UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 2019
000-55786
(Commission file number)
IBM CREDIT LLC
(Exact name of registrant as specified in its charter)
Delaware |
| 22-2351962 |
(State or Other Jurisdiction of | | (IRS employer identification number) |
| | |
One North Castle Drive | | |
Armonk, New York |
| 10504 |
(Address of principal executive offices) | | (Zip Code) |
914-765-1900
(Registrant’s telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐ |
| Accelerated filer ☐ |
| | |
Non-accelerated filer ☒ | | Smaller reporting company ☐ |
| | |
| | Emerging growth company ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Securities registered pursuant to Section 12(b) of the Act:
None.
All of the limited liability company interests ("Interests") in the registrant are held by an affiliate of the registrant. NaN of the Interests are publicly traded.
REDUCED DISCLOSURE FORMAT
IBM Credit LLC, an indirect, wholly owned subsidiary of International Business Machines Corporation (IBM), meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this form with the reduced disclosure format.
Index
2
Part I— Financial Information
Item 1. Consolidated Financial Statements:
IBM CREDIT LLC AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF EARNINGS
(UNAUDITED)
| | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, | | ||||||||
(Dollars in millions) |
| 2019 |
| 2018 |
| 2019 |
| 2018 | | ||||
Revenue | | |
|
| |
| | |
|
| |
| |
Financing revenue | | $ | 305 | | $ | 367 | | $ | 1,048 | | $ | 1,084 | |
Operating lease revenue | | | 67 | | | 85 | | | 216 | | | 250 | |
Total revenue | | $ | 372 | | $ | 452 | | $ | 1,265 | | $ | 1,334 | |
Financing cost (related party cost for the three and nine months: $58 and $189 in 2019, $81 and $215 in 2018) | | $ | 122 | | $ | 135 | | $ | 419 | | $ | 362 | |
Depreciation of equipment under operating lease | | | 39 | | | 50 | | | 127 | | | 146 | |
Net margin | | $ | 212 | | $ | 268 | | $ | 719 | | $ | 827 | |
Expense and other (income) | | | | | | | | | | | | | |
Selling, general and administrative | | $ | 87 | | $ | 89 | | $ | 281 | | $ | 292 | |
Provision for/(benefit from) credit losses | | | (1) | | | (10) | | | (4) | | | 24 | |
Other (income) and expense | | | (5) | | | 5 | | | (18) | | | (11) | |
Total expense and other (income) | | $ | 81 | | $ | 84 | | $ | 259 | | $ | 305 | |
Income before income taxes | | $ | 131 | | $ | 184 | | $ | 460 | | $ | 522 | |
Provision for income taxes | | | 22 | | | 39 | | | 195 | | | 112 | |
Net income | | $ | 109 | | $ | 144 | | $ | 265 | | $ | 410 | |
(Amounts may not add due to rounding.)
(The accompanying notes are an integral part of the financial statements.)
3
IBM CREDIT LLC AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)
| | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, | | ||||||||
(Dollars in millions) |
| 2019 |
| 2018 |
| 2019 |
| 2018 | | ||||
Net income | | $ | 109 | | $ | 144 | | $ | 265 | | $ | 410 | |
Other comprehensive income/(loss), before tax: | | | | | | | | | | | | | |
Foreign currency translation | | | (76) | | | (20) | | | (56) | | | (119) | |
Retirement-related benefit plans (1) | | | 0 | | | 0 | | | 1 | | | 1 | |
Other comprehensive income/(loss), before tax | | | (75) | | | (20) | | | (55) | | | (117) | |
Income tax (expense)/benefit related to items of other comprehensive income | | | (17) | | | (6) | | | (13) | | | (22) | |
Other comprehensive income/(loss), net of tax | | $ | (93) | | $ | (26) | | $ | (68) | | $ | (139) | |
Total comprehensive income | | $ | 16 | | $ | 118 | | $ | 197 | | $ | 270 | |
(1) | Amounts presented relate to multiple-employer plans. |
(Amounts may not add due to rounding.)
(The accompanying notes are an integral part of the financial statements.)
4
IBM CREDIT LLC AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(UNAUDITED)
| | | | | | | |
| | At September 30, | | At December 31, | | ||
(Dollars in millions) |
| 2019 |
| 2018 | | ||
Assets: |
| |
| | |
| |
Cash and cash equivalents | | $ | 2,079 | | $ | 1,828 | |
Financing receivables | |
| 15,289 | |
| 25,848 | |
(net of allowances of $154 in 2019 and $174 in 2018) | | | | | | | |
Equipment under operating leases | | | 243 | | | 386 | |
(net of accumulated depreciation of $231 in 2019 and $283 in 2018) | | | | | | | |
Financing receivables from IBM | |
| 3,756 | |
| 3,609 | |
Receivables purchased/participated from IBM | |
| 3,857 | |
| 5,433 | |
(net of allowances of $7 in 2019 and $18 in 2018) | | | | | | | |
Other receivables from IBM | | | 604 | | | 2,019 | |
Other assets | |
| 389 | |
| 373 | |
Total assets | | $ | 26,216 | | $ | 39,497 | |
| | | | | | | |
Liabilities: | | | | | | | |
Accounts payable | | $ | 318 | | $ | 1,705 | |
Accounts payable to IBM | | | 249 | | | 3,044 | |
Debt | |
| 7,410 | |
| 10,954 | |
Debt payable to IBM | |
| 14,928 | |
| 19,580 | |
Taxes | |
| 619 | |
| 547 | |
Other liabilities | |
| 192 | |
| 246 | |
Total liabilities | | $ | 23,716 | | $ | 36,076 | |
Member’s interest: | |
| | | | | |
Member's interest | | | 2,601 | | | 3,216 | |
Retained earnings | | | — | | | 238 | |
Accumulated other comprehensive income/(loss) | |
| (101) | | | (33) | |
Total member's interest | | $ | 2,500 | | $ | 3,420 | |
Total liabilities and member’s interest | | $ | 26,216 | | $ | 39,497 | |
(Amounts may not add due to rounding.)
(The accompanying notes are an integral part of the financial statements.)
5
IBM CREDIT LLC AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
| | | | | | | |
| | Nine Months Ended September 30, | | ||||
(Dollars in millions) |
| 2019 |
| 2018 |
| ||
Cash flows from operating activities: |
| |
|
| |
|
|
Net income | | $ | 265 | | $ | 410 | |
Adjustments to reconcile net income to cash provided by operating activities: | |
| | |
| | |
Provision for/(benefit from) credit losses | |
| (4) | |
| 24 | |
Depreciation | |
| 127 | |
| 146 | |
Deferred taxes | |
| 19 | |
| (6) | |
Net (gain)/loss on asset sales and other | |
| (61) | |
| (67) | |
Change in operating assets and liabilities: | |
| | |
| | |
Other assets/other liabilities | |
| (250) | |
| 306 | |
Net cash provided by operating activities | | $ | 95 | | $ | 812 | |
| | | | | | | |
Cash flows from investing activities: | |
| | |
|
| |
Originations of financing receivables | | $ | (10,167) | | $ | (10,978) | |
Collection of financing receivables | |
| 10,823 | |
| 10,566 | |
Short-term financing receivables - net (1) | |
| 7,242 | |
| 1,320 | |
Purchase of equipment under operating leases | |
| (43) | |
| (221) | |
Proceeds from disposition of equipment under operating lease | |
| 57 | |
| 53 | |
Other receivables from IBM - net | | | 1,371 | | | (1,682) | |
Other investing activities - net | |
| 91 | |
| 90 | |
Net cash provided by/(used in) investing activities | | $ | 9,374 | | $ | (853) | |
| | | | | | | |
Cash flows from financing activities: | |
| | |
|
| |
Proceeds from issuance of debt from IBM | | $ | 7,007 | | $ | 8,696 | |
Principal payments on debt from IBM | |
| (7,656) | |
| (8,262) | |
Proceeds from issuance of debt | |
| 739 | |
| 2,581 | |
Principal payments on debt | |
| (2,012) | |
| (755) | |
Short-term borrowings from/(repayments to) IBM - net (1) | |
| (3,782) | |
| (2,897) | |
Short-term borrowings/(repayments) - net (1) | |
| (2,312) | |
| 448 | |
Contributions from IBM | | | — | | | 148 | |
Distributions to IBM | | | (1,182) | | | (620) | |
Net cash used in financing activities | | $ | (9,199) | | $ | (661) | |
| | | | | | | |
Effect of exchange rate changes on cash and cash equivalents | | $ | (20) | | $ | (17) | |
Net change in cash and cash equivalents | | $ | 251 | | $ | (719) | |
| | | | | | | |
Cash and cash equivalents at January 1 | |
| 1,828 | |
| 2,680 | |
Cash and cash equivalents at September 30 | | $ | 2,079 | | $ | 1,961 | |
(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.)
6
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, July 1, 2019 | | $ | 2,733 | | $ | — | | $ | (8) | | $ | 2,724 |
Net income plus other comprehensive income/(loss): | |
| | | | | | | | | | |
Net income | |
| | | | 109 | | | | | | 109 |
Other comprehensive income/(loss), net of tax | |
| | | | | | | (93) | | | (93) |
Total comprehensive income/(loss) | |
| | | | | | | | | $ | 16 |
Contributions from IBM | | | — | | | | | | | | | — |
Distributions to IBM | | | (132) | | | (109) | | | | | | (240) |
Member’s Interest, September 30, 2019 | | $ | 2,601 | | $ | — | | $ | (101) | | $ | 2,500 |
(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, July 1, 2018 | | $ | 3,212 | | $ | 117 | | $ | 39 | | $ | 3,369 |
Net income plus other comprehensive income/(loss): | |
| | | | | | | | | | |
Net income | |
| | | | 144 | | | | | | 144 |
Other comprehensive income/(loss), net of tax | |
| | | | | | | (26) | | | (26) |
Total comprehensive income/(loss) | |
| | | | | | | | | $ | 118 |
Contributions from IBM | | | 3 | | | | | | | | | 3 |
Distributions to IBM | | | — | | | (130) | | | | | | (130) |
Member’s Interest, September 30, 2018 | | $ | 3,215 | | $ | 131 | | $ | 13 | | $ | 3,360 |
(Amounts may not add due to rounding.)
(The accompanying notes are an integral part of the financial statements.)
7
IBM CREDIT LLC AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF CHANGES IN MEMBER'S INTEREST – (CONTINUED)
(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 | |
| | | | 265 | | | | | | 265 |
Other comprehensive income/(loss), net of tax | |
| | | | | | | (68) | | | (68) |
Total comprehensive income/(loss) |
| | | | | | | | | $ | 197 | |
Contributions from IBM (1) | |
| 64 | | | | | | | | | 64 |
Distributions to IBM | | | (679) | | | (503) | | | | | | (1,182) |
Member’s Interest, September 30, 2019 | | $ | 2,601 | | $ | — | | $ | (101) | | $ | 2,500 |
(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 | |
| | | | 410 | | | | | | 410 |
Other comprehensive income/(loss), net of tax | |
| | | | | | | (139) | | | (139) |
Total comprehensive income/(loss) |
| | | | | | | | | $ | 270 | |
Contributions from IBM | | | 148 | | | | | | | | | 148 |
Distributions to IBM | | ��� | (34) | | | (586) | | | | | | (620) |
Member’s Interest, September 30, 2018 | | $ | 3,215 | | $ | 131 | | $ | 13 | | $ | 3,360 |
(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.)
8
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.
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.
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/
9
Level 2 transfer disclosures. As the guidance is 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. 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. A cross-functional team was established to evaluate the impact of the guidance on the financial instruments portfolio. All of the changes to systems, processes and policies are on track for completion before the effective date. The guidance is not expected to have a material impact in the consolidated financial results.
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. The guidance 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 (IDCs). From a lessor perspective, the changes in lease termination guidance, IDCs 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 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 in the consolidated financial results.
10
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.
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.
11
The following tables present the company’s financial assets and liabilities that are measured at fair value on a recurring basis at September 30, 2019 and December 31, 2018.
| | | | | | | | | | | | | |
(Dollars in millions) | | | | | | | | | | | | |
|
At September 30, 2019 |
| Level 1 |
| Level 2 |
| Level 3 |
| Total | | ||||
Assets: |
| |
|
| |
|
| |
|
| |
| |
Cash equivalents (1) | | | | | | | | | | | | | |
Time deposits and certificates of deposit |
| $ | — | | $ | 1,089 | | $ | — | | $ | 1,089 | |
Money market funds | | | 5 | | | — | | | — | | | 5 | |
Total | | | 5 | | | 1,089 | | | — | | | 1,094 | |
Derivative assets (2) | | | — | | | 51 | | | — | | | 51 | |
Total assets | | $ | 5 | | $ | 1,141 | | $ | — | | $ | 1,146 | |
Liabilities: | | | | | | | | | | | | | |
Derivative liabilities (3) | | $ | — | | $ | 2 | | $ | — | | $ | 2 | |
(1) | Included within cash and cash equivalents in the Consolidated Statement of Financial Position. |
(2) | Included within other assets in the Consolidated Statement of Financial Position. |
(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) | Included within cash and cash equivalents in the Consolidated Statement of Financial Position. |
(2) | Included within other assets in the Consolidated Statement of Financial Position. |
(3) | Included within other liabilities in the Consolidated Statement of Financial Position. |
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 September 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.
12
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 $15,430 million and $17,276 million, and the estimated fair value was $15,552 million and $17,199 million at September 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 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 September 30, 2019, the aggregate fair value of derivative contracts with IBM that were in an asset position totaled $51 million and the aggregate fair value of derivative contracts with IBM that were in a liability position totaled $2 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 $2 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.
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 September 30, 2019 and December 31, 2018, the total notional amount of the company's interest rate swap contracts with IBM was $2,550 million and $3,350 million, respectively. The weighted average remaining maturity of these instruments at September 30, 2019 and December 31, 2018, was approximately 2.2 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 September 30, 2019 and December 31, 2018.
13
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 September 30, 2019 and December 31, 2018, the total notional amount of derivative contracts with IBM designated as net investment hedges was $1,230 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 0 foreign exchange derivative contracts with third parties outstanding at September 30, 2019 and December 31, 2018.
The following tables provide a quantitative summary of the derivative instrument-related risk management activity at September 30, 2019 and December 31, 2018, as well as for the three and nine months ended September 30, 2019 and 2018, respectively.
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 |
| 9/30/2019 |
| 12/31/2018 |
| Classification |
| 9/30/2019 |
| 12/31/2018 | ||||
Designated as hedging instruments: | | | | | | | | | | | | | | | | |
Interest rate contracts with IBM |
| Other assets | | $ | 37 | | $ | 10 |
| Other liabilities | | $ | 2 | | $ | 27 |
Foreign exchange contracts with IBM |
| Other assets | |
| 14 | |
| 9 |
| Other liabilities | |
| — | |
| 11 |
|
| Fair value of derivative assets | | $ | 51 | | $ | 18 |
| Fair value of derivative liabilities | | $ | 2 | | $ | 37 |
| | | | | | | | | | | | | | | | |
Not designated as hedging instruments: | | | | | | | | | | | | | | | | |
Foreign exchange contracts |
| Other assets | | $ | — | | $ | — |
| Other liabilities | | $ | — | | $ | — |
|
| Fair value of derivative assets | | $ | — | | $ | — |
| Fair value of derivative liabilities | | $ | — | | $ | — |
| | | | | | | | | | | | | | | | |
Total | | | | $ | 51 | | $ | 18 | | | | $ | 2 | | $ | 37 |
At September 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 September 30, | | At December 31, | ||
(Dollars in millions) |
| 2019 |
| 2018 | ||
Debt: | | | | | | |
Carrying amount of the hedged item | | $ | (2,581) | | $ | (3,310) |
Cumulative hedging adjustments included in the carrying amount - assets/(liabilities) | | | (36) | | | 34 |
14
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 September 30: |
| 2019 |
| 2018 | | 2019 |
| 2018 | ||||
Financing cost | | $ | 122 |
| $ | 135 | | $ | 9 |
| $ | 6 |
Other (income) and expense | |
| (5) | |
| 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 September 30: |
| Earnings Line Item |
| 2019 |
| 2018 |
| 2019 |
| 2018 | ||||
Derivative instruments in fair value hedges (1): | | | | | | | | | | | | | | |
Interest rate contracts with IBM | | Financing cost | | $ | 5 | | $ | (10) | | $ | (8) | | $ | 7 |
| | | | | | | | | | | | | | |
Derivative instruments not designated as hedging instruments: | | | | | | | | | | | | | | |
Foreign exchange contracts | | Other (income) and expense | |
| — | |
| — | |
| N/A | |
| N/A |
Total | | | | $ | 5 | | $ | (10) |
| $ | (8) |
| $ | 7 |
| | | | | | | | | | | | | | | | | | | | |
| | 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 September 30: |
| 2019 |
| 2018 |
| Line Item |
| 2019 |
| 2018 |
| 2019 |
| 2018 | ||||||
Derivative instruments in net investment hedges: | | | | | | | | | | | | | | | | | | | | |
Foreign exchange contracts with IBM | | $ | 67 | | $ | 23 |
| Financing cost | | $ | — | | $ | — | | $ | 12 | | $ | 8 |
| | | | | | | | | | | | | | | | | | | | |
Total | | $ | 67 | | $ | 23 | | | | $ | — | | $ | — | | $ | 12 | | $ | 8 |
(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
| | | | | | | | | | | | |
| | | | Gains/(Losses) of | ||||||||
(Dollars in millions) | | Total | | Total Hedge Activity | ||||||||
For the nine months ended September 30: |
| 2019 |
| 2018 | | 2019 |
| 2018 | ||||
Financing cost | | $ | 419 |
| $ | 362 | | $ | 16 |
| $ | 22 |
Other (income) and expense | |
| (18) | |
| (11) | |
| — | |
| 7 |
15
| | | | | | | | | | | | | | |
| | Gain/(Loss) Recognized in Earnings | ||||||||||||
| | Consolidated | | Recognized | | Attributable to Risk | ||||||||
(Dollars in millions) | | Statement of | | on Derivatives | | Being Hedged (2) | ||||||||
For the nine months ended September 30: |
| Earnings Line Item |
| 2019 |
| 2018 |
| 2019 |
| 2018 | ||||
Derivative instruments in fair value hedges (1): | | | | | | | | | | | | | | |
Interest rate contracts with IBM |
| Financing cost | | $ | 57 | | $ | (45) | | $ | (70) | | $ | 43 |
| | | | | | | | | | | | | | |
Derivative instruments not designated as hedging instruments: | | | | | | | | | | | | | | |
Foreign exchange contracts |
| Other (income) and expense | |
| — | |
| 7 | |
| N/A | |
| N/A |
Total | | | | $ | 57 | | $ | (39) | | $ | (70) | | $ | 43 |
| | | | | | | | | | | | | | | | | | | | |
| | 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 nine months ended September 30: |
| 2019 |
| 2018 |
| Line Item |
| 2019 |
| 2018 |
| 2019 |
| 2018 | ||||||
Derivative instruments in net investment hedges: | | |
| |
|
|
|
| |
|
| |
|
| |
|
| |
|
|
Foreign exchange contracts with IBM | | $ | 49 | | $ | 84 |
| Financing cost | | $ | — | | $ | — | | $ | 28 | | $ | 24 |
| | | | | | | | | | | | | | | | | | | | |
Total | | $ | 49 | | $ | 84 |
|
| | $ | — | | $ | — | | $ | 28 | | $ | 24 |
(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 nine months ended September 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.
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. IBM equipment generally consists of IBM Z, Power Systems and Storage Systems products.
16
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, in an instance when the client 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.
The following tables present amounts included in the Consolidated Statement of Earnings related to lessor activity:
| | | |
(Dollars in millions) | | | |
For the three months ended September 30: |
| 2019 | |
Financing lease revenue | | $ | 50 |
Operating lease revenue | | | 67 |
Variable lease revenue | | | 6 |
Total lease revenue | | $ | 124 |
| | | |
(Dollars in millions) | | | |
For the nine months ended September 30: |
| 2019 | |
Financing lease revenue | | $ | 157 |
Operating lease revenue | | | 216 |
Variable lease revenue | | | 19 |
Total lease revenue | | $ | 391 |
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 residual value of the equipment, less unearned income and allowance for credit losses. At September 30, 2019, the unguaranteed residual value of sales-type and direct financing leases was $468 million. For further information on the company’s investment in leases, including 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.
17
For a direct financing lease, the investment in the 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. 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. 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, 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 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 income. For the three and nine months ended September 30, 2019 and 2018, impairment of residual values was immaterial.
The following table 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, as well as a reconciliation of the undiscounted cash flows to the financing receivables recognized in the Consolidated Statement of Financial Position at September 30, 2019:
| | | | |
(Dollars in millions) | | Total | | |
Remainder of 2019 | | $ | 630 | |
2020 | | | 1,820 | |
2021 | | | 1,238 | |
2022 | | | 607 | |
2023 | | | 158 | |
Thereafter | | | 22 | |
Total undiscounted cash flows | | $ | 4,475 | |
Present value of lease payments (recognized as financing receivables) | | | 4,134 | * |
Difference between undiscounted cash flows and discounted cash flows | | $ | 341 | |
*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 under 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 base is the original cost of the equipment less the estimated residual value of the equipment at the end of the lease term. At September 30, 2019, the unguaranteed residual value of equipment under operating leases was $92 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.
18
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 September 30, 2019:
| | | |
(Dollars in millions) | | Total | |
Remainder of 2019 | | $ | 80 |
2020 | | | 106 |
2021 | | | 31 |
2022 | | | 3 |
2023 | | | 0 |
Thereafter | | | — |
Total undiscounted cash flows | | $ | 219 |
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 nine months ended September 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. 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 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 significant 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 and other 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 the
program under which IBM Credit purchases an interest in IBM’s trade account receivables which has resulted in a
reduction of short-term purchased receivables from IBM. These receivables are primarily for 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.
19
| | | | | | | | | | | | |
| | | | | | Client Loans and | | | ||||
| | | | Commercial | | Installment | | | ||||
(Dollars in millions) | | Investment in | | Financing | | Payments | | | ||||
At September 30, 2019: |
| Leases |
| Receivables |
| (Loans) |
| Total | ||||
Financing receivables, gross | | $ | 4,475 | | $ | 2,691 | | $ | 8,365 | | $ | 15,531 |
Unearned income | | | (341) | | | (5) | | | (364) | | | (709) |
Deferred initial direct costs | | | 31 | | | — | | | 67 | | | 98 |
Recorded investment | | $ | 4,165 | | $ | 2,686 | | $ | 8,068 | | $ | 14,920 |
Allowance for credit losses | | | (59) | | | (9) | | | (86) | | | (154) |
Unguaranteed residual value | | | 468 | | | — | | | — | | | 468 |
Guaranteed residual value | | | 55 | | | — | | | — | | | 55 |
Total financing receivables, net | | $ | 4,628 | | $ | 2,677 | | $ | 7,983 | | $ | 15,289 |
| | | |
| | Purchased and | |
|
| Participated | |
(Dollars in millions) |
| Receivables | |
At September 30, 2019: |
| From IBM | |
Short-term purchased receivables from IBM |
| $ | 57 |
Allowance for credit losses | |
| 0 |
Total short-term purchased receivables from IBM, net |
| $ | 57 |
| | | |
Long-term participated receivables from IBM |
| $ | 3,806 |
Allowance for credit losses | |
| (7) |
Total long-term participated receivables from IBM, net |
| $ | 3,800 |
| | | |
Total purchased and participated receivables from IBM, net |
| $ | 3,857 |
| | | | | | | | | | | | |
| | | | | | 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 |
20
The company utilizes certain of its financing receivables as collateral for non-recourse borrowings. Financing receivables pledged as collateral for borrowings were $939 million and $710 million at September 30, 2019 and December 31, 2018, respectively.
The company did not have any financing receivables held for sale at September 30, 2019 and December 31, 2018.
Financing Receivables by Portfolio Segment
The following tables present the recorded investment in financing receivables and participated receivables from IBM, by portfolio segment and by class, excluding Commercial Financing receivables, purchased receivables from IBM and other miscellaneous financing receivables at September 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 results are not material. The company determines its allowance for credit losses based on 3 portfolio segments: lease receivables, loan receivables and participated receivables from IBM, and further segments the portfolio into 3 classes: Americas, Europe/Middle East/Africa (EMEA) and Asia Pacific.
| | | | | | | | | | | | |
(Dollars in millions) |
| | |
| | |
| | |
| | |
At September 30, 2019: | | Americas | | EMEA | | Asia Pacific | | Total | ||||
Recorded investment | | | | | | | | | | | | |
Lease receivables |
| $ | 3,066 |
| $ | 697 |
| $ | 401 |
| $ | 4,165 |
Loan receivables |
|
| 5,387 |
|
| 1,946 |
|
| 734 |
|
| 8,068 |
Participated receivables from IBM | | | 636 | | | 1,425 | | | 1,746 | | | 3,806 |
Ending balance | | $ | 9,090 | | $ | 4,068 | | $ | 2,882 | | $ | 16,040 |
Recorded investment collectively evaluated for impairment | | $ | 8,994 | | $ | 4,042 | | $ | 2,871 | | $ | 15,907 |
Recorded investment individually evaluated for impairment | | $ | 96 | | $ | 26 | | $ | 11 | | $ | 133 |
| | | | | | | | | | | | |
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 |
| $ | (11) |
| $ | (10) |
| $ | (1) |
| $ | (22) |
Recoveries |
|
| 0 |
|
| 0 |
|
| 0 |
|
| 0 |
Provision/(benefit) |
|
| 6 |
|
| (6) |
|
| (1) |
|
| (1) |
Foreign currency translation adjustment |
|
| (3) |
|
| (1) |
|
| 0 |
|
| (5) |
Other |
|
| 1 |
|
| 0 |
|
| 0 |
|
| 1 |
Ending balance at September 30, 2019 | | $ | 101 | | $ | 36 | | $ | 14 | | $ | 151 |
Lease receivables |
| $ | 28 |
| $ | 21 |
| $ | 10 |
| $ | 59 |
Loan receivables |
| $ | 68 |
| $ | 13 |
| $ | 5 |
| $ | 86 |
Participated receivables from IBM |
| $ | 5 |
| $ | 2 |
| $ | 0 |
| $ | 7 |
| | | | | | | | | | | | |
Related allowance, collectively evaluated for impairment | | $ | 28 | | $ | 10 | | $ | 3 | | $ | 42 |
Related allowance, individually evaluated for impairment | | $ | 73 | | $ | 26 | | $ | 11 | | $ | 110 |
Write-offs of lease and loan receivables were $13 million and $9 million, respectively, for the nine months ended September 30, 2019. Provisions for credit losses recorded for lease receivables, loan receivables and participated receivables from IBM were $4 million, $2 million, and a release of $7 million, respectively, for the nine months ended September 30, 2019.
The average recorded investment of impaired leases and loans for Americas, EMEA and Asia Pacific was $95 million, $26 million and $12 million, respectively, for the three months ended September 30, 2019, and $87 million, $43 million and $20 million, respectively, for the three months ended September 30, 2018. Both interest income recognized and
21
interest income recognized on a cash basis on impaired leases and loans were immaterial for the three months ended September 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 nine months ended September 30, 2019, and $76 million, $41 million and $19 million, respectively, for the nine months ended September 30, 2018. Both interest income recognized and interest income recognized on a cash basis on impaired leases and loans were immaterial for the nine months ended September 30, 2019 and 2018.
| | | | | | | | | | | | |
(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.
22
Past Due Financing Receivables
The company considers a client’s 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.
| | | | | | | | | | | | | | | |
| | | | | | | | Recorded | | Billed | | Recorded | |||
| | Total | | Recorded | | Investment | | Invoices | | Investment | |||||
(Dollars in millions) | | Recorded | | Investment | | > 90 Days and | | > 90 Days and | | Not | |||||
At September 30, 2019: |
| Investment |
| > 90 Days (1) |
| Accruing (1) |
| Accruing |
| Accruing (2) | |||||
Americas | | $ | 3,066 | | $ | 205 | | $ | 176 | | $ | 12 | | $ | 32 |
EMEA | |
| 697 | | | 30 | | | 14 | | | 2 | | | 18 |
Asia Pacific | |
| 401 | | | 21 | | | 13 | | | 1 | | | 9 |
Total lease receivables |
| $ | 4,165 |
| $ | 256 |
| $ | 203 |
| $ | 15 |
| $ | 58 |
| | | | | | | | | | | | | | | |
Americas |
| $ | 5,387 | | $ | 110 | | $ | 62 | | $ | 10 | | $ | 65 |
EMEA | |
| 1,946 | | | 55 | | | 11 | | | 4 | | | 46 |
Asia Pacific | |
| 734 | | | 14 | | | 12 | | | 3 | | | 3 |
Total loan receivables |
| $ | 8,068 |
| $ | 179 |
| $ | 85 |
| $ | 17 |
| $ | 113 |
| | | | | | | | | | | | | | | |
Americas |
| $ | 636 | | $ | 8 | | $ | 3 | | $ | 0 | | $ | 5 |
EMEA | |
| 1,425 | | | 9 | | | 8 | | | 2 | | | 1 |
Asia Pacific | |
| 1,746 | | | 3 | | | 3 | | | 1 | | | 0 |
Total participated receivables from IBM |
| $ | 3,806 |
| $ | 19 |
| $ | 14 |
| $ | 3 |
| $ | 5 |
| | | | | | | | | | | | | | | |
Total |
| $ | 16,040 |
| $ | 455 |
| $ | 302 |
| $ | 35 |
| $ | 177 |
(1) | At a contract level, which includes total billed and unbilled amounts for financing receivables aged greater than 90 days. |
(2) | Of the recorded investment not accruing, $133 million is individually evaluated for impairment with a related allowance of $110 million. |
23
| | | | | | | | | | | | | | | |
| | | | | | | | 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) | At a contract level, which includes total billed and unbilled amounts for financing receivables aged greater than 90 days. |
(2) | Of the recorded investment not accruing, $149 million is individually evaluated for impairment with a related allowance of $120 million. |
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 September 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 September 30, 2019: |
| Americas |
| EMEA |
| Pacific |
| Americas |
| EMEA |
| Pacific |
| Americas |
| EMEA |
| Pacific | |||||||||
Credit Ratings: | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| |
Aaa – Aa3 | | $ | 305 | | $ | 9 | | $ | 33 | | $ | 742 | | $ | 91 | | $ | 91 | | $ | 377 | | $ | 62 | | $ | 62 |
A1 – A3 | |
| 676 | |
| 133 | |
| 105 | |
| 830 | |
| 135 | |
| 256 | |
| 78 | |
| 220 | |
| 864 |
Baa1 – Baa3 | |
| 847 | |
| 152 | |
| 90 | |
| 1,453 | |
| 595 | |
| 118 | |
| 91 | |
| 681 | |
| 468 |
Ba1 – Ba2 | |
| 693 | |
| 199 | |
| 61 | |
| 1,331 | |
| 495 | |
| 179 | |
| 46 | |
| 385 | |
| 224 |
Ba3 – B1 | |
| 239 | |
| 134 | |
| 66 | |
| 431 | |
| 399 | |
| 48 | |
| 33 | |
| 58 | |
| 110 |
B2 – B3 | |
| 260 | |
| 45 | |
| 35 | |
| 491 | |
| 202 | |
| 33 | |
| 5 | |
| 16 | |
| 17 |
Caa – D | |
| 18 | |
| 4 | |
| 3 | |
| 43 | |
| 17 | |
| 5 | |
| 1 | |
| 1 | |
| 1 |
Total | | $ | 3,038 | | $ | 676 | | $ | 391 | | $ | 5,320 | | $ | 1,934 | | $ | 729 | | $ | 631 | | $ | 1,422 | | $ | 1,746 |
24
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 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 |
Troubled Debt Restructurings
The company did not have any significant troubled debt restructurings during the nine months ended September 30, 2019 or for the year ended December 31, 2018.
6. Segments:
The company’s operations consist of 2 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.
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 credit risk of IBM’s client 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 and other accounts receivable at a discount and assumes the credit risk of IBM’s client. Effective in 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.”
Each segment includes an allocation of interest expense and selling, general and administrative (SG&A) 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.
25
SEGMENT INFORMATION
| | | | | | | | | |
| | Client | | Commercial | | Total | |||
(Dollars in millions) |
| Financing |
| Financing |
| Segments | |||
For the three months ended September 30, 2019: | | | | | | | | | |
Total revenue |
| $ | 292 |
| $ | 80 |
| $ | 372 |
Pre-tax income | |
| 89 | |
| 42 | |
| 131 |
Depreciation of equipment under operating lease | |
| 39 | |
| — | |
| 39 |
Financing cost | |
| 102 | |
| 20 | |
| 122 |
Provision for/(benefit from) credit losses | |
| 5 | |
| (6) | |
| (1) |
| | | | | | | | | |
For the three months ended September 30, 2018: | | | | | | | | | |
Total revenue |
| $ | 307 |
| $ | 145 |
| $ | 452 |
Pre-tax income | |
| 124 | |
| 59 | |
| 184 |
Depreciation of equipment under operating lease | |
| 50 | |
| — | |
| 50 |
Financing cost | |
| 91 | |
| 44 | |
| 135 |
Provision for/(benefit from) credit losses | |
| (6) | |
| (4) | |
| (10) |
SEGMENT INFORMATION
| | | | | | | | | |
| | Client | | Commercial | | Total | |||
(Dollars in millions) |
| Financing |
| Financing |
| Segments | |||
For the nine months ended September 30, 2019: | | | | | | | | | |
Total revenue |
| $ | 906 |
| $ | 359 |
| $ | 1,265 |
Pre-tax income | |
| 303 | |
| 158 | |
| 460 |
Depreciation of equipment under operating lease | |
| 127 | |
| — | |
| 127 |
Financing cost | |
| 307 | |
| 111 | |
| 419 |
Provision for/(benefit from) credit losses | |
| (1) | |
| (4) | |
| (4) |
| | | | | | | | | |
For the nine months ended September 30, 2018: | | | | | | | | | |
Total revenue |
| $ | 913 |
| $ | 421 |
| $ | 1,334 |
Pre-tax income | |
| 354 | |
| 168 | |
| 522 |
Depreciation of equipment under operating lease | |
| 146 | |
| — | |
| 146 |
Financing cost | |
| 242 | |
| 119 | |
| 362 |
Provision for/(benefit from) credit losses | |
| 29 | |
| (5) | |
| 24 |
26
7. Equity Activity:
IBM Credit had 0 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 September 30, 2019: | | Amount |
| Benefit |
| Amount | |||
Other comprehensive income/(loss): | | | |
| | | | | |
Foreign currency translation adjustments |
| $ | (76) | | $ | (17) | | $ | (93) |
Retirement-related benefit plans (1): |
| | | | | | | | |
Net (losses)/gains arising during the period | | $ | — | | $ | — | | $ | — |
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) | | $ | (75) | | $ | (17) | | $ | (93) |
(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 three months ended September 30, 2018: |
| Amount |
| Benefit |
| Amount | |||
Other comprehensive income/(loss): | | | | | | | | | |
Foreign currency translation adjustments | | $ | (20) | | $ | (6) | | $ | (26) |
Retirement-related benefit plans (1): | | | | | | | | | |
Net (losses)/gains arising during the period | | $ | — | | $ | — | | $ | — |
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) | | $ | (20) | | $ | (6) | | $ | (26) |
(1) | These AOCI components are included in the computation of net periodic pension cost. (Refer to note 8, "Retirement-Related Benefits," for additional information.) |
27
Reclassifications and Taxes Related to Items of Other Comprehensive Income
| | | | | | | | | |
(Dollars in millions) | | Before Tax | | Tax (Expense)/ | | Net of Tax | |||
For the nine months ended September 30, 2019: |
| Amount |
| Benefit |
| Amount | |||
Other comprehensive income/(loss): | | | |
| | | | | |
Foreign currency translation adjustments | | $ | (56) |
| $ | (13) | | $ | (69) |
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 | | $ | 1 | | $ | 0 | | $ | 1 |
Other comprehensive income/(loss) | | $ | (55) | | $ | (13) | | $ | (68) |
(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 nine months ended September 30, 2018: |
| Amount |
| Benefit |
| Amount | |||
Other comprehensive income/(loss): | | | |
| | | | | |
Foreign currency translation adjustments | | $ | (119) |
| $ | (22) | | $ | (140) |
Retirement-related benefit plans (1): | | | | | | | | | |
Net (losses)/gains arising during the period | | $ | 1 |
| $ | 0 | | $ | 0 |
Curtailments and settlements | |
| — |
|
| — | |
| — |
Amortization of prior service (credits)/costs | |
| (1) |
|
| 0 | |
| 0 |
Amortization of net (gains)/losses | |
| 1 | | | 0 | | | 1 |
Total retirement-related benefit plans | | $ | 1 | | $ | 0 | | $ | 1 |
Other comprehensive income/(loss) | | $ | (117) | | $ | (22) | | $ | (139) |
(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 | |
| (69) | |
| 0 | |
| (69) |
Amount reclassified from accumulated other comprehensive income | |
| — | |
| 1 | |
| 1 |
Total change for the period | |
| (69) | |
| 1 | |
| (68) |
September 30, 2019 |
| $ | (92) |
| $ | (9) |
| $ | (101) |
* Foreign currency translation adjustments are presented gross except for any associated hedges which are presented net of tax.
28
| | | | | | | | | |
| | | | | 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 | |
| (140) | |
| 0 | |
| (140) |
Amount reclassified from accumulated other comprehensive income | |
| — | |
| 0 | |
| 0 |
Total change for the period | |
| (140) | |
| 1 | |
| (139) |
September 30, 2018 |
| $ | 20 |
| $ | (6) |
| $ | 13 |
* 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.
Charges from IBM to the company in relation to these plans (including non pension post retirement benefits) are limited to service costs and defined contribution plan costs for the current and previous periods, all of which are not material. Any other types of cost 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 AOCI in the three and nine months ended September 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 nine months ended September 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
29
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 38 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 $48 million and $145 million in the three and nine months ended September 30, 2019, respectively, an increase of $1 million each as compared to the same periods in 2018, respectively. The interest income is included in financing revenue in the Consolidated Statement of Earnings. For additional information, see note 5, “Financing Receivables, Receivables Purchased/Participated from IBM.”
The company purchases interests in certain of IBM’s trade and other 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 the program under which IBM Credit purchases interests in IBM’s trade accounts receivable. For the three months ended September 30, 2019, finance income earned from these receivables was $3 million, a decrease of $7 million as compared to the same period in 2018. For the nine months ended September 30, 2019, finance income earned from these receivables was $26 million, a decrease of $5 million as compared to the same period in 2018. The finance income is included in financing revenue in the Consolidated Statement of Earnings. 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 September 30, 2019, the interest income earned from these receivables was $40 million, a decrease of $5 million as compared to the same period in 2018. For the nine months ended September 30, 2019, interest income earned was $129 million, an increase of $2 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 $3,756 million at September 30, 2019 and $3,609 million at December 31, 2018.
The amount of other receivables from IBM of $604 million and $2,019 million at September 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 $601 million at September 30, 2019, and $2,014 million at December 31, 2018. The decline in the first nine months of 2019, was driven by the company’s decision to utilize its excess cash to repay a portion of its debt. The investment of excess cash with IBM is presented in other receivables from IBM in the Consolidated Statement of Financial Position and the investing section of the Consolidated Statement of Cash Flows. Interest income earned from these investments was $5 million and $21 million in the three and nine months ended September 30, 2019, respectively. Interest income earned for these investments was $17 million and $38 million for the three and nine months ended September 30, 2018, respectively. The interest income is included in financing revenue in the Consolidated Statement of Earnings.
30
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 September 30, 2019, was $34 million, a decrease of $5 million as compared to the same period in 2018. Fee income earned for the nine months ended September 30, 2019, was $115 million, a decrease of $3 million as compared to the same period in 2018. These fees are included in financing 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 $58 million and $189 million for the three and nine months ended September 30, 2019, respectively, as compared to $81 million and $215 million for the three and nine months ended September 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 $45 million and $53 million in the three months ended September 30, 2019 and 2018, respectively, and $147 million and $163 million for the nine months ended September 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, multiemployer retirement-related plans, and defined contributions expense during the periods reported were not material.
Expenses related to the services discussed above are included in SG&A 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 was $249 million at September 30, 2019, and $3,044 million at December 31, 2018. The decline in accounts payable to IBM reflects settlements of purchases of equipment and receivables/loans (for software and services). In the third quarter of 2019, the majority of such purchases were settled in the same period. 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 million and $8 million for the three months ended September 30, 2019 and 2018, respectively. The company's net profit from sales of returned equipment to IBM was $11 million and $35 million for the nine months ended September 30, 2019 and 2018, respectively. These sales are recorded net in other (income) and expense in the Consolidated Statement of Earnings.
31
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 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.
For the three months ended September 30, 2019, the company reported a provision for income taxes of $22 million and an effective tax rate of 17.0 percent, compared to a provision of $39 million and an effective tax rate of 21.5 percent for the three months ended September 30, 2018, with the change in the provision driven by a year-to-year benefit due to the “Global Intangible Low-Taxed Income” provision. For the nine months ended September 30, 2019, the company reported a provision for income taxes of $195 million and an effective tax rate of 42.4 percent, compared to a provision of $112 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 nine months ended September 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 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 from IBM. This was partially offset by a year-to-year benefit due to the “Global Intangible Low-Taxed Income” provision.
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 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 in the 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.
Short-Term Debt
| | | | | | | |
| | Balance | | Balance | | ||
(Dollars in millions) |
| 9/30/2019 |
| 12/31/2018 |
| ||
Commercial paper | | $ | 681 | | $ | 2,995 | |
Short-term loans | | | 52 | | | 17 | |
Secured borrowings | | | 156 | | | 23 | |
Debt | | $ | 889 | | $ | 3,035 | |
Debt payable to IBM | |
| 6,019 | |
| 10,223 | |
Total | | $ | 6,908 | | $ | 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 2.0 percent at September 30, 2019, and 2.5 percent at December 31, 2018.
32
The weighted-average interest rate for short-term loans was 6.0 percent and 4.3 percent at September 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 3.7 percent and 6.9 percent at September 30, 2019 and December 31, 2018, respectively. Short-term financing receivables pledged as collateral for short-term secured borrowings were $156 million at September 30, 2019, and $23 million at December 31, 2018.
The weighted-average interest rate for debt payable to IBM was 1.9 percent and 1.6 percent at September 30, 2019 and December 31, 2018, respectively.
Long-Term Debt
| | | | | | | | |
|
| |
| Balance |
| Balance | ||
(Dollars in millions) |
| Maturities | | 9/30/2019 |
| 12/31/2018 | ||
Long-term notes (weighted-average interest rate at September 30, 2019) | | | | | | | | |
2.2% | | 2019 | | $ | — | | $ | 1,400 |
3.0% | | 2020 | | | 1,500 | | | 1,500 |
2.7% | | 2021 | | | 2,850 | | | 2,850 |
2.2% | | 2022 | | | 500 | | | 500 |
3.0% | | 2023 | | | 750 | | | 750 |
| | | | $ | 5,600 | | $ | 7,000 |
| | | | | | | | |
Long-term loans (5.4% weighted-average interest rate at September 30, 2019) | | 2020-2021 | | | 110 | | | 276 |
Secured borrowings (5.3% weighted-average interest rate at September 30, 2019) | | 2019-2025 | | | 782 | | | 687 |
Long-term debt | | | | $ | 6,492 | | $ | 7,964 |
Less: net unamortized discount | | | | | 2 | | | 2 |
Less: net unamortized debt issuance costs | | | | | 5 | | | 9 |
Add: fair value adjustment* | | | | | (36) | | | 34 |
Debt | | | | $ | 6,521 | | $ | 7,919 |
Debt payable to IBM (1.5% weighted-average interest rate at September 30, 2019) | | | |
| 8,909 | |
| 9,357 |
Total | | | | $ | 15,430 | | $ | 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 company utilizes certain of its financing receivables as collateral. Long-term financing receivables pledged as collateral for long-term secured borrowings were $782 million at September 30, 2019, and $687 million at December 31, 2018.
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.
33
Pre-swap annual contractual obligations of long-term debt and long-term debt payable to IBM outstanding at September 30, 2019, are as follows:
| | | | | | | | | | | | | | | | | | | | | |
| | 2019 | | | | | | | | | | | | | 2024 and | | | | |||
(Dollars in millions) |
| (Q4) |
| 2020 |
| 2021 |
| 2022 |
| 2023 |
| beyond |
| Total | |||||||
Long-term debt | | $ | 99 | | $ | 1,944 | | $ | 3,115 | | $ | 573 | | $ | 760 | | $ | 1 | | $ | 6,492 |
Debt payable to IBM | |
| 1,227 | | | 3,539 | | | 2,181 | | | 1,349 | | | 457 | |
| 156 | | | 8,909 |
Total | | $ | 1,327 | | $ | 5,484 | | $ | 5,295 | | $ | 1,922 | | $ | 1,217 | | $ | 157 | | $ | 15,401 |
Interest on Debt
The company recognized interest expense of $115 million and $400 million for the three and nine months ended September 30, 2019, of which $58 million and $189 million was interest expense on debt payable to IBM, respectively. The company recognized interest expense of $135 million and $362 million for the three and nine months ended September 30, 2018, of which $81 million and $215 million was interest expense on debt payable to 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 18, 2019, IBM and the company (the Borrowers) entered into a new $2.5 billion 364-day Credit Agreement to replace the maturing $2.5 billion 364-day agreement, and extended the maturity date of their existing $2.5 billion Three-Year Credit Agreement (the Credit Agreements). The new maturity date for the Three-Year Credit Agreement is July 20, 2022. The size of each facility 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. At September 30, 2019, the company had 0 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.”
34
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 other actions 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 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 September 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 September 30, 2019, there were no such matters.
13. Commitments:
The company’s extended lines of credit to third-party entities include unused amounts of $2,809 million and $7,112 million at September 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. In addition, the company has committed to provide future financing to its clients in connection with client purchase agreements for approximately $325 million and $495 million at September 30, 2019 and December 31, 2018, respectively.
35
Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2019
Financial Results Summary - Three Months Ended September 30:
| | | | | | | | | |
|
| | |
| | |
| Yr.-to-Yr. |
|
| | | | | | | | Percent/ |
|
(Dollars in millions) | | | | | | | | Margin |
|
For the three months ended September 30: | | 2019 | | 2018 | | Change |
| ||
Revenue | | $ | 372 | | $ | 452 |
| (17.6) | % |
Net margin | | $ | 212 | | $ | 268 |
| (20.9) | % |
Net margin percentage | |
| 56.9 | % |
| 59.2 | % | (2.3) | pts. |
Total expense and other (income) | | $ | 81 | | $ | 84 |
| (3.7) | % |
Income before income taxes | | $ | 131 | | $ | 184 |
| (28.7) | % |
Provision for income taxes | | $ | 22 | | $ | 39 |
| (43.7) | % |
Net income | | $ | 109 | | $ | 144 |
| (24.6) | % |
Net income margin | | | 29.1 | % | | 31.9 | % | (2.7) | pts. |
Financial Performance Summary — Three Months Ended September 30:
In the third quarter of 2019, the company delivered revenue of $372 million and net income of $109 million, compared to revenue of $452 million and net income of $144 million in the same period of 2018.
Total revenue declined $80 million, or 17.6 percent, in the third quarter of 2019 as compared to the same period in 2018, driven by decreases in financing revenue of $61 million, or 16.8 percent, and by declines in operating lease revenue of $18 million, or 21.2 percent. The decrease in financing revenue reflects the company’s Commercial Financing portfolio actions which began in the second quarter of 2019. The decline in operating lease revenue was due to a lower average asset balance in the current period compared to the third quarter of 2018.
From a segment perspective, Client Financing revenue of $292 million in the third quarter of 2019 declined 4.9 percent as compared to the prior year. Commercial Financing revenue of $80 million in the third quarter of 2019 declined 44.5 percent as compared to the third quarter of 2018.
From a geographic perspective, Americas revenue of $229 million in the third quarter of 2019 decreased 12.8 percent as compared to the prior-year period. EMEA revenue of $80 million declined 30.4 percent and Asia Pacific revenue of $63 million decreased 14.9 percent as compared to the third quarter of 2018.
In the third quarter of 2019, net margin, which is calculated as revenue minus financing costs and depreciation of equipment under operating lease, was $212 million, a decrease of 20.9 percent when compared to the same period in 2018. The decline in revenue was partially offset by decreases in financing costs of $13 million, or 9.6 percent, and decreases in depreciation expense of $11 million, or 22.0 percent, when compared to the same period in the prior year. The decreases in financing costs were driven by a decrease in interest expense, partially offset by variable lease costs reported in the current year period due to the adoption of the new leasing standard. For additional information on variable leases, see note 4, “Leases.” The decrease in interest expense was due to a lower average debt balance, partially offset by higher interest rates 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 56.9 percent in the third quarter of 2019 decreased 2.3 points as compared to the net margin percentage in the same period in 2018.
Total expense and other (income) of $81 million in the third quarter of 2019 decreased $3 million, or 3.7 percent, compared to the same period in 2018.
36
Pre-tax income of $131 million in the third quarter of 2019 decreased 28.7 percent as compared to the third quarter of 2018. The pre-tax income margin in the third quarter of 2019 of 35.1 percent decreased on a year-to-year basis by 5.5 points.
The effective tax rate was 17.0 percent in the third quarter of 2019, a decrease of 4.5 points compared to the third quarter of 2018, driven by a year-to-year benefit due to the “Global Intangible Low-Taxed Income” provision.
Net income of $109 million decreased $36 million, or 24.6 percent, in the third quarter of 2019 as compared to the same period in 2018. In the third quarter of 2019, net income margin was 29.1 percent, a decrease of 2.7 points on a year-to-year basis.
Return on equity was 16.6 percent in the third quarter of 2019, a decrease of 0.5 points when compared to the prior-year period, driven by decreases in net income, partially offset by a lower average equity balance when compared to the same period in the prior year.
Net cash provided by operating activities in the third quarter of 2019 decreased by $214 million as compared to the prior-year period, primarily driven by higher net cash income tax payments and lower net income. Net cash provided by investing activities of $2,178 million in the third quarter of 2019 increased by $2,106 million when compared to the prior-year period, primarily driven by lower originations of short term financing receivables, reflecting the company’s Commercial Financing portfolio actions which began 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 $1,880 million in the third quarter of 2019 was higher by $1,410 million when compared to the prior-year period, primarily driven by higher net settlements of debt as a result of lower funding requirements associated with financing receivables.
Financial Results Summary - Nine Months Ended September 30:
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
| | | | | | | | Percent/ |
|
(Dollars in millions) | | | | | | | | Margin |
|
For the nine months ended September 30: |
| 2019 |
| 2018 |
| Change |
| ||
Revenue | | $ | 1,265 | | $ | 1,334 |
| (5.2) | % |
Net margin | | $ | 719 | | $ | 827 |
| (13.0) | % |
Net margin percentage | |
| 56.9 | % |
| 62.0 | % | (5.1) | pts. |
Total expense and other (income) | | $ | 259 | | $ | 305 |
| (15.1) | % |
Income before income taxes | | $ | 460 | | $ | 522 |
| (11.8) | % |
Provision for income taxes (1) | | $ | 195 | | $ | 112 |
| 74.1 | % |
Net income (1) | | $ | 265 | | $ | 410 |
| (35.3) | % |
Net income margin | | | 21.0 | % | | 30.7 | % | (9.8) | 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 September 30, | | At December 31, | | Percent | | ||
(Dollars in millions) | | 2019 |
| 2018 |
| Change | | ||
Assets | | $ | 26,216 | | $ | 39,497 |
| (33.6) | % |
Liabilities | | $ | 23,716 | | $ | 36,076 |
| (34.3) | % |
Member’s interest | | $ | 2,500 | | $ | 3,420 |
| (26.9) | % |
37
Debt-to-Equity
| | | | | |
| | At September 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 | |
| Nine Months Ended |
| ||||||||
| September 30, | |
| September 30, |
| ||||||||
(Dollars in millions) | 2019 | | 2018 | | | 2019 | | 2018 | | ||||
Net income | $ | 109 | | $ | 144 | | | $ | 265 | | $ | 410 | |
Annualized net income | $ | 434 | | $ | 576 | | | $ | 353 | | $ | 546 | |
Average equity (1) | $ | 2,612 | | $ | 3,364 | | | $ | 2,952 | | $ | 3,398 | |
Return on equity (2) |
| 16.6 | % |
| 17.1 | % | |
| 12.0 | % |
| 16.1 | % |
(1) | Average of the ending member's interest for the last two quarters and four quarters, for the three and nine months ended September 30, respectively |
(2) | The company’s return on equity for the three months ended September 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 nine months ended September 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 four quarters. |
Financial Performance Summary —Nine Months Ended September 30:
In the first nine months of 2019, the company delivered revenue of $1,265 million and net income of $265 million. In the first nine months of 2018, the company had revenue of $1,334 million and net income of $410 million.
Total revenue declined $69 million, or 5.2 percent, in the first nine months of 2019 as compared to 2018, driven by decreases in financing revenue of $35 million, or 3.3 percent, and by declines in operating lease revenue of $34 million, or 13.5 percent. The decline in financing revenue reflects the company’s Commercial Financing portfolio actions which began in the second quarter of 2019. The decline in operating lease revenue was due to a lower average asset balance compared to the same period in the prior year.
From a segment perspective, Client Financing revenue of $906 million in the first nine months of 2019 declined 0.7 percent as compared to the prior year. Commercial Financing revenue of $359 million in the first nine months of 2019 declined 14.8 percent as compared to the first nine months of 2018.
From a geographic perspective, Americas revenue of $749 million in the first nine months of 2019 decreased 1.0 percent as compared to the same period in 2018. EMEA revenue of $307 million declined 12.9 percent and Asia Pacific revenue of $209 million decreased 7.2 percent as compared to the same period in 2018.
Net margin in the first nine months of 2019 was $719 million, a decrease of 13.0 percent when compared to the same period in 2018. The decline in revenue and increases in financing costs of $57 million, or 15.8 percent, were partially offset by decreases in depreciation expense of $19 million, or 13.0 percent, when compared to the same period in the prior year. The increases in financing costs were driven by an increase in interest expense and by variable lease costs reported in the current year period due to the adoption of the new leasing standard. The increase in interest expense was due to higher interest rates, partially offset by a lower 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 of 56.9 percent in the first nine months of 2019 decreased 5.1 points as compared to the same period in 2018.
38
Total expense and other (income) of $259 million in the first nine months of 2019 decreased $46 million, or 15.1 percent, compared to the same period in 2018.
Pre-tax income of $460 million in the first nine months of 2019 decreased 11.8 percent as compared to the first nine months of 2018. The pre-tax income margin in the first nine months of 2019 of 36.4 percent decreased on a year-to-year basis by 2.7 points.
The effective tax rate was 42.4 percent in the first nine months of 2019, an increase of 20.9 points compared to the first nine months of 2018. The change in the effective tax rate for the nine months ended September 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 $265 million decreased 35.3 percent in the first nine 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 nine months of 2019, net income margin of 21.0 percent decreased 9.8 points on a year-to-year basis.
Return on equity of 12.0 percent decreased 4.1 points in the first nine months of 2019, driven by decreases in net income which were partially offset by a lower average equity balance year-to-year.
The company generated $95 million in cash flow from operating activities in the first nine months of 2019, a decrease of $717 million when compared to the first nine 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 of $9,374 million in the first nine months of 2019 increased by $10,227 million when compared to the prior-year period, primarily driven by lower originations of short term financing receivables, reflecting the company’s Commercial Financing portfolio actions which began 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 in financing activities of $9,199 million in the first nine months of 2019 was higher by $8,537 million when compared to the prior-year period, primarily driven by higher net settlements of debt 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.
39
Third Quarter and First Nine Months in Review
Results of Operations
Segment Details
The following is an analysis of the reportable segment results for the third quarter and first nine months of 2019 versus the third quarter and first nine months of 2018. The table below presents each reportable segment’s revenue and net margin results.
| | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | Yr.-to-Yr. |
| | | | | | | | | | Yr.-to-Yr. |
|
| | Three Months Ended | | | Percent/ |
| | Nine Months Ended | | | Percent/ |
| ||||||||||
| | September 30, | | | Margin |
| | September 30, | | | Margin |
| ||||||||||
(Dollars in millions) |
| 2019 |
| | 2018 |
| | Change |
|
| 2019 |
| | 2018 |
| | Change |
| ||||
Client Financing | | |
|
| | |
|
| |
| | | |
|
| | |
|
| |
| |
Revenue | | $ | 292 | | | $ | 307 |
| | (4.9) | % | | $ | 906 | | | $ | 913 |
| | (0.7) | % |
Net margin | |
| 151 | | |
| 166 |
| | (9.0) | % | |
| 472 | | |
| 525 |
| | (10.1) | % |
Net margin percentage | |
| 51.8 | % | |
| 54.1 | % | | (2.4) | pts. | |
| 52.1 | % | |
| 57.5 | % | | (5.4) | pts. |
Pre-tax income | | $ | 89 | | | $ | 124 |
| | (28.2) | % | | $ | 303 | | | $ | 354 |
| | (14.4) | % |
Pre-tax margin | |
| 30.5 | % | |
| 40.5 | % | | (9.9) | pts. | |
| 33.4 | % | |
| 38.8 | % | | (5.3) | pts. |
Commercial Financing | |
| | | |
| |
| | | | |
| | | |
| |
| | | |
Revenue | | $ | 80 | | | $ | 145 |
| | (44.5) | % | | $ | 359 | | | $ | 421 |
| | (14.8) | % |
Net margin | |
| 61 | | |
| 101 |
| | (40.2) | % | |
| 247 | | |
| 302 |
| | (18.1) | % |
Net margin percentage | |
| 75.4 | % | |
| 69.9 | % | | 5.5 | pts. | |
| 69.0 | % | |
| 71.7 | % | | (2.7) | pts. |
Pre-tax income | | $ | 42 | | | $ | 59 |
| | (29.8) | % | | $ | 158 | | | $ | 168 |
| | (6.3) | % |
Pre-tax margin | |
| 51.7 | % | |
| 40.9 | % | | 10.8 | pts. | |
| 43.9 | % | |
| 39.9 | % | | 4.0 | pts. |
Total Segments | |
| | | |
| |
| | | | |
| | | |
| |
| | | |
Revenue | | $ | 372 | | | $ | 452 |
| | (17.6) | % | | $ | 1,265 | | | $ | 1,334 |
| | (5.2) | % |
Net margin | |
| 212 | | |
| 268 |
| | (20.9) | % | |
| 719 | | |
| 827 |
| | (13.0) | % |
Net margin percentage | |
| 56.9 | % | |
| 59.2 | % | | (2.3) | pts. | |
| 56.9 | % | |
| 62.0 | % | | (5.1) | pts. |
Pre-tax income | | $ | 131 | | | $ | 184 |
| | (28.7) | % | | $ | 460 | | | $ | 522 |
| | (11.8) | % |
Pre-tax margin | |
| 35.1 | % | |
| 40.6 | % | | (5.5) | pts. | |
| 36.4 | % | |
| 39.1 | % | | (2.7) | pts. |
Client Financing
Client Financing revenue of $292 million in the third quarter of 2019 declined $15 million, or 4.9 percent, as compared to the same period in 2018. The decline was driven by operating lease revenue, which decreased $18 million year to year. Client Financing revenue of $906 million in the first nine months of 2019 declined $7 million, or 0.7 percent, as compared to the same period in 2018, driven by a decline in operating lease revenue, which decreased $34 million, or 13.5 percent. The decline was partially offset by variable lease revenue reported in the current year period due to the adoption of the new leasing standard.
Net margin decreased $15 million, or 9.0 percent, and decreased $53 million, or 10.1 percent, as compared to the prior year period, for three and nine month periods ended September 30, 2019, respectively. The decrease for the three months ended September 30, 2019 was driven by the decline in revenue and increases in financing costs of $11 million, partially offset by decreases in depreciation expense of $11 million. The increase in financing costs was driven by variable lease costs reported in the current year period due to the adoption of the new leasing standard and by an increase in interest expense. The decrease in net margin for the nine months ended September 30, 2019 was driven by an increase in financing costs of $65 million. The increase in financing costs was driven by an increase in interest expense and by variable lease costs reported in the current year period due to the adoption of the new leasing standard. The increases in interest expense in both periods were due to higher interest rates compared to the respective prior year periods.
Pre-tax income decreased $35 million, or 28.2 percent, and decreased $51 million, or 14.4 percent, as compared to the prior-year period, for the three and nine month periods ended September 30, 2019, respectively. The year-to-year
40
decrease for the three month period ended September 30, 2019 was driven by a decline in net margin and lower releases of unallocated reserves for credit losses compared to the prior-year period. The year-to-year decrease for the nine month period ended September 30, 2019 was driven by a decline in net margin and 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 lower provisions for credit losses compared to the prior-year period.
Commercial Financing
Commercial Financing revenue of $80 million in the third quarter of 2019 declined $65 million, or 44.5 percent, as compared to the same period in 2018, reflecting the company’s Commercial Financing portfolio actions which began in the second quarter of 2019. Commercial Financing revenue of $359 million in the first nine months of 2019 declined $63 million, or 14.8 percent, as compared to the same period in 2018, primarily driven by the same factors.
Net margin decreased $41 million, or 40.2 percent and decreased $55 million, or 18.1 percent as compared to the prior-year period, for the three and nine month periods ended September 30, 2019, respectively. The decreases in both periods were driven by a decline in revenue, partially offset by decreases in financing costs. The decreases in financing costs were due to a lower average debt balance, partially offset by higher interest rates in the current year period.
Pre-tax income in the third quarter of 2019 decreased $18 million, or 29.8 percent, as compared to the same period in 2018. The year-to-year decrease was driven by a lower net margin, partially offset by a reduction in selling, general and administrative expenses. For the first nine months of 2019, pre-tax income decreased $11 million, or 6.3 percent, as compared to the same period in 2018. The year-to-year decrease was driven by a lower net margin, partially offset by a pre-tax gain of $16 million from divested commercial financing capabilities and a reduction in selling, general and administrative expenses.
Geographic Revenue
The following provides revenue performance by geography.
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
(Dollars in millions) | | | | | | | | Percent |
|
For the three months ended September 30: |
| 2019 |
| 2018 |
| Change |
| ||
Revenue | | $ | 372 | | $ | 452 |
| (17.6) | % |
Geographies | |
| | |
| |
| | |
Americas | | $ | 229 | | $ | 263 |
| (12.8) | % |
Europe/Middle East/Africa (EMEA) | |
| 80 | |
| 115 |
| (30.4) | |
Asia Pacific | |
| 63 | |
| 74 |
| (14.9) | |
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
(Dollars in millions) | | | | | | | | Percent |
|
For the nine months ended September 30: |
| 2019 |
| 2018 |
| Change |
| ||
Revenue | | $ | 1,265 | | $ | 1,334 |
| (5.2) | % |
Geographies | |
| | |
| |
| | |
Americas | | $ | 749 | | $ | 756 |
| (1.0) | % |
Europe/Middle East/Africa (EMEA) | |
| 307 | |
| 353 |
| (12.9) | |
Asia Pacific | |
| 209 | |
| 225 |
| (7.2) | |
Total revenue of $372 million declined $80 million, or 17.6 percent, in the third quarter of 2019 compared to the same period in 2018, with declines in each geography primarily reflecting the company’s Commercial Financing portfolio actions which began in the second quarter of 2019.
Americas revenue of $229 million decreased $34 million, or 12.8 percent, in the third quarter of 2019 compared to the same period in 2018, driven by declines in financing revenue of $27 million, as well as declines in operating lease
41
revenue of $6 million. EMEA revenue of $80 million declined $35 million, or 30.4 percent, in the third quarter of 2019 compared to the same period in 2018, driven by declines in financing revenue of $29 million, as well as declines in operating lease revenue of $6 million. Asia Pacific revenue of $63 million decreased $11 million, or 14.9 percent, in the third quarter of 2019 when compared to the same period in 2018, driven by lower operating lease revenue of $6 million, as well as declines in financing revenue of $5 million.
Total revenue of $1,265 million declined $69 million, or 5.2 percent, in the first nine months of 2019 compared to the same period in 2018, with declines in each geography primarily reflecting the company’s Commercial Financing portfolio actions which began in the second quarter of 2019.
Americas revenue of $749 million decreased $7 million, or 1.0 percent, in the first nine months of 2019 compared to the first nine months of the prior year, driven by declines in operating lease revenue of $16 million, partially offset by an increase in financing revenue of $8 million. EMEA revenue of $307 million declined $46 million, or 12.9 percent, driven by declines in financing revenue of $35 million, as well as declines in operating lease revenue of $11 million. Asia Pacific revenue of $209 million decreased $16 million, or 7.2 percent, driven by declines in financing revenue of $9 million, as well as declines in operating lease revenue of $7 million.
Expense
Total Expense and Other (Income)
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
| | | | | | | | Percent/ |
|
(Dollars in millions) | | | | | | | | Margin |
|
For the three months ended September 30: |
| 2019 |
| 2018 |
| Change |
| ||
Total expense and other (income) |
| |
|
| |
|
|
| |
Selling, general and administrative | | $ | 87 | | $ | 89 |
| (2.5) | % |
Provisions for/(benefit from) credit losses | |
| (1) | |
| (10) |
| (93.6) | |
Other (income) and expense | |
| (5) | |
| 5 |
| NM | |
Total expense and other (income) | | $ | 81 | | $ | 84 |
| (3.7) | % |
Total expense-to-revenue ratio | |
| 21.7 | % |
| 18.6 | % | 3.2 | pts. |
NM - Not Meaningful
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
| | | | | | | | Percent/ |
|
(Dollars in millions) | | | | | | | | Margin |
|
For the nine months ended September 30: |
| 2019 |
| 2018 |
| Change |
| ||
Total expense and other (income) |
| |
|
| |
|
|
| |
Selling, general and administrative | | $ | 281 | | $ | 292 |
| (3.6) | % |
Provisions for/(benefit from) credit losses | |
| (4) | |
| 24 |
| NM | |
Other (income) and expense | |
| (18) | |
| (11) |
| 66.1 | |
Total expense and other (income) | | $ | 259 | | $ | 305 |
| (15.1) | % |
Total expense-to-revenue ratio | |
| 20.5 | % |
| 22.8 | % | (2.4) | pts. |
NM - Not Meaningful
Total expense and other (income) of $81 million decreased $3 million, or 3.7 percent, in the third quarter of 2019 as compared to the same period in 2018. For the nine months ended September 30, 2019, total expense and other (income) of $259 million decreased $46 million, or 15.1 percent, as compared to the prior-year period. For additional information regarding total expense and other (income), see the following analyses by category.
42
Selling, General and Administrative
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
(Dollars in millions) | | | | | | | | Percent |
|
For the three months ended September 30: |
| 2019 |
| 2018 |
| Change |
| ||
Selling, general and administrative expense: |
| |
|
| |
|
|
| |
Selling, general and administrative - other | | $ | 38 | | $ | 32 |
| 18.6 | % |
Contracted services | |
| 4 | |
| 4 |
| (11.4) | |
Functional support services and other related party expenses | |
| 45 | |
| 53 |
| (14.4) | |
Total selling, general and administrative expense | | $ | 87 | | $ | 89 |
| (2.5) | % |
Selling, General and Administrative
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
(Dollars in millions) | | | | | | | | Percent |
|
For the nine months ended September 30: |
| 2019 |
| 2018 |
| Change |
| ||
Selling, general and administrative expense: |
| |
|
| |
|
|
| |
Selling, general and administrative - other | | $ | 122 | | $ | 115 |
| 6.1 | % |
Contracted services | |
| 12 | |
| 13 |
| (7.7) | |
Functional support services and other related party expenses | |
| 147 | |
| 163 |
| (10.0) | |
Total selling, general and administrative expense | | $ | 281 | | $ | 292 |
| (3.6) | % |
Total selling, general and administrative (SG&A) expense decreased $2 million, or 2.5 percent, in the third quarter of 2019 as compared to the third quarter of 2018. Functional support services and other related party expenses decreased $8 million, partially offset by other SG&A which increased $6 million for the third quarter when compared to the prior-year period. SG&A expense decreased $10 million, or 3.6 percent, in the first nine months of 2019 as compared to the prior-year period, driven by lower functional support services expenses and other related party expenses which decreased $16 million, partially offset by other SG&A which increased $7 million. 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 increased $9 million and decreased $28 million as compared to the prior-year period, for the three- and nine-month periods ended September 30, 2019, respectively. The increase for the three-month period ended September 30, 2019, was driven by lower releases of unallocated reserves in the current year. The decrease for the nine-month period ended September 30, 2019, was driven by lower specific reserve requirements 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 September 30: |
| 2019 |
| 2018 |
| Change |
| ||
Other (income) and expense: |
| |
|
| |
|
|
| |
Foreign currency transaction (gains)/losses | | $ | 2 | | $ | 1 |
| 128.6 | % |
(Gains)/losses on derivative instruments | |
| — | |
| 0 |
| (100.0) | |
(Gains)/losses on sale of equipment upon lease termination | |
| (9) | |
| (14) |
| (36.0) | |
Other expense and (income) | |
| 2 | |
| 18 |
| (88.1) | |
Total other (income) and expense | | $ | (5) | | $ | 5 |
| NM | |
NM - Not Meaningful
43
Other (Income) and Expense
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
(Dollars in millions) | | | | | | | | Percent |
|
For the nine months ended September 30: |
| 2019 |
| 2018 |
| Change |
| ||
Other (income) and expense: |
| |
|
| |
|
|
| |
Foreign currency transaction (gains)/losses | | $ | 2 | | $ | 8 |
| (72.5) | % |
(Gains)/losses on derivative instruments | |
| — | |
| (7) |
| (100.0) | |
(Gains)/losses on sale of equipment upon lease termination | |
| (28) | |
| (61) |
| (54.3) | |
Other expense and (income) | |
| 8 | |
| 49 |
| (84.4) | |
Total other (income) and expense | | $ | (18) | | $ | (11) |
| 66.1 | % |
Other (income) and expense was $5 million of income in the third quarter of 2019, as compared to $5 million of expense in the same period of 2018. The year-to-year change was in line with the performance of the Commercial Financing business. Other (income) and expense was $18 million of income in the first nine months of 2019 as compared to $11 million of income in the same period of 2018. The year-to-year change was in line with the performance of the Commercial Financing business, and was primarily driven by a pre-tax gain of $16 million from divested commercial financing capabilities. Year-to-year benefits were partially offset by a decrease in gains on sales of equipment which was a result of lower levels of equipment returned to IBM upon early lease termination, primarily due to client migration to IBM’s z14 mainframe during the first quarter of 2018.
Taxes
For the three months ended September 30, 2019, the company recorded a provision for income taxes of $22 million and an effective tax rate of 17.0 percent compared to a provision of $39 million and an effective tax rate of 21.5 percent for the three months ended September 30, 2018. For the nine-month period ended September 30, 2019, the company reported a provision for income taxes of $195 million and an effective tax rate of 42.4 percent compared to a provision of $112 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 nine months ended September 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 September 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 $9 million and $33 million higher in the three and nine months ended September 30, 2019, respectively, due to the “Global Intangible Low-Taxed Income” provision. For the period ended September 30, 2018, there was no material difference in the total taxes
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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 sales-type 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.”
Receivables purchased/participated from IBM include purchased interests in certain of IBM’s trade and other 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 $26,216 million at September 30, 2019 declined $13,281 million (including a decrease of $376 million from currency) as compared to year-end 2018, primarily driven by:
● | A decline in total financing receivables of $11,990 million (including a decrease of $304 million from currency), primarily driven by a decline in commercial financing receivables of $8,697 million, a decline in client financing loans and installment payment receivables of $1,233 million and a decline in purchased receivables from IBM of $1,312 million. These declines primarily reflect the company’s Commercial Financing portfolio actions which began 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;" and |
● | A decline in other receivables from IBM of $1,415 million (including a decrease of $42 million from currency), predominantly due to decreased cash invested with IBM of $1,413 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 September 30, 2019, substantially all Client and Commercial Financing assets were IT related assets with no direct exposure to consumers. Approximately 60 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 7 points to 68 percent.
Total liabilities of $23,716 million at September 30, 2019, decreased $12,361 million (including a decrease of $240 million from currency), as compared to year-end 2018, primarily driven by:
● | A decrease in total debt of $8,197 million (including a decrease of $254 million from currency) driven by lower funding requirements associated with financing receivables and the company’s decision to utilize its excess cash to repay a portion of its debt; |
● | A decline in accounts payable to IBM of $2,795 million (including an increase of $28 million from currency), which reflects the settlements of purchases of equipment and receivables/loans (for software and services). In the third quarter of 2019, the majority of such purchases were settled in the same period; and |
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● | A decline in accounts payable to third-parties of $1,387 million (including a decrease of $6 million from currency), primarily driven by the settlement of fourth-quarter 2018 originations and the company’s wind-down of it’s OEM IT Commercial Financing operations. |
Total member’s interest of $2,500 million at September 30, 2019 declined by $921 million as compared to year-end 2018, primarily driven by:
● | Cash distributions to IBM of $1,182 million; and |
● | Foreign currency translation loss of $68 million; partially offset by |
● | Net income for the first nine months of 2019 of $265 million; and |
● | A non-cash capital contribution from IBM of $64 million. |
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. |
| | Nine Months Ended | | Yr.-to-Yr. | |
| ||||||||
| | September 30, | | Percent |
| | September 30, | | Percent | | | ||||||||
(Dollars in millions) |
| 2019 |
| 2018 |
| Change |
|
| 2019 |
| 2018 |
| Change | |
| ||||
Client Financing | | $ | 2,887 | | $ | 3,126 |
| (7.6) | % |
| $ | 8,915 | | $ | 9,798 |
| (9.0) | % | |
Commercial Financing | |
| 4,474 | |
| 16,571 |
| (73.0) | % |
|
| 30,910 | |
| 50,587 |
| (38.9) | % | |
Total originations | | $ | 7,361 | | $ | 19,697 |
| (62.6) | % |
| $ | 39,825 | | $ | 60,385 |
| (34.0) | % | |
In the third quarter of 2019, the company originated $2,887 million of Client Financing receivables as compared to $3,126 million in the third quarter of 2018. The company originated $8,915 million of Client Financing receivables in the first nine months of 2019 as compared to $9,798 million in the first nine months of 2018. The decreases of $239 million and $883 million in the third quarter and first nine months, respectively, as compared to the same periods in the prior year, was driven by lower OEM IT originations in the current year and higher lease volumes in the prior year due to client migration to the IBM z14 mainframe.
In the third quarter of 2019, the company originated $4,474 million of Commercial Financing receivables as compared to $16,571 million in the third quarter of 2018. The company originated $30,910 million of Commercial Financing receivables in the first nine months of 2019 as compared to $50,587 million in the first nine months of 2018. The decreases of $12,097 million and $19,676 million in the third quarter and first nine months, respectively, as compared to the same periods in the prior year, reflect the company’s Commercial Financing portfolio actions which began in the second quarter of 2019. For additional information see note 5, "Financing Receivables, Receivables Purchased/Participated from IBM."
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Segment Assets
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | Yr.-to-Date | |
(Dollars in millions) | | At September 30, | | At December 31, | | Percent | | ||
Client Financing |
| 2019 |
| 2018 |
| Change | | ||
Financing receivables, net | | $ | 12,611 | | $ | 14,474 |
| (12.9) | % |
Equipment under operating leases, net | |
| 243 | |
| 386 |
| (37.1) | |
Financing receivables from IBM | |
| 3,756 | |
| 3,609 |
| 4.1 | |
Receivables participated from IBM, net | |
| 3,800 | |
| 4,065 |
| (6.5) | |
Total assets | | $ | 20,409 | | $ | 22,533 |
| (9.4) | % |
| | | | | | | | | |
| | | | | | | | Yr.-to-Date | |
(Dollars in millions) | | At September 30, | | At December 31, | | Percent | | ||
Commercial Financing |
| 2019 |
| 2018 |
| Change | | ||
Financing receivables, net | | $ | 2,677 | | $ | 11,374 |
| (76.5) | % |
Receivables purchased from IBM, net | |
| 57 | |
| 1,369 |
| (95.9) | |
Total assets | | $ | 2,734 | | $ | 12,743 |
| (78.5) | % |
The decrease in Client Financing assets of $2,124 million at September 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.
The Client Financing receivables portfolio at September 30, 2019 represented the following industry profile: Financial (33 percent), Manufacturing (16 percent), Government (14 percent), Services (12 percent), Retail (7 percent), Communications (7 percent), Healthcare (6 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 $10,009 million at September 30, 2019 as compared to December 31, 2018, reflects the company’s Commercial Financing portfolio actions which began 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 $22,337 million of total debt at September 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 September 30, | | At December 31, | | ||
(Dollars in millions) |
| 2019 |
| 2018 |
| ||
Recorded investment | | $ | 18,783 | | $ | 30,906 | |
Specific allowance for credit losses | |
| 114 | |
| 121 | |
Unallocated allowance for credit losses | |
| 46 | |
| 71 | |
Total allowance for credit losses | |
| 160 | |
| 192 | |
Net financing receivables | | $ | 18,623 | | $ | 30,714 | |
Allowance for credit losses coverage | |
| 0.9 | % |
| 0.6 | % |
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Roll Forward of Financing Receivables Allowance for Credit Losses
(Dollars in millions)
| | | | | | | | | | | | | |
January 1, 2019 |
| Additions |
| Write-offs * |
| Other ** |
| September 30, 2019 | |||||
$ | 192 | | $ | (4) | | $ | (25) | | $ | (4) | | $ | 160 |
* Represents reserved receivables that were written off during the period.
** Represents primarily translation adjustments.
The allowance for credit losses on financing receivables at September 30, 2019, was $160 million, or 0.9 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 $114 million at September 30, 2019, a decrease of $7 million as compared to year-end 2018.
Unallocated reserves were $46 million at September 30, 2019, a decrease of $25 million as compared to year-end 2018, primarily within the Americas and EMEA, driven by lower reserve requirements and lower average asset balances in the Client and Commercial Financing businesses.
Provisions for credit losses were a release of $1 million for the three months ended September 30, 2019 as compared to a release of $10 million for the same period in 2018. The year-to-year change was driven by higher unallocated reserve requirements in the current year compared to the prior-year period. Provisions for credit losses were a release of $4 million for the nine months ended September 30, 2019, as compared to $24 million of expense for the same period in 2018. The nine months year-to-year decrease of $28 million in provisions for credit losses was driven by lower specific reserve requirements in the current year.
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 September 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 September 30, 2019 and December 31, 2018, is expected to be returned to the company.
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Unguaranteed Residual Value
| | | | | | | | | | | | | | | | | | |
| | At | | At | | Estimated Run Out of September 30, 2019 Balance | ||||||||||||
| | December 31, | | September 30, | | | | | | | | | | | 2022 and | |||
(Dollars in millions) |
| 2018 |
| 2019 |
| 2019 |
| 2020 |
| 2021 |
| Beyond | ||||||
Direct financing leases | | $ | 491 | | $ | 468 | | $ | 34 | | $ | 91 | | $ | 141 | | $ | 202 |
Operating leases | |
| 114 | |
| 92 | |
| 35 | |
| 32 | |
| 20 | |
| 5 |
Total unguaranteed residual value | | $ | 605 | | $ | 560 | | $ | 68 | | $ | 123 | | $ | 161 | | $ | 207 |
Related original amount financed | | $ | 10,148 | | $ | 8,697 | |
|
| |
|
| |
|
| |
|
|
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- 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 at September 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 nine months ended, or at, as applicable, September 30, 2019, those amounts were $95 million for net cash provided by operating activities, $2,079 million of cash and cash equivalents and $601 million in cash invested with IBM.
The company's debt-to-equity ratio was 8.9 to 1 for the periods ending at September 30, 2019, December 31, 2018, and September 30, 2018, respectively. Refer to the company’s debt-to-equity ratio on page 52 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 nine months of 2019, the company made cash distributions to IBM, including a return of profit, of $1,182 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. At September 30, 2019, there was $681 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 to July 20, 2022. The size of each facility was unchanged. As of September 30, 2019, the company had no borrowings outstanding against any of its Credit Agreements.
The major rating agencies’ ratings on the company’s debt securities at September 30, 2019 appear in the table below.
| | | | |
|
| STANDARD |
| MOODY’S |
| | AND | | INVESTORS |
| | POOR’S | | SERVICE |
Long-term debt |
| A |
| A2 |
Commercial paper |
| A-1 |
| Prime-1 |
On July 9, 2019, IBM closed the acquisition 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
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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 July 2017, the UK's Financial Conduct Authority, which regulates the London Interbank Offered Rate (LIBOR), announced that it intends to phase out LIBOR by the end of 2021. Various central bank committees and working groups continue to discuss replacement of benchmark rates, the process for amending existing LIBOR-based contracts, and the potential economic impacts of different alternatives. The Alternative Reference Rates Committee has identified the Secured Overnight Financing Rate (SOFR) as its preferred alternative rate for USD LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions. The use of LIBOR is primarily within the company's Commercial Financing segment where agreements are short term in nature and generally range from 30 to 90 days. The company is evaluating the potential impact of the replacement of the LIBOR benchmark interest rate, including risk management, internal operational readiness and monitoring the FASB standard-setting process to address financial reporting issues that might arise in connection with transition from LIBOR to a new benchmark rate.
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.
Cash Flow and Liquidity Trends
| | | | | | | |
(Dollars in millions) | | | | | | | |
For the nine months ended September 30: |
| 2019 |
| 2018 | | ||
Net cash provided by operating activities | | $ | 95 | | $ | 812 | |
Net cash provided by/(used in) investing activities | | | 9,374 | | | (853) | |
Net cash used in financing activities | | | (9,199) | | | (661) | |
| | | | | | | |
At September 30: |
| 2019 |
| 2018 | | ||
Cash and cash equivalents | | $ | 2,079 | | $ | 1,961 | |
Cash invested with IBM, available on-demand (1) | |
| 601 | |
| 2,538 | |
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 18, 2019. |
Net cash provided by operating activities in the first nine months of 2019 decreased by $717 million as compared to the first nine months of 2018 primarily driven by lower net income and higher net cash payments to IBM related to outstanding accounts payable.
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Net cash provided by investing activities in the first nine months of 2019 increased by $10,227 million as compared to the first nine months of 2018, primarily driven by the following factors:
● | Lower net originations of short-term financing receivables of $5,922 million, reflecting the company’s Commercial Financing portfolio actions which began in the second quarter of 2019. For further information see note 5, “Financing Receivables, Receivables Purchased/Participated from IBM." |
● | A decrease in the investment of excess cash with IBM of $3,053 million, driven by the company’s decision to utilize its excess cash to repay a portion of its debt. |
Net cash used in financing activities in the first nine months of 2019 was higher by $8,537 million as compared to the first nine months of 2018, primarily driven by the following factors:
● | An increase in net payments on total debt of $7,828 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 financing receivables. |
● | An increase in net cash distributions to IBM of $710 million, which reflects the company's objective of achieving a target debt-to-equity ratio of 9 to 1. |
Debt
| | | | | | |
| | At September 30, | | At December 31, | ||
(Dollars in millions) | | 2019 | | 2018 | ||
Short-term debt |
| |
|
| |
|
Debt | | $ | 889 | | $ | 3,035 |
Debt payable to IBM | |
| 6,019 | |
| 10,223 |
Total short-term debt | | $ | 6,908 | | $ | 13,258 |
| | | | | | |
Long-term debt | |
| | |
|
|
Debt | | $ | 6,521 | | $ | 7,919 |
Debt payable to IBM | |
| 8,909 | |
| 9,357 |
Total long-term debt | | $ | 15,430 | | $ | 17,276 |
Total debt | | $ | 22,337 | | $ | 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 $22,337 million at September 30, 2019, a decrease of $8,197 million from year-end 2018. Total debt payable to IBM was $14,928 million at September 30, 2019, a decrease of $4,653 million from December 31, 2018. Total third-party debt was $7,410 million at September 30, 2019, a decrease of $3,544 million from December 31, 2018. The decrease in total debt during the first nine 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 $939 million at September 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.”
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Interest on Debt
The company recognized interest expense of $115 million and $400 million for the three and nine months ended September 30, 2019, respectively, of which $58 million and $189 million was interest expense on debt payable to IBM in each of those periods, respectively. The company recognized interest expense of $135 million and $362 million for the three and nine months ended 2018, respectively, of which $81 million and $215 million was interest expense on debt payable to IBM in each of those periods, respectively.
The decrease in interest expense in the third quarter of 2019 as compared to the same period in 2018 was driven by a lower average asset balance, partially offset by an increase in interest rates on both internal and external borrowings. The increase in interest expense in the first nine months of 2019 as compared to the same period in 2018 was driven by an increase in interest rates on both internal and external borrowings, partially offset by a lower average asset 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.”
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 September 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. |
The company’s debt-to-equity ratio was 8.9 to 1 at September 30, 2019, as compared to the debt-to-equity ratio of 8.9 to 1 at December 31, 2018. Total member’s interest of $2,500 million declined by $921 million, or 26.9 percent, while total debt of $22,337 million, decreased by $8,197 million, or 26.8 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- and long-term debt markets as an issuer in the capital markets and as a borrower from IBM. In 2019, the company made distributions to IBM, 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.
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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 significant reduction of commercial financing receivables. The company had receivables of $8.5 billion at December 31, 2018 and $1.2 billion at September 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 the primary asset balance of $1,369 million within the short term purchased receivables from IBM at December 31, 2018.
IBM Credit has policies in place designed to manage the risks involved in financing, including credit losses, residual values, liquidity, currency and interest rates.
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.
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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 35 of this Form 10-Q.
Item 6. Exhibits
Exhibit Number |
| Description |
| | |
31.1 | | |
| | |
31.2 | | |
| | |
32.1 | | |
| | |
32.2 | | |
| | |
101.INS | | XBRL Instance Document - the instance document does not appear on the Interactive Data File because its XBRL tags are embedded within the Inline XBRL 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 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. |
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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: | October 30, 2019 | | | |
| | | ||
| By: | /s/ Adam Wilson | ||
| | Adam Wilson | ||
| | Vice President, Finance |
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