 |
|
| |
|
| | | |
Assets: | | | |
Mark-to-market | - | | 27 |
Provision for losses | 243 | | 168 |
Deferred costs and fees | 271 | | 211 |
Net operating loss and foreign tax credit carryforwards | 37 | | 272 |
|
| |
|
Deferred taxassets | 551 | | 678 |
Valuation allowance | (13) | | (13) |
|
| |
|
Net deferred tax assets | 538 | | 665 |
| | | |
Net deferred income tax liability | $2,585 | | $2,225 |
|
| |
|
| | | | | | | |
During fiscal 2005, TMCC and its domestic subsidiaries have fully utilizedfollowing (dollars in millions):
| | March 31, |
| | 2007 | | 2006 |
| | |
Liabilities: | | | |
| Lease transactions | $3,227 | | $2,684 |
| State taxes | 234 | | 270 |
| Mark-to-market of investments in marketable securities and derivatives | 31 | | - |
| Other | 117 | | 79 |
| Deferred tax liabilities | 3,609 | | 3,033 |
| | | | |
Assets: | | | |
| Mark-to-market of investments in marketable securities and derivatives | - | | 26 |
| Provision for losses | 262 | | 227 |
| Deferred costs and fees | 90 | | 329 |
| Net operating loss and tax credit carryforwards | 117 | | 36 |
Deferred tax assets | 469 | | 618 |
| Valuation allowance | (13) | | (13) |
| Net deferred tax assets | 456 | | 605 |
| | | | |
| Net deferred income tax liability | $3,153 | | $2,428 |
We generated federal tax net operating loss carryforwards of
$631 million.$128 million for fiscal 2007. At March 31,
2005, TMCC and its domestic subsidiaries2007, we have
a deferred tax asset of $35 million for state tax net operating loss carryforwards
of $438 million which expire in fiscal
20062008 through
2024.fiscal 2027. In addition, at March 31,
2005, TMCC and its domestic subsidiaries2007, we have a deferred federal tax asset for foreign tax credits totaling $20 million
whichand federal and state hybrid credits totaling $45 million. The foreign tax credit is reduced by a $13 million valuation allowance.
We received a net income tax refund of $149 million in fiscal 2007. Cash paid
(received) for income taxes
in fiscal 2006 and fiscal 2005 was
$659 million and $32 million,
$57 million, and ($362) million in fiscal 2005, 2004, and 2003, respectively.
- 95 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 13 -14 – Income Tax Provision for Income Taxes (Continued)
At March 31, 2004, TMCC and its domestic subsidiaries2007, we had a payablereceivable of $11$21 million to TMS for theirTMA’s share of the income tax in those states where the Companywe filed consolidated/combined returns with TMA and/or other domestic parent and subsidiaries of TMCC for the fiscal year endedits subsidiaries. At March 31, 2003. No such amounts were outstanding for2006, the March 31, 2004 statereceivable amount was $2 million.
Our effective tax
returns between TMCCrate was 34.86 percent and
its affiliates at March 31, 2005.Tax Related Contingencies
In the normal course of business, the Company’s tax filings are examined by various tax authorities, including the Internal Revenue Service (“IRS”). During the year ended March 31, 2004, the IRS concluded its examination of the tax years37.20 percent during fiscal 2007 and fiscal 2006, respectively. The decrease in income taxes during fiscal 2007 compared to fiscal 2006 was due to a one time favorable adjustment related to a change in Texas franchise tax law (Texas margin tax (H.B. No. 3)) recorded in fiscal 1992 through fiscal 1996, resulting in2007 and a federal income tax refund of $45 million and associated interest income of $33 million accrued on the amount. The IRS continues to examine the tax yearsbenefit related to fiscal 1997 through fiscal 2003.
the Hybrid vehicle credit. The hybrid tax credit is based on lease volume and amount of credit, both of which vary from quarter to quarter.
Note 14 -15 – Commitments and Contingencies
Commitments and GuaranteesTMCC has
We have entered into certain commitments and guarantees described below. The maximum
commitment amounts under these commitments and guarantees
as are summarized in the table
below: | Maximum Commitment Amount |
|
|
| March 31, |
| 2005 | | 2004 |
|
| |
|
| (Dollars in millions) |
Commitments: | | | |
Credit facilities with vehicle and industrial equipment dealers | $3,928 | | $3,697 |
Credit facilities with affiliates | 190 | | 99 |
Facilities lease commitments1 | 117 | | 129 |
|
| |
|
Total commitments | 4,235 | | 3,925 |
Guarantees and other contingencies: | | | |
Guarantees of affiliate pollution control and solid waste disposal bonds | 148 | | 148 |
Revolving liquidity notes related to securitizations | 40 | | 48 |
Guarantees of affiliate debt | - | | 30 |
|
| |
|
Total commitments and guarantees | $4,423 | | $4,151 |
|
| |
|
1
| Includes $82 million and $96 million in facilities lease commitments with affiliates at March 31, 2005 and 2004, respectively.
|
- 96 -
below (dollars in millions): | | Maximum Commitment Amount |
| | March 31, |
| | 2007 | | 2006 |
| | |
| Commitments: | | | |
Credit facilities with vehicle and industrial equipment dealers1 | $4,259 | | $3,708 |
| Credit facilities with affiliates | 110 | | 221 |
Facilities lease commitments2 | 101 | | 113 |
| Total commitments | 4,470 | | 4,042 |
| Guarantees and other contingencies: | | | |
| Guarantees of affiliate pollution control and solid waste disposal bonds | 148 | | 148 |
| Revolving liquidity notes related to securitizations | 17 | | 17 |
| Total commitments and guarantees | $4,635 | | $4,207 |
1 Excludes $8.1 billion and $6.6 billion of wholesale financing lines not considered to be contractual commitments at March 31,
2007 and 2006, respectively, of which $5.2 billion and $4.3 billion were outstanding at March 31, 2007 and 2006, respectively.
2 Includes $69 million and $75 million in facilities lease commitments with affiliates at March 31, 2007 and 2006, respectively.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 14 -15 – Commitments and Contingencies (Continued)
CommitmentsThe Company provides
We provide fixed and variable rate credit facilities to vehicle and industrial equipment dealers. These credit facilities are typically used for business acquisitions, facilities refurbishment, real estate purchases, and working capital requirements. These loans are typically collateralized with liens on real estate, vehicle inventory, and/or other dealership assets, as appropriate.
The Company obtainsWe obtain a personal guarantee from the vehicle or industrial equipment dealer or a corporate guarantee from the dealership when deemed prudent. Although the loans are typically collateralized or guaranteed, the value of the underlying collateral or guarantees may not be sufficient to cover
the Company’sour exposure under such agreements.
The Company pricesWe price the credit facilities to reflect the credit risks assumed in entering into the
credit facility. Amounts drawn under these facilities are reviewed for collectibility quarterly, in conjunction with
the Company’sour evaluation of the allowance for credit losses.
The CompanyWe also
providesprovide financing to various multi-franchise dealer organizations, referred to as dealer groups, often as part of a lending consortium, for wholesale, working capital, real estate, and business acquisitions. Of the total credit facilities available to vehicle and industrial equipment dealers,
$2,511 million$2.9 billion and
$2,249 million$2.4 billion were outstanding at March 31,
20052007 and
2004,2006, respectively, and were recorded in finance receivables,
net in the Consolidated Balance Sheet.
TCPR has extended a
$90$110 million revolving line of credit to Toyota de Puerto Rico Corp. (“TDPR”), a
wholly ownedwholly-owned subsidiary of TMS. The revolving line of credit has a one-year renewable term, with interest due monthly. Any loans outstanding under the revolving line of credit are not guaranteed by TMS and are unsecured.
AmountsNo amount was outstanding with TDPR at March 31,
2005 and 2004 were $10 million and $25 million, respectively.In addition, TMCC has entered into a reciprocal credit agreement2007. The amount outstanding with TFSA which allows each companyTDPR at March 31, 2006 was $47 million.
We are party to
borrow up to $100 million from the other at a daily market interest rate, generally the federal funds rate, determined on the date of each advance, with no stated maturity date. Any amounts drawn by TFSA are accounted for as a distribution of assets, and, accordingly, a reduction of shareholder’s equity. During fiscal 2005, $60 million was drawn by TFSA under the credit agreement. No such amounts were drawn prior to fiscal 2005.The Company has entered into a 15-year lease agreement with TMS. The lease agreement isTMS for the Company’s newour headquarters location in the TMS headquarters complex in Torrance, California. At March 31, 2005,2007, minimum future commitments under lease agreements to which the Company iswe are a lessee, including those under the agreement discussed above, are as follows: fiscal years ending 20062008 – $19 million; 20072009 – $18$15 million; 2008 –2010 - $12 million; 20092011 - $11$10 million; 20102012 - $8 million; and thereafter – $49$37 million.
Guarantees and Other Contingencies
TMCC has guaranteed certain bond obligations relating to two affiliates totaling $148 million of principal and interest that were issued by Putnam County, West Virginia and Gibson County, Indiana. The bonds mature in the following fiscal years: 2028 - $20 million; 2029 - $50 million; 2030 - $38 million; 2031 - $30 million; and 2032 - $10 million. TMCC would be required to perform under the guarantees in the event of failure by the affiliates to fulfill their obligations; bankruptcy involving the affiliates or TMCC; or failure to observe any covenant, condition, or agreement under the guarantees by the affiliates, bond issuers, or TMCC.
- 97 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 14 -15 – Commitments and Contingencies (Continued)
These guarantees include provisions whereby TMCC is entitled to reimbursement by the affiliates for amounts paid. TMCC receives an annual fee of $102,000 for guaranteeing such payments. TMCC has not been required to perform under any of these affiliate bond guarantees as of March 31,
20052007 and
2004.2006. The fair value of these guarantees as of March 31,
20052007 and
20042006 was approximately $1 million.
Because these are affiliate guarantees, TMCC is not required to recognize a liability for the fair value of the guarantees.In certain securitization structures, revolving liquidity notes (“RLN”) are used in lieu of deposits to a cash reserve fund. The securitization trust may draw upon the RLN to cover any shortfall in interest and principal payments to investors. The Company funds any draws, and the terms of the RLN obligate the securitization trust to repay amounts drawn plus accrued interest. Repayments of principal and interest due under the RLN are subordinate to principal and interest payments on the asset-backed securities and, in some circumstances, to deposits into a reserve account. If collections are insufficient to repay amounts outstanding under RLN, the Company will recognize a loss for the outstanding amounts. The Company must fund the entire amount available under the RLN into a reserve account if the Company’s short term unsecured debt ratings are downgraded below P-1 by Moody’s Investors Service, Inc. or A-1 by Standard & Poor’s Ratings Group, a division of the McGraw-Hill Companies, Inc. No amounts were outstanding under the RLN asAs of March 31, 20052007 and 2004. The RLN had2006, no material fair valueliability amounts have been recorded related to the guarantees as of March 31, 2005 and 2004. The Companymanagement has determined that it is not recognized a liability for the RLN because it does not expect toprobable that we would be required to fund any amountsperform under the RLN.
TMCC had guaranteed payments of up to $30 million in principal, interest, fees, and expenses with respect to the offshore bank loan of BTB. The loan matured and was paid in full by BTB, and the guarantee was terminated during fiscal 2005. The guarantee had no material fair value as of March 31, 2004. Because this was anthese affiliate guarantee, TMCC was not required to recognize a liability for the fair value of the guarantee.
bond guarantees.
In the ordinary course of business,
the Company enterswe enter into agreements containing indemnification provisions standard in the industry related to several types of transactions, including, but not limited to, debt funding, derivatives, securitization transactions, and
itsour vendor and supplier agreements. Performance under these indemnities would occur upon a breach of the representations, warranties or covenants made or given, or a third party claim. In addition,
the Company haswe have agreed in certain debt and derivative issuances, and subject to certain exceptions, to gross-up payments due to third parties in the event that withholding tax is imposed on such payments. In addition, certain of
the Company’sour funding arrangements would require
the Companyus to pay lenders for increased costs due to certain changes in laws or regulations. Due to the difficulty in predicting events which could cause a breach of the indemnification provisions or trigger a gross-up or other payment obligation,
the Company iswe are not able to estimate
itsour maximum exposure to future payments that could result from claims made under such provisions.
The Company hasWe have not made any material payments in the past as a result of these provisions, and as of March 31,
2005, the Company does not believe2007, we determined that it is
not probable that
itwe will be required to make any material payments in the future. As
such,of March 31, 2007 and 2006, no amounts have been recorded under these
indemnifications as of March 31, 2005.- 98 -
indemnifications.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 14 - Commitments and Contingencies (Continued)LitigationReceivable Repurchase Obligations
The Company sells discrete pools of retail finance receivables to wholly owned consolidated bankruptcy remote special purpose entities (“SPEs”). TMCC makes certain representations and warranties to the SPEs, and the SPEs make corresponding representations and warranties to the securitization trusts, relating to the receivables sold in securitization transactions. TMCC and the SPEs may be required to repurchase any receivable in the event of a breach of a representation and warranty that would materially and adversely affect the interest of the SPEs, or any securitization trust, as applicable. In addition, TMCC, as the servicer of the receivables, may be required to repurchase any receivable in the event of a breach of a covenant by the servicer that would materially and adversely affect the interest of any securitization trust, or if extensions or modifications to a receivable are made, and TMCC, as the servicer, does not elect to make advances to cover any resulting reductions in interest payments. The repurchase price is generally the outstanding principal balance of the receivable plus any accrued interest thereon. These provisions are customary in the securitization industry. No receivables were repurchased under these provisions during fiscal 2005.Receivables repurchased during fiscal 2004 and 2003 totaled $1 million in each year. The Company does not believe it is probable that it will be required to make any material payments in the future and, as such, no amounts have been recorded under these obligations as of March 31, 2005.
Advancing Requirements
As a servicer of receivables sold through securitizations, TMCC is required to advance delinquent amounts contractually owed by an obligor to the applicable securitization trust to the extent it believes the advance will be recovered from future collections of the related receivable. Each securitization trust is required to reimburse the Company for any outstanding advances from collections on all receivables before making other required payments. These provisions are customary in the securitization industry. Advances outstanding at March 31, 2005 and 2004 totaled $5 million and $13 million, respectively.
Litigation
Various legal actions, governmental proceedings and other claims are pending or may be instituted or asserted in the future against
the Companyus with respect to matters arising in the ordinary course of business. Certain of these actions are or purport to be class action suits, seeking sizeable damages and/or changes in
the Company’sour business operations, policies and practices. Certain of these actions are similar to suits that have been filed against other financial institutions and captive finance companies.
ManagementOur management and internal and external counsel perform periodic reviews of pending claims and actions to determine the probability of adverse verdicts and resulting amounts of liability.
The Company establishesWe establish reserves for legal claims when payments associated with the claims become probable and the costs can be reasonably estimated. The actual costs of resolving legal claims and associated costs of defense may be substantially higher or lower than the amounts reserved for these claims. However, based on information currently available, the advice of counsel, and established reserves,
in the opinion ofour management
expects that the ultimate liability resulting therefrom will not have a material adverse effect on
the Company'sour consolidated financial statements.
- 99 -
We caution that the eventual development, outcome and cost of legal proceedings are by their nature uncertain and subject to many factors, including but not limited to, the discovery of facts not presently known to us or determinations by judges, juries or other finders of fact which do not accord with our evaluation of the possible liability from existing litigation.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 14 - Commitments and Contingencies (Continued)Fair Lending Class Actions
An alleged class action in the U.S. District Court – Central District of California,Baltimore v. Toyota Motor Credit Corporation filed in November 2000 claims that the Company’s pricing practices discriminate against African-Americans. Two additional cases pending in the state courts in California, (Herra v. Toyota Motor Credit CorporationandGonzales v. Toyota Motor Credit Corporation) filed in the Superior Court of California Alameda County in April 2003 and in the Superior Court of the State of California in August 2003, respectively, contain similar allegations claiming discrimination against minorities. The cases have been brought by various individuals. Injunctive relief is being sought in all three cases and the cases also include a claim for actual damages in an unspecified amount. The parties have conducted a series of mediation sessions and have reached agreement on the principal terms of a settlement. However, continued settlement discussions are ongoing and a final resolution is subject to execution of a settlement agreement. The Company believes it has strong defenses to these claims.
New Jersey Consumer Fraud Action
An action in the New Jersey Superior Court,Jorge v Toyota Motor Insurance Services (“TMIS”), filed in November 2002 claims that the TMIS Gold Plan Vehicle Service Agreement (“VSA”) is unconscionable on its face and violates the New Jersey Consumer Fraud Act. In September 2004, the case was certified as a class action consisting of all New Jersey consumers who purchased a VSA. The plaintiffs are seeking injunctive relief as well as actual damages and treble damages. The Company believes it has strong defenses to these claims.
- 100 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1516 – Related Party Transactions
The tables below summarize amounts included in
the Company’sour Consolidated Balance Sheet and Statement of Income under various related party agreements or
relationships: | March 31, |
|
|
| 2005 | | 2004 |
|
| |
|
| (Dollars in millions) |
Assets: | | | |
Subvention receivable from affiliates | $45 | | $24 |
Finance receivables with affiliates | $10 | | $25 |
Notes receivable under home loan program | $7 | | $7 |
Intercompany receivables | $5 | | $1 |
Deferred subvention income | | | |
Finance receivables | ($241) | | ($193) |
Operating leases | ($97) | | ($57) |
| | | |
Liabilities: | | | |
Intercompany payables | $87 | | $95 |
| | | |
Shareholder’s Equity: | | | |
Reduction of retained earnings for advance to TFSA under credit agreement | $60 | | $- |
Reduction of retained earnings for distribution of net assets to TFSA | $23 | | $- |
| Years Ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
| (Dollars in millions) |
Revenues: | | | | | |
Manufacturers’ subvention support and other revenues | $233 | | $198 | | $144 |
Affiliate insurance premiums and commissions revenues | $63 | | $49 | | $40 |
| | | | | |
Expenses: | | | | | |
Shared services charges and other amounts | $73 | | $83 | | $65 |
Employee benefits expense | $54 | | $43 | | $38 |
Credit support fees incurred | $18 | | $16 | | $13 |
relationships (dollars in millions):
| | March 31, |
| | 2007 | | 2006 |
Assets: | | | |
Finance receivables, net | | | |
| Receivables with affiliates | $23 | | $60 |
| Notes receivable under home loan program | $6 | | $7 |
| Deferred retail subvention income from affiliates | ($468) | | ($284) |
| | | | |
Investments in operating leases, net | | | |
| Leases to affiliates | $41 | | - |
| Deferred lease subvention income from affiliates | ($401) | | ($308) |
| | | | |
Other assets | | | |
| Subvention receivable from affiliates | $58 | | $72 |
| Intercompany receivables | $44 | | $8 |
| | | | |
Liabilities: | | | |
Other liabilities | | | |
| Intercompany payables | $159 | | $146 |
| | | | |
Shareholder’s Equity: | | | |
Advances to TFSA1 | $155 | | $24 |
Reclassification to re-establish receivable due from TFSA2 | ($131) | | ($96) |
Dividends paid3 | $130 | | $115 |
1 Represents advances to TFSA under its credit agreement with TMCC during each fiscal year presented.
2 Represents reclassifications to intercompany receivables during each fiscal year presented to record TFSA’s settlements of
advances from TMCC.
3 During fiscal 2007 and fiscal 2006, our Board of Directors declared and paid cash dividends of $130 million and $115 million,
respectively, to TFSA.
| | Years Ended March 31, |
| | 2007 | | 2006 | | 2005 |
Net Financing Revenues: | | | | | |
| Manufacturers’ subvention support and other revenues | $495 | | $309 | | $233 |
| Credit support fees incurred | ($34) | | ($28) | | ($18) |
| | | | | | |
Other Revenues: | | | | | |
Affiliate insurance premiums, commissions, and other revenues | $75 | | $74 | | $63 |
| | | | | | |
Expenses: | | | | | |
| Shared services charges and other expenses | $60 | | $69 | | $73 |
| Employee benefits expense | $63 | | $61 | | $54 |
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16 – Related Party Transactions (Continued)
Receivables with Affiliates
Receivables with affiliates represent wholesale flooring loans to certain dealerships owned by Toyota Material Handling, U.S.A., Inc. (“TMHU”) and amounts due under industrial equipment leasing arrangements (classified as direct finance leases) with various affiliates.
At March 31, 2006, receivables with affiliates also included loans outstanding under the revolving line of credit to TDPR discussed in Note 15 – Commitments and Contingencies. No amount was outstanding at March 31, 2007.
Notes Receivable under Home Loan Program
Under a program available to certain levels of our management, certain officers, directors, and other members of our management have received mortgage loans from us secured by residential real property. Amounts receivable under this program from executive officers and directors relate to loans made prior to July 30, 2002.
Leases to Affiliates
Leases to affiliates represent the investment in operating leases of industrial equipment leased to Toyota Logistics Services and other affiliates.
Subvention Receivable from Affiliates, Deferred Subvention Income from Affiliates, and Manufacturer’s Subvention Support and Other Revenues
Subvention receivables represent amounts due from TMS and other affiliates
and Toyota Material Handling, U.S.A., Inc. (“TMHU”) in support of retail, lease, and industrial equipment subvention programs offered by TMCC. Deferred subvention income represents the unearned portion of amounts received from these transactions, and manufacturers’ subvention support and other revenues primarily represent the earned portion of such amounts.
- 101 -
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 15 – Related Party Transactions (Continued)Finance Receivables with Affiliates
Finance receivables with affiliates represent loans outstanding under the revolving line of credit to TDPR discussed in Note 14 – Commitments and Contingencies.
Notes Receivable under Home Loan Program
Under a program available to certain levels of management of the Company, certain officers, directors, and other members of management of the Company have received mortgage loans from the Company secured by residential real property. The table above includes amounts receivable under this program from executive officers and directors, all of which relate to loans made prior to July 30, 2002.
Intercompany Receivables and Payables
Amounts represent balances due to and from TMS, TFSC, and other affiliates arising from various transactions betweenprimarily relating to the Companyfollowing:
Affiliate insurance premiums and such affiliates. The naturecommissions, shared services charges, employee benefits, and credit support fees, which are further discussed later in this note.
Amounts relating to income taxes as discussed in the “Income Taxes” section of such transactionsNote 2 – Summary of Significant Accounting Policies.
TMCC and TCPR provide wholesale financing to vehicle dealers, and as a result of funding the loans, have payables to TMS and TDPR, respectively. TMCC also provides wholesale financing to industrial equipment dealers, and as a result has payables to TMHU and Hino Motor Sales, U.S.A., Inc. (“HINO”). TMHU is
discussed throughout this footnote.Reductionsthe primary distributor of Retained Earnings for AdvanceToyota lift trucks in the U.S., and HINO is the exclusive U.S. distributor of commercial trucks manufactured by Hino Motors Ltd. of Japan.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16 – Related Party Transactions (Continued)
Advances to TFSA under Credit Agreement and Distribution of Net AssetsReclassification to Re-establish Receivable Due from TFSA
TMCC and TFSA are parties to reciprocal credit agreements which allow each company to borrow up to $200 million from the other. Advances to TFSA
Amounts represent are recorded as reductions of retained earnings in connection withand are reclassified to intercompany receivables upon TFSA’s settlement of its advances to TFSA under the reciprocal credit agreement discussed in Note 14 – Commitments and Contingencies and the transfer of the Company’s interests in TSM, TSV and BTB to TFSA discussed in Note 1 – Nature of Operations.
from TMCC.
Affiliate Insurance Premiums, Commissions, and CommissionsOther RevenuesTMIS provides
Affiliate insurance premiums, commissions, and other revenues primarily represent TMIS’ revenues for administrative services and various levels and types of insurance coverage
provided to
TMS, includingTMS. This includes the warranty coverage for TMS’ certified pre-owned vehicle program and various umbrella liability policies.
TMIS, through its wholly-owned subsidiary, provides umbrella liability insurance to TMS and affiliates covering certain dollar value layers of risk above various primary or self-insured retentions. On all layers in which TMIS has provided coverage, 99 percent of the risk has been ceded to various reinsurers.
Shared Services Charges and Other AmountsExpenses
TMCC and TMS
and TMCC entered intoare parties to a Shared Services Agreement
coveringwhich cover certain technological and administrative services, such as information systems support, facilities, insurance coverage, and corporate services provided by each entity to the
other after the ownership of TMCC was transferred to TFSA. Included under the Shared Services Agreement areother. In addition, we pay rent charges
to TMS for
the Company’sour headquarters facility in the TMS headquarters complex in Torrance, California and
its Iowaour Central Customer Service
Center, both of which are leased from TMS.During fiscal 2005, TMCC entered into a Master Services Agreement with Toyota Financial Savings Bank, a Nevada thrift company owned by TFSA (“TFSB”) to provide a number of administrative and other services to TFSB in exchange for TFSB’s willingness to make available certain financial products and services to TMCC’s customers and dealers. Under the terms of the agreement, the amount TMCC will charge TFSB will not exceed an amount that would be charged to an unaffiliated third party. The fees may be amended from time to time by written agreement, and the agreement may be terminated by either party with 30 days notice. TMCC has waived the fee for such services for the first three years of the agreement.
- 102 -
Center.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 15 – Related Party Transactions (Continued)Employee Benefits Expense
Refer to Note
1213 – Pension and Other Benefit Plans for a discussion of the TMS-sponsored pension and savings plans and other employee benefits.
Credit Support Fees Incurred
In connection with the creation of TFSC and the transfer of ownership of TMCC from TMS to TFSA, TMC and TFSC entered into a credit support agreement (the “TMC Credit Support Agreement”). Under the terms of this agreement, TMC has agreed to certain ownership, subsidiary net worth, and debt service provisions in support of TFSC operations. The agreement is not a guarantee by TMC of any securities or obligations of TFSC.
Concurrent with the execution of the TMC Credit Support Agreement, TFSC and TMCC entered into a credit support agreement (the “TFSC Credit Support Agreement”). Under this agreement, TFSC agreed to certain ownership, subsidiary net worth, and debt service provisions similar to those under the TMC Credit Support Agreement. This agreement is not a guarantee by TFSC of any securities or other obligations of TMCC. The TMC Credit Support Agreement and the TFSC Credit Support Agreement are governed by, and construed in accordance with, the laws of Japan.
TCPR is the beneficiary of a credit support agreement with TFSC containing the same provisions as the TFSC Credit Support Agreement described above. This agreement is not a guarantee by TFSC of any securities or other obligations of TCPR.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16 – Related Party Transactions (Continued)
In
fiscal 2001,addition, TMCC and
TFSCTCPR have each entered into
a credit support fee agreement which requires TMCCagreements to pay
to TFSC a semi-annual fee equal to
0.05%0.06 percent per annum of the weighted average outstanding amount of
TMCC’s bonds and other liabilities or securities entitled to credit
support under the TMC and TFSC credit support agreements described above.The credit support fee payable is included in intercompany payables.
support.
Other Agreements with Affiliates
TMCC and TMS are parties to an Amended and Restated Repurchase
Agreement. This agreement statesAgreement, which provides that TMS will arrange for the repurchase of new Toyota and Lexus vehicles
financed at wholesale by TMCC at the aggregate cost financed
by TMCC in the event of vehicle dealer
default. The Companydefault under floorplan financing. TMCC is also a party to similar agreements with TMHU,
HINO, and other domestic and import manufacturers.
TMHU is the primary distributor of Toyota lift trucks in the U.S. No vehicles were repurchased under these agreements during fiscal
2005.2007.
TMCC has guaranteed the payments of principal and interest with respect to the bonds of manufacturing facilities of certain affiliates. TMCC receives an annual fee of $102,000 for guaranteeing such payments. The nature, business purpose, and amounts of these guarantees are described in Note
1415 – Commitments and Contingencies.
- 103 -
TMCC provides administrative support in the form of shared services to support the operations of Toyota Financial Services Securities USA Corporation (“TFSS”), an affiliate of TMCC.
TMCC and Toyota Financial Savings Bank (“TFSB”) are parties to a Master Services Agreement under which TMCC and TFSB provide certain services to the other. Under the Master Services Agreement, TMCC provides certain marketing, administrative, systems, and operational support to TFSB in exchange for TFSB’s willingness to make available certain financial products and services to TMCC’s customers and dealers meeting TFSB’s credit worthy standards.
During the first quarter of fiscal 2008, TMCC and TFSB signed a Promissory Note which allows TFSB to borrow up to $400 million with terms up to 10 years at agreed competitive rates. As of May 31, 2007, $20 million was outstanding under the Promissory Note.
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16 -17 – Segment InformationThe Company’s
Our reportable segments include finance and insurance operations. Finance operations include retail financing, leasing, and dealer financing provided to authorized vehicle dealers and their customers in the U.S. and the Commonwealth of Puerto Rico. Insurance operations are performed by TMIS and its subsidiaries. The principal activities of TMIS include marketing, underwriting, claims administration, and providing certain insurance and contractual coverage to Toyota and Lexus vehicle dealers and their customers. In addition, TMIS insures and reinsures certain TMS and TMCC risks, including
warranty coverage for TMS’ certified pre-owned vehicle program, various umbrella liability policies, and insurance of vehicle dealers’ inventory financed by TMCC. The finance and insurance operations segment information presented below includes allocated corporate expenses for the respective segments. Other amounts include financing provided to industrial equipment dealers and intersegment eliminations and reclassifications.
The accounting policies of the operating segments are the same as those described in Note 2 – Summary of Significant Accounting Policies. Currently,
the Company’sour finance and insurance segments operate only in the U.S. and the Commonwealth of Puerto Rico. Substantially all of
the Company’sour finance and insurance segments are located within the U.S.
Financial results for
the Company’sour operating segments are summarized
below: | March 31, |
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
| (Dollars in millions) |
Assets: | | | | | |
| | | | | |
Finance operations | $48,717 | | $42,932 | | $37,481 |
Insurance operations | 1,100 | | 939 | | 728 |
Other | 859 | | 763 | | 792 |
|
| |
| |
|
Total assets | $50,676 | | $44,634 | | $39,001 |
|
| |
| |
|
- 104 -
below (dollars in millions):
| | March 31, |
| | 2007 | | 2006 | | 2005 |
| | |
| Assets: | | | | | |
| Finance operations | $66,118 | | $55,913 | | $48,717 |
| Insurance operations | 2,084 | | 1,591 | | 1,339 |
| Other | 1,166 | | 757 | | 620 |
| Total assets | $69,368 | | $58,261 | | $50,676 |
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16 -17 – Segment Information (Continued) | Years Ended March 31, |
|
|
| 2005 | | 2004 | | 2003 |
|
| |
| |
|
| (Dollars in millions) |
Gross revenues: | | | | | |
Finance operations | $3,982 | | $3,778 | | $3,725 |
Insurance operations | 299 | | 263 | | 201 |
Other | 195 | | 189 | | 197 |
|
| |
| |
|
Total gross revenues | $4,476 | | $4,230 | | $4,123 |
|
| |
| |
|
| | | | | |
Depreciation on operating leases: | | | | | |
Finance operations | $1,446 | | $1,429 | | $1,368 |
Insurance operations | - | | - | | - |
Other | 133 | | 132 | | 134 |
|
| |
| |
|
Total depreciation on operating leases | $1,579 | | $1,561 | | $1,502 |
|
| |
| |
|
| | | | | |
Interest expense: | | | | | |
Finance operations | $651 | | $557 | | $1,222 |
Insurance operations | - | | - | | - |
Other | 19 | | 21 | | 27 |
|
| |
| |
|
Total interest expense | $670 | | $578 | | $1,249 |
|
| |
| |
|
| | | | | |
Provision for credit losses: | | | | | |
Finance operations | $234 | | $347 | | $596 |
Insurance operations | - | | - | | - |
Other | (4) | | 4 | | 8 |
|
| |
| |
|
Total provision for credit losses: | $230 | | $351 | | $604 |
|
| |
| |
|
| | | | | |
Operating and administrative expenses: | | | | | |
Finance operations | $537 | | $489 | | $445 |
Insurance operations | 92 | | 79 | | 76 |
Other | 21 | | 15 | | 16 |
|
| |
| |
|
Total operating and administrative expenses | $650 | | $583 | | $537 |
|
| |
| |
|
| | | | | |
Provision for income taxes: | | | | | |
Finance operations | $435 | | $377 | | $36 |
Insurance operations | 35 | | 34 | | 13 |
Other | 11 | | 7 | | 5 |
|
| |
| |
|
Total provision for income taxes | $481 | | $418 | | $54 |
|
| |
| |
|
| | | | | |
Net income: | | | | | |
Finance operations | $678 | | $579 | | $57 |
Insurance operations | 67 | | 50 | | 25 |
Other | 17 | | 12 | | 8 |
|
| |
| |
|
Net income | $762 | | $641 | | $90 |
|
| |
| |
|
- 105 -
| | Years Ended March 31, |
| | 2007 | | 2006 | | 2005 |
| | |
| Gross revenues: | | | | | |
| Finance operations | $6,565 | | $5,031 | | $3,982 |
| Insurance operations | 494 | | 346 | | 299 |
| Other | 237 | | 208 | | 195 |
| Total gross revenues | $7,296 | | $5,585 | | $4,476 |
| | | | | | |
| Depreciation on operating leases: | | | | | |
| Finance operations | $2,529 | | $1,891 | | $1,446 |
| Insurance operations | - | | - | | - |
| Other | 144 | | 136 | | 133 |
| Total depreciation on operating leases | $2,673 | | $2,027 | | $1,579 |
| | | | | | |
| Interest expense: | | | | | |
| Finance operations | $2,624 | | $1,471 | | $651 |
| Insurance operations | - | | - | | - |
| Other | 42 | | 31 | | 19 |
| Total interest expense | $2,666 | | $1,502 | | $670 |
| | | | | | |
| Provision for credit losses: | | | | | |
| Finance operations | $407 | | $302 | | $234 |
| Insurance operations | - | | - | | - |
| Other | 3 | | 3 | | (4) |
| Total provision for credit losses: | $410 | | $305 | | $230 |
| | | | | | |
| Operating and administrative expenses: | | | | | |
| Finance operations | $587 | | $589 | | $537 |
| Insurance operations | 144 | | 102 | | 92 |
| Other | 27 | | 21 | | 21 |
| Total operating and administrative expenses | $758 | | $712 | | $650 |
| | | | | | |
| Provision for income taxes: | | | | | |
| Finance operations | $141 | | $302 | | $435 |
| Insurance operations | 83 | | 34 | | 35 |
| Other | 7 | | 8 | | 11 |
| Total provision for income taxes | $231 | | $344 | | $481 |
| | | | | | |
| Net income: | | | | | |
| Finance operations | $277 | | $495 | | $678 |
| Insurance operations | 141 | | 72 | | 67 |
| Other | 14 | | 13 | | 17 |
| Total net income | $432 | | $580 | | $762 |
TOYOTA MOTOR CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 17 -18 – Selected Quarterly Financial Data (Unaudited) | | | | | | | | | |
| Total financing revenues | | Depreciation on operating leases | | Interest expense | | Provision for credit losses | | Net income |
|
| |
| |
| |
| |
|
| (Dollars in millions) |
Fiscal 2005: | | | | | | | | | |
| | | | | | | | | |
First quarter | $966 | | $389 | | $117 | | $46 | | $198 |
Second quarter | 1,000 | | 391 | | 200 | | 50 | | 171 |
Third quarter | 1,040 | | 380 | | 144 | | 47 | | 225 |
Fourth quarter | 1,080 | | 419 | | 209 | | 87 | | 168 |
|
| |
| |
| |
| |
|
Total | $4,086 | | $1,579 | | $670 | | $230 | | $762 |
|
| |
| |
| |
| |
|
| | | | | | | | | |
Fiscal 2004: | | | | | | | | | |
| | | | | | | | | |
First quarter | $940 | | $420 | | $240 | | $109 | | $57 |
Second quarter | 960 | | 383 | | 96 | | 78 | | 216 |
Third quarter | 956 | | 373 | | 93 | | 76 | | 228 |
Fourth quarter | 966 | | 385 | | 149 | | 88 | | 140 |
|
| |
| |
| |
| |
|
Total | $3,822 | | $1,561 | | $578 | | $351 | | $641 |
|
| |
| |
| |
| |
|
| | | | | | | | | | |
| | Total financing revenues | | Depreciation on operating leases | | Interest expense | | Provision for credit losses | | Net income |
| | (Dollars in millions) |
| Fiscal 2007: | | | | | | | | | |
| | | | | | | | | | |
| First quarter | $1,522 | | $605 | | $500 | | $66 | | $169 |
| Second quarter | 1,630 | | 648 | | 760 | | 91 | | 42 |
| Third quarter | 1,741 | | 693 | | 664 | | 111 | | 123 |
| Fourth quarter | 1,817 | | 727 | | 742 | | 142 | | 98 |
| Total | $6,710 | | $2,673 | | $2,666 | | $410 | | $432 |
| | | | | | | | | | �� |
| Fiscal 2006: | | | | | | | | | |
| | | | | | | | | | |
| First quarter | $1,177 | | $450 | | $351 | | $38 | | $150 |
| Second quarter | 1,259 | | 499 | | 301 | | 96 | | 158 |
| Third quarter | 1,331 | | 521 | | 438 | | 59 | | 135 |
| Fourth quarter | 1,414 | | 557 | | 412 | | 112 | | 137 |
| Total | $5,181 | | $2,027 | | $1,502 | | $305 | | $580 |
Note 18 – Subsequent EventsIn May 2005, the New Jersey Supreme Court issued a ruling in connection withJorge v Toyota Motor Insurance Services (“TMIS”)(discussed in Note 14 – Commitments and Contingencies) granting TMIS’ motion for leave to appeal the trial court’s denial of TMIS’ motion for summary judgment. The case has been remanded to the Appellate Division for reconsideration on the merits.
In June 2005, the semi-annual fee the Company is required to pay to TFSC under the credit support agreement discussed in Note 15 – Related Party Transactions increased from 0.05% to 0.06% per annum of the weighted average outstanding amounts entitled to credit support of the Company’s securities.
In June 2005, the Master Services Agreement between TMCC and TFSB discussed in Note 15 – Related Party Transactions was amended and restated to include a number of additional services to be provided to TFSB by TMCC and certain limited services to be provided to TMCC by TFSB.
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There is nothing to report with regard to this item.
We maintain “disclosure controls and
proceduresprocedures” as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (“the Exchange Act���) that are designed to ensure that information required to be disclosed in
the reports filed or submitted under the
Securities Exchange Act,
of 1934, as amended,
(“Exchange Act”), is recorded, processed, summarized, and reported within the time periods specified
inby the Securities and Exchange
CommissionCommission’s (“SEC”) rules and
forms.regulations. Disclosure controls and procedures are designed to ensure that information required to be disclosed by
the Companyus in
itsour Exchange Act reports is accumulated and communicated to
the Company’s management including its principal executive and financial officers, as appropriate, to allow timely decisions regarding required disclosure.
The Company’s
Our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) evaluated the effectiveness of
the Company’s disclosureour “disclosure controls and
procedures in placeprocedures” as of the end of the
most recent fiscal quarterperiod covered by this
annual report pursuant to Rule 13a-15(b) of the Exchange Act.report. Based on this evaluation, the CEO and CFO concluded that the disclosure controls and procedures
do not provide reasonable assurance of effectiveness as of the end of the period covered by this annual report because of the material weaknesses relatedwere effective to
Statement of Financial Accounting Standards No.133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”) and Statement of Financial Accounting Standards No. 52, “Foreign Currency Translation” (“FAS 52”) discussed below. In light of these material weaknesses described below, the Company performed additional proceduresensure that information required to
provide additional assurance that its consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).The Companybe disclosed in its Quarterly Report on Form 10-Q forreports filed under the period ended September 30, 2004 that prior financial results for certainExchange Act was recorded, processed, summarized and reported within the time periods had been restated primarily due to errors inspecified by the accounting related to incremental direct costs and incentive payments made to dealers, certain debt, and unearned income related to finance receivables, net, and investments in operating leases, net.
That restatement of the Company’s financial results was fully set forth in the amendment to the Company’s annual report on Form 10-K/A for the year ended March 31, 2004 as filed with the SEC on December 8, 2004 and the amendments to the Company’s quarterly reports on Form 10-Q/A for the quarterly periods ended December 31, 2003 and June 30, 2004 as filed with the SEC on December 16, 2004. The consolidated financial statements included in this Form 10-K as of and for the years ended March 31, 2004 and 2003 reflect the adjustments made in the amended filings referenced above.
In January 2005, the Company identified accounting errors primarily relating to its accounting for certain debt and related derivative transactions as governed by FAS 133 and FAS 52. The Company also identified an error in the accounting for depreciation expense on leasehold improvements and an error in the accounting for gains recognized upon the sale of securitized receivables. In the third quarter of fiscal 2005, the Company recorded an adjustment representing the cumulative effect of these errors through September 30, 2004. The cumulative adjustment has been fully set forth in the Company’s quarterly report on Form 10-Q for the quarter ended December 31, 2004 as filed with the SEC on February 22, 2005. The consolidated financial statements included in this Form 10-K reflect this adjustment.
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SEC. Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the
Company,company, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.
The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with GAAP. Internal control over financial reporting includes those policies and procedures that: pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the Company;
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.
A material weakness is a control deficiency, or a combination of control deficiencies, that results in a more than remote likelihood that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected. Management has concluded that material weaknesses existed in the following areas as of March 31, 2005:
The application of FAS 133 and FAS 52 as it relates to the determination and amortization of hedging basis differences and foreign currency transaction gains and losses on debt, adjustments for debt issuance costs, and premiums and discounts.
The policies and procedures supporting the accounting for, and reporting and monitoring of, derivatives and hedging activities.
The underlying technology systems used to support the complexity of FAS 133 accounting for derivatives and hedging activities.
These control deficiencies contributed to the restatement and cumulative adjustment identified above and could cause a material misstatement to the consolidated financial statements that would not be prevented or detected.
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Changes in Internal Control over Financial Reporting
The Company made the following changes to internal control over financial reporting during the most recent fiscal quarter to address the control deficiencies described above:
•
| Application of FAS 133 and FAS 52:Upon identifying the material weakness relating to the application of FAS 133 and FAS 52 identified above in connection with its derivatives and hedging activities, the Company launched a comprehensive review of its accounting policies for its debt and related derivatives and made the necessary changes to those policies. Additionally, the Company hired a manager dedicated to the development, documentation, and proper application of the Company’s accounting policies (the “Accounting Policies Manager”), who joined the Company in the first quarter of fiscal 2006. The Accounting Policies Manager, having expertise in the application of FAS 133 and FAS 52, is assisting in the proper accounting for transactions in the Company’s derivatives portfolio. Management believes that existing policies and procedures combined with heightened management oversight and review and its current technology systems are sufficient to accurately account for current transactions. Management observed the controls functioning as designed during the fourth quarter of fiscal 2005 but believes that further evaluation time is necessary to ensure the controls provide a reasonable assurance of effectiveness and that the material weakness has been remediated.
|
•
| Policies and Procedures Supporting the Accounting for, and Reporting and Monitoring of, Derivatives and Hedging Activities:In conjunction with the changes made to the Company’s policies for FAS 133 and to address the material weakness in its policies and procedures supporting the accounting for, and reporting and monitoring of, derivative and hedging activities, the Company reevaluated its processes and procedures for forecasting derivative and hedging results and the uses of such forecasts as a control. Additionally, the Company reevaluated its supervisory and review controls as they relate to financial reporting of derivatives and hedging activities. The Company developed a set of analytical tools to enhance the closing process and help ensure accuracy of such financial results. These processes and controls were implemented as of March 31, 2005. Management observed the controls functioning as designed during the fourth quarter of fiscal 2005 but believes that further evaluation time is necessary to ensure the controls provide a reasonable assurance of effectiveness and that the material weakness has been remediated.
|
•
| Underlying Technology Systems Used to Support FAS 133 Accounting: The implementation of the processes and controls described above also enhanced management’s review of the information generated by the underlying technology systems used to support FAS 133 accounting for derivatives and hedging activities. Management believes that the enhancements above will remediate the material weakness that exists related to the underlying technology used to support FAS 133 accounting. Management observed the controls functioning as designed during the fourth quarter of fiscal 2005 but believes that further evaluation time is necessary to ensure the controls provide a reasonable assurance of effectiveness and that the material weakness has been remediated.
|
The information systems in this area rely heavily upon manual rather than automated system processes and controls. As a result, management believes that opportunities for stronger and more efficient controls exist. Accordingly, the Company is pursuing additional remediation efforts and intends to upgrade its technology systems to replace manual processes with automated system processes and controls. The Company has launched an initiative to identify a new treasury accounting system to support the accounting for its debt and automate the accounting for its derivatives portfolio. Management anticipates identifying the new technology system to enhance controls by August 31, 2005 and the implementation of the new system by August 2006.
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Additionally, the Company made the changes to internal control over financial reporting to address and remediate the following material weaknesses identified during the year in the following areas:
•
| Design and Review of Revenue Recognition Policies:The Company reported ineffective controls over its design and review of revenue recognition policies in the September 30, 2004 Form 10-Q, particularly in the areas of incremental direct costs and incentive payments made to dealers associated with the acquisition of retail and vehicle lease contracts.The Company devoted significant resources to revising its policies, procedures, and financial information systems to comply with the methods required by GAAP related to revenue recognition to ensure accurate measurement of estimates and recording of amounts associated with the acquisition of retail and vehicle lease contracts and dealer incentive and rate participation payments at acquisition and over the life of the contracts. In addition, the Company hired a new Corporate Manager and Chief Accounting Officer, who joined the Company in November 2004. The Company also appointed a manager dedicated to the valuation of and accounting for deferred fees and costs, who assumed his duties in December 2004, and also hired the Accounting Policies Manager as described above. As a result of these efforts, management believes this material weakness has been remediated as of March 31, 2005 and no longer constitutes a material weakness.
|
•
| Policies and Procedures Necessary to Ensure Accurate Measurement of Estimates and Recording of Amounts over the Life of the Retail and Vehicle Lease Contracts: The Company reported ineffective controls in its policies and procedures necessary to ensure accurate measurement of estimates and recording of amounts over the life of the retail and vehicle lease contracts in the September 30, 2004 Form 10-Q.The accounting policies group in conjunction with the marketing group now reviews new marketing and related programs to ensure proper application of accounting policies and practices. The Company also completed the development of financial models for calculating incremental direct cost and fee amortization. As a result of these efforts, management believes this material weakness has been remediated as of March 31, 2005 and no longer constitutes a material weakness. The Company also intends to further refine its processes in this area. In that connection, the Company is currently reviewing existing systems to confirm that proper calculations are used within the system to eliminate the need to use external financial models.
|
•
| Financial Reporting and Determination of Gain on Sale Accounting Related to Securitization of Receivable Contracts: The Company reported ineffective controls over the financial reporting and determination of gain on sale accounting related to securitization of receivable contracts in the December 31, 2004 Form 10-Q,particularly in the application of the accounting guidance to properly determine the gain on sale of securitized receivables. As a result of this deficiency, an error existed in the calculation of gains relating to the securitization of receivables, which the Company identified in the third quarter. The Company changed its staff responsible for securitization accounting several quarters ago and employed different personnel with the required level of expertise. No new transactions have occurred since that time. Management believes that the current staff has the appropriate training and experience to ensure that such errors do not recur in the future. As a result of these efforts, management believes this material weakness has been remediated as of March 31, 2005 and no longer constitutes a material weakness. The Company intends to further enhance its controls in this area and is in the process of upgrading its securitization accounting systems. Management anticipates that this upgrade will be completed by September 30, 2005.
|
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Preparation for Compliance with Section 404 of the Sarbanes Oxley Act of 2002
The Company is