~~Index~~

Index

		Page
Part I - Financial Information:

Item 1. Consolidated Financial Statements (Unaudited):

Consolidated Statement of Earnings for the three and six months ended M~~arch~~ ~~31,~~June 30, 2019 and 2018		3

Consolidated Statement of Comprehensive Income for the three and six months ended M~~arch 31~~,June 30, 2019 and 2018		4

Consolidated Statement of Financial Position at ~~March 31,~~June 30, 2019 and December 31, 2018		5

Consolidated Statement of Cash Flows for the ~~three~~six months ended ~~March 31,~~June 30, 2019 and 2018		6

Consolidated Statement of Changes in Member’s Interest for the three and six months ended ~~March 31,~~June 30, 2019 and 2018		7

Notes to Consolidated Financial Statements		8 9

Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition		34 35

Item 4. Controls and Procedures		48 53

Part II - Other Information:

Item 1. Legal Proceedings		49 53

~~Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities~~		49

Item 6. Exhibits		49 53

Table of Contents

Part I— Financial Information

Item 1. Consolidated Financial Statements:

IBM CREDIT LLC AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF EARNINGS

(UNAUDITED)


	Three Months Ended June 30,				Six Months Ended June 30,
(Dollars in millions)	2019		2018		2019		2018
Revenue
Financing revenue	$	339	$	352	$	743	$	717
Operating lease revenue		70		80		149		165
Total revenue	$	410	$	433	$	892	$	882
Financing cost (related party cost for the three and six months: $58 and $131 in 2019, $75 and $134 in 2018)	$	137	$	125	$	297	$	227
Depreciation of equipment under operating lease		43		48		88		96
Net margin	$	230	$	259	$	507	$	559
Expense and other (income)
Selling, general and administrative	$	97	$	104	$	194	$	203
Provision for/(benefit from) credit losses		(8)		25		(4)		34
Other (income) and expense		5		(17)		(13)		(16)
Total expense and other (income)	$	94	$	111	$	178	$	221
Income before income taxes	$	136	$	148	$	330	$	339
Provision for income taxes		23		31		173		73
Net income	$	113	$	117	$	156	$	266

~~(UNAUDITED)~~

Three Months Ended March 31,

(Dollars in millions)

2019

2018

Revenue





Financing revenue

$
404

$
365

Operating lease revenue

78

84

Total revenue

$
482

$
449

Financing cost (related party cost of $74 in 2019 and $57 in 2018)

$
160

$
102

Depreciation of equipment under operating lease

45

48

Net margin

$
277

$
300

Expense and other (income)

Selling, general and administrative

$
97

$
98

Provision for credit losses

4

9

Other (income) and expense

(18)

1

Total expense and other (income)

$
83

$
109

Income before income taxes

$
193

$
191

Provision for income taxes

150

42

Net income

$
43

$
149

(Amounts may not add due to rounding.)

(The accompanying notes are an integral part of the financial statements.)

Table of Contents

Consolidated Financial Statements — (continued)

IBM CREDIT LLC AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)

~~(UNAUDITED)~~


	Three Months Ended June 30,				Six Months Ended June 30,
(Dollars in millions)	2019		2018		2019		2018
Net income	$	113	$	117	$	156	$	266
Other comprehensive income/(loss), before tax:
Foreign currency translation		16		(168)		20		(98)
Retirement-related benefit plans (1)		0		0		0		1
Other comprehensive income/(loss), before tax		17		(168)		20		(97)
Income tax (expense)/benefit related to items of other comprehensive income		2		(27)		5		(16)
Other comprehensive income/(loss), net of tax	$	19	$	(195)	$	25	$	(113)
Total comprehensive income	$	132	$	(78)	$	181	$	152

Three Months Ended March 31,

(Dollars in millions)

2019

2018

Net income

$
43

$
149

Other comprehensive income/(loss), before tax:

Foreign currency translation

3

70

Retirement-related benefit plans (1)

0

1

Other comprehensive income/(loss), before tax

3

71

Income tax benefit related to items of other comprehensive income

3

11

Other comprehensive income/(loss), net of tax

$
6

$
82

Total comprehensive income

$
49

$
230

(1)

~~(1)~~

Amounts ~~represented~~presented relate to multiple-employer plans.

(Amounts may not add due to rounding.)

(The accompanying notes are an integral part of the financial statements.)

Table of Contents

Consolidated Financial Statements — (continued)

IBM CREDIT LLC AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

(UNAUDITED)


	At June 30,		At December 31,
(Dollars in millions)	2019		2018
Assets:
Cash and cash equivalents	$	1,732	$	1,828
Financing receivables		18,740		25,848
(net of allowances of $161 in 2019 and $174 in 2018)
Equipment under operating leases		295		386
(net of accumulated depreciation of $260 in 2019 and $283 in 2018)
Financing receivables from IBM		3,703		3,609
Receivables purchased/participated from IBM		4,275		5,433
(net of allowances of $11 in 2019 and $18 in 2018)
Other receivables from IBM		329		2,019
Other assets		422		373
Total assets	$	29,495	$	39,497

Liabilities:
Accounts payable	$	518	$	1,705
Accounts payable to IBM		1,170		3,044
Debt		9,598		10,954
Debt payable to IBM		14,641		19,580
Taxes		608		547
Other liabilities		235		246
Total liabilities	$	26,771	$	36,076
Member’s interest:
Member's interest		2,733		3,216
Retained earnings		—		238
Accumulated other comprehensive income/(loss)		(8)		(33)
Total member's interest	$	2,724	$	3,420
Total liabilities and member’s interest	$	29,495	$	39,497

~~(UNAUDITED)~~

At March 31,

At December 31,

(Dollars in millions)

2019

2018

Assets:





Cash and cash equivalents

$
1,573

$
1,828

Financing receivables

23,431

25,848

(net of allowances of $171 in 2019 and $174 in 2018)

Equipment under operating leases

345

386

(net of accumulated depreciation of $286 in 2019 and $283 in 2018)

Financing receivables from IBM

3,869

3,609

Receivables purchased/participated from IBM

5,331

5,433

(net of allowances of $11 in 2019 and $18 in 2018)

Other receivables from IBM

301

2,019

Other assets

366

373

Total assets

$
35,217

$
39,497

Liabilities:

Accounts payable

$
1,362

$
1,705

Accounts payable to IBM

950

3,044

Debt

10,577

10,954

Debt payable to IBM

18,367

19,580

Taxes

594

547

Other liabilities

203

246

Total liabilities

$
32,053

$
36,076

Member’s interest:

Member's interest

3,191

3,216

Retained earnings

—

238

Accumulated other comprehensive income/(loss)

(27)

(33)

Total member's interest

$
3,164

$
3,420

Total liabilities and member’s interest

$
35,217

$
39,497

(Amounts may not add due to rounding.)

(The accompanying notes are an integral part of the financial statements.)

Table of Contents

Consolidated Financial Statements — (continued)

IBM CREDIT LLC AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

~~(UNAUDITED)~~


	Six Months Ended June 30,
(Dollars in millions)	2019		2018
Cash flows from operating activities:
Net income	$	156	$	266
Adjustments to reconcile net income to cash provided by operating activities:
Provision for/(benefit from) credit losses		(4)		34
Depreciation		88		96
Deferred taxes		27		(28)
Net (gain)/loss on asset sales and other		(44)		(48)
Change in operating assets and liabilities:
Other assets/other liabilities		(198)		209
Net cash provided by operating activities	$	26	$	529

Cash flows from investing activities:
Originations of financing receivables	$	(6,872)	$	(7,310)
Collection of financing receivables		7,446		7,111
Short-term financing receivables - net (1)		4,884		1,065
Purchase of equipment under operating leases		(29)		(130)
Proceeds from disposition of equipment under operating lease		32		28
Other receivables from IBM - net		1,697		(1,769)
Other investing activities - net		39		81
Net cash provided by/(used in) investing activities	$	7,197	$	(924)

Cash flows from financing activities:
Proceeds from issuance of debt from IBM	$	5,858	$	6,882
Principal payments on debt from IBM		(5,903)		(6,377)
Proceeds from issuance of debt		500		2,413
Principal payments on debt		(431)		(560)
Short-term borrowings from/(repayments to) IBM - net (1)		(4,914)		(2,667)
Short-term borrowings/(repayments) - net (1)		(1,486)		463
Contributions from IBM		—		145
Distributions to IBM		(942)		(490)
Net cash used in financing activities	$	(7,318)	$	(191)

Effect of exchange rate changes on cash and cash equivalents	$	0	$	(14)
Net change in cash and cash equivalents	$	(96)	$	(600)

Cash and cash equivalents at January 1		1,828		2,680
Cash and cash equivalents at June 30	$	1,732	$	2,080

Three Months Ended March 31,

(Dollars in millions)

2019

2018

Cash flows from operating activities:





Net income

$
43

$
149

Adjustments to reconcile net income to cash provided by operating activities:

Provision for credit losses

4

9

Depreciation

45

48

Deferred taxes

(2)

(25)

Net (gain)/loss on asset sales and other

(6)

(44)

Change in operating assets and liabilities:

Other assets/other liabilities

4

103

Net cash provided by operating activities

$
88

$
240

Cash flows from investing activities:



Originations of financing receivables

$
(4,219)

$
(4,943)

Collection of financing receivables

4,023

3,751

Short-term financing receivables - net (1)

46

863

Purchase of equipment under operating leases

(20)

(57)

Proceeds from disposition of equipment under operating lease

13

15

Other receivables from IBM - net

1,738

(214)

Other investing activities - net

(10)

(65)

Net cash provided by/(used in) investing activities

$
1,572

$
(650)

Cash flows from financing activities:



Proceeds from issuance of debt from IBM

$
2,545

$
4,841

Principal payments on debt from IBM

(2,388)

(4,299)

Proceeds from issuance of debt

300

2,122

Principal payments on debt

(196)

(247)

Short-term borrowings from/(repayments to) IBM - net (1)

(1,299)

(2,517)

Short-term borrowings/(repayments) - net (1)

(500)

480

Distributions to IBM

(370)

(490)

Net cash used in financing activities

$
(1,910)

$
(111)

Effect of exchange rate changes on cash and cash equivalents

$
(5)

$
11

Net change in cash and cash equivalents

$
(255)

$
(510)

Cash and cash equivalents at January 1

1,828

2,680

Cash and cash equivalents at March 31

$
1,573

$
2,170

(1)

~~(1)~~

Short-term represents original maturities of 90 days or less.

(Amounts may not add due to rounding.)

(The accompanying notes are an integral part of the financial statements.)

Table of Contents

Consolidated Financial Statements — (continued)

IBM CREDIT LLC AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CHANGES IN MEMBER'S INTEREST

(UNAUDITED)


					Accumulated
					Other		Total
	Member's		Retained		Comprehensive		Member’s
(Dollars in millions)	Interest		Earnings		Income/(Loss)		Interest
Member’s Interest, April 1, 2019	$	3,191	$	—	$	(27)	$	3,164
Net income plus other comprehensive income/(loss):
Net income				113				113
Other comprehensive income/(loss), net of tax						19		19
Total comprehensive income/(loss)							$	132
Contributions from IBM		—						—
Distributions to IBM		(459)		(113)				(572)
Member’s Interest, June 30, 2019	$	2,733	$	—	$	(8)	$	2,724

(Amounts may not add due to rounding.)

(The accompanying notes are an integral part of the financial statements.)


					Accumulated
					Other		Total
	Member's		Retained		Comprehensive		Member’s
(Dollars in millions)	Interest		Earnings		Income/(Loss)		Interest
Member’s Interest, April 1, 2018	$	3,067	$	—	$	234	$	3,302
Net income plus other comprehensive income/(loss):
Net income				117				117
Other comprehensive income/(loss), net of tax						(195)		(195)
Total comprehensive income/(loss)							$	(78)
Contributions from IBM		145						145
Distributions to IBM		—		—				—
Member’s Interest, June 30, 2018	$	3,212	$	117	$	39	$	3,369

(Amounts may not add due to rounding.)

(The accompanying notes are an integral part of the financial statements.)

Table of Contents

Consolidated Financial Statements — (continued)

IBM CREDIT LLC AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CHANGES IN MEMBER'S INTEREST – (CONTINUED)

(UNAUDITED)

~~(UNAUDITED)~~


					Accumulated
					Other		Total
	Member's		Retained		Comprehensive		Member’s
(Dollars in millions)	Interest		Earnings		Income/(Loss)		Interest
Member’s Interest, January 1, 2019	$	3,216	$	238	$	(33)	$	3,420
Net income plus other comprehensive income/(loss):
Net income				156				156
Other comprehensive income/(loss), net of tax						25		25
Total comprehensive income/(loss)							$	181
Contributions from IBM (1)		64						64
Distributions to IBM		(547)		(395)				(942)
Member’s Interest, June 30, 2019	$	2,733	$	—	$	(8)	$	2,724

Accumulated

Other

Total

Member's

Retained

Comprehensive

Member’s
(Dollars in millions)

Interest

Earnings

Income/(Loss)

Interest
Member’s Interest, January 1, 2019

$
3,216

$
238

$
(33)

$
3,420
Net income plus other comprehensive income/(loss):



Net income

43



43
Other comprehensive income/(loss), net of tax

6


6
Total comprehensive income/(loss)


$
49
Contributions from IBM (1)

64



64
Distributions to IBM

(88)

(282)

(370)
Member’s Interest, March 31, 2019

$
3,191

$
—

$
(27)

$
3,164

(1) Includes $64 million non-cash equity contribution from IBM. Refer to note 9, "Relationship with IBM and Related Party Transactions."

(Amounts may not add due to rounding.)

(The accompanying notes are an integral part of the financial statements.)


					Accumulated
					Other		Total
	Member's		Retained		Comprehensive		Member’s
(Dollars in millions)	Interest		Earnings		Income/(Loss)		Interest
Member’s Interest, January 1, 2018	$	3,101	$	302	$	158	$	3,562
Cumulative effect of change in accounting principle (1)				5		(5)		—
Net income plus other comprehensive income/(loss):
Net income				266				266
Other comprehensive income/(loss), net of tax						(113)		(113)
Total comprehensive income/(loss)							$	152
Contributions from IBM		145						145
Distributions to IBM		(34)		(456)				(490)
Member’s Interest, June 30, 2018	$	3,212	$	117	$	39	$	3,369

Accumulated

Other

Total

Member's

Retained

Comprehensive

Member’s
(Dollars in millions)

Interest

Earnings

Income/(Loss)

Interest
Member’s Interest, January 1, 2018

$
3,101

$
302

$
158

$
3,562
Cumulative effect of change in accounting principle (1)



5

(5)

—
Net income plus other comprehensive income/(loss):

Net income

149



149
Other comprehensive income/(loss), net of tax

82


82
Total comprehensive income/(loss)


$
230
Distributions to IBM

(34)

(456)

(490)
Member’s Interest, March 31, 2018

$
3,067

$
—

$
234

$
3,302

(1) Reflects the adoption of the FASB guidance on stranded tax effects. Refer to note 2, "Accounting Changes."

(Amounts may not add due to rounding.)

(The accompanying notes are an integral part of the financial statements.)

Table of Contents

Notes to Consolidated Financial Statements:

1. Basis of Presentation:

The accompanying Consolidated Financial Statements and footnotes of IBM Credit LLC (IBM Credit or the company) have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial statements and footnotes are unaudited. In the opinion of the company’s management, these statements include all adjustments, which are only of a normal recurring nature, necessary to present a fair statement of the company’s results of operations, financial position and cash flows.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amount of assets, liabilities, revenue, costs, expenses and other comprehensive income/(loss) that are reported in the Consolidated Financial Statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events, historical experience, actions that the company may undertake in the future and on various other assumptions that are believed to be reasonable under the circumstances. As a result, actual results may be different from these estimates.

Member’s Interest in the Consolidated Statement of Financial Position represents the accumulation of the company’s net income over time and contributions from IBM and distributions to IBM. Distributions by the company to IBM are considered first to be a return of profit as reflected in retained earnings in the Consolidated Statement of Financial Position. Any amount distributed to IBM in excess of the company’s available balance in retained earnings is considered a return of a portion of member’s interest as reflected in the Consolidated Statement of Financial Position.

Income tax expense is based on reported income before income taxes. Whereas the majority of non-U.S. entities are separate legal tax filers, the company’s U.S. federal and certain state and foreign operations will continue to be included in various IBM consolidated tax returns. In such cases, the income taxes for these entities are calculated using a separate return method modified to apply the benefits-for-loss approach, which is consistent with the company’s Tax Sharing Agreement with IBM. Under this approach, the provision for income taxes is computed as if the company filed tax returns on a separate tax return basis and is then adjusted, as necessary, to reflect IBM’s reimbursement for any tax benefits generated by the company.

In the first quarter of 2019, the company reported a provision for income taxes of $150 million and an effective tax rate of 77.5 percent, compared to a provision of $42 million and an effective tax rate of 22.0 percent in the first quarter of 2018. The change in the effective tax rate was primarily attributable to an additional tax expense of $116 million related to guidance issued by the U.S. Treasury in January 2019 regarding U.S. tax reform repatriation tax. In accordance with the previously executed Tax Sharing Agreement between IBM and the company, $64 million of the resulting liability was settled through a non-cash contribution to member’s interest. For additional information, refer to Note 9, “Relationship with IBM and Related Party Transactions.”

The amount of restricted cash included in the Consolidated Statement of Financial Position and Consolidated Statement of Cash Flows is immaterial for the periods presented.

All significant intracompany transactions between IBM Credit’s businesses have been eliminated. All significant intercompany transactions between IBM Credit and IBM have been included in these Consolidated Financial Statements.

Interim results are not necessarily indicative of financial results for a full year. The information included in this Form 10-Q should be read in conjunction with the Consolidated Financial Statements included in the company’s 2018 Form 10-K.

Within the financial statements and tables presented, certain columns and rows may not add due to the use of rounded numbers for disclosure purposes. Percentages presented are calculated from the underlying whole-dollar amounts. Certain prior year amounts have been reclassified to conform to the current year presentation. This is annotated where applicable.

~~Table of Contents~~

~~Notes to Consolidated Financial Statements — (continued)~~

2. Accounting Changes:

New Standards to be Implemented

In August 2018, the Financial Accounting Standards Board (FASB) issued guidance which changed the disclosure requirements for fair value measurements. The guidance is effective on January 1, 2020 with early adoption of certain provisions permitted. The company early adopted the provision in the fair value guidance that removed the Level 1/Level 2 transfer disclosures. The company is evaluating the adoption date for the remaining changes. As the guidance is

Table of Contents

Notes to Consolidated Financial Statements — (continued)

a change to disclosures only, the company does not expect the guidance to have a material impact in the consolidated financial results.

In June 2016, with amendments in 2018 and 2019, the FASB issued guidance for credit impairment based on an expected loss model rather than an incurred loss model. The guidance requires the consideration of all available relevant information when estimating expected credit losses, including past events, current conditions and forecasts and their implications for expected credit losses. A cross-functional team was established that is evaluating the financial instruments portfolio and the system, process and policy change requirements and continues to make substantial progress. The new guidance expands the scope of financial instruments subject to impairment, including off-balance sheet commitments and residual value. The guidance is effective January 1, 2020 with one-year early adoption permitted. The company will adopt the guidance as of the effective date and is continuing to evaluate the impact.

Standards Implemented

The FASB issued guidance in February 2016, with amendments in 2018 and 2019, which changed the accounting for leases. The guidance requires lessees to recognize right-of-use (ROU) assets and lease liabilities for most leases in the Consolidated Statement of Financial Position. The guidance also made some changes to lessor accounting, including the elimination of the use of third-party residual value guarantee insurance in the lease classification test, and overall aligns with the new revenue recognition ~~guidance~~.guidance. The guidance also requires qualitative and quantitative disclosures to assess the amount, timing and uncertainty of cash flows arising from leases. The company adopted the guidance effective January 1, 2019 using the transition option whereby prior comparative periods were not retrospectively presented in the consolidated financial statements. The company elected the package of practical expedients not to reassess prior conclusions related to contracts containing leases, lease classification and initial direct costs (IDC’s). From a lessor perspective, the changes in lease termination guidance, IDC and removal of third-party residual value guarantee insurance in the lease classification test did not have a material impact on the consolidated financial results. There are no material impacts of adoption from a lessee perspective as there are no material lease arrangements in which the company is a lessee. Refer to note 4, “Leases,” for additional information, including further discussion on the impact of adoption.

In February 2018, the FASB issued guidance that allows entities to elect an option to reclassify the stranded tax effects related to the application of U.S. tax reform from accumulated other comprehensive income/(loss) (AOCI) to retained earnings. The guidance was effective January 1, 2019, with early adoption permitted, and can be applied either in the period of adoption or retrospectively to all applicable periods. The company adopted the guidance effective January 1, 2018, and elected not to reclassify prior periods. In accordance with its accounting policy, the company releases income tax effects from AOCI once the reason the tax effects were established ceases to exist (e.g., when available-for-sale debt securities are sold or if a pension plan is liquidated). This guidance allows for the reclassification of stranded tax effects as a result of the change in tax rates from U.S. tax reform to be recorded upon adoption of the guidance rather than at the actual cessation date. At adoption on January 1, 2018, $5 million was reclassified from AOCI to retained earnings.

In August 2017, the FASB issued guidance to simplify the application of hedge accounting in certain areas, better portray the economic results of an entity’s risk management activities in its financial statements and make targeted improvements to presentation and disclosure requirements. The guidance was effective January 1, 2019, with early adoption permitted. The company adopted the guidance as of January 1, 2018, and it did not have a material impact in the consolidated financial results.

The FASB issued guidance on the recognition of revenue from contracts with customers in May 2014 with amendments in 2015 and 2016. Revenue recognition depicts the transfer of promised goods or services to customers in an amount that

~~Table of Contents~~

~~Notes to Consolidated Financial Statements — (continued)~~

reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires specific disclosures relating to revenue recognition. The company adopted the guidance on January 1, 2018 using the modified-retrospective transition method. The company concluded that substantially all of its financing and operating lease revenue streams are not within the scope of the guidance, as they are governed by other accounting standards. The guidance did not have an impact on the company’s consolidated financial results. ~~The company concluded its assessment~~

Table of ~~the data availability and presentation necessary to meet the additional disclosure requirements of the guidance in the~~ Contents

Notes to ~~the~~ Consolidated Financial Statements ~~and there was no material change to disclosures as a result of the adoption of the guidance.~~— (continued)

3. Financial Instruments:

Fair Value Measurements

Accounting guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Under this guidance, the company is required to classify certain assets and liabilities based on the following fair value hierarchy:

●

Level 1—Quoted prices (unadjusted) in active markets for identical assets or liabilities that can be accessed at the measurement date;

●

Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and

●

Level 3—Unobservable inputs for the asset or liability.

The guidance requires the use of observable market data if such data is available without undue cost and effort.

When available the company uses unadjusted quoted market prices in active markets to measure the fair value and classifies such items as Level 1. If quoted market prices are not available, fair value is based upon internally developed models that use current market-based or independently sourced market parameters such as interest rates and currency rates. Items valued using internally generated models are classified according to the lowest level input or value driver that is significant to the valuation.

The determination of fair value considers various factors including interest rate yield curves and time value underlying the financial instruments. For derivatives and debt securities, the company uses a discounted cash flow analysis using discount rates commensurate with the duration of the instrument.

In determining the fair value of financial instruments, the company considers certain market valuation adjustments to the “base valuations” calculated using the methodologies described below for several parameters that market participants would consider in determining fair value:

●

Counterparty credit risk adjustments are applied to financial instruments, taking into account the actual credit risk of a counterparty as observed in the credit default swap market to determine the true fair value of such an instrument.

●

Credit risk adjustments are applied to reflect the company’s own credit risk when valuing all liabilities measured at fair value. The methodology is consistent with that applied in developing counterparty credit risk adjustments, but incorporates the company’s own credit risk as observed in the credit default swap market.

As an example, the fair value of derivatives is derived utilizing a discounted cash flow model that uses observable market inputs such as known notional value amounts, yield curves, spot and forward exchange rates as well as discount rates. These inputs relate to liquid, heavily traded currencies with active markets which are available for the full term of the derivative.

~~Table of Contents~~

~~Notes to Consolidated Financial Statements — (continued)~~

Certain assets that are measured at fair value on a recurring basis can be subject to nonrecurring fair value measurements. These assets include available-for-sale debt securities that are deemed to be other-than-temporarily impaired. In the event of an other-than-temporary impairment of a debt security, fair value is measured using a model described above.

Accounting guidance permits the measurement of eligible financial assets, financial liabilities and firm commitments at fair value, on an instrument-by-instrument basis, that are otherwise not permitted to be accounted for at fair value under other accounting standards. This election is irrevocable. The company has not applied the fair value option to any eligible assets or liabilities.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

The following tables present the company’s financial assets and ~~financial~~ liabilities that are measured at fair value on a recurring basis at ~~March 31,~~June 30, 2019 and December 31, 2018.


(Dollars in millions)
At June 30, 2019	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents (1)
Time deposits and certificates of deposit	$	—	$	807	$	—	$	807
Money market funds		5		—		—		5
Total		5		807		—		812
Derivative assets (2)		—		46		—		46
Total assets	$	5	$	853	$	—	$	858
Liabilities:
Derivative liabilities (3)	$	—	$	15	$	—	$	15

(Dollars in millions)

At March 31, 2019

Level 1

Level 2

Level 3

Total

Assets:









Cash equivalents (1)

Time deposits and certificates of deposit

$
—

$
750

$
—

$
750

Money market funds

5

—

—

5

Total

5

750

—

755

Derivative assets (2)

—

21

—

21
(4)
Total assets

$
5

$
771

$
—

$
776

Liabilities:

Derivative liabilities (3)

$
—

$
23

$
—

$
23
(4)

(1)

~~(1)~~

Included within cash and cash equivalents in the Consolidated Statement of Financial Position.

(2)

~~(2)~~

Included within other assets in the Consolidated Statement of Financial Position.

(3)

~~(3)~~

Included within other liabilities in the Consolidated Statement of Financial Position.


(Dollars in millions)
At December 31, 2018	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents (1)
Time deposits and certificates of deposit	$	—	$	792	$	—	$	792
Money market funds		5		—		—		5
Total		5		792		—		797
Derivative assets (2)		—		18		—		18
Total assets	$	5	$	810	$	—	$	815
Liabilities:
Derivative liabilities (3)	$	—	$	37	$	—	$	37

(1)

~~(4)~~

If derivative exposures covered by a qualifying master netting agreement with IBM had been netted in the Consolidated Statement of Financial Position, the total derivative asset and liability positions would each have been reduced by $1 million.

(Dollars in millions)

At December 31, 2018

Level 1

Level 2

Level 3

Total

Assets:









Cash equivalents (1)









Time deposits and certificates of deposit

$
—

$
792

$
—

$
792

Money market funds

5

—

—

5

Total

5

792

—

797

Derivative assets (2)

—

18

—

18
(4)
Total assets

$
5

$
810

$
—

$
815

Liabilities:









Derivative liabilities (3)

$
—

$
37

$
—

$
37
(4)

~~(1)~~

Included within cash and cash equivalents in the Consolidated Statement of Financial Position.

(2)

~~(2)~~

Included within other assets in the Consolidated Statement of Financial Position.

(3)

~~(3)~~

Included within other liabilities in the Consolidated Statement of Financial Position.

~~(4)~~

~~Table of Contents~~

~~Notes to Consolidated Financial Statements — (continued)~~

Financial Assets and Liabilities Not Measured at Fair Value

Short-Term Receivables and Payables

Short-term financing receivables are financial assets with carrying values that approximate fair value. Accounts payable, other accrued expenses and short-term debt (including debt payable to IBM) are financial liabilities with carrying values that approximate fair value. If measured at fair value in the financial statements, these financial instruments would be classified as Level 3 in the fair value hierarchy, except for short-term debt, which would be classified as Level 2.

Long-Term Receivables

Fair values are based on discounted future cash flows using current interest rates offered for similar loans to clients with similar credit ratings for the same remaining maturities. At ~~March 31,~~June 30, 2019 and December 31, 2018, the difference between the carrying amount and estimated fair value for long-term receivables was immaterial. If measured at fair value in the financial statements, these financial instruments would be classified as Level 3 in the fair value hierarchy.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Long-Term Debt

Fair value of publicly traded long-term debt is based on quoted market prices for the identical liability when traded as an asset in an active market. For other long-term debt, which includes debt payable to IBM, for which a quoted market price is not available, an expected present value technique that uses rates currently available to the company for debt with similar terms and remaining maturities is used to estimate fair value. The carrying amount of long-term debt (including debt payable to IBM) was ~~$17,796~~$17,443 million and $17,276 million and the estimated fair value was ~~$17,829~~$17,560 million and $17,199 million at ~~March 31,~~June 30, 2019 and December 31, 2018, respectively. If measured at fair value in the financial statements, long-term debt (including the current portion) would be classified as Level 2 in the fair value hierarchy.

Derivative Financial Instruments

The company operates in multiple currencies and is a lender and issuer in the capital markets and a borrower from IBM. In the normal course of business, the company may be exposed to the impact of interest rate changes and foreign currency fluctuations. The company limits its exposure to core market risks by following established risk management policies and procedures, and through the use of match funding with IBM and third parties. Although the company seeks to substantially ~~match fund~~match-fund the terms, currency and interest rate variability of its debt against its underlying financial assets, risks may arise between assets and the related liabilities used for funding. The company may also choose to mitigate any remaining exposure relating to interest rate changes and foreign currency fluctuations through the use of interest rate or foreign exchange derivatives.

Derivative assets and liabilities are recorded in other assets and other liabilities in the Consolidated Statement of Financial Position and are presented on a gross basis. The notional amounts of the derivative instruments do not necessarily represent amounts exchanged by the company with IBM and third parties, and are not necessarily a direct measure of the financial exposure. The company also enters into master netting agreements with certain counterparties that allow for netting of exposures in the event of default or breach. However, in the Consolidated Statement of Financial Position, the company does not offset derivative assets against liabilities in master netting arrangements. At ~~March 31,~~June 30, 2019, the aggregate fair value of derivative contracts with IBM that were in an asset position totaled ~~$21~~$46 million and the aggregate fair value of derivative contracts with IBM that were in a liability position totaled ~~$23~~$15 million. If derivatives exposures covered by a qualifying master netting agreement with IBM had been netted in the Consolidated Statement of Financial Position, the total derivative asset and liability positions would each have been reduced by $1$15 million. At December 31, 2018, the aggregate fair value of derivative contracts with IBM that were in an asset position totaled $18 million and the aggregate fair value of derivative contracts with IBM that were in a liability position totaled $37 million. If derivatives exposures covered by a qualifying master netting agreement with IBM had been netted in the Consolidated Statement of Financial Position, the total derivative asset and liability positions would each have been reduced by $11 million.

~~Table of Contents~~

~~Notes to Consolidated Financial Statements — (continued)~~

Interest Rate Risk

Fixed and Variable Rate Borrowings

The company issues debt in the capital markets to fund its operations. Access to cost-effective financing can result in interest rate mismatches with the underlying assets. To manage these mismatches and to reduce overall interest cost, the company may enter into interest-rate swaps with IBM to convert specific fixed-rate debt issuances into variable-rate debt (i.e., fair value hedges) and to convert variable-rate debt issuances into fixed-rate debt (i.e., cash flow hedges). At ~~March 31,~~June 30, 2019 and December 31, 2018, the total notional amount of the company's interest rate swap contracts with IBM was $3,350 million at both periods. The weighted average remaining maturity of these instruments at ~~March 31,~~June 30, 2019 and December 31, 2018, was approximately ~~2.2~~1.9 years and 2.4 years, respectively. These interest rate contracts were accounted for as fair value hedges. The company did not have any cash flow hedges relating to this program outstanding at ~~March 31,~~June 30, 2019 and December 31, 2018.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Foreign Exchange Risk

Long-Term Investments in Foreign Subsidiaries (Net Investment)

The company enters into foreign exchange derivatives with IBM as a hedge of net investment of its foreign subsidiaries to reduce the volatility in member's interest caused by changes in foreign currency exchange rates in the functional currency of major foreign subsidiaries with respect to the U.S. dollar. At ~~March 31,~~June 30, 2019 and December 31, 2018, the total notional amount of derivative contracts with IBM designated as net investment hedges was ~~$1,356~~$1,255 million and $1,986 million, respectively. The weighted average remaining maturity of these instruments was 0.2 years at both periods.

Foreign Currency Asset/Liability Management

The company enters into foreign exchange derivative contracts to manage foreign currency exposures associated with the company’s funding from IBM and third parties. These derivatives are not designated as hedges for accounting purposes. However, these derivatives represent economic hedges which provide an economic offset to the underlying foreign currency exposure. The terms of these derivative contracts are generally less than one year. The gains and losses recognized on economic hedges are recorded in other (income) and expense in the Consolidated Statement of Earnings, and the associated cash flows are included in other investing activities-net, in the Consolidated Statement of Cash Flows.

There were no foreign exchange derivative contracts with third parties outstanding at ~~March 31,~~June 30, 2019 and December 31, 2018.

The following tables included in this note provide a quantitative summary of the derivative instrument-related risk management activity at ~~March 31,~~June 30, 2019 and December 31, 2018, as well as for the three and six months ended ~~March 31,~~June 30, 2019 and 2018, respectively.

~~Table of Contents~~

~~Notes to Consolidated Financial Statements — (continued)~~

Fair Values of Derivative Instruments in the Consolidated Statement of Financial Position

Fair Value of Derivative Assets

Fair Value of Derivative Liabilities

Balance Sheet

Balance Sheet

(Dollars in millions)

Classification

3/31/2019

12/31/2018

Classification

3/31/2019

12/31/2018
Designated as hedging instruments:

Interest rate contracts with IBM

Other assets

$
11

$
10

Other liabilities

$
23

$
27
Foreign exchange contracts with IBM

Other assets

10

9

Other liabilities

1

11

Fair value of derivative assets

$
21

$
18

Fair value of derivative liabilities

$
23

$
37

Not designated as hedging instruments:

Foreign exchange contracts

Other assets

—

—

Other liabilities

—

—

Fair value of derivative assets

$
—

$
—

Fair value of derivative liabilities

$
—

$
—

Total

$
21

$
18

$
23

$
37


	Fair Value of Derivative Assets					Fair Value of Derivative Liabilities
	Balance Sheet					Balance Sheet
(Dollars in millions)	Classification	6/30/2019		12/31/2018		Classification	6/30/2019		12/31/2018
Designated as hedging instruments:
Interest rate contracts with IBM	Other assets	$	46	$	10	Other liabilities	$	1	$	27
Foreign exchange contracts with IBM	Other assets		—		9	Other liabilities		15		11
	Fair value of derivative assets	$	46	$	18	Fair value of derivative liabilities	$	15	$	37

Not designated as hedging instruments:
Foreign exchange contracts	Other assets		—		—	Other liabilities		—		—
	Fair value of derivative assets	$	—	$	—	Fair value of derivative liabilities	$	—	$	—

Total		$	46	$	18		$	15	$	37

As of ~~March 31,~~June 30, 2019 and December 31, 2018, the following amounts were recorded in the Consolidated Statement of Financial Position related to cumulative basis adjustments for fair value ~~hedges:~~

At March 31,

At December 31,
(Dollars in millions)

2019

2018
Debt:

Carrying amount of the hedged item

$
(3,335)

$
(3,310)
Cumulative hedging adjustments included in the carrying amount - assets/(liabilities)

9

34

hedges.


	At June 30,		At December 31,
(Dollars in millions)	2019		2018
Debt:
Carrying amount of the hedged item	$	(3,373)	$	(3,310)
Cumulative hedging adjustments included in the carrying amount - assets/(liabilities)		(28)		34

Table of Contents

Notes to Consolidated Financial Statements — (continued)

The Effect of Derivative Instruments in the Consolidated Statement of Earnings

The total amounts of income and expense line items presented in the Consolidated Statement of Earnings in which the effects of fair value hedges, net investment hedges and derivatives not designated as hedging instruments are recorded and the total effect of hedge activity on these income and expense line items, are as follows:

Gains/(Losses) of
(Dollars in millions)

Total

Total Hedge Activity
For the three months ended March 31:

2019

2018

2019

2018
Financing cost

$
160

$
102

$
4

$
9
Other (income) and expense

(18)

1

—

1


					Gains/(Losses) of
(Dollars in millions)	Total				Total Hedge Activity
For the three months ended June 30:	2019		2018		2019		2018
Financing cost	$	137	$	125	$	2	$	8
Other (income) and expense		5		(17)		—		5


	Gain/(Loss) Recognized in Earnings
	Consolidated	Recognized on				Attributable to Risk
(Dollars in millions)	Statement of	Derivatives				Being Hedged (2)
For the three months ended June 30:	Earnings Line Item	2019		2018		2019		2018
Derivative instruments in fair value hedges (1):
Interest rate contracts with IBM	Financing cost	$	32	$	(14)	$	(37)	$	13

Derivative instruments not designated as hedging instruments:
Foreign exchange contracts	Other (income) and expense		—		5		N/A		N/A
Total		$	32	$	(9)	$	(37)	$	13


	Gain/(Loss) Recognized in Earnings and Other Comprehensive Income
					Consolidated
					Statement of	Reclassified				Amounts Excluded from
(Dollars in millions)	Recognized in OCI				Earnings	from AOCI				Effectiveness Testing (3)
For the three months ended June 30:	2019		2018		Line Item	2019		2018		2019		2018
Derivative instruments in net investment hedges:
Foreign exchange contracts with IBM	$	(8)	$	105	Financing cost	$	—	$	—	$	7	$	8

Total	$	(8)	$	105		$	—	$	—	$	7	$	8

Gain/(Loss) Recognized in Earnings

Consolidated

Recognized on

Attributable to Risk
(Dollars in millions)

Statement of

Derivatives

Being Hedged (2)
For the three months ended March 31:

Earnings Line Item

2019

2018

2019

2018
Derivative instruments in fair value hedges (1):

Interest rate contracts with IBM

Financing cost

$
20

$
(21)

$
(25)

$
23

Derivative instruments not designated as hedging instruments:

Foreign exchange contracts

Other (income) and expense

—

1

N/A

N/A
Total

$
20

$
(20)

$
(25)

$
23

Gain/(Loss) Recognized in Earnings and Other Comprehensive Income

Consolidated

Statement of

Reclassified

Amounts Excluded from
(Dollars in millions)

Recognized in OCI

Earnings

from AOCI

Effectiveness Testing (3)
For the three months ended March 31:

2019

2018

Line Item

2019

2018

2019

2018
Derivative instruments in net investment hedges:

Foreign exchange contracts with IBM

$
(10)

$
(43)

Financing cost

$
—

$
—

$
10

$
7

Total

$
(10)

$
(43)

$
—

$
—

$
10

$
7

(1)

~~(1)~~

The amount includes changes in clean fair values of the derivative instruments in fair value hedging relationships and the periodic accrual for coupon payments required under these derivative contracts.

(2)

~~(2)~~

The amount includes basis adjustments to the carrying value of the hedged item recorded during the period.

(3)

~~(3)~~

The company's policy is to recognize all fair value changes in amounts excluded from effectiveness testing in net income each period.

N/A - Not Applicable


					Gains/(Losses) of
(Dollars in millions)	Total				Total Hedge Activity
For the six months ended June 30:	2019		2018		2019		2018
Financing cost	$	297	$	227	$	7	$	16
Other (income) and expense		(13)		(16)		—		7

Table of Contents

Notes to Consolidated Financial Statements — (continued)


	Gain/(Loss) Recognized in Earnings
	Consolidated	Recognized				Attributable to Risk
(Dollars in millions)	Statement of	on Derivatives				Being Hedged (2)
For the six months ended June 30:	Earnings Line Item	2019		2018		2019		2018
Derivative instruments in fair value hedges (1):
Interest rate contracts with IBM	Financing cost	$	52	$	(36)	$	(62)	$	36

Derivative instruments not designated as hedging instruments:
Foreign exchange contracts	Other (income) and expense		—		7		N/A		N/A
Total		$	52	$	(29)	$	(62)	$	36


	Gain/(Loss) Recognized in Earnings and Other Comprehensive Income
					Consolidated
					Statement of					Amounts Excluded from
(Dollars in millions)	Recognized in OCI				Earnings	Reclassified from AOCI				Effectiveness Testing (3)
For the six months ended June 30:	2019		2018		Line Item	2019		2018		2019		2018
Derivative instruments in net investment hedges:
Foreign exchange contracts with IBM	$	(18)	$	62	Financing cost	$	—	$	—	$	17	$	16

Total	$	(18)	$	62		$	—	$	—	$	17	$	16

(1)	The amount includes changes in clean fair values of the derivative instruments in fair value hedging relationships and the periodic accrual for coupon payments required under these derivative contracts.

(2)	The amount includes basis adjustments to the carrying value of the hedged item recorded during the period.

(3)	The company's policy is to recognize all fair value changes in amounts excluded from effectiveness testing in net income each period.

N/A - Not Applicable

For the three and six months ending ~~March 31,~~June 30, 2019 and 2018, there were no material gains or losses excluded from the assessment of hedge effectiveness (for fair value hedges); nor are there any anticipated in the normal course of business.

~~Table of Contents~~4.Leases

~~Notes to Consolidated Financial Statements — (continued)~~

4. ~~Leases:~~

Accounting for leases as a lessee

IBM Credit’s global operations are primarily conducted in IBM leased or owned facilities, whereby IBM charges the company for occupancy expenses based on square footage space usage, with no fixed term commitment. As such, these arrangements do not represent leases and the company did not record any ROU assets or associated lease liabilities in the Consolidated Statement of Financial Position at January 1, 2019. For additional information, see Note 9, “Relationship with IBM and Related Party Transactions.” The company has no other material lease arrangements in which it is a lessee.

Accounting for leases as lessor

The company enters into leases as a means to provide financing to its clients. Assets under lease include new and used IBM equipment and certain original equipment manufacturers’ (OEM) IT products. ~~Equipment~~IBM equipment generally consists of IBM Z, Power Systems and Storage ~~Systems.~~Systems products.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

When entering into a contract with its clients, the company determines whether an arrangement contains a lease at its inception. As part of that evaluation, the company considers whether there is an implicitly or explicitly identified asset in the arrangement and whether the client has the right to control that asset.

The company determines whether there is a right to control the use of the asset by assessing the client’s rights to obtain substantially all of the economic benefits from the use of the identified asset and rights to direct the use of the identified asset. The company determines the classification of the lease at the lease commencement date.

Lease payments due to IBM Credit are typically fixed and paid in equal installments over the lease term. The majority of the company’s leases do not contain variable payments that are dependent on an index or a rate. Variable lease payments that do not depend on an index or a rate (e.g., property taxes) that are paid directly by the company and are reimbursed by the client, are recorded as finance income, along with the related cost, in the period in which collection of these payments is probable. Payments that are made directly by the client to a third party, including certain property taxes and insurance, are not considered part of variable payments and therefore are not recorded by the company. The company has made a policy election to exclude from consideration in contracts all collections from sales and other similar taxes.

The company’s payment terms for leases are typically unconditional. Therefore, ~~while~~in an instance when the client ~~could~~requests to terminate the lease prior to the end of the lease term, the client would typically be required to pay the remaining lease payments in full. At the end of the lease term, the company allows the client to either return the equipment, purchase the equipment at the then-current fair market value or a pre-stated purchase price, or renew the lease based on mutually agreed upon terms. With respect to a client purchase of leased assets, the lease agreement would include an option to purchase the equipment at either a stated price or at the then-current fair market value of the equipment at the end of the lease.

The following ~~table presents~~tables present amounts included in the Consolidated Statement of Earnings related to lessor activity:


~~(Dollars in millions)~~
~~For the three months ended March 31:~~	~~2019~~
~~Financing lease revenue~~	$	55
~~Operating lease revenue~~		78
~~Variable lease revenue~~		11
~~Total lease revenue~~	$	~~144~~


(Dollars in millions)
For the three months ended June 30:	2019
Financing lease revenue	$	51
Operating lease revenue		70
Variable lease revenue		2
Total lease revenue	$	124


(Dollars in millions)
For the six months ended June 30:	2019
Financing lease revenue	$	107
Operating lease revenue		149
Variable lease revenue		12
Total lease revenue	$	268

~~Table of Contents~~

~~Notes to Consolidated Financial Statements — (continued)~~

Sales-Type and Direct Financing Leases

If a lease is classified as a sales-type or direct financing lease, a net investment in the lease is recorded. For a sales-type lease, the net investment in the lease is measured at commencement date as the sum of the lease receivable and the estimated ~~guaranteed and unguaranteed~~ residual value of the equipment, less unearned income and allowance for credit losses. At ~~March 31,~~June 30, 2019, the unguaranteed residual value of sales-type and direct financing leases was ~~$472~~$481 million. For further information on the company’s investment in leases, including ~~guaranteed and unguaranteed~~ residual values, refer to note 5, “Financing Receivables, Receivables Purchased/Participated from IBM.”

IBM Credit enters into lease arrangements for the purpose of generating revenue by providing financing. As a result, any profit or loss at the lease commencement date is presented on a net basis within a single line item on the Consolidated Statement of Earnings. Under a net sales-type lease, eligible IDCs are deferred and recognized over the lease term. Over the term of a sales-type lease, the company recognizes financing revenue on the net investment in the lease and any variable lease payments, which are not included in the net investment in the lease.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

For a direct financing lease, the investment in lease is measured similarly to a sales-type lease, however, the net investment in the lease is reduced by any selling profit, which is typically zero. In a direct financing lease, the selling profit and IDCs are deferred at commencement and recognized over the lease term. ~~The company rarely enters into direct financing leases.~~ Prior to the adoption of the new lease guidance, the company’s leases were generally classified as direct financing leases. Due to the changes in the lease classification requirements under the new lease guidance, the company’s leases are generally classified as sales-type leases and presented on a net basis. The company rarely enters into direct financing leases.

The estimated residual value represents the estimated fair value of the equipment under lease at the end of the lease. Estimating residual value is a risk unique to financing activities, and management of this risk is dependent upon the ability to accurately project future equipment ~~values at lease inception.~~values. The company has insight into product plans and cycles for the IBM products under lease. The company estimates the future fair value of leased equipment by using historical models, analyzing the current market for new and used equipment and obtaining forward-looking product information such as marketing plans and technology innovations.

The company optimizes the recovery of residual values by extending lease arrangements, ~~with existing clients.~~or selling to IBM all equipment that has been returned at the end of lease. The company has historically managed residual value risk both through insight into ~~its~~IBM’s own product cycles and monitoring of OEM IT product announcements. The company periodically reassesses the realizable value of its lease residual values. Anticipated decreases in specific future residual values that are considered to be other-than-temporary are recognized immediately upon identification and are recorded as an adjustment to the residual value estimate. For sales-type and direct financing leases, this reduction lowers the recorded net investment and is recognized as a loss charged to finance income in the period in which the estimate is changed, as well as an adjustment to unearned income to reduce future-period financing activities. For the three and six months ended ~~March 31,~~June 30, 2019 and 2018, impairment of residual values was immaterial.

~~Table of Contents~~

~~Notes to Consolidated Financial Statements — (continued)~~

The following table ~~provides~~presents a maturity analysis of the lease payments due to IBM Credit on sales-type and direct financing leases over the next five years and thereafter, ~~with the exception of 2019, which presents the undiscounted cash flows for the remaining nine months of the year,~~ as well as a reconciliation of the undiscounted cash flows to the financing receivables recognized in the Consolidated Statement of Financial Position at ~~March 31,~~June 30, 2019:


(Dollars in millions)	Total
Remainder of 2019	$	1,231
2020		1,606
2021		1,062
2022		498
2023		110
Thereafter		10
Total undiscounted cash flows	$	4,517
Present value of lease payments (recognized as financing receivables)		4,156	*
Difference between undiscounted cash flows and discounted cash flows	$	361

(Dollars in millions)

Total

2019

$
1,691

2020

1,638

2021

1,018

2022

468

2023

103

Thereafter

6

Total undiscounted cash flows

$
4,923

Present value of lease payments (recognized as financing receivables)

4,536
*
Difference between undiscounted cash flows and discounted cash flows

$
387

*The present value of the lease payments will not equal the financing receivable balance in the Consolidated Statement of Financial Position due to certain items, including IDCs, allowance for credit losses and residual value, which are included in the financing receivable balance, but are not included in the future lease payments.

Operating Leases

Equipment provided to clients under an operating lease is carried at cost within ~~Equipment~~equipment under ~~Operating Lease~~operating leases in the Consolidated Statement of Financial Position and depreciated over the lease term using the straight-line method, generally ranging from one to six years. The depreciable ~~basis~~base is the original cost of the equipment less the estimated residual value of the equipment at the end of the lease term. At ~~March 31,~~June 30, 2019, the unguaranteed residual value of equipment under operating leases was ~~$106~~$100 million.

At commencement of an operating lease, IDCs are deferred. As lease payments are made, the company records financing revenue over the lease term. IDCs are amortized over the lease term on the same basis as lease income is recorded.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

The following table provides a maturity analysis of the undiscounted lease payments due to IBM Credit on operating leases over the next five years and thereafter, at ~~March 31, 2019, with the exception of 2019, which presents the undiscounted cash flows for the remaining nine months of the year:~~June 30, 2019:



(Dollars in millions)	Total		Total
2019	$	162
Remainder of 2019			$	136
2020		122		102
2021		40		29
2022		2		2
2023		0		0
Thereafter		—		—
Total undiscounted cash flows	$	327	$	269

Assets under operating lease are tested for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The impairment test is based on undiscounted cash flows, and, if impaired, the asset is written down to fair value based on either discounted cash flows or appraised values. There were no material impairment losses incurred during the three and six months ended June 30, 2019 for assets under operating leases. These assets are included in equipment under operating leases in the Consolidated Statement of Financial Position.

5. Financing Receivables, Receivables Purchased/Participated from IBM:

Financing receivables consist of Client Financing leases, loans and installment payment plans to end-user ~~clients as well as loans to IBM for terms up to seven years.~~clients. Assets financed are primarily IT products and services where IBM and the company have experience. Client Financing arrangements are priced to achieve a market yield. Financing receivables also include Commercial Financing, which generally consists of working capital financing to suppliers, distributors and

~~Table of Contents~~

~~Notes to Consolidated Financial Statements — (continued)~~

resellers of IBM and OEM IT products and services. Payment terms for working capital financing receivables generally range from 30 to 90 days. Beginning in the second quarter of 2019 and continuing throughout the year, the company is winding down the OEM IT portion of its commercial financing operations which has resulted in a reduction in commercial financing receivables. IBM Credit will continue to provide differentiated end-to-end financing solutions, including commercial financing in support of IBM partner relationships.

The company purchases interests in certain of IBM’s trade accounts receivable at a ~~discount.~~discount and assumes the associated credit risk of IBM’s client. Effective in the second quarter of 2019, IBM and the company have suspended this program which has resulted in a reduction of short-term purchased receivables from IBM. These receivables are primarily for ~~IT-related~~IT related products and services, which are due within 30 days, and IBM performs all servicing under these arrangements. These receivables are included within the Commercial Financing segment. The company also participates in receivables from IBM for certain long-term financing receivables generated from IBM’s Total Solution Offerings in certain countries as well as for certain government and other contracts. These receivables are included in the Client Financing segment. The company carries the credit risk of IBM’s clients for all purchased and participated receivables from IBM.

Client Loans and

Commercial

Installment

(Dollars in millions)

Investment in

Financing

Payments

At March 31, 2019:

Leases

Receivables

(Loans)

Total
Financing receivables, gross

$
4,923

$
9,902

$
8,988

$
23,814
Unearned income

(387)

(33)

(436)

(856)
Deferred initial direct costs

40

—

66

107
Recorded investment

$
4,576

$
9,869

$
8,619

$
23,065
Allowance for credit losses

(58)

(15)

(98)

(171)
Unguaranteed residual value

472

—

—

472
Guaranteed residual value

65

—

—

65
Total financing receivables, net

$
5,056

$
9,854

$
8,521

$
23,431


					Client Loans and
			Commercial		Installment
(Dollars in millions)	Investment in		Financing		Payments
At June 30, 2019:	Leases		Receivables		(Loans)		Total
Financing receivables, gross	$	4,517	$	5,578	$	8,962	$	19,057
Unearned income		(361)		(18)		(427)		(805)
Deferred initial direct costs		34		—		72		107
Recorded investment	$	4,190	$	5,561	$	8,608	$	18,359
Allowance for credit losses		(56)		(12)		(92)		(161)
Unguaranteed residual value		481		—		—		481
Guaranteed residual value		61		—		—		61
Total financing receivables, net	$	4,676	$	5,548	$	8,515	$	18,740


	~~Purchased and~~
	~~Participated~~
~~(Dollars in millions)~~	~~Receivables~~
~~At March 31, 2019:~~	~~From IBM~~
~~Short-term purchased receivables from IBM~~	$	~~1,434~~
~~Allowance for credit losses~~		~~(5)~~
~~Total short-term purchased receivables from IBM, net~~	$	~~1,430~~

~~Long-term participated receivables from IBM~~	$	~~3,908~~
~~Allowance for credit losses~~		~~(6)~~
~~Total long-term participated receivables from IBM, net~~	$	~~3,902~~

~~Total purchased and participated receivables from IBM, net~~	$	~~5,331~~

Client Loans and

Commercial

Installment

(Dollars in millions)

Investment in

Financing

Payments

At December 31, 2018:

Leases

Receivables

(Loans)

Total
Financing receivables, gross

$
5,120

$
11,422

$
9,694

$
26,236
Unearned income

(411)

(36)

(453)

(900)
Deferred initial direct costs

46

—

73

119
Recorded investment

$
4,755

$
11,386

$
9,314

$
25,455
Allowance for credit losses

(65)

(11)

(98)

(174)
Unguaranteed residual value

491

—

—

491
Guaranteed residual value

77

—

—

77
Total financing receivables, net

$
5,258

$
11,374

$
9,216

$
25,848

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Purchased and

Participated
(Dollars in millions)

Receivables
At December 31, 2018:

From IBM
Short-term purchased receivables from IBM

$
1,373
Allowance for credit losses

(4)
Total short-term purchased receivables from IBM, net

$
1,369

Long-term participated receivables from IBM

$
4,079
Allowance for credit losses

(14)
Total long-term participated receivables from IBM, net

$
4,065

Total purchased and participated receivables from IBM, net

$
5,433


	Purchased and
	Participated
(Dollars in millions)	Receivables
At June 30, 2019:	From IBM
Short-term purchased receivables from IBM	$	331
Allowance for credit losses		(5)
Total short-term purchased receivables from IBM, net	$	326

Long-term participated receivables from IBM	$	3,955
Allowance for credit losses		(6)
Total long-term participated receivables from IBM, net	$	3,949

Total purchased and participated receivables from IBM, net	$	4,275


					Client Loans and
			Commercial		Installment
(Dollars in millions)	Investment in		Financing		Payments
At December 31, 2018:	Leases		Receivables		(Loans)		Total
Financing receivables, gross	$	5,120	$	11,422	$	9,694	$	26,236
Unearned income		(411)		(36)		(453)		(900)
Deferred initial direct costs		46		—		73		119
Recorded investment	$	4,755	$	11,386	$	9,314	$	25,455
Allowance for credit losses		(65)		(11)		(98)		(174)
Unguaranteed residual value		491		—		—		491
Guaranteed residual value		77		—		—		77
Total financing receivables, net	$	5,258	$	11,374	$	9,216	$	25,848


	Purchased and
	Participated
(Dollars in millions)	Receivables
At December 31, 2018:	From IBM
Short-term purchased receivables from IBM	$	1,373
Allowance for credit losses		(4)
Total short-term purchased receivables from IBM, net	$	1,369

Long-term participated receivables from IBM	$	4,079
Allowance for credit losses		(14)
Total long-term participated receivables from IBM, net	$	4,065

Total purchased and participated receivables from IBM, net	$	5,433

The company utilizes certain of its financing receivables as collateral for non-recourse borrowings. Financing receivables pledged as collateral for borrowings were ~~$868~~$938 million and $710 million at ~~March 31,~~June 30, 2019 and December 31, 2018, respectively.

The company did not have any financing receivables held for sale as of ~~March 31,~~June 30, 2019 and December 31, 2018.

Financing Receivables by Portfolio Segment

The following tables present ~~Client Financing~~the recorded investment in financing receivables ~~on a gross basis, excluding the allowance for credit losses~~ and ~~residual value,~~participated receivables from IBM, by portfolio segment and by class, excluding Commercial Financing receivables, purchased receivables from IBM and other miscellaneous financing receivables at ~~March 31,~~June 30, 2019 and December 31, 2018. Commercial Financing receivables and purchased receivables from IBM are excluded from the presentation of financing receivables by portfolio segment as they are short term in nature and the current estimated risk of loss and resulting impact to the company’s financing

Table of Contents

Notes to Consolidated Financial Statements — (continued)

results are not material. The company determines its allowance for credit losses based on three portfolio segments: lease receivables, loan receivables and participated receivables from IBM, and further segments the portfolio into three classes: Americas, Europe/Middle East/Africa (EMEA) and Asia Pacific.

~~Table of Contents~~


(Dollars in millions)
At June 30, 2019:	Americas		EMEA		Asia Pacific		Total
Recorded investment
Lease receivables	$	3,070	$	706	$	415	$	4,190
Loan receivables		5,630		2,153		825		8,608
Participated receivables from IBM		728		1,392		1,835		3,955
Ending balance	$	9,428	$	4,250	$	3,075	$	16,752
Recorded investment collectively evaluated for impairment	$	9,333	$	4,224	$	3,062	$	16,618
Recorded investment individually evaluated for impairment	$	95	$	26	$	13	$	134

Allowance for credit losses
Beginning balance at January 1, 2019
Lease receivables	$	38	$	17	$	10	$	65
Loan receivables		66		28		5		98
Participated receivables from IBM		3		8		3		14
Total	$	107	$	53	$	17	$	177
Write-offs	$	(9)	$	(10)	$	0	$	(19)
Recoveries		0		0		0		0
Provision/(benefit)		0		(5)		0		(6)
Foreign currency translation adjustment		1		0		0		2
Other		0		0		0		0
Ending balance at June 30, 2019	$	100	$	38	$	17	$	154
Lease receivables	$	34	$	12	$	11	$	56
Loan receivables	$	64	$	24	$	4	$	92
Participated receivables from IBM	$	1	$	3	$	2	$	6

Related allowance, collectively evaluated for impairment	$	27	$	12	$	4	$	44
Related allowance, individually evaluated for impairment	$	72	$	26	$	13	$	111

~~Notes to Consolidated Financial Statements — (continued)~~

(Dollars in millions)








At March 31, 2019:

Americas

EMEA

Asia Pacific

Total
Recorded investment

Lease receivables

$
3,358

$
632

$
586

$
4,576
Loan receivables


5,674


2,100


845


8,619
Participated receivables from IBM

652

1,587

1,669

3,908
Ending balance

$
9,684

$
4,319

$
3,100

$
17,104
Recorded investment collectively evaluated for impairment

$
9,585

$
4,294

$
3,087

$
16,966
Recorded investment individually evaluated for impairment

$
99

$
25

$
13

$
138

Allowance for credit losses

Beginning balance at January 1, 2019

Lease receivables

$
38

$
17

$
10

$
65
Loan receivables


66


28


5


98
Participated receivables from IBM


3


8


3


14
Total

$
107

$
53

$
17

$
177
Write-offs

$
(3)

$
(9)

$
—

$
(13)
Recoveries


—


0


0


0
Provision


4


(5)


0


(1)
Foreign currency translation adjustment


(1)


—


0


(1)
Other


—


0


0


—
Ending balance at March 31, 2019

$
106

$
38

$
17

$
162
Lease receivables

$
35

$
11

$
11

$
58
Loan receivables

$
70

$
24

$
4

$
98
Participated receivables from IBM

$
1

$
3

$
2

$
6

Related allowance, collectively evaluated for impairment

$
33

$
13

$
4

$
49
Related allowance, individually evaluated for impairment

$
74

$
25

$
13

$
112

Write-offs of lease and loan receivables were $8$11 million and $5$7 million, respectively, for the ~~three~~six months ended ~~March 31,~~June 30, 2019. Provisions for credit losses recorded for ~~lease receivables,~~ loan receivables and participated receivables from IBM were ~~$1 million, $5~~$2 million and a ~~reduction~~release of $7$8 million, respectively, for the ~~three~~six months ended ~~March 31,~~June 30, 2019.

The average recorded investment of impaired leases and loans for Americas, EMEA and Asia Pacific was ~~$98~~$97 million, ~~$30~~$26 million and $13 million, respectively, for the three months ended ~~March 31,~~June 30, 2019 and ~~$65~~$70 million, ~~$39~~$41 million and ~~$19~~$20 million, respectively, for the three months ended ~~March 31,~~June 30, 2018. Both interest income recognized and interest income recognized on a cash basis on impaired leases and loans were immaterial for the three months ended ~~March 31,~~June 30, 2019 and 2018.

The average recorded investment of impaired leases and loans for Americas, EMEA and Asia Pacific was $97 million, $29 million and $13 million, respectively, for the six months ended June 30, 2019 and $67 million, $40 million and $20 million, respectively, for the six months ended June 30, 2018. Both interest income recognized and interest income recognized on a cash basis on impaired leases and loans were immaterial for the six months ended June 30, 2019 and 2018.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

(Dollars in millions)








At December 31, 2018:

Americas

EMEA

Asia Pacific

Total
Recorded investment

Lease receivables

$
3,433

$
687

$
635

$
4,755
Loan receivables

6,167


2,231


916


9,314
Participated receivables from IBM

735

1,627

1,717

4,079
Ending balance

$
10,335

$
4,545

$
3,268

$
18,147
Recorded investment collectively evaluated for impairment

$
10,239

$
4,505

$
3,254

$
17,998
Recorded investment individually evaluated for impairment

$
96

$
39

$
13

$
149

Allowance for credit losses








Beginning balance at January 1, 2018








Lease receivables

$
42

$
6

$
15

$
62
Loan receivables

57


34


4


96
Participated receivables from IBM


9


4


2


14
Total

$
107

$
43

$
21

$
172
Write-offs

$
(6)

$
(1)

$
(8)

$
(16)
Recoveries

0

0


2


2
Provision

11

13


3


27
Foreign currency translation adjustment

(6)

(3)


(1)


(10)
Other

1

1


1


2
Ending balance at December 31, 2018

$
107

$
53

$
17

$
177
Lease receivables

$
38

$
17

$
10

$
65
Loan receivables

$
66

$
28

$
5

$
98
Participated receivables from IBM

$
3

$
8

$
3

$
14

Related allowance, collectively evaluated for impairment

$
38

$
15

$
4

$
56
Related allowance, individually evaluated for impairment

$
69

$
38

$
13

$
120


(Dollars in millions)
At December 31, 2018:	Americas		EMEA		Asia Pacific		Total
Recorded investment
Lease receivables	$	3,433	$	687	$	635	$	4,755
Loan receivables		6,167		2,231		916		9,314
Participated receivables from IBM		735		1,627		1,717		4,079
Ending balance	$	10,335	$	4,545	$	3,268	$	18,147
Recorded investment collectively evaluated for impairment	$	10,239	$	4,505	$	3,254	$	17,998
Recorded investment individually evaluated for impairment	$	96	$	39	$	13	$	149

Allowance for credit losses
Beginning balance at January 1, 2018
Lease receivables	$	42	$	6	$	15	$	62
Loan receivables		57		34		4		96
Participated receivables from IBM		9		4		2		14
Total	$	107	$	43	$	21	$	172
Write-offs	$	(6)	$	(1)	$	(8)	$	(16)
Recoveries		—		—		2		2
Provision		11		13		3		27
Foreign currency translation adjustment		(6)		(3)		(1)		(10)
Other		1		1		1		2
Ending balance at December 31, 2018	$	107	$	53	$	17	$	177
Lease receivables	$	38	$	17	$	10	$	65
Loan receivables	$	66	$	28	$	5	$	98
Participated receivables from IBM	$	3	$	8	$	3	$	14

Related allowance, collectively evaluated for impairment	$	38	$	15	$	4	$	56
Related allowance, individually evaluated for impairment	$	69	$	38	$	13	$	120

Write-offs of lease receivables and loan receivables were $13 million and $3 million, respectively, for the year ended December 31, 2018. Provisions for credit losses recorded for lease receivables, loan receivables and participated receivables from IBM were $9 million, $6 million and $12 million, respectively, for the year ended December 31, 2018.

When determining the allowances, financing receivables are evaluated either on an individual or a collective basis. For individually evaluated receivables, the company determines the expected cash flow for the receivable and calculates an estimate of the potential loss and the probability of loss. For those accounts in which the loss is probable, the company records a specific reserve. The company considers any receivable with an individually evaluated reserve as an impaired receivable.

In addition, the company records an unallocated reserve that is determined by applying a reserve rate to its different portfolios, excluding accounts that have been specifically reserved. This general reserve rate is based upon credit rating, probability of default, term, characteristics (lease/loan) and loss history.

Past Due Financing Receivables

The company considers a clients’ financing receivables past due when an installment is aged over 90 days. The following table summarizes the information about the recorded investment in lease and loan receivables and participated receivables from IBM, including recorded investments aged over 90 days and still accruing, billed invoices aged over 90 days and accruing, and recorded investment not accruing.

Table of Contents

Notes to Consolidated Financial Statements — (continued)


					Recorded		Billed		Recorded
	Total		Recorded		Investment		Invoices		Investment
(Dollars in millions)	Recorded		Investment		> 90 Days and		> 90 Days and		Not
At June 30, 2019:	Investment		> 90 Days (1)		Accruing (1)		Accruing		Accruing (2)
Americas	$	3,070	$	359	$	345	$	13	$	36
EMEA		706		27		10		3		17
Asia Pacific		415		14		6		1		8
Total lease receivables	$	4,190	$	400	$	361	$	16	$	61

Americas	$	5,630	$	151	$	103	$	16	$	70
EMEA		2,153		59		12		3		47
Asia Pacific		825		7		6		2		2
Total loan receivables	$	8,608	$	217	$	121	$	21	$	119

Americas	$	728	$	9	$	2	$	1	$	7
EMEA		1,392		4		3		1		0
Asia Pacific		1,835		1		1		0		—
Total participated receivables from IBM	$	3,955	$	13	$	6	$	2	$	7

Total	$	16,752	$	630	$	488	$	40	$	187

Recorded

Billed

Recorded

Total

Recorded

Investment

Invoices

Investment
(Dollars in millions)

Recorded

Investment

> 90 Days and

> 90 Days and

Not
At March 31, 2019:

Investment

> 90 Days (1)

Accruing (1)

Accruing

Accruing (2)
Americas

$
3,358

$
280

$
239

$
13

$
41
EMEA

632

38

22

3

16
Asia Pacific

586

14

2

—

11
Total lease receivables

$
4,576

$
331

$
263

$
16

$
68

Americas

$
5,674

$
193

$
128

$
22

$
64
EMEA

2,100

56

10

3

46
Asia Pacific

845

5

2

1

3
Total loan receivables

$
8,619

$
253

$
140

$
26

$
114

Americas

$
652

$
5

$
5

$
3

$
—
EMEA

1,587

6

6

2

—
Asia Pacific

1,669

—

—

—

—
Total participated receivables from IBM

$
3,908

$
11

$
11

$
4

$
—

Total

$
17,104

$
596

$
414

$
47

$
182

(1)

~~(1)~~

At a contract level, which includes total billed and unbilled amounts for financing receivables aged greater than 90 days.

(2)

~~(2)~~

Of the recorded investment not accruing, ~~$138~~$134 million is individually evaluated for impairment with a related allowance of ~~$112~~$111 million.


					Recorded		Billed		Recorded
	Total		Recorded		Investment		Invoices		Investment
(Dollars in millions)	Recorded		Investment		> 90 Days and		> 90 Days and		Not
At December 31, 2018:	Investment		> 90 Days (1)		Accruing (1)		Accruing		Accruing (2)
Americas	$	3,433	$	288	$	247	$	18	$	44
EMEA		687		24		9		1		15
Asia Pacific		635		29		19		2		11
Total lease receivables	$	4,755	$	341	$	275	$	21	$	70

Americas	$	6,167	$	217	$	161	$	22	$	61
EMEA		2,231		80		24		3		57
Asia Pacific		916		13		9		1		4
Total loan receivables	$	9,314	$	310	$	194	$	25	$	122

Americas	$	735	$	11	$	11	$	2	$	—
EMEA		1,627		9		4		1		5
Asia Pacific		1,717		—		—		—		—
Total participated receivables from IBM	$	4,079	$	20	$	15	$	3	$	5

Total	$	18,147	$	671	$	484	$	49	$	197

Recorded

Billed

Recorded

Total

Recorded

Investment

Invoices

Investment
(Dollars in millions)

Recorded

Investment

> 90 Days and

> 90 Days and

Not
At December 31, 2018:

Investment

> 90 Days (1)

Accruing (1)

Accruing

Accruing (2)
Americas

$
3,433

$
288

$
247

$
18

$
44
EMEA

687

24

9

1

15
Asia Pacific

635

29

19

2

11
Total lease receivables

$
4,755

$
341

$
275

$
21

$
70

Americas

$
6,167

$
217

$
161

$
22

$
61
EMEA

2,231

80

24

3

57
Asia Pacific

916

13

9

1

4
Total loan receivables

$
9,314

$
310

$
194

$
25

$
122

Americas

$
735

$
11

$
11

$
2

$
—
EMEA

1,627

9

4

1

5
Asia Pacific

1,717

—

—

—

—
Total participated receivables from IBM

$
4,079

$
20

$
15

$
3

$
5

Total

$
18,147

$
671

$
484

$
49

$
197

(1)

~~(1)~~

At a contract level, which includes total billed and unbilled amounts for financing receivables aged greater than 90 days.

(2)

~~(2)~~

Of the recorded investment not accruing, $149 million is individually evaluated for impairment with a related allowance of $120 million.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Credit Quality Indicators

The company’s credit quality indicators, which are based on rating agency data, publicly available information and information provided by clients, as well as other information, are reviewed periodically based on the relative level of risk. The resulting indicators are a numerical rating system that maps to Moody’s Investors Service credit ratings as shown below. The company uses information provided by Moody’s, where available, as one of many inputs in its determination of client credit ratings.

The following tables present the net recorded investment for each class of receivables, by credit quality indicator, at ~~March 31,~~June 30, 2019 and December 31, 2018. Receivables with a credit quality indicator ranging from Aaa to Baa3 are considered investment grade. All others are considered non-investment grade. In certain circumstances, the company may mitigate credit risk through arrangements with third parties, including credit insurance, financial guarantees, or non-recourse borrowings. The credit quality indicators do not reflect these mitigation actions.

Lease Receivables

Loan Receivables

Participated Receivables from IBM
(Dollars in millions)

Asia

Asia

Asia
At March 31, 2019:

Americas

EMEA

Pacific

Americas

EMEA

Pacific

Americas

EMEA

Pacific
Credit Ratings:



















Aaa – Aa3

$
285

$
9

$
45

$
673

$
49

$
102

$
380

$
72

$
68
A1 – A3

761

108

237

859

139

256

76

100

733
Baa1 – Baa3

933

122

118

1,514

604

171

81

800

507
Ba1 – Ba2

673

181

72

1,412

595

208

48

532

295
Ba3 – B1

430

128

60

562

401

56

59

66

36
B2 – B3

197

58

37

511

263

42

8

14

27
Caa – D

44

15

6

75

26

6

—

—

1
Total

$
3,323

$
621

$
575

$
5,605

$
2,076

$
841

$
651

$
1,584

$
1,667


	Lease Receivables						Loan Receivables						Participated Receivables from IBM

																			Lease Receivables						Loan Receivables						Participated Receivables from IBM
(Dollars in millions)					Asia						Asia						Asia						Asia						Asia						Asia
At December 31, 2018	Americas		EMEA		Pacific		Americas		EMEA		Pacific		Americas		EMEA		Pacific
At June 30, 2019:																			Americas		EMEA		Pacific		Americas		EMEA		Pacific		Americas		EMEA		Pacific
Credit Ratings:
Aaa – Aa3	$	520	$	24	$	49	$	935	$	79	$	71	$	112	$	58	$	134	$	283	$	10	$	33	$	737	$	84	$	120	$	419	$	62	$	67
A1 – A3		617		82		241		1,108		269		351		133		198		659		678		121		164		815		128		203		115		90		844
Baa1 – Baa3		807		214		169		1,450		704		246		174		517		463		776		157		77		1,497		672		173		89		670		544
Ba1 – Ba2		772		207		102		1,387		681		149		167		500		280		825		201		54		1,478		559		220		56		496		311
Ba3 – B1		391		90		36		703		297		52		84		218		99		206		138		45		438		450		58		43		58		39
B2 – B3		264		47		26		475		156		37		57		114		70		250		63		28		573		215		41		4		13		27
Caa – D		23		5		3		42		17		5		5		12		9		18		5		2		27		21		6		0		0		1
Total	$	3,395	$	670	$	625	$	6,101	$	2,204	$	912	$	733	$	1,618	$	1,714	$	3,036	$	694	$	404	$	5,565	$	2,129	$	821	$	727	$	1,389	$	1,833


	Lease Receivables						Loan Receivables						Participated Receivables from IBM
(Dollars in millions)					Asia						Asia						Asia
At December 31, 2018	Americas		EMEA		Pacific		Americas		EMEA		Pacific		Americas		EMEA		Pacific
Credit Ratings:
Aaa – Aa3	$	520	$	24	$	49	$	935	$	79	$	71	$	112	$	58	$	134
A1 – A3		617		82		241		1,108		269		351		133		198		659
Baa1 – Baa3		807		214		169		1,450		704		246		174		517		463
Ba1 – Ba2		772		207		102		1,387		681		149		167		500		280
Ba3 – B1		391		90		36		703		297		52		84		218		99
B2 – B3		264		47		26		475		156		37		57		114		70
Caa – D		23		5		3		42		17		5		5		12		9
Total	$	3,395	$	670	$	625	$	6,101	$	2,204	$	912	$	733	$	1,618	$	1,714

T~~roubled~~Troubled Debt Restructurings

The company did not have any significant troubled debt restructurings during the ~~three~~six months ended ~~March 31,~~June 30, 2019 or for the year ended December 31, 2018.

6. Segments:

The company’s operations consist of two business segments: Client Financing and Commercial Financing. The segments represent components of the company for which separate financial information is available that is utilized on a regular basis by the chief operating decision maker in determining how to allocate resources and evaluate performance. The company is organized on the basis of its financing offerings. The company’s reportable segments are business units that offer different financing solutions based upon clients’ needs.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Client Financing provides leases and loan financing to end-user clients, acquires installment payment plans offered to end-user clients by IBM, and acquires participation interests in IBM financing receivables for which the company assumes the IBM client’s credit risk from IBM. End-user clients are primarily IBM clients that elect to finance their acquisition of IBM’s hardware, software and services, as well as OEM IT hardware, software and services, to meet their total solution requirements. In addition, the company provides loans to IBM, primarily in support of IBM’s Global Technology Services segment’s acquisition of IT assets, which IBM uses in external, revenue-producing services contracts.

Commercial Financing provides working capital financing for suppliers, distributors and resellers of IBM and OEM IT products and services. Beginning in the second quarter of 2019 and continuing throughout the year, the company is winding down the OEM IT portion of its commercial financing operations. IBM Credit will continue to provide differentiated end-to-end financing solutions, including commercial financing in support of IBM partner relationships. Commercial Financing also purchases interests in certain of IBM’s trade accounts receivable at a discount and assumes the credit risk with IBM’s client. Effective in second quarter of 2019, IBM and the company have suspended this program. For additional information, see note 5, "Financing Receivables, Receivables Purchased/Participated from IBM.”

~~The segment’s expense~~Each segment includes an allocation of interest expense and selling, general and administrative (SG&A) ~~expense by the company to each of its operating segments.~~expense. Interest expense is allocated based on the average assets in each segment. SG&A expense is allocated based on a measurable financial driver, such as net margin.

IBM Credit and its consolidated subsidiaries are reported by the company’s parent, IBM, as part of IBM’s Global Financing segment, which also includes IBM’s remanufacturing and remarketing business.

SEGMENT INFORMATION


	Client		Commercial		Total

							Client		Commercial		Total
(Dollars in millions)	Financing		Financing		Segments		Financing		Financing		Segments
For the three months ended March 31, 2019:
For the three months ended June 30, 2019:
Total revenue	$	322	$	160	$	482	$	292	$	118	$	410
Pre-tax income		117		76		193		96		40		136
Depreciation of equipment under operating lease		45		—		45		43		—		43
Financing cost		107		53		160		98		39		137
Provision for/(benefit from) credit losses		(1)		5		4		(5)		(3)		(8)

For the three months ended March 31, 2018:

For the three months ended June 30, 2018:
Total revenue	$	308	$	142	$	449	$	298	$	135	$	433
Pre-tax income		128		63		191		101		47		148
Depreciation of equipment under operating lease		48		—		48		48		—		48
Financing cost		69		33		102		84		41		125
Provision for/(benefit from) credit losses		10		(1)		9		26		(1)		25

Table of Contents

Notes to Consolidated Financial Statements — (continued)

SEGMENT INFORMATION


	Client		Commercial		Total
(Dollars in millions)	Financing		Financing		Segments
For the six months ended June 30, 2019:
Total revenue	$	614	$	278	$	892
Pre-tax income		213		116		330
Depreciation of equipment under operating lease		88		—		88
Financing cost		205		92		297
Provision for/(benefit from) credit losses		(6)		2		(4)

For the six months ended June 30, 2018:
Total revenue	$	606	$	276	$	882
Pre-tax income		230		109		339
Depreciation of equipment under operating lease		96		—		96
Financing cost		151		76		227
Provision for/(benefit from) credit losses		35		(1)		34

7. Equity Activity:

IBM Credit had no unrealized gains or (losses) on cash flow hedges and gains and losses on available-for-sale securities were immaterial during the periods presented in the following tables:

Reclassifications and Taxes Related to Items of Other Comprehensive Income


(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the three months ended June 30, 2019:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	16	$	2	$	19
Retirement-related benefit plans (1):
Net (losses)/gains arising during the period	$	—	$	0	$	0
Curtailments and settlements		—		—		—
Amortization of prior service (credits)/costs		0		0		0
Amortization of net (gains)/losses		0		0		0
Total retirement-related benefit plans	$	0	$	0	$	0
Other comprehensive income/(loss)	$	17	$	2	$	19

(Dollars in millions)

Before Tax

Tax (Expense)/

Net of Tax
For the three months ended March 31, 2019:

Amount

Benefit

Amount
Other comprehensive income/(loss):



Foreign currency translation adjustments

$
3

$
3

$
6
Retirement-related benefit plans (1):


Prior service costs/(credits)

$
—

$
—

$
—
Net (losses)/gains arising during the period

0

0

0
Curtailments and settlements

—

—

—
Amortization of prior service (credits)/costs

0

0

0
Amortization of net (gains)/losses

0

0

0
Total retirement-related benefit plans

$
0

$
0

$
0
Other comprehensive income/(loss)

$
3

$
3

$
6

(1)

~~(1)~~

These AOCI components are included in the computation of net periodic pension cost. ~~(See~~(Refer to note 8, "Retirement-Related Benefits," for additional information.)

Reclassifications and Taxes Related to Items of Other Comprehensive Income


(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the three months ended June 30, 2018:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	(168)	$	(27)	$	(195)
Retirement-related benefit plans (1):
Net (losses)/gains arising during the period	$	—	$	0	$	0
Curtailments and settlements		—		—		—
Amortization of prior service (credits)/costs		0		0		0
Amortization of net (gains)/losses		0		0		0
Total retirement-related benefit plans	$	0	$	0	$	0
Other comprehensive income/(loss)	$	(168)	$	(27)	$	(195)

(Dollars in millions)

Before Tax

Tax (Expense)/

Net of Tax
For the three months ended March 31, 2018:

Amount

Benefit

Amount
Other comprehensive income/(loss):

Foreign currency translation adjustments

$
70

$
11

$
81
Retirement-related benefit plans (1):

Net (losses)/gains arising during the period

$
1

$
0

$
1
Curtailments and settlements

—

—

—
Amortization of prior service (credits)/costs

0

0

0
Amortization of net (gains)/losses

0

0

0
Total retirement-related benefit plans

$
1

$
0

$
1
Other comprehensive income/(loss)

$
71

$
11

$
82

(1)

~~(1)~~

These AOCI components are included in the computation of net periodic pension cost. ~~(See~~(Refer to note 8, "Retirement-Related Benefits," for additional information.)

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Reclassifications and Taxes Related to Items of Other Comprehensive Income


(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the six months ended June 30, 2019:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	20	$	5	$	25
Retirement-related benefit plans (1):
Net (losses)/gains arising during the period	$	0	$	0	$	0
Curtailments and settlements		—		—		—
Amortization of prior service (credits)/costs		0		0		0
Amortization of net (gains)/losses		1		0		1
Total retirement-related benefit plans	$	0	$	0	$	0
Other comprehensive income/(loss)	$	20	$	5	$	25

(1)	These AOCI components are included in the computation of net periodic pension cost. (Refer to note 8, "Retirement-Related Benefits," for additional information.)

Reclassifications and Taxes Related to Items of Other Comprehensive Income


(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the six months ended June 30, 2018:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	(98)	$	(16)	$	(114)
Retirement-related benefit plans (1):
Net (losses)/gains arising during the period	$	1	$	0	$	0
Curtailments and settlements		—		—		—
Amortization of prior service (credits)/costs		0		0		0
Amortization of net (gains)/losses		1		0		1
Total retirement-related benefit plans	$	1	$	0	$	1
Other comprehensive income/(loss)	$	(97)	$	(16)	$	(113)

(1)	These AOCI components are included in the computation of net periodic pension cost. (Refer to note 8, "Retirement-Related Benefits," for additional information.)

Accumulated Other Comprehensive Income/(Loss) (net of tax)


			Net Change
	Foreign		Retirement-		Accumulated
	Currency		Related		Other
	Translation		Benefit		Comprehensive
(Dollars in millions)	Adjustments*		Plans		Income/(Loss)
January 1, 2019	$	(23)	$	(10)	$	(33)
Other comprehensive income before reclassification		25		0		24
Amount reclassified from accumulated other comprehensive income		—		1		1
Total change for the period		25		0		25
June 30, 2019	$	1	$	(9)	$	(8)

Net Change

Foreign

Retirement-

Accumulated

Currency

Related

Other

Translation

Benefit

Comprehensive
(Dollars in millions)

Adjustments*

Plans

Income/(Loss)
January 1, 2019

$
(23)

$
(10)

$
(33)
Other comprehensive income before reclassification

6

0

6
Amount reclassified from accumulated other comprehensive income

—

0

0
Total change for the period

6

0

6
March 31, 2019

$
(17)

$
(10)

$
(27)

* Foreign currency translation adjustments are presented gross except for any associated hedges which are presented net of tax.

Table of Contents

Notes to Consolidated Financial Statements — (continued)


			Net Change
	Foreign		Retirement-		Accumulated
	Currency		Related		Other
	Translation		Benefit		Comprehensive
(Dollars in millions)	Adjustments*		Plans		Income/(Loss)
January 1, 2018	$	165	$	(7)	$	158
Cumulative effect of a change in accounting principle**		(5)		—		(5)
Other comprehensive income before reclassification		(114)		0		(114)
Amount reclassified from accumulated other comprehensive income		—		0		0
Total change for the period		(114)		1		(113)
June 30, 2018	$	46	$	(7)	$	39

Net Change

Foreign

Retirement-

Accumulated

Currency

Related

Other

Translation

Benefit

Comprehensive
(Dollars in millions)

Adjustments*

Plans

Income/(Loss)
January 1, 2018

$
165

$
(7)

$
158
Cumulative effect of a change in accounting principle**

(5)

—

(5)
Other comprehensive income before reclassification

81

0

81
Amount reclassified from accumulated other comprehensive income

—

0

0
Total change for the period

81

1

82
March 31, 2018

$
241

$
(7)

$
234

* Foreign currency translation adjustments are presented gross except for any associated hedges which are presented net of tax.

** Reflects the adoption of the FASB guidance on stranded tax effects. Refer to note 2, "Accounting Changes."

8. Retirement-Related Benefits:

IBM Credit employees are eligible to participate in IBM’s retirement plans. Retirement-related plans are accounted for as multiemployer or multiple-employer plans as required by local regulations.

Multiemployer Plans:

For multiemployer plans, IBM allocates charges to the company based on the number of employees. The charges related to multiemployer plans are recorded in the company’s Consolidated Statement of Earnings. The amounts of expense attributed to the company by IBM for the three and six months ended ~~March 31,~~June 30, 2019 and 2018, were not material.

Charges from IBM to the company in relation to these plans (including ~~non-pension, post-retirement~~non pension post retirement benefits) are limited to service costs. Contributions and any other types of costs are the responsibility of IBM.

Multiple-Employer Plans:

For multiple-employer plans (mainly in Germany, Spain and Japan), assets and obligations are based on actuarial valuations or allocations and are recorded in the Consolidated Statement of Financial Position.

Any gains or losses recorded to Accumulated Other Comprehensive Income in the three and six months ended ~~March 31,~~June 30, 2019 and 2018, were not material.

Costs related to multiple-employer plans are recorded in the company’s Consolidated Statement of Earnings. The total costs for multiple-employer plans for the three and six months ended ~~March 31,~~June 30, 2019 and 2018, were not material.

9. Relationship with IBM and Related Party Transactions:

IBM Credit is a captive finance company and an indirect, wholly owned subsidiary of IBM. IBM Credit generally conducts its financing activities with IBM on an arm’s-length basis, subject in certain cases, particularly with respect to originations, to commercial factors, including IBM’s relationship with a client. The following is a description of certain material relationships between IBM Credit and IBM, regarding support, operating, borrowing, licensing, service and other arrangements.

Support Agreement

Pursuant to a Support Agreement between IBM and IBM Credit, IBM has agreed to retain, directly or indirectly, beneficial ownership of at least 51 percent of the equity voting interests in the company at all times. IBM has also agreed to cause the company to have a minimum consolidated tangible net worth of at least $50 million on the last day of each

2728

Table of Contents

Notes to Consolidated Financial Statements — (continued)

of the company’s fiscal years (with consolidated tangible net worth for purposes of this discussion of the Support Agreement understood to mean (a) the total assets of IBM Credit and its consolidated subsidiaries less (b) the intangible assets and total liabilities of IBM Credit and its consolidated subsidiaries). IBM has also agreed to cause the company to maintain a leverage ratio not to exceed 11 to 1 for each of the company’s fiscal quarters. Leverage ratio for purposes of this discussion of the Support Agreement is understood to mean, for any calendar quarter, IBM Credit’s debt-to-equity ratio as reported in, and calculated in the manner set forth in, IBM Credit’s periodic report covering such fiscal quarter (refer to page 3437 of this Form 10-Q). In the event that the company’s leverage ratio at the end of any fiscal quarter is higher than 11 to 1, then, upon demand by the company, IBM has agreed to make or cause to be made a capital contribution to the company in an amount sufficient to cause the company’s leverage ratio to not exceed 11 to 1. The Support Agreement is not a guarantee by IBM of any indebtedness, other obligation, or liability of any kind of IBM Credit.

Operating Relationship

The company originates financing with end-user clients, which are primarily IBM customers that elect to finance their acquisition of IBM’s hardware, software, and services.

The company participates in receivables from IBM for certain long-term financing receivables generated from IBM’s Total Solution Offerings in certain countries as well as for certain government and other contracts. The company carries the credit risk of IBM’s clients for all participated receivables from IBM. These receivables earned interest income of ~~$50~~$46 million and $97 million in the three and six months ended ~~March 31,~~June 30, 2019, ~~an increase~~respectively, a decrease of $1 million and flat as compared to the same ~~period~~periods in ~~2018.~~2018, respectively. The interest income is included in financing revenue in the Consolidated Statement of ~~Earnings as financing revenue.~~Earnings. For additional information, see note 5, “Financing Receivables, Receivables Purchased/Participated from IBM.”

The company purchases interests in certain of IBM’s trade accounts receivable at a discount and assumes the associated credit risk of IBM’s client. Effective in the second quarter of 2019, IBM and the company have suspended this program. For the three months ended ~~March 31,~~June 30, 2019, finance income earned from these receivables was ~~$15~~$8 million, a decrease of $1 million as compared to the same period in 2018. For the six months ended June 30, 2019, finance income earned from these receivables was $23 million, an increase of $2$1 million as compared to the same period in 2018. The finance income is included in financing revenue in the Consolidated Statement of Earnings. ~~Effective in the second quarter of 2019, IBM and the company have suspended the program under which IBM Credit LLC purchases interests in IBM's trade accounts receivable.~~ For additional information, see note 5, “Financing Receivables, Receivables Purchased/Participated from IBM.”

In certain countries, the company provides loans to IBM, primarily in support of IBM’s Global Technology Services segment’s acquisition of IT assets, which it uses in external, revenue-producing services contracts. This financing is included in the Consolidated Statement of Financial Position as financing receivables from IBM. For the three months ended ~~March 31,~~June 30, 2019, the interest income earned from these receivables was ~~$44~~$45 million, an increase of $5$2 million as compared to the same period in 2018. ~~Interest~~For the six months ended June 30, 2019, interest income earned was $89 million, an increase of $6 million as compared to the same period in 2018. The interest income is included in financing revenue in the Consolidated Statement of Earnings. The amount of such financings outstanding was ~~$3,869~~$3,703 million at ~~March 31,~~June 30, 2019 and $3,609 million at December 31, 2018.

The amount of other receivables from IBM of ~~$301~~$329 million and $2,019 million at ~~March 31,~~June 30, 2019 and December 31, 2018, respectively, primarily relate to the investment of a portion of the company's excess cash in short-term interest bearing accounts with IBM, which can be withdrawn upon demand. The company's investment of excess cash with IBM was ~~$282~~$327 million at ~~March 31,~~June 30, 2019 and $2,014 million at December 31, 2018. The decline in the first ~~quarter~~six months of 2019 was driven by the company’s decision to utilize its excess cash to ~~retire~~repay a portion of its ~~debt with IBM.~~debt. The investment of excess cash with IBM is presented in other receivables from IBM in the Consolidated Statement of Financial Position and in the investing section of the Consolidated Statement of Cash Flows. Interest income earned from these investments was $8$7 million and $6$15 million in the three months and six months ended ~~March 31,~~June 30, 2019, respectively. Interest income earned for these investments was $15 million and $21 million for the three and six months ended June 30, 2018, respectively. The interest income is included in financing revenue in the Consolidated Statement of Earnings.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

In addition, the company provides financing at market rates to suppliers, distributors and resellers of IBM products and services, a portion of which is supplemented by financing incentives from IBM to cover an interest free period. Fee income earned from these financing incentives under these arrangements for the three months ended ~~March 31,~~June 30, 2019 was ~~$49~~$33 million, flat as compared to the same period in 2018. Fee income earned for the six months ended June 30, 2019 was $82 million, an increase of $2 million as compared to the same period in 2018. These fees are included in financing

~~Table of Contents~~

~~Notes to Consolidated Financial Statements — (continued)~~

revenue in the Consolidated Statement of Earnings and are deferred and recognized over the term of the financing arrangement.

Borrowing Relationship

The company has a credit facility with IBM that allows the company to obtain short-term and long-term funding. These loans are included in the Consolidated Statement of Financial Position as debt payable to IBM. Interest expense incurred on loans from IBM was ~~$74~~$58 million and ~~$57~~$131 million for the three and six months ended ~~March 31,~~June 30, 2019, respectively, as compared to $75 million and $134 million for the three and six months ended June 30, 2018, respectively. Interest expense is included in financing cost in the Consolidated Statement of Earnings. For additional information on short-term and long-term funding, see note 11, “Borrowings.”

Services and Other Arrangements

The company sources a number of services from IBM, including functional support for collection administration, treasury, accounting, legal, tax, human resources, marketing and IT. In certain instances, IBM acts as IBM Credit’s billing and collection agent and forwards the financing payments to IBM Credit. The company also has the right to use certain IBM intangible assets in its business. In addition, the company conducts its global operations primarily from IBM leased or IBM owned facilities. For these support services and occupancy expenses, IBM charged the company ~~$48~~$54 million and ~~$52~~$59 million in the ~~three~~second quarter of 2019 and 2018, respectively, and $102 million and $110 million for the six months ended ~~March 31,~~June 30, 2019 and 2018, respectively.

The company participates in the various IBM stock-based compensation plans, including awards of Restricted Stock Units and Performance Share Units. In addition, the company participates in certain multiemployer retirement-related plans that are sponsored by IBM. Amounts charged by IBM to the company related to stock-based compensation and multiemployer retirement-related plans expense during the periods reported were not material.

Expenses related to the services discussed above are included in selling, general and administrative expense in the Consolidated Statement of Earnings. These expenses may not be indicative of the expenses that IBM Credit will incur in the future, or would have incurred if the company had obtained these services from a third party.

The outstanding amount of accounts payable to IBM of ~~$950~~$1,170 million at ~~March 31,~~June 30, 2019, and $3,044 million at December 31, 2018, primarily relate to unsettled purchases of equipment or receivables/loans (for software and services) from IBM. This payable account is non-interest bearing, short term in nature and is expected to be settled in the normal course of business.

The company sells equipment returned from lease to IBM at cost, which approximates fair value. In addition, IBM may migrate a client to new technology. In the event this migration results in an early termination of a lease, IBM will purchase the returned equipment at a pre-negotiated price, which is a function of the discounted value of the scheduled future lease payments and the residual value. The company's net profit from sales of returned equipment to IBM was $2$7 million and $8$19 million for the three months ended ~~March 31,~~June 30, 2019 and 2018, respectively. The company's net profit from sales of returned equipment to IBM was $9 million and $27 million for the six months ended June 30, 2019 and 2018 respectively. These sales are recorded net in other (income) and expense in the Consolidated Statement of Earnings.

Tax Sharing Agreement

The company’s U.S. federal and certain state and foreign operations are included in various IBM consolidated tax returns; and, in such cases, IBM makes payments to tax authorities on the company’s behalf. IBM and the company

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Notes to Consolidated Financial Statements — (continued)

maintain a Tax Sharing Agreement for any operations included in an IBM consolidated tax return, pursuant to which IBM charges the company for any taxes owed and reimburses the company for any tax attributes generated. Such charges or reimbursements are based upon a calculation of the company’s relevant pro forma stand-alone tax return.

In the ~~first quarter of~~three months ended June 30, 2019, the company reported a provision for income taxes of ~~$150~~$23 million and an effective tax rate of ~~77.5~~17.0 percent, compared to a provision of ~~$42~~$31 million and an effective tax rate of ~~22.0~~20.9 percent in the ~~first quarter~~three months ended June 30, 2018. In the six months ended June 30, 2019, the company reported a provision for income taxes of $173 million and an effective tax rate of 52.5 percent, compared to a provision of $73 million and an effective tax rate of 21.5 percent in the six months ended June 30, 2018. The change in the effective tax rate for the six months ended June 30, 2019 was primarily attributable to an additional tax expense of $116 million related to guidance issued by the U.S. Treasury in January 2019 regarding U.S. tax reform repatriation tax. In accordance with

~~Table of Contents~~

~~Notes to Consolidated Financial Statements — (continued)~~

the previously executed Tax Sharing Agreement between IBM and the company, $64 million of the resulting liability was settled through a non-cash contribution to member’s interest. This contribution is included in the Consolidated Statement of Changes in Member’s Interest as ~~Contributions~~contributions from IBM.

10. Divestiture:

In the fourth quarter of 2018, IBM entered into a definitive agreement to sell certain commercial financing capabilities and assign a number of its commercial financing contracts, excluding related receivables which ~~will~~continue to be collected as they become due in the normal course of business. The transaction closed in the first quarter of 2019 and resulted in a pre-tax gain of $16 ~~million. The cash proceeds from the divestiture of $20~~ million ~~are expected to be remitted to the company by IBM~~ in the ~~second quarter of 2019.~~first quarter.

11. Borrowings:

The company may, at times, pledge financing receivables as collateral for non-recourse short-term and long-term borrowings. The amount of these secured borrowings is reflected in the following short-term and long-term debt ~~tables below.~~tables.

Short-Term Debt

Balance

Balance

(Dollars in millions)

3/31/2019

12/31/2018

Commercial paper

$
2,494

$
2,995

Short-term loans

22

17

Secured borrowings

28

23

Debt

$
2,543

$
3,035

Debt payable to IBM

8,605

10,223

Total

$
11,148

$
13,258


	Balance		Balance
(Dollars in millions)	6/30/2019		12/31/2018
Commercial paper	$	1,510	$	2,995
Short-term loans		16		17
Secured borrowings		121		23
Debt	$	1,647	$	3,035
Debt payable to IBM		5,148		10,223
Total	$	6,796	$	13,258

IBM Credit maintains a commercial paper program under which the company is permitted to issue unsecured commercial paper notes from time to time, up to a maximum aggregate amount outstanding at any one time of $5 billion. The proceeds of the commercial paper can be used for general corporate purposes, including, among other items, the repayment of indebtedness and other short-term liquidity needs. The maturity of the commercial paper notes issued can vary but may not exceed 364 days from the date of issuance. The notes are sold under customary terms in the commercial paper marketplace, and can be issued either at a discount from par, or at par, and bear interest rates as agreed upon under the terms and conditions of the agreements between the company and each commercial paper dealer.

The weighted-average interest rate for commercial paper was 2.5 percent at ~~March 31,~~June 30, 2019 and at December 31, 2018.

The weighted-average interest rate for short-term loans was ~~7.2~~6.1 percent and 4.3 percent at ~~March 31,~~June 30, 2019 and December 31, 2018, respectively, and relates primarily to borrowings in Latin America in 2019 and in Asia Pacific in 2018.

The weighted-average interest rate for secured borrowings was ~~6.8~~4.2 percent and 6.9 percent at ~~March 31,~~June 30, 2019 and December 31, 2018, respectively. Short-term financing receivables pledged as collateral for short-term secured borrowings were ~~$28~~$121 million at ~~March 31,~~June 30, 2019 and $23 million at December 31, 2018.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

The weighted-average interest rate for debt payable to IBM was ~~1.3~~1.9 percent and 1.6 percent at ~~March 31,~~June 30, 2019 and December 31, 2018, respectively.

At June 30,

~~Table~~ 2019, total short-term debt of ~~Contents~~

~~Notes~~$6,796 million declined $6,462 million driven by the company’s decision to ~~Consolidated Financial Statements — (continued)~~

utilize its excess cash to repay a portion of its debt and lower funding requirements associated with financing receivables. For additional information, see note 5, “Financing Receivables, Receivables Purchased/Participated from IBM.”

Long-Term Debt


		Balance		Balance
(Dollars in millions)	Maturities	6/30/2019		12/31/2018
Long-term notes (weighted-average interest rate at June 30, 2019)
2.1%	2019	$	1,400	$	1,400
3.2%	2020		1,500		1,500
2.7%	2021		2,850		2,850
2.2%	2022		500		500
3.0%	2023		750		750
		$	7,000	$	7,000

Long-term loans (5.5% weighted-average interest rate at June 30, 2019)	2020-2021		115		276
Secured borrowings (5.3% weighted-average interest rate at June 30, 2019)	2019-2025		816		687
Long-term debt		$	7,931	$	7,964
Less: net unamortized discount			2		2
Less: net unamortized debt issuance costs			6		9
Add: fair value adjustment*			28		(34)
Debt		$	7,951	$	7,919
Debt payable to IBM (1.5% weighted-average interest rate at June 30, 2019)			9,493		9,357
Total		$	17,443	$	17,276

Balance

Balance
(Dollars in millions)

Maturities

3/31/2019

12/31/2018
Long-term notes (weighted-average interest rate at March 31, 2019)

2.1%

2019

$
1,400

$
1,400
3.3%

2020

1,500

1,500
2.8%

2021

2,850

2,850
2.2%

2022

500

500
3.0%

2023

750

750

$
7,000

$
7,000

Long-term loans (6.2% weighted-average interest rate at March 31, 2019)

2019-2021

213

276
Secured borrowings (5.1% weighted-average interest rate at March 31, 2019)

2019-2024

840

687
Long-term debt

$
8,053

$
7,964
Less: net unamortized discount

2

2
Less: net unamortized debt issuance costs

7

9
Less: fair value adjustment*

9

34
Debt

$
8,034

$
7,919
Debt payable to IBM (1.4% weighted-average interest rate at March 31, 2019)

9,762

9,357
Total

$
17,796

$
17,276

*The portion of the company's fixed-rate debt obligations that is hedged is reflected in the Consolidated Statement of Financial Position as an amount equal to the sum of the debt's carrying value and a fair value adjustment representing changes in the fair value of the hedged debt obligations attributable to movements in benchmark interest rates.

The portion of the company's fixed-rate debt obligations that is hedged is reflected in the Consolidated Statement of Financial Position as an amount equal to the sum of the debt's carrying value and a fair value adjustment representing changes in the fair value of the hedged debt obligations attributable to movements in benchmark interest rates.

The company utilizes certain of its financing receivables as collateral. Long-term financing receivables pledged as collateral for long-term secured borrowings were ~~$840~~$816 million at ~~March 31,~~June 30, 2019 and $687 million at December 31, 2018.

~~The company has a shelf registration statement in place with the~~ ~~U.S. Securities and Exchange Commission (~~SEC) allowing it to offer for sale public debt securities. The company issued fixed- and floating-rate debt securities in September 2017 in the aggregate amount of $3,000 million with maturity dates ranging from 2019 to 2022. During 2018, the company issued fixed- and floating-rate debt securities in the aggregate amount of $4,000 million with maturity dates ranging from 2020 to 2023. The net proceeds from the issuance of debt securities are utilized for general corporate purposes. This debt is included in the long-term debt table above.

The company’s indenture governing its debt securities contains significant covenants which obligate the company to promptly pay principal and interest, limit the aggregate amount of liens (other than permitted liens as such term is defined under the indenture) to 15 percent of the company’s consolidated net tangible assets, and restrict the company’s ability to merge or consolidate unless certain conditions are met.

Pre-swap annual contractual obligations of long-term debt and long-term debt payable to IBM outstanding at ~~March 31,~~June 30, 2019, are as follows:

2019

2024 and

(Dollars in millions)

(Q2-Q4)

2020

2021

2022

2023

beyond

Total
Long-term debt

$
1,775

$
1,898

$
3,063

$
560

$
757

$
0

$
8,053
Debt payable to IBM

3,235

3,068

1,834

1,188

335

102

9,762
Total

$
5,010

$
4,966

$
4,898

$
1,748

$
1,092

$
102

$
17,815


	2019										2024 and
(Dollars in millions)	(Q3-Q4)		2020		2021		2022		2023		beyond		Total
Long-term debt	$	1,593	$	1,927	$	3,091	$	561	$	758	$	1	$	7,931
Debt payable to IBM		2,417		3,344		1,958		1,264		397		112		9,493
Total	$	4,010	$	5,271	$	5,049	$	1,825	$	1,155	$	113	$	17,424

3132

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Interest on Debt

The company recognized interest expense of ~~$150~~$135 million and $285 million for the three and six months ended ~~March 31,~~June 30, 2019, of which ~~$74~~$58 million and $131 million was interest expense on debt payable to ~~IBM.~~IBM, respectively. The company recognized interest expense of ~~$102~~$125 million and $227 million for the three and six months ended ~~March 31,~~June 30, 2018, of which ~~$57~~$75 million and $134 million was interest expense on debt payable to ~~IBM.~~IBM, respectively.

Lines of Credit

The company has committed lines of credit in some of the geographies which are not significant in the aggregate. Interest rates and other terms of borrowing under these lines of credit vary from country to country, depending on local market conditions.

On July ~~19, 2018,~~18, 2019, IBM and the company (the Borrowers) entered into a new $2.5 billion ~~364-Day~~364-day Credit Agreement to replace the maturing $2.5 billion ~~364-Day~~364-day agreement, and ~~also amended~~extended the maturity date of their existing $2.5 billion Three-Year Credit Agreement (the Credit Agreements). ~~The amended Three-Year Credit Agreement included a modification of terms to account for the potential discontinuation of LIBOR and to extend the maturity date by one year.~~ The new maturity date for the Three-Year Agreement is July 20, ~~2021.~~2022. The size of each facility ~~size remains~~was unchanged. The Credit Agreements permit the Borrowers to borrow up to an aggregate of $5 billion on a revolving basis. Neither Borrower is a guarantor or co-obligor of the other Borrower under the Credit Agreements. Subject to certain conditions stated in the Credit Agreements, the Borrowers may borrow, prepay and re-borrow amounts under the Credit Agreements at any time during the term of the Credit Agreements. Funds borrowed may be used for the general corporate purposes of the Borrowers. Interest rates on borrowings under the Credit Agreements will be based on prevailing market interest rates, as further described in the Credit Agreements. The Credit Agreements contain customary representations and warranties, covenants, events of default, and indemnification provisions. As of ~~March 31,~~June 30, 2019, the company had no borrowings outstanding against the Credit Agreements.

The company’s Credit Agreements each contain significant debt covenants, which obligate the company to promptly pay principal and interest, limit the aggregate amount of secured indebtedness and sale and leaseback transactions to 10 percent of IBM’s consolidated net tangible assets, and restrict the ability of the company or IBM to merge or consolidate with a third party, unless certain conditions are met. The Credit Agreements also include several financial covenants, including that (i) IBM will not permit the consolidated net interest expense ratio, for any period of four consecutive fiscal quarters taken as a single accounting period, to be less than 2.20 to 1.0; (ii) the company will not permit its tangible net worth to be less than $50 million as of the end of the fiscal year and (iii) the company’s leverage ratio cannot be greater than 11 to 1 as of the last day of the fiscal quarter. The Credit Agreements each contain a cross default provision with respect to other defaulted indebtedness of at least $500 million.

The company is in compliance with all of its significant debt covenants, and is obligated to provide periodic certifications to its lenders. The failure to comply with its debt covenants could constitute an event of default. If certain events of default were to occur, the principal and interest on the debt to which any event of default applied would become immediately due and payable. The Borrowers are also restricted from amending, modifying or terminating the Support Agreement in any manner materially adverse to the lenders. For additional information on the Support Agreement, , see note 9, “Relationship with IBM and Related Party Transactions.”

12. Contingencies:

The company is, or may be, involved, either as plaintiff or defendant, in a variety of ongoing claims, demands, suits, investigations, tax matters and proceedings that arise in the ordinary course of its business. Certain of these actions and proceedings are similar to suits filed against other financial institutions and captive finance companies. These may include collection and bankruptcy proceedings related to its leases and loans and proceedings concerning client allegations of wrongful repossession or defamation of credit.

The company reviews claims, suits, investigations and proceedings at least quarterly, and decisions are made with respect to recording or adjusting provisions and disclosing reasonably possible losses or range of losses (individually or in the aggregate). In addition, the company also discloses matters based on its consideration of other matters and

3233

Table of Contents

Notes to Consolidated Financial Statements — (continued)

qualitative factors, including the experience of other companies in the industry, and investor, client and employee relations considerations.

In accordance with the relevant accounting guidance, the company records a provision with respect to a claim, suit, investigation or proceeding when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Any recorded liabilities, including any changes to such liabilities for the quarter ended ~~March 31,~~June 30, 2019 were not material to the Consolidated Financial Statements.

Also in accordance with the relevant accounting guidance, the company provides disclosures of matters for which the likelihood of material loss is at least reasonably possible. As of ~~March 31,~~June 30, 2019, there were no matters for which the likelihood of material loss is at least reasonably possible.

13. Commitments:

The company’s extended lines of credit to third-party entities include unused amounts of ~~$7,635~~$4,590 million and $7,112 million at ~~March 31,~~June 30, 2019 and December 31, 2018, respectively. A portion of these amounts is available to the company’s Commercial Financing clients to support their working capital needs. The decrease reflects the company’s wind-down of its OEM IT commercial financing operations. In addition, the company has committed to provide future financing to its clients in connection with client purchase agreements for approximately ~~$384~~$459 million and $495 million at ~~March 31,~~June 30, 2019 and December 31, 2018, respectively.

3334

Table of Contents

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

FOR THE THREE AND SIX MONTHS ENDED ~~MARCH 31,~~JUNE 30, 2019

Financial Results Summary - Three Months Ended ~~March 31:~~June 30:

Yr.-to-Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended March 31:

2019

2018

Change

Revenue

$
482

$
449

7.4
%
Net margin

$
277

$
300

(7.7)
%
Net margin percentage

57.4
%

66.8
%
(9.4)
pts.
Total expense and other (income)

$
83

$
109

(23.5)
%
Income before income taxes

$
193

$
191

1.4
%
Provision for income taxes

$
150

$
42

NM

Net income

$
43

$
149

(70.8)
%
Net income margin

9.0
%

33.1
%
(24.1)
pts


							Yr.-to-Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended June 30:	2019			2018			Change
Revenue	$	410		$	433		(5.2)	%
Net margin	$	230		$	259		(11.0)	%
Net margin percentage		56.2	%		59.9	%	(3.7)	pts.
Total expense and other (income)	$	94		$	111		(15.4)	%
Income before income taxes	$	136		$	148		(7.8)	%
Provision for income taxes	$	23		$	31		(24.8)	%
Net income	$	113		$	117		(3.3)	%
Net income margin		27.6	%		27.0	%	0.6	pts.

~~NM - Not Meaningful~~

Yr.-to-Date

At March 31,

At December 31,

Percent

(Dollars in millions)

2019

2018

Change

Assets

$
35,217

$
39,497

(10.8)
%
Liabilities

$
32,053

$
36,076

(11.2)
%
Member’s interest

$
3,164

$
3,420

(7.5)
%

~~Debt-to-Equity~~

At March 31,

At December 31,

2019

2018

Debt-to-Equity Ratio *

9.1
x
8.9
x

*The debt-to-equity ratio is calculated by dividing the total amount of debt outstanding by the total amount of member’s interest in the company at the end of the reporting period presented.

~~Return on Equity~~

(Dollars in millions)

For the three months ended March 31:

2019

2018

Net income

$
43

$
149

Annualized net income

174

595

Average equity (1)

3,292

3,432

Return on equity (2)

5.3
%

17.3
%

~~(1)~~

~~Average of the ending Member’s interest for the last two quarters~~

~~(2)~~

~~The company’s return on equity is calculated by dividing annualized net income by the average ending balance of member’s interest for the last two quarters, for the reporting periods presented.~~

~~Table of Contents~~

~~Management Discussion – (continued)~~

Financial Performance Summary — Three Months Ended ~~March 31:~~June 30:

In the ~~first~~second quarter of 2019, the company delivered revenue of ~~$482~~$410 million and net income of ~~$43~~$113 million, compared to revenue of ~~$449~~$433 million and net income of ~~$149~~$117 million in the same period of 2018. ~~In the first quarter of 2019, return on equity was 5.3 percent, compared to 17.3~~

Total revenue declined $23 million, or 5.2 percent, in the ~~prior year period.~~

~~Total revenue increased $33 million, or 7.4 percent, in the first~~second quarter of 2019 as compared to the same period in 2018, driven by ~~increases~~decreases in financing revenue of ~~$39~~$13 million, or ~~10.6~~3.6 percent, ~~partially offset~~and by declines in operating lease revenue of $6$10 million, or ~~6.8~~12.4 percent. The ~~increase~~decrease in financing revenue was primarily driven by declines in commercial financing. Within commercial financing, the decrease was driven by a decline in the average asset balance, partially offset by increases in ~~commercial and client financing~~ yields. Yields from any category of assets are the company’s rate of return on these assets and are calculated by dividing income from these assets by the average assets during the period. The decline in operating lease revenue was driven by a decline in the average asset balance ~~when~~in the current period compared to the ~~prior year.~~second quarter of 2018.

From a segment perspective, Client Financing revenue of ~~$322~~$292 million in the ~~first~~second quarter of 2019 ~~increased 4.7~~declined 2.1 percent as compared to the ~~prior-year period. The increase was driven by higher asset yields in the current year period.~~prior year. Commercial Financing revenue of ~~$160~~$118 million in the ~~first~~second quarter of 2019 ~~increased 13.1~~decreased 12.3 percent as compared to the ~~first~~second quarter of 2018. ~~The increase in revenue was driven by increases in average financing assets and increases in yields.~~

From a geographic perspective, Americas revenue of ~~$281~~$238 million in the ~~first~~second quarter ~~increased 14.8~~decreased 4.1 percent when compared to the prior-year period. EMEA revenue of ~~$127~~$100 million ~~declined 0.9~~decreased 8.7 percent, and Asia Pacific revenue of ~~$74~~$71 million ~~declined 2.7%~~decreased 4.1 percent when compared to the ~~first~~second quarter of 2018.

In the ~~first~~second quarter of 2019, net margin, which is calculated as revenue minus financing costs and depreciation of equipment under operating lease, was ~~$277~~$230 million, a decrease of ~~7.7~~11.0 percent when compared to the same period in 2018. ~~Increased~~The decrease in revenue and increases in financing costs of ~~$59~~$12 million, or ~~57.7~~9.2 percent, were partially offset by ~~increases in revenues and~~ declines in depreciation expense of $2$6 million, or ~~5.2~~11.6 percent, when compared to the same period in the prior year. The increase in financing cost was due to an increase in interest rates, and was partially offset by a decrease in the average debt balance when compared to the same period in 2018. The decline in depreciation expense was driven by lower average operating lease asset balances. Net margin percentage of ~~57.4~~56.2 percent in the ~~first~~second quarter of 2019 decreased ~~9.4~~3.7 points as compared to the net margin percentage in the same period in 2018.

Total expense and other (income) of ~~$83~~$94 million in the ~~first~~second quarter of 2019 decreased ~~$26~~$17 million, or ~~23.5~~15.4 percent, compared to the same period in 2018.

Table of Contents

Management Discussion – (continued)

Pre-tax income of $136 million in the second quarter of 2019 decreased 7.8 percent as compared to the second quarter of 2018. The pre-tax income margin in the second quarter of 2019 of 33.2 percent decreased on a year-to-year ~~decline~~basis by 0.9 points.

The effective tax rate was 17.0 percent in the second quarter of 2019, a decrease of 3.9 points compared to the second quarter of 2018, driven by a year-to-year benefit due to the “Global Intangible Low-Taxed Income” provision.

Net income of $113 million decreased $4 million, or 3.3 percent, in the second quarter of 2019 as compared to the same period in 2018. In the second quarter of 2019, net income margin was 27.6 percent, an increase of 0.6 points on a year-to-year basis.

Return on equity was 15.4 percent in the second quarter of 2019, an increase of 1.3 points when compared to the prior-year period, driven primarily by a lower average equity balance, partially offset by decreases in net income when compared to the same period in the prior year.

Net cash provided by operating activities in the second quarter of 2019 decreased by $351 million as compared to the prior-year period, primarily driven by higher net cash payments to IBM related to outstanding accounts payable. Net cash provided by investing activities of $5,625 million in the second quarter of 2019 was higher by $5,899 million when compared to the prior-year period, primarily driven by lower originations of short term financing receivables, which reflects the company’s Commercial Financing portfolio actions taken in the second quarter of 2019. For additional information see note 5, "Financing Receivables, Receivables Purchased/Participated from IBM." Net cash used in financing activities of $5,409 million in the second quarter of 2019 was higher by $5,329 million when compared to the prior year period, primarily driven by higher short term debt payments and higher net cash distributions to IBM, which reflect the company’s decision to utilize its excess cash to repay a portion of its debt and lower funding requirements associated with financing receivables.

Financial Results Summary - Six Months Ended June 30:


							Yr.-to-Yr.
							Percent/
(Dollars in millions)							Margin
For the six months ended June 30:	2019			2018			Change
Revenue	$	892		$	882		1.2	%
Net margin	$	507		$	559		(9.2)	%
Net margin percentage		56.9	%		63.4	%	(6.5)	pts.
Total expense and other (income)	$	178		$	221		(19.4)	%
Income before income taxes	$	330		$	339		(2.6)	%
Provision for income taxes (1)	$	173		$	73		137.9	%
Net income (1)	$	156		$	266		(41.1)	%
Net income margin		17.5	%		30.1	%	(12.6)	pts.

(1)	In the first quarter of 2019, the company recorded an additional tax expense of $116 million related to guidance issued by the U.S. Treasury in January 2019 regarding U.S. tax reform repatriation tax.


					Yr.-to-Date
	At June 30,		At December 31,		Percent
(Dollars in millions)	2019		2018		Change
Assets	$	29,495	$	39,497	(25.3)	%
Liabilities	$	26,771	$	36,076	(25.8)	%
Member’s interest	$	2,724	$	3,420	(20.4)	%

Table of Contents

Management Discussion – (continued)

Debt-to-Equity


	At June 30,		At December 31,
	2019		2018
Debt-to-Equity Ratio *	8.9	x	8.9	x

*	The debt-to-equity ratio is calculated by dividing the total amount of debt outstanding by the total amount of member’s interest in the company at the end of the reporting period presented.

Return on Equity


	Three Months Ended						Six Months Ended
	June 30,						June 30,
(Dollars in millions)	2019			2018			2019			2018
Net income	$	113		$	117		$	156		$	266
Annualized net income	$	452		$	468		$	313		$	531
Average equity (1)	$	2,944		$	3,335		$	3,103		$	3,411
Return on equity (2)		15.4	%		14.0	%		10.1	%		15.6	%

(1)	Average of the ending member's interest for the last two quarters and three quarters, for the three and six months ended June 30, respectively

(2)

The company’s return on equity for the three months ended June 30, 2019 and 2018, is calculated by dividing annualized net income by the average of the ending balance of member’s interest for the previous two quarters. The company’s return on equity for the six months ending June 30, 2019 and 2018, is calculated by dividing annualized net income by the average of the ending balance of member’s interest for the previous three quarters.

Financial Performance Summary — Six Months Ended June 30:

In the first six months of 2019, the company delivered revenue of $892 million and net income of $156 million. In the first six months of 2018, the company had revenue of $882 million and net income of $266 million.

Total revenue increased $10 million, or 1.2 percent, in the first six months of 2019 as compared to 2018, driven by increases in financing revenue of $26 million, or 3.6 percent, partially offset by declines in operating lease revenue of $16 million, or 9.5 percent. The increase in financing revenue was driven by ~~an increase~~increases in ~~other income~~client financing yields, which were partially offset by a decline in average client financing assets, and ~~lower provisions for credit losses.~~ by reporting property tax and insurance as cost and the related revenue on a gross basis due to the adoption of the new lease standard. The decline in operating lease revenue was driven by a decline in the average asset balance compared to the same period in the prior year.

~~Pre-tax income~~From a segment perspective, Client Financing revenue of ~~$193~~$614 million in the first ~~quarter~~six months of 2019 increased 1.4 percent as compared to the prior year. Commercial Financing revenue of $278 million in the first ~~quarter~~six months of 2019 increased 0.8 percent as compared to the first six months of 2018.

From a geographic perspective, Americas revenue of $519 million in the first six months of 2019 increased 5.3 percent as compared to the same period in 2018. EMEA revenue of $227 million decreased 4.5 percent and Asia Pacific revenue of $146 million decreased 3.4 percent as compared to the same period in 2018.

Net margin in the first six months of 2019 was $507 million, a decline of 9.2 percent when compared to the same period in 2018. Increases in financing costs of $70 million, or 30.9 percent, were partially offset by increases in revenue and declines in depreciation expense of $8 million, or 8.4 percent, when compared to the same period in the prior year. The increase in ~~2019~~financing cost was primarily ~~driven by increases in other income and lower provisions for credit losses,~~due to higher interest rates, partially offset by ~~declines~~a lower average debt balance compared to the same period in ~~net margin.~~2018. The decline in depreciation expense was driven by lower average operating lease asset balances. Net margin of 56.9 percent in the first six months of 2019 decreased 6.5 points as compared to the same period in 2018.

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Management Discussion – (continued)

Total expense and other (income) of $178 million in the first six months of 2019 decreased $43 million, or 19.4 percent, compared to the same period in 2018.

Pre-tax income of $330 million in the first six months of 2019 decreased 2.6 percent as compared to the first six months of 2018. The pre-tax income margin in the first ~~quarter~~six months of 2019 of ~~40.1~~36.9 percent decreased on a year-to-year basis by ~~2.4~~1.4 points.

The effective tax rate was ~~77.5~~52.5 percent in the first ~~quarter~~six months of 2019, an increase of ~~55.5~~31.0 points compared to the first ~~quarter~~six months of 2018. The change in the effective tax rate ~~was driven by discrete tax charges occurring in~~for the ~~first quarter of~~six months ended June 30, 2019 was primarily attributable to an additional tax expense of $116 million related to guidance issued by the U.S. Treasury in January 2019 regarding U.S. tax reform repatriation tax. This was partially offset by a year-to-year benefit due to the “Global Intangible Low-Taxed Income” provision.

Net income of ~~$43~~$156 million decreased ~~$105 million, or 70.8~~41.1 percent in the first ~~quarter~~six months of 2019 as compared to the same period in 2018. The decline was primarily driven by the increase in the provision for income taxes. In the first ~~quarter~~six months of 2019, net income margin ~~was 9.0~~of 17.5 percent ~~a decrease of 24.1~~decreased 12.6 points on a year-to-year basis.

Return on equity ~~was 5.3~~of 10.1 percent decreased 5.5 points in the first ~~quarter~~six months of 2019 ~~a decrease of 12.1 points when compared to the prior-year period,~~ driven by ~~the decrease~~decreases in net ~~income.~~income which were partially offset by a lower average equity balance year-to-year.

The company generated ~~$88~~$26 million in cash flow from operating activities in the first ~~quarter~~six months of 2019, a decrease of ~~$152~~$503 million when compared to the first ~~quarter~~six months of ~~2018.~~2018, primarily driven by higher net cash income tax payments and higher net cash payments to IBM related to outstanding accounts payable. Net cash provided by investing activities of ~~$1,572~~$7,197 million in the

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~~Management Discussion – (continued)~~

first ~~quarter~~half of 2019 ~~increased $2,222~~was higher by $8,121 million when compared to the prior-year period, primarily driven by lower originations of short term financing receivables, which reflects the company’s Commercial Financing portfolio actions taken in the second quarter of 2019, and a decrease in the investment of excess cash with IBM. For additional information see note 5, "Financing Receivables, Receivables Purchased/Participated from IBM" and note 9, “Relationship with IBM and Related Party Transactions." Net cash used ~~for~~in financing activities of ~~$1,910~~$7,318 million in the first ~~quarter~~half of 2019 ~~increased $1,799~~was higher by $7,127 million when compared to the ~~first quarter~~prior-year period, primarily driven by higher net short term debt payments, lower long term debt net proceeds and higher net cash distributions to IBM, which reflect the company’s decision to utilize its excess cash to repay a portion of ~~2018.~~its debt and lower funding requirements associated with financing receivables.

Table of Contents

Management Discussion – (continued)

Second Quarter and First ~~Quarter~~Six Months in Review

Results of Operations

Segment Details

The following is an analysis of the reportable segment results for the second quarter and first ~~quarter~~six months of 2019 versus the second quarter and first ~~quarter~~six months of 2018. The table below presents each reportable segment’s revenue and net margin results.



							Yr.-to-Yr.
							Percent/

															Yr.-to-Yr.								Yr.-to-Yr.
									Three Months Ended						Percent/		Six Months Ended						Percent/
									June 30,						Margin		June 30,						Margin
(Dollars in millions)							Margin		2019			2018			Change		2019			2018			Change
For the three months ended March 31:	2019			2018			Change
Client Financing
Revenue	$	322		$	308		4.7	%	$	292		$	298		(2.1)	%	$	614		$	606		1.4	%
Net margin		170			191		(11.2)	%		151			165		(8.7)	%		321			359		(10.6)	%
Net margin percentage		52.7	%		62.2	%	(9.5)	pts.		51.7	%		55.5	%	(3.8)	pts.		52.2	%		59.2	%	(7.0)	pts.
Pre-tax income	$	117		$	128		(8.6)	%	$	96		$	101		(5.0)	%	$	213		$	230		(7.1)	%
Pre-tax margin		36.3	%		41.5	%	(5.2)	pts.		32.9	%		33.9	%	(1.0)	pts.		34.7	%		37.9	%	(3.2)	pts.
Commercial Financing
Revenue	$	160		$	142		13.1	%	$	118		$	135		(12.3)	%	$	278		$	276		0.8	%
Net margin		107			109		(1.6)	%		79			94		(15.1)	%		187			200		(6.8)	%
Net margin percentage		67.0	%		76.7	%	(9.7)	pts.		67.3	%		69.6	%	(2.3)	pts.		67.1	%		72.6	%	(5.5)	pts.
Pre-tax income	$	76		$	63		21.3	%	$	40		$	47		(13.8)	%	$	116		$	109		6.8	%
Pre-tax margin		47.7	%		44.6	%	3.1	pts.		34.2	%		34.8	%	(0.6)	pts.		41.8	%		39.4	%	2.4	pts.
Total Segments
Revenue	$	482		$	449		7.4	%	$	410		$	433		(5.2)	%	$	892		$	882		1.2	%
Net margin		277			300		(7.7)	%		230			259		(11.0)	%		507			559		(9.2)	%
Net margin percentage		57.4	%		66.8	%	(9.4)	pts.		56.2	%		59.9	%	(3.7)	pts.		56.9	%		63.4	%	(6.5)	pts.
Pre-tax income	$	193		$	191		1.4	%	$	136		$	148		(7.8)	%	$	330		$	339		(2.6)	%
Pre-tax margin		40.1	%		42.5	%	(2.4)	pts.		33.2	%		34.1	%	(0.9)	pts.		36.9	%		38.4	%	(1.4)	pts.

Client Financing

Client Financing revenue of ~~$322~~$292 million in the ~~first~~second quarter of 2019 ~~increased $14~~decreased $6 million, or ~~4.7~~2.1 percent, as compared to the same period in 2018. The ~~improvement~~decrease was driven by operating lease revenue, which declined $10 million year to year. Client Financing revenue in the first six months of 2019 increased $8 million, or 1.4 percent, as compared to the same period in 2018, driven by increases in yields, which were partially offset by a lower average asset balance, and by reporting property tax and insurance as cost and the related revenue on a gross basis ~~of $11 million~~ due to the adoption of the new lease ~~standard, along with increases in yields, offset by a lower average financing asset balance and declines in operating lease revenue of $6 million.~~standard.

Net margin decreased ~~$21~~$14 million, or ~~11.2~~8.7 percent and decreased $38 million, or 10.6 percent as compared to the prior year period, for the three and six month periods ended June 30, 2019, respectively. The decreases were primarily driven by increases in interest expense of $14 million and $54 million for the three and six month periods, respectively. The increases in interest expense were due to higher interest rates compared to the prior year.

Pre-tax income decreased $5 million, or 5.0 percent and decreased $16 million, or 7.1 percent as compared to the prior-year ~~period.~~period, for the three and six month periods ended June 30, 2019, respectively. The year-to-year decreases were driven by a decrease in gains on sale of equipment which was a result of lower levels of equipment returned to IBM upon early lease termination as compared to the same period in 2018, primarily due to client migration to IBM’s z14 mainframe during the first quarter of 2018, and by a decline in net margin, partially offset by lower provisions for credit losses compared to the prior-year period.

Table of Contents

Management Discussion – (continued)

Commercial Financing

Commercial Financing revenue of $118 million in the second quarter of 2019 decreased $17 million, or 12.3 percent, as compared to the same period in 2018, driven by a decline in the average asset balance, partially offset by increases in yields. Commercial Financing revenue in the first six months of 2019 increased $2 million, or 0.8 percent, as compared to the same period in 2018, driven by increases in yields, partially offset by a lower average asset balance.

Net margin decreased $14 million, or 15.1 percent and decreased $14 million, or 6.8 percent as compared to the prior-year period, for the three and six month periods ended June 30, 2019, respectively. The decrease in the second quarter of 2019 was primarily due to the decline in revenue as compared to the same period in 2018. The decrease in the first six months of 2019 was primarily driven by increases in ~~financing cost~~interest expense of ~~$38 million. The increase in financing cost was due~~$16 million compared to ~~rising interest rates and reporting property tax and insurance as cost and~~ the ~~related revenue on a gross basis, which was partially offset by a lower average debt balance year to~~prior year.

Pre-tax income in the ~~first~~second quarter of 2019 decreased ~~$11~~$6 million, or ~~8.6~~13.8 percent, as compared to the same period in 2018. ~~Declines in net margin and sales of equipment returned from lease were~~The year-to-year decrease was driven by revenue declines, partially offset by lower ~~expense allocations and lower~~ provisions for credit losses and a reduction in selling, general and administrative expenses. For the first six months of 2019, pre-tax income increased $7 million, or 6.8 percent, as compared to the same period in 2018. The year-to-year increase was driven by a pre-tax gain of $16 million from divested commercial financing capabilities, partially offset by a lower net margin due to increases in interest expense.

Geographic Revenue

The following provides revenue performance by geography.


					Yr.-to-Yr.
(Dollars in millions)					Percent
For the three months ended June 30:	2019		2018		Change
Revenue	$	410	$	433	(5.2)	%
Geographies
Americas	$	238	$	248	(4.1)	%
Europe/Middle East/Africa (EMEA)		100		110	(8.7)
Asia Pacific		71		74	(4.1)


					Yr.-to-Yr.
(Dollars in millions)					Percent
For the six months ended June 30:	2019		2018		Change
Revenue	$	892	$	882	1.2	%
Geographies
Americas	$	519	$	493	5.3	%
Europe/Middle East/Africa (EMEA)		227		238	(4.5)
Asia Pacific		146		151	(3.4)

Total revenue of $410 million decreased $23 million, or 5.2 percent, in the second quarter of 2019 compared to the same period in 2018, with declines in each geography.

Americas revenue of $238 million decreased $10 million, or 4.1 percent, in the second quarter of 2019 compared to the same period in 2018, driven by declines in financing revenue of $6 million, as well as declines in operating lease revenue of $5 million.

EMEA revenue of $100 million decreased $10 million, or 8.7 percent, in the second quarter of 2019 compared to the same period in 2018, driven by declines in financing revenue of $6 million, as well as declines in operating lease revenue of $4 million.

Asia Pacific revenue of $71 million decreased $3 million, or 4.1 percent, in the second quarter of 2019 when compared to the same period in 2018, driven by lower operating lease revenue of $2 million.

Table of Contents

Management Discussion – (continued)

Total revenue of $892 million increased $10 million, or 1.2 percent, in the first six months of 2019 compared to the same period in 2018, driven by increases in the Americas, partially offset by declines in EMEA and Asia Pacific.

Americas revenue of $519 million increased $26 million, or 5.3 percent, in the first six months of 2019 compared to the first six months of the prior year, primarily driven by an increase in financing revenue of $36 million, partially offset by declines in operating lease revenue of $9 million. EMEA revenue of $227 million decreased $11 million, or 4.5 percent, driven by declines in financing revenue of $6 million, as well as declines in operating lease revenue of $5 million. Asia Pacific revenue of $146 million decreased $5 million, or 3.4 percent.

Expense

Total Expense and Other (Income)


							Yr.-to-Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended June 30:	2019			2018			Change
Total expense and other (income)
Selling, general and administrative	$	97		$	104		(6.8)	%
Provisions for/(benefit from) credit losses		(8)			25		NM
Other (income) and expense		5			(17)		NM
Total expense and other (income)	$	94		$	111		(15.4)	%
Total expense-to-revenue ratio		23.0	%		25.7	%	(2.8)	pts.

NM - Not Meaningful


							Yr.-to-Yr.
							Percent/
(Dollars in millions)							Margin
For the six months ended June 30:	2019			2018			Change
Total expense and other (income)
Selling, general and administrative	$	194		$	203		(4.1)	%
Provisions for/(benefit from) credit losses		(4)			34		NM
Other (income) and expense		(13)			(16)		(18.8)
Total expense and other (income)	$	178		$	221		(19.4)	%
Total expense-to-revenue ratio		19.9	%		25.0	%	(5.1)	pts.

NM - Not Meaningful

Total expense and other (income) of $94 million decreased $17 million, or 15.4 percent, in the second quarter of 2019 as compared to the same period in 2018. For the six months ended June 30, 2019, total expense and other (income) of $178 million decreased $43 million, or 19.4 percent, as compared to the prior-year period. For additional information regarding total expense and other (income), see the following analyses by category.

Selling, General and Administrative


					Yr.-to-Yr.
(Dollars in millions)					Percent
For the three months ended June 30:	2019		2018		Change
Selling, general and administrative expense:
Selling, general and administrative - other	$	38	$	40	(5.2)	%
Contracted services		5		6	(8.8)
Functional support services and other related party expenses		54		59	(7.6)
Total selling, general and administrative expense	$	97	$	104	(6.8)	%

Table of Contents

Management Discussion – (continued)

Selling, General and Administrative


					Yr.-to-Yr.
(Dollars in millions)					Percent
For the six months ended June 30:	2019		2018		Change
Selling, general and administrative expense:
Selling, general and administrative - other	$	84	$	83	1.3	%
Contracted services		9		9	(6.1)
Functional support services and other related party expenses		102		110	(7.9)
Total selling, general and administrative expense	$	194	$	203	(4.1)	%

SG&A expense decreased $7 million, or 6.8 percent, in the second quarter of 2019 as compared to the second quarter of 2018. Functional support services and other related party expenses, other SG&A, and contracted services improved $4 million, $2 million, and $1 million, respectively, for the second quarter when compared to the prior-year period. SG&A expense decreased $8 million, or 4.1 percent, in the first six months of 2019 as compared to the prior-year period, driven by lower functional support services expenses charged by IBM. For additional information on functional support services, see note 9, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements.

Provision for Credit Losses

Provisions for credit losses decreased $32 million and $38 million as compared to the prior-year period, for the three and six-month periods ended June 30, 2019, respectively, driven by lower unallocated and specific reserve requirements in the Americas and EMEA in the current year. For additional information on provisions for credit losses, see note 5, “Financing Receivables, Receivables Purchased/Participated from IBM,” to the Consolidated Financial Statements.

Other (Income) and Expense


					Yr.-to-Yr.
(Dollars in millions)					Percent
For the three months ended June 30:	2019		2018		Change
Other (income) and expense:
Foreign currency transaction (gains)/losses	$	0	$	4	(95.6)	%
(Gains)/losses on derivative instruments		—		(5)	NM
(Gains)/losses on sale of equipment upon lease termination		(12)		(32)	(62.3)
Other expense and (income)		17		16	5.2
Total other (income) and expense	$	5	$	(17)	NM

NM - Not Meaningful

Other (Income) and Expense


					Yr.-to-Yr.
(Dollars in millions)					Percent
For the six months ended June 30:	2019		2018		Change
Other (income) and expense:
Foreign currency transaction (gains)/losses	$	1	$	8	(90.4)	%
(Gains)/losses on derivative instruments		—		(7)	NM
(Gains)/losses on sale of equipment upon lease termination		(19)		(48)	(59.7)
Other expense and (income)		5		31	(82.2)
Total other (income) and expense	$	(13)	$	(16)	(18.8)	%

NM - Not Meaningful

3642

Table of Contents

Management Discussion – (continued)

Other (income) and expense was $5 million of expense in the second quarter of 2019, an increase of $22 million when compared to the same period of 2018, driven by a decrease in gains on sale of equipment which was a result of lower levels of equipment returned to IBM upon early lease termination as compared to the same period in 2018, primarily due to client migration to IBM’s z14 mainframe during the first quarter of 2018. Other (income) and expense was $13 million of income in the first six months of 2019 as compared to $16 million of income in the same period of 2018. The year-to-year change was driven by a decrease in gains on sale of equipment which was a result of lower levels of equipment returned to IBM upon early lease termination as compared to the same period in 2018, primarily due to client migration to IBM’s z14 mainframe during the first quarter of 2018, and was partially offset by a pre-tax gain of $16 million from divested commercial financing capabilities.

Taxes

For the three months ended June 30, 2019, the company recorded a provision for income taxes of $23 million and an effective tax rate of 17.0 percent, compared to a provision of $31 million and an effective tax rate of 20.9 percent for the three months ended June 30, 2018. For the six-month period ended June 30, 2019, the company reported a provision for income taxes of $173 million and an effective tax rate of 52.5 percent compared to a provision of $73 million and an effective tax rate of 21.5 percent for the same period in 2018. The change in the effective tax rate for the six months ended June 30, 2019 was primarily attributable to an additional tax expense of $116 million related to guidance issued by the U.S. Treasury in January 2019 regarding U.S. tax reform repatriation tax. This was partially offset by a year-to-year benefit due to the “Global Intangible Low-Taxed Income” provision.

The company is subject to taxation in the U.S. and various state and foreign jurisdictions. With respect to the company’s U.S. federal and certain state and foreign operations that are included in applicable IBM consolidated tax returns, pursuant to the Tax Sharing Agreement between IBM and the company, any subsequent changes to the company’s income tax liability as a result of valuation allowances and tax examinations are the responsibility of IBM. Therefore, any recognition and subsequent changes in assessment about the sustainability of related tax positions, including interest and penalties, are the responsibility of IBM. As such, there have been no uncertain tax liabilities recorded in the Consolidated Financial Statements for entities that file as part of IBM’s consolidated tax filings as the company bears no risk associated with any subsequent change in the sustainability of uncertain tax positions.

For the company’s separate income tax return filings, the company is generally no longer subject to tax examinations for years prior to 2014. The open years contain matters that could be subject to differing interpretations of applicable tax laws and regulations as it relates to the amount and/or timing of income, deductions and tax credits. Although the outcome of tax audits is always uncertain, the company believes that adequate amounts of tax and interest have been provided for any adjustments that are expected to result for these years.

The amount of unrecognized tax benefits at June 30, 2019 of $10 million increased $5 million from December 31, 2018.

If the company’s provision for income taxes had been prepared using the separate return method without modification for the benefits-for-loss approach, total taxes included in net income reported would have been $11 million and $24 million higher in the three and six months ended June 30, 2019, respectively, due to the “Global Intangible Low-Taxed Income” provision. For the period ended June 30, 2018, there was no material difference in the total taxes included in net income using the separate return method without modification for the benefits-for-loss approach. For additional information, see note 1, “Basis of Presentation.”

Financial Position Summary

The company’s primary use of funds is to originate financing receivables and operating leases with end-users, suppliers, distributors, resellers and IBM. Financing receivables consist of direct financing leases and loans to end-user clients, purchases of installment payment plans from IBM and working capital financing to suppliers, distributors and resellers. Operating leases are for IBM and OEM IT products. Beginning in the second quarter of 2019 and continuing throughout the year, the company is winding down the OEM IT portion of its commercial financing operations. For additional information see note 5, "Financing Receivables, Receivables Purchased/Participated from IBM."

Table of Contents

Management Discussion – (continued)

Receivables purchased/participated from IBM include purchased interests in certain of IBM’s trade accounts receivable and IBM receivables that have been participated to IBM Credit. Effective in the second quarter of 2019, IBM and the company have suspended the program under which IBM Credit purchases interests in IBM's trade accounts receivable. For additional information see note 5, "Financing Receivables, Receivables Purchased/Participated from IBM." Financing receivables from IBM include loan financing to IBM’s Global Technology Services segment. For additional information relating to financing activities with IBM, see note 9, “Relationship with IBM and Related Party Transactions.”

Total assets of $29,495 million at June 30, 2019 declined $10,002 million (including an increase of $76 million from currency) as compared to year-end 2018, primarily driven by:

●

A decline in total financing receivables of $8,173 million (including an increase of $58 million from currency), primarily driven by a decline in commercial financing receivables of $5,826 million, a decline in client financing loans and installment payment receivables of $1,282 million and a decline in purchased receivables from IBM of $1,043 million. These declines primarily reflect the company’s Commercial Financing portfolio actions taken in the second quarter of 2019 and lower client originations due to client migration to the IBM z14 mainframe in the prior year. For additional information see note 5, "Financing Receivables, Receivables Purchased/Participated from IBM."

●

A decline in other receivables from IBM of $1,690 million (including an increase of $10 million from currency), predominantly due to decreased cash invested with IBM of $1,687 million. The decline in 2019 was driven by the company’s decision to utilize its excess cash to repay a portion of its debt. For additional information relating to other receivables from IBM, see note 9, “Relationship with IBM and Related Party Transactions.”

At June 30, 2019, substantially all client and commercial financing assets were IT related assets with no direct exposure to consumers. Approximately 57 percent of the total portfolio, excluding financing receivables from IBM and receivables purchased from IBM, was with investment grade clients. This investment grade percentage is based on the credit ratings of the companies in the portfolio. Additionally, the company takes actions to transfer exposure to third parties. On that basis, the investment grade content would increase by 12 points to 69 percent.

Total liabilities of $26,771 million at June 30, 2019 decreased $9,306 million (including an increase of $52 million from currency), as compared to year-end 2018, primarily driven by:

●

A decrease in total debt of $6,295 million (including an increase of $17 million from currency) driven by the company’s decision to utilize its excess cash to repay a portion of its debt and lower funding requirements associated with financing receivables.

●

A decline in accounts payable to IBM of $1,874 million (including an increase of $32 million from currency) and a decline in accounts payable to third-parties of $1,187 million (including an increase of $2 million from currency), both of which were primarily driven by settlement of fourth-quarter 2018 originations.

Total member’s interest of $2,724 million at June 30, 2019 decreased $696 million as compared to year-end 2018, primarily driven by:

●

Cash distributions to IBM of $942 million, partially offset by

●

Net income for the first six months of 2019 of $156 million,

●

A capital contribution from IBM of $64 million, and

●

Foreign currency translation gains of $25 million.

Table of Contents

Management Discussion – (continued)

Originations of Financing Receivables and Operating Leases

Originations are management’s estimate of the gross additions for Client Financing and Commercial Financing assets. There are no industry standards or requirements governing the reporting of financing asset originations. Management believes that the estimated values of financing asset originations disclosed in the table below provide insight into the potential future cash flows and earnings of the company.

The Client Financing origination values presented below exclude the company’s loans to IBM’s Global Technology Services segment, which are executed under a loan facility and are not considered originations.

Originations



	Three Months Ended				Yr.-to-Yr.		Six Months Ended				Yr.-to-Yr.
	June 30,				Percent		June 30,				Percent
(Dollars in millions)	2019		2018		Change		2019		2018		Change
Client Financing	$	3,010	$	3,523	(14.6)	%	$	6,028	$	6,672	(9.7)	%
Commercial Financing		9,045		16,336	(44.6)	%		26,436		34,016	(22.3)	%
Total originations	$	12,054	$	19,859	(39.3)	%	$	32,463	$	40,687	(20.2)	%

In the second quarter of 2019, the company originated $3,010 million of Client Financing receivables as compared to $3,523 million in the second quarter of 2018. The company originated $6,028 million of Client Financing receivables in the first six months of 2019 as compared to $6,672 million in the first six months of 2018. The decreases of $513 million and $644 million in the second quarter and first six months, respectively, as compared to the same periods in the prior year, were driven by higher lease volumes in the prior year due to client migration to the IBM z14 mainframe.

In the second quarter of 2019, the company originated $9,045 million of Commercial Financing receivables as compared to $16,336 million in the second quarter of 2018. The company originated $26,436 million of Commercial Financing receivables in the first six months of 2019 as compared to $34,016 million in the first six months of 2018. The decreases of $7,291 million and $7,580 million in the second quarter and first six months, respectively, as compared to the same periods in the prior year, reflect the company’s Commercial Financing portfolio actions taken in the second quarter of 2019. For additional information see note 5, "Financing Receivables, Receivables Purchased/Participated from IBM."

Segment Assets



					Yr.-to-Date
(Dollars in millions)	At June 30,		At December 31,		Percent
Client Financing	2019		2018		Change
Financing receivables, net	$	13,192	$	14,474	(8.9)	%
Equipment under operating leases, net		295		386	(23.5)
Financing receivables from IBM		3,703		3,609	2.6
Receivables participated from IBM, net		3,949		4,065	(2.8)
Total assets	$	21,138	$	22,533	(6.2)	%


					Yr.-to-Date
(Dollars in millions)	At June 30,		At December 31,		Percent
Commercial Financing	2019		2018		Change
Financing receivables, net	$	5,548	$	11,374	(51.2)	%
Receivables purchased from IBM, net		326		1,369	(76.2)
Total assets	$	5,874	$	12,743	(53.9)	%

The decrease in Client Financing assets of $1,395 million at June 30, 2019 as compared to December 31, 2018 was primarily driven by cash collections of financing receivables in excess of new originations, as a result of higher year-end balances.

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Management Discussion – (continued)

The Client Financing receivables portfolio at June 30, 2019 represented the following industry profile: Financial (32 percent), Manufacturing (15 percent), Government (14 percent), Services (12 percent), Retail (7 percent), Communications (7 percent), Healthcare (7 percent) and Other (6 percent). The Client Financing receivables portfolio at December 31, 2018 represented the following industry profile: Financial (33 percent), Government (14 percent), Manufacturing (14 percent), Services (13 percent), Retail (7 percent), Communications (7 percent), Healthcare (6 percent) and Other (6 percent).

The decrease in Commercial Financing assets of $6,869 million at June 30, 2019 as compared to December 31, 2018,reflects the company’s Commercial Financing portfolio actions taken in the second quarter of 2019. For additional information see note 5, "Financing Receivables, Receivables Purchased/Participated from IBM."

The assets of the company were financed with $24,239 million of total debt at June 30, 2019, as compared to $30,534 million of debt at December 31, 2018. The decline reflects the company’s decision to utilize its excess cash to repay a portion of its debt and lower funding requirements associated with financing receivables.

Financing Receivables and Allowances

The following table presents financing receivables excluding residual values, miscellaneous receivables and loan financing to IBM’s Global Technology Services segment which the company considers collectable and without third-party risk.


	At June 30,			At December 31,
(Dollars in millions)	2019			2018
Recorded investment	$	22,644		$	30,906
Specific allowance for credit losses		120			121
Unallocated allowance for credit losses		52			71
Total allowance for credit losses		172			192
Net financing receivables	$	22,472		$	30,714
Allowance for credit losses coverage		0.8	%		0.6	%

Roll Forward of Financing Receivables Allowance for Credit Losses

(Dollars in millions)


January 1, 2019		Additions		Write-offs *		Other **		June 30, 2019
$	192	$	(4)	$	(19)	$	2	$	172

* Represents reserved receivables that were written off during the period.

** Represents primarily translation adjustments.

The allowance for credit losses on financing receivables at June 30, 2019 was $172 million, or 0.8 percent of gross financing receivables. At December 31, 2018, the allowance for credit losses on financing receivables was $192 million, or 0.6 percent of gross financing receivables.

Specific reserves were $120 million at June 30, 2019, a decrease of $1 million as compared to year-end 2018.

Unallocated reserves were $52 million at June 30, 2019, a decrease of $19 million as compared to year-end 2018, primarily within the Americas and EMEA, driven by lower reserve requirements and declines in average asset balances in the client and commercial financing businesses.

Provisions for credit losses were a release of $8 million for the three months ended June 30, 2019 as compared to $25 million of expense for the same period in 2018. The year-to-year decrease in expense was driven by lower specific and unallocated reserve requirements in the Americas and EMEA as compared to the prior year period. Provisions for credit

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Management Discussion – (continued)

losses were a release of $4 million for the six months ended June 30, 2019 as compared to $34 million of expense for the same period in 2018. The six-month year-to-year decrease of $38 million in provisions for credit losses were due to lower specific and unallocated reserve requirements in the Americas and EMEA.

Residual Value

Residual value is a risk of the company’s business, and management of this risk is dependent upon the ability to accurately project future equipment values at lease inception. The company has insight into product plans and cycles for IBM products and closely monitors OEM IT product announcements. Based upon this product information, the company continually monitors projections of future equipment values and compares them with the residual values reflected in the portfolio.

The company optimizes the recovery of residual values by extending lease arrangements with current clients. Assets returned from lease are sold to IBM at cost, which approximates fair value. In addition, IBM may migrate a client to new technology. In the event this migration results in an early lease termination, IBM will purchase the returned equipment from the company at a pre-negotiated price, which is a function of the discounted value of the scheduled future lease payments and the residual value.

The following table presents the recorded amount of unguaranteed residual value for direct financing and operating leases at June 30, 2019 and December 31, 2018. In addition, the table presents the residual value as a percentage of the related original amount financed and a run out of when the unguaranteed residual value assigned to equipment on leases at June 30, 2019 and December 31, 2018, is expected to be returned to the company.

Unguaranteed Residual Value


	At			At			Estimated Run Out of June 30, 2019 Balance
	December 31,			June 30,									2022 and
(Dollars in millions)	2018			2019			2019		2020		2021		Beyond
Direct financing leases	$	491		$	481		$	61	$	98	$	142	$	180
Operating leases		114			100			40		34		21		5
Total unguaranteed residual value	$	605		$	582		$	101	$	133	$	163	$	185
Related original amount financed	$	10,148		$	9,124
Percentage		6.0	%		6.4	%

Liquidity and Capital Resources

IBM Credit funds current and future obligations through the generation of cash flows from operations and its access to the short-term and long-term capital markets, as well as the support given by IBM’s overall liquidity position and access to capital markets. The debt used to fund the company’s financing assets as of June 30, 2019 was primarily comprised of loans from IBM.

In the company’s 2018 Form 10-K filed with the SEC on February 27, 2019, the company included information on its liquidity, including a table presenting the company’s cash flow and liquidity trending for the past four years. The table includes net cash provided by operating activities, cash and cash equivalents and cash invested with IBM. For the six months ended, or as of, as applicable, June 30, 2019, those amounts were $26 million for net cash provided by operating activities, $1,732 million of cash and cash equivalents and $327 million in cash invested with IBM.

At June 30, 2019, the debt-to-equity ratio was 8.9 to 1 as compared to 8.9 to 1 at December 31, 2018 and 9.0 to 1 at June 30, 2018. Refer to the company’s debt-to-equity ratio on page 51 for additional information.

In the first quarter of 2019, IBM made a non-cash contribution to the company in the amount of $64 million. During the first six months of 2019, the company made cash distributions to IBM, including return of profit, of $942 million. The future amount of third-party debt and contributions from and distributions to IBM may vary as the company continues to

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Management Discussion – (continued)

manage leverage to the targeted debt-to-equity ratio of 9 to 1. The company’s actual debt-to-equity ratio may vary based on several factors, including differences between management’s expectations and actual results of operations.

In 2017, the company established a commercial paper program under which the company is permitted to issue unsecured commercial paper notes from time to time, up to a maximum aggregate amount outstanding at any one time of $5 billion. As of June 30, 2019, there was $1,510 million of commercial paper outstanding.

On July 18, 2019, the company entered into a new $2.5 billion 364-day Credit Agreement to replace its existing $2.5 billion 364-day Credit Agreement, and extended the maturity date of its existing $2.5 billion Three-Year Credit Agreement. The new maturity date for the Three-Year Credit Agreement is July 20, 2022. The size of each facility was unchanged. As of June 30, 2019, the company had no borrowings outstanding against the Credit Agreements.

The major rating agencies’ ratings on the company’s debt securities at June 30, 2019 appear in the table below.


	STANDARD	MOODY’S
	AND	INVESTORS	FITCH
	POOR’S	SERVICE	RATINGS
Long-term debt	A	A1	A
Commercial ~~Financing revenue of $160 million~~paper	A-1	Prime-1	F1

On July 9, 2019, IBM completed the acquisition of all the outstanding shares of Red Hat, Inc. After closing the transaction, as expected, Moody’s downgraded IBM and IBM Credit’s long-term debt rating from A1 to A2 and improved its outlook to stable. The commercial paper rating from Moody’s remains unchanged. Standard and Poor’s ratings remain unchanged. Additionally, Fitch affirmed its rating before withdrawing coverage on IBM and IBM Credit for commercial reasons.

IBM Credit will continue with a disciplined financial policy and is committed to maintaining strong investment grade credit ratings. The company does not have “ratings trigger” provisions in its debt covenants or documentation, which would allow the holders to declare an event of default and seek to accelerate payments thereunder in the event of a change in credit rating.

In the normal course of business, the company may be exposed to the impact of foreign currency fluctuations and interest rate changes. Although the company seeks to substantially match-fund the term, currency and interest rate variability of its debt against its underlying financing assets, risks may arise from a mismatch between assets and the related liabilities used for funding. The company also employs a rigorous process to optimize portfolio risk management. Portfolio risks include credit and residual value risk. For additional information on the management of these risks by the company, see note A, “Significant Accounting Policies” and note D, “Financial Instruments,” to the Consolidated Financial Statements in the company’s 2018 Form 10-K.

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Management Discussion – (continued)

Cash Flow and Liquidity Trends


(Dollars in millions)
For the six months ended June 30:	2019		2018
Net cash provided by operating activities	$	26	$	529
Net cash provided by/(used in) investing activities		7,197		(924)
Net cash used in financing activities		(7,318)		(191)

At June 30:	2019		2018
Cash and cash equivalents	$	1,732	$	2,080
Cash invested with IBM, available on-demand (1)		327		2,640
Committed credit facilities (2)		5,000		5,000

(1)

Excess cash is periodically invested in interest bearing, on-demand accounts with IBM and is presented in other receivables from IBM in the ~~first quarter~~Consolidated Statement of ~~2019 increased $19 million, or 13.1 percent, when compared to~~Financial Position and the ~~same period in 2018, driven by increases in yields and higher average financing receivable asset balances.~~

~~Net margin in the first quarter~~Consolidated Statement of ~~2019 decreased $2 million, or 1.6 percent when compared to the same period in 2018, with increases in interest expense of $20 million offset by the growth in revenue of $19 million.~~

~~Pre-tax income in the first quarter of 2019 increased $13 million, or 21.3 percent, as compared to the same period in 2018, driven by a divestiture gain of $16 million.~~Cash Flows. For additional information, ~~on divestitures, see note 10, “Divestiture,” to the Consolidated Financial Statements.~~

~~Geographic Revenue~~

~~The following table provides revenue performance by geography:~~

Yr.-to-Yr.

(Dollars in millions)

Percent

For the three months ended March 31:

2019

2018

Change

Revenue

$
482

$
449

7.4
%
Geographies

Americas

$
281

$
245

14.8
%
Europe/Middle East/Africa (EMEA)

127

128

(0.9)

Asia Pacific

74

76

(2.7)

~~Total revenue of $482 million increased $33 million, or 7.4 percent, in the first quarter of 2019 compared to the same period in 2018, primarily driven by increased revenue in the Americas.~~

Americas revenue of $281 million increased $36 million, or 14.8 percent, in the first quarter of 2019 compared to the same period in 2018. Increased financing revenue of $41 million was driven by improvements in commercial financing of $15 million and increases from sales-type lease revenues of $12 million.

EMEA revenue of $127 million decreased $1 million, or 0.9 percent, in the first quarter of 2019 compared to the same period in 2018. Decreases in operating lease revenues and revenues from participated receivables were partially offset by improvements in commercial financing, when compared to the first quarter of 2018.

Asia Pacific revenue of $74 million decreased $2 million, or 2.7 percent, in the first quarter of 2019 when compared to the same period in 2018. The decline was primarily driven by lower revenues from sales-type leases when compared to the same period in the prior year.

~~Table of Contents~~

~~Management Discussion – (continued)~~

~~Expense~~

~~Total Expense and Other (Income)~~

Yr.-to-Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended March 31:

2019

2018

Change

Total expense and other (income)







Selling, general and administrative

$
97

$
98

(1.2)
%
Provisions for credit losses

4

9

(57.4)

Other (income) and expense

(18)

1

NM

Total expense and other (income)

$
83

$
109

(23.5)
%
Total expense-to-revenue ratio

17.3
%

24.3
%
(7.0)
pts.

~~NM - Not Meaningful~~

Total expense and other (income) of $83 million decreased $26 million, or 23.5 percent, in the first quarter of 2019 as compared to the same period in 2018. For additional information regarding total expense and other (income), see the following analyses by category.

~~Selling, General and Administrative~~

Yr.-to-Yr.

(Dollars in millions)

Percent

For the three months ended March 31:

2019

2018

Change

Selling, general and administrative expense:







Selling, general and administrative - other

$
46

$
43

6.3
%
Contracted services

3

4

(1.7)

Functional support services and other related party expenses

48

52

(7.5)

Total selling, general and administrative expense

$
97

$
98

(1.2)
%

SG&A expense decreased $1 million, or 1.2 percent, in the first quarter of 2019 as compared to the first quarter of 2018. Other SG&A increased $3 million while functional support services and other related party expenses were lower by $4 million when compared to the prior-year period. For additional information on functional support services, see note 9, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements.

~~Provision for~~

(2)	The Credit ~~Losses~~Agreements were entered into and amended on July 18, 2019.

Net cash provided by operating activities in the first six months of 2019 decreased by $503 million as compared to the first six months of 2018 primarily driven by higher net cash income tax payments and higher net cash payments to IBM related to outstanding accounts payable.

Net cash provided by investing activities in the first six months of 2019 increased by $8,121 million as compared to the first six months of 2018 primarily driven by the following factors:

~~Provisions for credit losses decreased $5~~
● Lower net originations of short-term financing receivables of $3,818 million, which reflects the company’s Commercial Financing portfolio actions taken in the ~~first~~second quarter of ~~2019 when compared to the first quarter of 2018, due to lower reserve requirements in Latin America and Middle East/Africa, partially offset by higher reserve requirements in North America and China.~~2019. For ~~additional~~further information ~~on provisions for credit losses,~~ see note 5, ~~“Financing~~Financing Receivables, Receivables Purchased/Participated from ~~IBM,” to the Consolidated Financial Statements.~~
IBM."

~~Table of Contents~~

~~Management Discussion – (continued)~~

~~Other (Income) and Expense~~

Yr.-to-Yr.

(Dollars in millions)

Percent

For the three months ended March 31:

2019

2018

Change

Other (income) and expense:







Foreign currency transaction (gains)/losses

$
1

$
4

(85.0)
%
(Gains)/losses on derivative instruments

—

(1)

NM

(Gains)/losses on sale of equipment upon lease termination

(7)

(16)

(54.4)

Other expense and (income)

(11)

15

NM

Total other (income) and expense

$
(18)

$
1

NM
%

~~NM - Not Meaningful~~

~~Other (income) and expense was $18 million of income~~
● A decrease in the ~~first quarter~~investment of 2019, an increase of $19 million when compared to the same period of 2018. The year-to-year improvement was driven by a pre-tax gain of $16 million from divested commercial financing capabilities which was partially offset by lower gains from sales of equipment returned from lease. For additional information on the divestiture, see note 10, “Divestiture,” to the Consolidated Financial Statements.
~~Taxes~~
For the three months ended March 31, 2019, the company recorded a provision for income taxes of $150 million and an effective tax rate of 77.5 percent, compared to a provision of $42 million and an effective tax rate of 22.0 percent for the three months ended March 31, 2018. The year-to-year change in the effective tax rate was driven by discrete tax charges occurring in the first quarter of 2019, primarily attributable to an additional tax expense of $116 million related to guidance issued by the U.S. Treasury in January 2019 regarding U.S. tax reform repatriation tax.
The company is subject to taxation in the U.S. and various state and foreign jurisdictions. With respect to the company’s U.S. federal and certain state and foreign operations that are included in applicable IBM consolidated tax returns, pursuant to the Tax Sharing Agreement between IBM and the company, any subsequent changes to the company’s income tax liability as a result of valuation allowances and tax examinations are the responsibility of IBM. Therefore, any recognition and subsequent changes in assessment about the sustainability of related tax positions, including interest and penalties, are the responsibility of IBM. As such, there have been no uncertain tax liabilities recorded in the Consolidated Financial Statements for entities that file as part of IBM’s consolidated tax filings as the company bears no risk associated with any subsequent change in the sustainability of uncertain tax positions.
For the company’s separate income tax return filings, the company is generally no longer subject to tax examinations for years prior to 2014. The open years contain matters that could be subject to differing interpretations of applicable tax laws and regulations as it relates to the amount and/or timing of income, deductions and tax credits. Although the outcome of tax audits is always uncertain, the company believes that adequate amounts of tax and interest have been provided for any adjustments that are expected to result for these years.
~~The amount of unrecognized tax benefits at March 31, 2019 of $10 million increased $5 million from December 31, 2018.~~
If the company’s provision for income taxes had been prepared using the separate return method without modification for the benefits-for-loss approach, total taxes included in net income reported for the first quarter of 2019 would have been $13 million higher due to a difference in the calculation of the “Global Intangible Low-Taxed Income” provision resulting from U.S. tax reform. For the period ended March 31, 2018, there was no material difference in the total taxes included in net income using the separate return method without modification for the benefits-for-loss approach. For additional information, see note 1, “Basis of Presentation.”
39
~~Table of Contents~~
~~Management Discussion – (continued)~~
~~Financial Position Summary~~
The company’s primary use of funds is to originate financing receivables and operating leases with end-users, suppliers, distributors, resellers and IBM. Financing receivables consist of direct financing leases and loans to end-user clients, purchases of installment payment plans from IBM and working capital financing to suppliers, distributors and resellers. Operating leases are for IBM and OEM IT products. Receivables purchased/participated from IBM include purchased interests in certain of IBM’s trade accounts receivable and IBM receivables that have been participated to IBM Credit. Financing receivables from IBM include loan financing to IBM’s Global Technology Services segment. For additional information relating to financing activitiesexcess cash with IBM ~~see note 9, “Relationship with IBM and Related Party Transactions.”~~
~~Total assets~~ of ~~$35,217~~$3,466 million ~~at March 31, 2019 declined $4,280 million (including a decrease of $14 million from currency) as compared to year-end 2018, primarily driven by:~~
·
A decline in total financing receivables of $2,259 million (including a decrease of $19 million from currency), primarily driven by a decline in Commercial Financing receivables of $1,520 million and a decline in Client Financing loans and installment payment receivables of $897 million. These declines are seasonal, resulting from collections of higher year-end balances, and
·
~~A decline in other receivables from IBM of $1,718 million, predominantly due to decreased cash invested with IBM of $1,732 million. The decline in the first quarter of 2019 was~~ driven by the ~~company’s decision to utilize its excess cash to retire a portion of its debt with IBM.~~ ~~For additional information relating to other receivables from IBM originating from excess cash invested with IBM, see note 9, “Relationship with IBM and Related Party Transactions.”~~
At March 31, 2019, substantially all client and commercial financing assets were IT related assets with no direct exposure to consumers. Approximately 55 percent of the total portfolio, excluding financing receivables from IBM and receivables purchased from IBM, was with investment grade clients. This investment grade percentage is based on the credit ratings of the companies in the portfolio. Additionally, the company takes actions to transfer exposure to third parties. On that basis, the investment grade content would increase by 16 points to 71 percent.
~~Total liabilities of $32,053 million at March 31, 2019 decreased $4,024 million (including a decrease of $56 million from currency), as compared to year-end 2018, primarily driven by:~~
·
A decline in accounts payable to IBM of $2,094 million and a decline in accounts payable to third-parties of $343 million, both of which were primarily driven by settlement of fourth-quarter 2018 originations, and
·
A decrease in total debt of $1,590 million (including a decrease of $77 million from currency), including a decrease in debt payable to IBM of $1,214 million and a decrease in debt with third parties of $376 million. T~~he decline in the first quarter of 2019 was driven by~~ ~~lower funding requirements associated with financing receivables and the~~ ~~company’s decision to utilize its excess cash to retire a portion of its debt with IBM.~~
~~Total member’s interest of $3,164 million at March 31, 2019 decreased $257 million as compared to year-end 2018, primarily driven by:~~
·
~~A cash distribution to IBM of $370 million; partially offset by~~
·
~~Net income for the first three months of 2019 of $43 million,~~
·
~~Foreign currency translation increases of $6 million, and~~
·
~~A capital contribution from IBM of $64 million.~~
40
~~Table of Contents~~
~~Management Discussion – (continued)~~
~~Originations of Financing Receivables and Operating Leases~~
Originations are management’s estimate of the gross additions for Client Financing and Commercial Financing assets. There are no industry standards or requirements governing the reporting of financing asset originations. Management believes that the estimated values of financing asset originations disclosed in the table below provide insight into the potential future cash flows and earnings of the company.
The Client Financing origination values presented below exclude the company’s loans to IBM’s Global Technology Services segment, which are executed under a loan facility and are not considered originations.
~~Originations~~

Yr.-to-Yr.

(Dollars in millions)

Percent

For the three months ended March 31:

2019

2018

Change


Client Financing

$
3,018

$
3,149

(4.2)
%

Commercial Financing

17,391

17,680

(1.6)
%

Total originations

$
20,409

$
20,829

(2.0)
%

In the first quarter of 2019, the company originated $3,018 million of Client Financing receivables as compared to $3,149 million in the first quarter of 2018, mainly driven by stronger lease volumes in the prior year due to client migration to the IBM z14 mainframe.
In the first quarter of 2019, the company originated $17,391 million of Commercial Financing receivables as compared to $17,680 million in the first quarter of 2018, primarily impacted by the strengthening of the dollar in the current year.
~~Segment Assets~~

Yr.-to-Date

(Dollars in millions)

At March 31,

At December 31,

Percent

Client Financing

2019

2018

Change

Financing receivables, net

$
13,577

$
14,474

(6.2)
%
Equipment under operating leases, net

345

386

(10.7)

Financing receivables from IBM

3,869

3,609

7.2

Receivables purchased/participated from IBM, net

3,902

4,065

(4.0)

Total assets

$
21,692

$
22,533

(3.7)
%

Yr.-to-Date

(Dollars in millions)

At March 31,

At December 31,

Percent

Commercial Financing

2019

2018

Change

Financing receivables, net

$
9,854

$
11,374

(13.4)
%
Receivables purchased from IBM, net

1,430

1,369

4.4

Total assets

$
11,284

$
12,743

(11.5)
%
The decrease in Client Financing assets of $841 million at March 31, 2019 as compared to December 31, 2018 was primarily driven by cash collections of financing receivables in excess of new originations, as a result of higher year-end balances.
The decrease in Commercial Financing assets of $1,460 million at March 31, 2019 as compared to December 31, 2018 was driven by cash collections exceeding new originations, primarily due to declines from higher year-end balances.
The company’s receivables portfolio at March 31, 2019 represented the following industry profile: Financial (32 percent), Manufacturing (15 percent), Government (14 percent), Services (12 percent), Retail (7 percent), Communications (7 percent), Healthcare (7 percent) and Other (6 percent).
41
~~Table of Contents~~
~~Management Discussion – (continued)~~
~~The company’s receivables portfolio at December 31, 2018 represented the following industry profile:~~ Financial (33 percent), Government (14 percent), Manufacturing (14 percent), Services (13 percent), Retail (7 percent), Communications (7 percent), Healthcare (6 percent) and Other (6 percent).
~~The assets of the company were financed with $28,944 million of total debt at March 31, 2019, as compared to $30,534 million at December 31, 2018.~~
~~Financing Receivables and Allowances~~
The following table presents financing receivables excluding residual values, miscellaneous receivables and loan financing to IBM’s Global Technology Services segment which the company considers collectable and without third party risk.

At March 31,

At December 31,

(Dollars in millions)

2019

2018

Recorded investment

$
28,408

$
30,906

Specific allowance for credit losses

117

121

Unallocated allowance for credit losses

65

71

Total allowance for credit losses

182

192

Net financing receivables

$
28,225

$
30,714

Allowance for credit losses coverage

0.6
%

0.6
%
~~Roll Forward of Financing Receivables Allowance for Credit Losses~~
~~(Dollars in millions)~~

January 1, 2019

Additions

Write-offs *

Other **

March 31, 2019
$
192

$
4

$
(13)

$
(1)

$
182
*     Represents reserved receivables that were written off during the period.
**   Represents primarily translation adjustments.
The allowance for credit losses on financing receivables at March 31, 2019 was $182 million, or 0.6 percent of gross financing receivables. At December 31, 2018, the allowance for credit losses on financing receivables was $192 million, or 0.6 percent of gross financing receivables.
Specific reserves were $117 million at March 31, 2019, a decrease of $4 million as compared to year-end 2018, primarily due to write-offs in EMEA, offset with additional reserve requirements in the Americas and China.
~~Unallocated reserves were $65 million at March 31, 2019, a decrease of $6 million as compared to year-end 2018, with lower unallocated reserve requirements in the Americas and EMEA.~~
Bad debt expense was $4 million of income for the three months ended March 31, 2019 as compared to $9 million of expense for the same period in 2018. The year-to-year decrease in expense was driven by ~~lower reserve requirements in Latin America and Middle East/Africa, partially offset by higher reserve requirements in North America and China~~.
~~Residual Value~~
Residual value is a risk of the company’s business, and management of this risk is dependent upon the ability to accurately project future equipment values at lease inception. The company has insight into product plans and cycles for IBM products and closely monitors OEM IT product announcements. Based upon this product information, the company continually monitors projections of future equipment values and compares them with the residual values reflected in the portfolio.
42
~~Table of Contents~~
~~Management Discussion – (continued)~~
The company optimizes the recovery of residual values by extending lease arrangements with current clients. Assets returned from lease are sold to IBM at cost, which approximates fair value. In addition, IBM may migrate a client to new technology. In the event this migration results in an early lease termination, IBM will purchase the returned equipment from the company at a pre-negotiated price, which is a function of the discounted value of the scheduled future lease payments and the residual value.
The following table presents the recorded amount of unguaranteed residual value for direct financing and operating leases at March 31, 2019 and December 31, 2018. In addition, the table presents the residual value as a percentage of the related original amount financed and a run out of when the unguaranteed residual value assigned to equipment on leases at March 31, 2019 and December 31, 2018, is expected to be returned to the company.
~~Unguaranteed Residual Value~~

At

At

Estimated Run Out of March 31, 2019 Balance

December 31,

March 31,

2022 and
(Dollars in millions)

2018

2019

2019

2020

2021

Beyond
Direct financing leases

$
491

$
472

$
85

$
99

$
141

$
146
Operating leases

114

106

44

36

22

4
Total unguaranteed residual value

$
605

$
578

$
129

$
135

$
163

$
151
Related original amount financed

$
10,148

$
9,557








Percentage

6.0
%

6.1
%








~~Liquidity and Capital Resources~~
IBM Credit funds current and future obligations through the generation of cash flows from operations and its access to the short-term and long-term capital markets, as well as the support given by IBM’s overall liquidity position and access to capital markets. The debt used to fund the company’s financing assets as of March 31, 2019 was primarily comprised of loans from IBM.
In the company’s 2018 Form 10‑K filed with the SEC on February 27, 2019, the company included information on its liquidity, including a table presenting the company’s cash flow and liquidity trending for the past four years. The table includes net cash provided by operating activities, cash and cash equivalents and cash invested with IBM. For the three months ended, or as of, as applicable, March 31, 2019, those amounts are $88 million for net cash provided by operating activities, $1,573 million of cash and cash equivalents and $282 million in cash invested with IBM.
In early 2017, the company announced an increase in its target debt-to-equity ratio from 7:1 to 9:1. At March 31, 2019, the debt-to-equity ratio was 9.1 to 1 as compared to 8.9 to 1 at December 31, 2018 and 9.4 to 1 at March 31, 2018. Refer to ~~page 46 regarding the company’s debt-to-equity ratio.~~
In the first quarter of 2019, IBM made a non-cash contribution to the company in the amount of $64 million. During the first quarter of 2019, the company made a cash distribution to IBM, including a return of profit, of $370 million. The future amount of third-party debt and contributions from and distributions to IBM may vary as the company continues to manage leverage to the targeted debt-to-equity ratio of 9 to 1. The company’s actual debt-to-equity ratio may vary based on several factors, including differences between management’s expectations and actual results of operations.
In 2017, the company established a commercial paper program under which the company is permitted to issue unsecured commercial paper notes from time to time, up to a maximum aggregate amount outstanding at any one time of $5 billion. As of March 31, 2019, there was $2,494 million of commercial paper outstanding.
The company and IBM entered into two committed credit facilities in 2017, a $2.5 billion 364‑Day Credit Agreement and a $2.5 billion Three-Year Credit Agreement. On July 19, 2018, the company and IBM entered into a new $2.5 billion, 364‑Day Credit Agreement to replace the maturing $2.5 billion, 364‑Day Credit Agreement, and also amended their existing $2.5 billion Three-Year Credit Agreement. The amended Three-Year Credit Agreement included a modification of terms to account for the potential discontinuation of LIBOR and to extend the maturity date by one year.
43
~~Table of Contents~~
~~Management Discussion – (continued)~~
The new maturity date for the Three-Year Credit Agreement is July 20, 2021. The facility size remains unchanged. As of March 31, 2019, the company has no borrowings outstanding against these Credit Agreements.
The major rating agencies’ ratings on the company’s debt securities at March 31, 2019 appear in the table below. The ratings remain unchanged from December 31, 2018. The company does not have “ratings trigger” provisions in its debt covenants or documentation, which would allow the holders to declare an event of default and seek to accelerate payments thereunder in the event of a change in credit rating.
~~STANDARD~~
~~MOODY’S~~
~~AND~~
~~INVESTORS~~
~~FITCH~~
~~POOR’S~~
~~SERVICE~~
~~RATINGS~~
~~Long-term debt~~
A
A1
A
~~Commercial paper~~
~~A-1~~
~~Prime-1~~
F1
In the normal course of business, the company may be exposed to the impact of foreign currency fluctuations and interest rate changes. Although the company seeks to substantially match fund the term, currency and interest rate variability of its debt against its underlying financing assets, risks may arise from a mismatch between assets and the related liabilities used for funding. The company also employs a rigorous process to optimize portfolio risk management. Portfolio risks include credit and residual value risk. For additional information on the management of these risks by the company, see note A, “Significant Accounting Policies” and note D, “Financial Instruments,” to the Consolidated Financial Statements in the company’s 2018 Form 10‑K filed with the SEC on February 27, 2019.
~~Cash Flow and Liquidity Trends~~

(Dollars in millions)

For the three months ended March 31:

2019

2018

Net cash provided by operating activities

$
88

$
240

Net cash provided by/(used in) investing activities

1,572

(650)

Net cash used in financing activities

(1,910)

(111)

At March 31:

2019

2018

Cash and cash equivalents

$
1,573

$
2,170

Cash invested with IBM, available on-demand (1)

282

1,198

Committed credit facilities (2)

5,000

5,000

~~(1)~~
Excess cash is periodically invested in interest bearing, on-demand accounts with IBM and is presented in other receivables from IBM in the Consolidated Statement of Financial Position and the Consolidated Statement of Cash Flows. For additional information, see note 9, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements.
~~(2)~~
~~The Credit Agreements were entered into and amended on July 19, 2018.~~
~~Net cash provided by operating activities in the first three months of 2019 decreased by $152 million as compared to the first three months of 2018 driven by higher net cash income tax payments of $150 million.~~
~~Net cash provided by investing activities in the first three months of 2019 increased by $2,222 million as compared to the first three months of 2018 driven by the following factors:~~
·
~~A decline in the investment of excess cash with IBM of $1,952 million, and~~
·
~~Lower net originations of financing receivables of $179 million, and~~
·
~~Lower cash payments relating to derivative contracts of $62 million.~~
44
~~Table of Contents~~
~~Management Discussion – (continued)~~
~~Net cash used in financing activities in the first three months of 2019 increased by $1,799 million as compared to the first three months of 2018 driven by the following factors:~~
·
~~A decrease in net proceeds on total debt of $1,919 million, offset by~~
·
~~A decrease in net cash distributions to IBM of $120 million.~~
~~Debt~~

At March 31,

At December 31,
(Dollars in millions)

2019

2018
Short-term debt




Debt

$
2,543

$
3,035
Debt payable to IBM

8,605

10,223
Total short-term debt

$
11,148

$
13,258

Long-term debt


Debt

$
8,034

$
7,919
Debt payable to IBM

9,762

9,357
Total long-term debt

$
17,796

$
17,276
Total debt

$
28,944

$
30,534
Total debt changes generally correspond with the level of Client Financing and Commercial Financing receivables, the level of cash and cash equivalents, the change in payables to IBM and external parties and the change in net investment from IBM.
Total debt was $28,944 million at March 31, 2019, a decrease of $1,590 million from year-end 2018. Total debt payable to IBM was $18,367 million at March 31, 2019, a decrease of $1,214 million from December 31, 2018. Total third-party debt was $10,577 million at March 31, 2019, a decrease of $376 million from December 31, 2018. The decrease in total debt during the first three months of 2019 was primarily due to lower funding requirements associated with financing receivables ~~and the~~company’s decision to utilize its excess cash to ~~retire~~repay a portion of its debt.

Net cash used in financing activities in the first six months of 2019 increased by $7,127 million as compared to the first six months of 2018 primarily driven by the following factors:

●

An increase in net payments on total debt of $6,531 million, which reflects the company’s decision to utilize its excess cash to repay a portion of its debt and lower funding requirements associated with ~~IBM, while continuing~~financing receivables.

●

An increase in net cash distributions to ~~maintain~~IBM of $597 million, which reflects the ~~company’s targeted~~company's management of its target debt-to-equity ratio of 9 to 1.

The company utilizes certain of its financing receivables as collateral for non-recourse borrowings. Financing receivables pledged as collateral for these borrowings was $868 million at March 31, 2019 and $710 million at December 31, 2018.

~~The company’s interest rate and foreign currency rate risk management policies and procedures are discussed in note 3, “Financial Instruments.”~~

~~Interest on Debt~~

The company recognized interest expense of $150 million in the three months ended March 31, 2019, of which $74 million was interest expense on debt payable to IBM. The company recognized interest expense of $102 million in the three months ended March 31, 2018, of which $57 million was interest expense on debt payable to IBM.

The increase in interest expense in the first three months of 2019 versus the same period in 2018 was driven by an increase in interest rates on both internal and external borrowings. Interest expense is presented in cost of financing in the Consolidated Statement of Earnings.

~~For additional information on interest expense, see note 11, “Borrowings.”~~

Table of Contents

Management Discussion – (continued)

Debt


	At June 30,		At December 31,
(Dollars in millions)	2019		2018
Short-term debt
Debt	$	1,647	$	3,035
Debt payable to IBM		5,148		10,223
Total short-term debt	$	6,796	$	13,258

Long-term debt
Debt	$	7,951	$	7,919
Debt payable to IBM		9,493		9,357
Total long-term debt	$	17,443	$	17,276
Total debt	$	24,239	$	30,534

Total debt changes generally correspond with the level of Client Financing and Commercial Financing receivables, the level of cash and cash equivalents, the change in payables to IBM and external parties and the change in net investment from IBM.

Total debt was $24,239 million at June 30, 2019, a decrease of $6,295 million from year-end 2018. Total debt payable to IBM was $14,641 million at June 30, 2019, a decrease of $4,940 million from December 31, 2018. Total third-party debt was $9,598 million at June 30, 2019, a decrease of $1,356 million from December 31, 2018. The decrease in total debt during the first six months of 2019 was primarily due to the company’s decision to utilize its excess cash to repay a portion of its debt and lower funding requirements associated with financing receivables while continuing to maintain the company’s targeted debt-to-equity ratio of 9 to 1.

The company utilizes certain of its financing receivables as collateral for non-recourse borrowings. Financing receivables pledged as collateral for these borrowings was $938 million at June 30, 2019 and $710 million at December 31, 2018.

The company’s interest rate and foreign currency rate risk management policies and procedures are discussed in note 3, “Financial Instruments.”

Interest on Debt

The company recognized interest expense of $135 million and $285 million for the three and six months ended June 30, 2019, respectively, of which $58 million and $131 million was interest expense on debt payable to IBM in each of those periods, respectively. The company recognized interest expense of $125 million and $227 million for the three and six months ended June 30, 2018, respectively, of which $75 million and $134 million was interest expense on debt payable to IBM in each of those periods, respectively.

The increase in interest expense in the second quarter and first six months of 2019 versus the same periods in 2018 was driven by an increase in interest rates on both internal and external borrowings partially offset by a decrease in the average debt balance. Interest expense is presented in cost of financing in the Consolidated Statement of Earnings.

For additional information on interest expense, see note 11, “Borrowings.”

Table of Contents

Management Discussion – (continued)

Debt-to-Equity

The debt-to-equity ratio as reported in the following table is the ratio of total debt to total member’s interest.


	At June 30,		At December 31,
	2019		2018
Debt-to-Equity Ratio *	8.9	x	8.9	x

~~Table of Contents~~

~~Management Discussion – (continued)~~

~~Debt-to-Equity~~

~~The debt-to-equity ratio as reported in the following table is the ratio of total debt to total member’s interest.~~

At March 31,

At December 31,

2019

2018

Debt-to-Equity Ratio *

9.1
x
8.9
x

*The debt-to-equity ratio is calculated by dividing the total amount of debt outstanding by the total amount of member’s interest in the company at the end of the reporting period presented.

The company’s debt-to-equity ratio was 8.9 to 1 at June 30, 2019, as compared to the debt-to-equity ratio of 8.9 to 1 at December 31, 2018. Total member’s interest of $2,724 million declined by $696 million, or 20.4 percent, while total debt of $24,239 million, decreased by $6,295 million, or 20.6 percent. The debt-to-equity ratio may vary based on several factors, including differences between management’s expectations and actual results of operations.

Looking Forward

The company’s debt-to-equity ratio was 9.1 to 1 at March 31, 2019, as compared to the debt-to-equity ratio of 8.9 to 1 at December 31, 2018. Total member’s interest of $3,164 million declined by $257 million, or 7.5 percent, while debt of $28,944 million decreased $1,590 million, or 5.2 percent. The debt-to-equity ratio may vary based on several factors, including differences between management’s expectations and actual results of operations.

~~Looking Forward~~

In 2017, IGF’s legal entity structure was reorganized globally to consolidate Client Financing and Commercial Financing under IBM Credit which drives operational benefits. The company has access to the short-term and long-term debt markets as an issuer in the capital markets and as a borrower from IBM. In 2019, the company ~~issued third-party debt and~~ made distributions to IBM, ~~of $370 million,~~ including a return of profit. The company will continue to target a debt-to-equity ratio of 9 to 1. The company’s actual debt-to-equity ratio may vary based on several factors, including differences between management’s expectations and actual results of operations. The future amount of third-party debt and contributions from and distributions to IBM may vary as the company continues to manage leverage to the targeted debt-to-equity ratio. Absent other funding alternatives, a protracted period where the company or IBM could not access the capital markets would likely lead to a slowdown in originations. Financing originations, which determine the asset base of the company’s annuity-like business, are also dependent upon the demand for IT products and services as well as client participation rates.

The company’s financial position provides flexibility and funding capacity which enables the company to be well positioned in the current environment. As a captive finance company, the company’s financing assets result primarily from the financing of IBM products and services, but also include OEM IT products and services to meet the total financing requirements of the company’s and IBM’s clients. Substantially all of the company’s financing assets are IT-related, which provide a stable base of business. The company’s financing offerings are competitive and available to clients as a result of factors including the company’s borrowing cost, financing incentive programs and access to the capital markets.

Beginning in the second quarter of 2019 and continuing throughout the year, the company is winding down the portion of its commercial financing operations which provides short-term working capital solutions for OEM information technology suppliers, distributors and resellers, which has resulted in a reduction of commercial financing receivables. The company had receivables of $8.5 billion as of December 31, 2018 and $3.6 billion as of June 30, 2019 relating to the financing of OEM IT suppliers, distributors, and resellers. The company’s borrowings declined at a similar rate, consistent with the targeted 9 to 1 debt-to-equity ratio. The company will continue to provide differentiated end-to-end financing solutions, including commercial financing in support of IBM partner relationships.

Effective in the second quarter of 2019, IBM and the company suspended the program under which IBM Credit purchases interests in IBM's trade accounts receivable. These receivables represented an asset balance of $1,369 million and $326 million in the Statement of Financial Position as of December 31, 2018 and June 30, 2019, respectively.

IBM Credit has policies in place designed to manage the risks involved in financing, including credit losses, residual values, liquidity, currency and interest rates.

Table of Contents

Management Discussion – (continued)

The economy could impact the credit quality of the company’s receivables portfolio and therefore the level of provision for credit losses. IBM Credit will continue to apply rigorous credit policies in both the origination of new business and the evaluation of the existing portfolio and will take risk mitigation actions when necessary.

The company has historically been able to manage residual value risk both through insight into IBM’s product cycles and monitoring of OEM IT product announcements.

Interest rates and the overall economy (including currency fluctuations) will have an effect on both revenue and net margin. Interest rates directly impact the company by increasing or decreasing financing revenue and associated borrowing costs. The company’s interest rate risk management policy, combined with its pricing strategy, should mitigate margin erosion due to changes in interest rates.

The company’s geographically diverse client base, product and client knowledge, and strategy to substantially match fund the term, currency and interest rate variability of its debt to the underlying financing assets should enable prudent management of the business going forward, even during periods of uncertainty with respect to the global economy.

Forward-looking and Cautionary Statements

Except for the historical information and discussions contained herein, statements contained in this Form 10 Q may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on the company’s current assumptions regarding future business and financial performance. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including, but not limited to, the following: the company’s financial condition being in large part dependent upon IBM; a downturn in the economic environment; innovations in the technology sector impacting clients’ propensity to enter in financing arrangements; the company’s reliance on partner relationships; client credit risk and an inability to collect receivables in a timely manner, which could impact financial results; changes to residual value, which could affect the profitability of lease transactions; impact of exposure to currency and financing risks and changes in market liquidity conditions; changes in financial regulation, supervision and licensing laws and regulations; changes in local legal, economic, political and health conditions; cybersecurity and data privacy considerations; risks from legal proceedings and investigatory risks; adverse effects from tax matters; impacts of business with government clients; the company’s use of accounting estimates; ineffective internal controls; and other risks, uncertainties and factors discussed in Item 1A, “Risk Factors” in the company’s Annual Report Form 10-K filed on February 27, 2019 with the SEC or in materials incorporated therein or herein by reference. Except as required by law, the company assumes no obligation to update or revise any forward-looking statements.

Table of Contents

Item 4. Controls and Procedures

The company’s management evaluated, with the participation of the Chairman and President, and the Vice President of Finance, the effectiveness of the company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chairman and President, and the Vice President of Finance have concluded that the company’s disclosure controls and procedures were effective as of the end of the period covered by this report. There has been no change in the company’s internal control over financial reporting that occurred during the quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting.

Part II. Other Information

Item 1. Legal Proceedings

Refer to note 12, “Contingencies,” on page 33 of this Form 10-Q.

Item 6. Exhibits

Exhibit Number

Description

31.1

Certification by principal executive officer pursuant to Rule 13A14(a) or 15D14(a) of the ~~company’s annuity-like business, are also dependent upon the demand for IT products and services~~Securities Exchange Act of 1934, as ~~well as client participation rates.~~

~~The company’s financial position provides flexibility and funding capacity which enables the company~~adopted pursuant to be well positioned in the current environment. As a captive finance company, the company’s financing assets result primarily from the financing of IBM products and services, but also include OEM IT products and services to meet the total financing requirementsSection 302 of the ~~company’s and IBM’s clients. Substantially all~~Sarbanes-Oxley Act of 2002.

31.2

Certification by principal financial officer pursuant to Rule 13A14(1) or 15D14(a) of the ~~company’s financing assets are IT-related, which provide a stable base~~Securities Exchange Act of ~~business. The company’s financing offerings are competitive and available~~1934, as adopted pursuant to ~~clients as a result of factors including the company’s borrowing cost, financing incentive programs and access to the capital markets.~~

In 2019, the company will wind down the portion of its Commercial Financing operations that provides short-term working capital solutions for OEM IT suppliers, distributors and resellers. This wind-down will start in the second quarter and is expected to conclude by the endSection 302 of the ~~year,~~Sarbanes-Oxley Act of 2002.

32.1

Certification by principal executive officer pursuant to 18 U.S.C. Section 1350, as the receivables are collected in the normal course of business. The company’s borrowings will decline at a similar rate, consistent with the targeted 9:1 debt-to-equity ratio. The company had receivables of $8.5 billion as of December 31, 2018 and $8.1 billion as of March 31, 2019 relatingadopted pursuant to the financing of OEM IT suppliers, distributors, and resellers. The company will continue to provide differentiated end-to-end financing solutions, including commercial financing in support of IBM partner relationships.

Effective in the second quarter of 2019, IBM and the company have suspended the program under which IBM Credit LLC purchases interests in IBM's trade accounts receivable. These receivables generated financing income of $42 million in 2018 and $15 million in the first quarter of 2019 and represented an asset balance of $1,369 million and $1,430 million in the Statement of Financial Position as of December 31, 2018 and March 31, 2019 respectively.

~~IBM Credit has policies in place designed to manage the risks involved in financing, including credit losses, residual values, liquidity, currency and interest rates.~~

~~Table of Contents~~

~~Management Discussion – (continued)~~

~~The economy could impact the credit quality~~Section 906 of the ~~company’s receivables portfolio and therefore the level~~Sarbanes-Oxley Act of ~~provision for credit losses. IBM Credit will continue~~2002.

32.2

Certification by principal financial officer pursuant to ~~apply rigorous credit policies in both the origination of new business and the evaluation~~18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the ~~existing portfolio and will take risk mitigation actions when necessary.~~

~~The company has historically been able to manage residual value risk both through insight into IBM’s product cycles and monitoring~~Sarbanes-Oxley Act of ~~OEM IT product announcements.~~2002.

~~Interest rates and~~

101.INS

XBRL Instance Document - the ~~overall economy (including currency fluctuations) will have an effect~~instance document does not appear on ~~both revenue and net margin. Interest rates directly impact~~ the ~~company by increasing or decreasing financing revenue and associated borrowing costs. The company’s interest rate risk management policy, combined with~~Interactive Data File because its ~~pricing strategy, should mitigate margin erosion due to changes in interest rates.~~

~~Forward-looking and Cautionary Statements~~

~~Except for the historical information and discussions contained herein, statements contained in this Form 10‑Q may constitute forward-looking statements~~XBRL tags are embedded within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on the company’s current assumptions regarding future business and financial performance. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including, but not limited to, the following: the company’s financial condition being in large part dependent upon IBM; a downturn in the economic environment; innovations in the technology sector impacting clients’ propensity to enter in financing arrangements; the company’s reliance on partner relationships; client credit risk and an inability to collect receivables in a timely manner, which could impact financial results; changes to residual value, which could affect the profitability of lease transactions; impact of exposure to currency and financing risks and changes in market liquidity conditions; changes in financial regulation, supervision and licensing laws and regulations; changes in local legal, economic, political and health conditions; cybersecurity and data privacy considerations; risks from legal proceedings and investigatory risks; adverse effects from tax matters; impacts of business with government clients; the company’s use of accounting estimates; ineffective internal controls; and other risks, uncertainties and factors discussed in Item 1A, “Risk Factors” in the company’s Annual Report Form 10‑K filed on February 27, 2019 with the SEC or in materials incorporated therein or herein by reference. The company assumes no obligation to update or revise any forward-looking statements.Inline XBRL document

101.SCH

XBRL Taxonomy Extension Schema Document

~~Table of Contents~~

~~Item 4. Controls and Procedures~~

XBRL Taxonomy Extension Calculation Linkbase Document

~~Table of Contents~~101.DEF

~~Part II. Other Information~~XBRL Taxonomy Extension Definition Linkbase Document

~~Item 1. Legal Proceedings~~

~~Refer to note 12, “Contingencies,” on page 32 of this Form 10‑Q.~~

~~Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities~~

~~Not applicable.~~101.LAB

~~Item 6. Exhibits~~

~~Exhibit Number~~		~~Description~~

~~31.1~~		Certification by principal executive officer pursuant to Rule 13‑A‑14(a) or 15‑D‑14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

~~31.2~~		Certification by principal financial officer pursuant to Rule 13A‑14(1) or 15D‑14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

~~32.1~~		~~Certification by principal executive officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.~~

~~32.2~~		~~Certification by principal financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.~~

~~101.INS~~		~~XBRL Instance Document~~

~~101.SCH~~		~~XBRL Taxonomy Extension Schema Document~~

~~101.CAL~~		~~XBRL Taxonomy Extension Calculation Linkbase Document~~

~~101.DEF~~		~~XBRL Taxonomy Extension Definition Linkbase Document~~

~~101.LAB~~		~~XBRL Taxonomy Extension Label Linkbase Document~~

~~101.PRE~~		XBRL Taxonomy Extension Label Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

104

Cover Page Interactive Data File - the cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document

Table of Contents

~~Table of Contents~~

SIGNATURE

Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

		IBM CREDIT LLC
		(Registrant)

Date:	~~April 30,~~August 5, 2019

		By:	/s/ Adam Wilson
			Adam Wilson
			Vice President, Finance

5054

Delaware		22-2351962
(State or Other Jurisdiction of Incorporation or Organization)		(IRS employer identification number)

Armonk, New York		10504
(Address of principal executive offices)		(Zip Code)

Large accelerated filer ☐		Accelerated filer ☐

Non-accelerated filer☒		Smaller reporting company ☐


		Emerging growth company ☐


	Three Months Ended March 31,
(Dollars in millions)	2019		2018
Revenue
Financing revenue	$	404	$	365
Operating lease revenue		78		84
Total revenue	$	482	$	449
Financing cost (related party cost of $74 in 2019 and $57 in 2018)	$	160	$	102
Depreciation of equipment under operating lease		45		48
Net margin	$	277	$	300
Expense and other (income)
Selling, general and administrative	$	97	$	98
Provision for credit losses		4		9
Other (income) and expense		(18)		1
Total expense and other (income)	$	83	$	109
Income before income taxes	$	193	$	191
Provision for income taxes		150		42
Net income	$	43	$	149


	At March 31,		At December 31,
(Dollars in millions)	2019		2018
Assets:
Cash and cash equivalents	$	1,573	$	1,828
Financing receivables		23,431		25,848
(net of allowances of $171 in 2019 and $174 in 2018)
Equipment under operating leases		345		386
(net of accumulated depreciation of $286 in 2019 and $283 in 2018)
Financing receivables from IBM		3,869		3,609
Receivables purchased/participated from IBM		5,331		5,433
(net of allowances of $11 in 2019 and $18 in 2018)
Other receivables from IBM		301		2,019
Other assets		366		373
Total assets	$	35,217	$	39,497

Liabilities:
Accounts payable	$	1,362	$	1,705
Accounts payable to IBM		950		3,044
Debt		10,577		10,954
Debt payable to IBM		18,367		19,580
Taxes		594		547
Other liabilities		203		246
Total liabilities	$	32,053	$	36,076
Member’s interest:
Member's interest		3,191		3,216
Retained earnings		—		238
Accumulated other comprehensive income/(loss)		(27)		(33)
Total member's interest	$	3,164	$	3,420
Total liabilities and member’s interest	$	35,217	$	39,497


					Accumulated
					Other		Total
	Member's		Retained		Comprehensive		Member’s
(Dollars in millions)	Interest		Earnings		Income/(Loss)		Interest
Member’s Interest, January 1, 2019	$	3,216	$	238	$	(33)	$	3,420
Net income plus other comprehensive income/(loss):
Net income				43				43
Other comprehensive income/(loss), net of tax						6		6
Total comprehensive income/(loss)							$	49
Contributions from IBM (1)		64						64
Distributions to IBM		(88)		(282)				(370)
Member’s Interest, March 31, 2019	$	3,191	$	—	$	(27)	$	3,164


(Dollars in millions)
At March 31, 2019	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents (1)
Time deposits and certificates of deposit	$	—	$	750	$	—	$	750
Money market funds		5		—		—		5
Total		5		750		—		755
Derivative assets (2)		—		21		—		21	(4)
Total assets	$	5	$	771	$	—	$	776
Liabilities:
Derivative liabilities (3)	$	—	$	23	$	—	$	23	(4)


	Fair Value of Derivative Assets					Fair Value of Derivative Liabilities
	Balance Sheet					Balance Sheet
(Dollars in millions)	Classification	3/31/2019		12/31/2018		Classification	3/31/2019		12/31/2018
Designated as hedging instruments:
Interest rate contracts with IBM	Other assets	$	11	$	10	Other liabilities	$	23	$	27
Foreign exchange contracts with IBM	Other assets		10		9	Other liabilities		1		11
	Fair value of derivative assets	$	21	$	18	Fair value of derivative liabilities	$	23	$	37

Not designated as hedging instruments:
Foreign exchange contracts	Other assets		—		—	Other liabilities		—		—
	Fair value of derivative assets	$	—	$	—	Fair value of derivative liabilities	$	—	$	—

Total		$	21	$	18		$	23	$	37


					Gains/(Losses) of
(Dollars in millions)	Total				Total Hedge Activity
For the three months ended March 31:	2019		2018		2019		2018
Financing cost	$	160	$	102	$	4	$	9
Other (income) and expense		(18)		1		—		1


	Gain/(Loss) Recognized in Earnings
	Consolidated	Recognized on				Attributable to Risk
(Dollars in millions)	Statement of	Derivatives				Being Hedged (2)
For the three months ended March 31:	Earnings Line Item	2019		2018		2019		2018
Derivative instruments in fair value hedges (1):
Interest rate contracts with IBM	Financing cost	$	20	$	(21)	$	(25)	$	23

Derivative instruments not designated as hedging instruments:
Foreign exchange contracts	Other (income) and expense		—		1		N/A		N/A
Total		$	20	$	(20)	$	(25)	$	23


					Client Loans and
			Commercial		Installment
(Dollars in millions)	Investment in		Financing		Payments
At March 31, 2019:	Leases		Receivables		(Loans)		Total
Financing receivables, gross	$	4,923	$	9,902	$	8,988	$	23,814
Unearned income		(387)		(33)		(436)		(856)
Deferred initial direct costs		40		—		66		107
Recorded investment	$	4,576	$	9,869	$	8,619	$	23,065
Allowance for credit losses		(58)		(15)		(98)		(171)
Unguaranteed residual value		472		—		—		472
Guaranteed residual value		65		—		—		65
Total financing receivables, net	$	5,056	$	9,854	$	8,521	$	23,431


	Purchased and
	Participated
(Dollars in millions)	Receivables
At December 31, 2018:	From IBM
Short-term purchased receivables from IBM	$	1,373
Allowance for credit losses		(4)
Total short-term purchased receivables from IBM, net	$	1,369

Long-term participated receivables from IBM	$	4,079
Allowance for credit losses		(14)
Total long-term participated receivables from IBM, net	$	4,065

Total purchased and participated receivables from IBM, net	$	5,433


					Recorded		Billed		Recorded
	Total		Recorded		Investment		Invoices		Investment
(Dollars in millions)	Recorded		Investment		> 90 Days and		> 90 Days and		Not
At March 31, 2019:	Investment		> 90 Days (1)		Accruing (1)		Accruing		Accruing (2)
Americas	$	3,358	$	280	$	239	$	13	$	41
EMEA		632		38		22		3		16
Asia Pacific		586		14		2		—		11
Total lease receivables	$	4,576	$	331	$	263	$	16	$	68

Americas	$	5,674	$	193	$	128	$	22	$	64
EMEA		2,100		56		10		3		46
Asia Pacific		845		5		2		1		3
Total loan receivables	$	8,619	$	253	$	140	$	26	$	114

Americas	$	652	$	5	$	5	$	3	$	—
EMEA		1,587		6		6		2		—
Asia Pacific		1,669		—		—		—		—
Total participated receivables from IBM	$	3,908	$	11	$	11	$	4	$	—

Total	$	17,104	$	596	$	414	$	47	$	182


(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the three months ended March 31, 2019:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	3	$	3	$	6
Retirement-related benefit plans (1):
Prior service costs/(credits)	$	—	$	—	$	—
Net (losses)/gains arising during the period		0		0		0
Curtailments and settlements		—		—		—
Amortization of prior service (credits)/costs		0		0		0
Amortization of net (gains)/losses		0		0		0
Total retirement-related benefit plans	$	0	$	0	$	0
Other comprehensive income/(loss)	$	3	$	3	$	6


			Net Change
	Foreign		Retirement-		Accumulated
	Currency		Related		Other
	Translation		Benefit		Comprehensive
(Dollars in millions)	Adjustments*		Plans		Income/(Loss)
January 1, 2019	$	(23)	$	(10)	$	(33)
Other comprehensive income before reclassification		6		0		6
Amount reclassified from accumulated other comprehensive income		—		0		0
Total change for the period		6		0		6
March 31, 2019	$	(17)	$	(10)	$	(27)


	Balance		Balance
(Dollars in millions)	3/31/2019		12/31/2018
Commercial paper	$	2,494	$	2,995
Short-term loans		22		17
Secured borrowings		28		23
Debt	$	2,543	$	3,035
Debt payable to IBM		8,605		10,223
Total	$	11,148	$	13,258


	2019										2024 and
(Dollars in millions)	(Q2-Q4)		2020		2021		2022		2023		beyond		Total
Long-term debt	$	1,775	$	1,898	$	3,063	$	560	$	757	$	0	$	8,053
Debt payable to IBM		3,235		3,068		1,834		1,188		335		102		9,762
Total	$	5,010	$	4,966	$	4,898	$	1,748	$	1,092	$	102	$	17,815


					Yr.-to-Date
	At March 31,		At December 31,		Percent
(Dollars in millions)	2019		2018		Change
Assets	$	35,217	$	39,497	(10.8)	%
Liabilities	$	32,053	$	36,076	(11.2)	%
Member’s interest	$	3,164	$	3,420	(7.5)	%