UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended December 31, 2018
OR
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from _______ to _______
Commission File Number 001-36111
AMERICAN HONDA FINANCE CORPORATION
(Exact name of registrant as specified in its charter)
California | 95-3472715 |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) |
20800 Madrona Avenue, Torrance, California | 90503 |
(Address of principal executive offices) | (Zip Code) |
(310) 972-2555
(Registrant’s telephone number, including area code)
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
As of January 31, 2019, the number of outstanding shares of common stock of the registrant was 13,660,000 all of which shares were held by American Honda Motor Co., Inc. None of the shares are publicly traded.
REDUCED DISCLOSURE FORMAT
American Honda Finance Corporation, a wholly-owned subsidiary of American Honda Motor Co., Inc., which in turn is a wholly-owned subsidiary of Honda Motor Co., Ltd., meets the requirements set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q with the reduced disclosure format.
AMERICAN HONDA FINANCE CORPORATION
QUARTERLY REPORT ON FORM 10-Q
For the quarter ended December 31, 2018
Table of Contents
Page | ||||
PART I – FINANCIAL INFORMATION | ||||
PART II – OTHER INFORMATION | ||||
i
Cautionary Statement Regarding Forward-Looking Statements
Certain statements included herein constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 that involve a number of risks and uncertainties. Certain such forward-looking statements can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “scheduled,” or “anticipates” or similar expressions or the negative thereof or other variations thereof or comparable terminology, or by discussions of strategy, plans, or intentions. In addition, all information included herein with respect to projected or future results of operations, cash flows, financial condition, financial performance, or other financial or statistical matters constitute forward-looking statements. Such forward-looking statements are necessarily dependent on assumptions, data, or methods that may be incorrect or imprecise and that may be incapable of being realized. The following factors, among others, could cause actual results and other matters to differ materially from those in such forward-looking statements:
• | declines in the financial condition or performance of Honda Motor Co., Ltd. or the sales of Honda or Acura products; |
• | changes in economic and general business conditions, both domestically and internationally, including changes in international trade policy; |
• | fluctuations in interest rates and currency exchange rates; |
• | the failure of our customers, dealers or counterparties to meet the terms of any contracts with us, or otherwise fail to perform as agreed; |
• | our inability to recover the estimated residual value of leased vehicles at the end of their lease terms; |
• | changes or disruption in our funding sources or access to the capital markets; |
• | changes in our, or Honda Motor Co., Ltd.’s, credit ratings, including, for example, S&P Global Ratings downgrade of the credit rating of Honda Motor Co., Ltd.'s and its subsidiaries, including us, on February 6, 2019; |
• | increases in competition from other financial institutions seeking to increase their share of financing of Honda and Acura products; |
• | changes in laws and regulations, including the result of financial services legislation, and related costs; |
• | changes in accounting standards; |
• | a failure or interruption in our operations; and |
• | a security breach or cyber attack. |
Additional information regarding these and other risks and uncertainties to which our business is subject is contained in our Annual Report on Form 10-K for the fiscal year ended March 31, 2018 filed with the Securities and Exchange Commission on June 21, 2018. Readers of this Quarterly Report should review the information contained in that report, and in any subsequent reports that we file with the Securities and Exchange Commission as such risks and uncertainties may be amended, supplemented or superseded from time to time. We do not intend, and undertake no obligation to, update any forward-looking information to reflect actual results or future events or circumstances, except as required by applicable law.
ii
PART I – FINANCIAL INFORMATION
Item1. Financial Statements
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(U.S. dollars in millions, except share amounts)
December 31, 2018 | March 31, 2018 | |||||||
Assets | ||||||||
Cash and cash equivalents | $ | 811 | $ | 783 | ||||
Finance receivables, net | 39,504 | 37,956 | ||||||
Investment in operating leases, net | 32,193 | 31,817 | ||||||
Due from Parent and affiliated companies | 158 | 139 | ||||||
Income taxes receivable | 2 | 16 | ||||||
Vehicles held for disposition | 210 | 231 | ||||||
Other assets | 1,036 | 934 | ||||||
Derivative instruments | 455 | 750 | ||||||
Total assets | $ | 74,369 | $ | 72,626 | ||||
Liabilities and Equity | ||||||||
Debt | $ | 48,578 | $ | 47,861 | ||||
Due to Parent and affiliated companies | 125 | 87 | ||||||
Accrued interest expense | 190 | 146 | ||||||
Income taxes payable | 128 | 105 | ||||||
Deferred income taxes | 6,232 | 6,035 | ||||||
Other liabilities | 1,414 | 1,382 | ||||||
Derivative instruments | 501 | 414 | ||||||
Total liabilities | 57,168 | 56,030 | ||||||
Commitments and contingencies (Note 8) | ||||||||
Shareholder’s equity: | ||||||||
Common stock, $100 par value. Authorized 15,000,000 shares; issued and outstanding 13,660,000 shares as of December 31, 2018 and March 31, 2018 | 1,366 | 1,366 | ||||||
Retained earnings | 15,083 | 14,449 | ||||||
Accumulated other comprehensive loss | (139 | ) | (85 | ) | ||||
Total shareholder’s equity | 16,310 | 15,730 | ||||||
Noncontrolling interest in subsidiary | 891 | 866 | ||||||
Total equity | 17,201 | 16,596 | ||||||
Total liabilities and equity | $ | 74,369 | $ | 72,626 |
The following table presents the assets and liabilities of consolidated variable interest entities. These assets and liabilities are included in the consolidated balance sheets presented above. Refer to Note 9 for additional information.
December 31, 2018 | March 31, 2018 | |||||||
Finance receivables, net | $ | 9,012 | $ | 8,895 | ||||
Vehicles held for disposition | 4 | 4 | ||||||
Other assets | 566 | 452 | ||||||
Total assets | $ | 9,582 | $ | 9,351 | ||||
Secured debt | $ | 8,706 | $ | 8,733 | ||||
Accrued interest expense | 8 | 6 | ||||||
Total liabilities | $ | 8,714 | $ | 8,739 |
See accompanying notes to consolidated financial statements.
1
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(U.S. dollars in millions)
Three months ended December 31, | Nine months ended December 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
Revenues: | ||||||||||||||||
Direct financing leases | $ | — | $ | 3 | $ | 3 | $ | 11 | ||||||||
Retail | 415 | 353 | 1,189 | 1,010 | ||||||||||||
Dealer | 59 | 44 | 169 | 128 | ||||||||||||
Operating leases | 1,826 | 1,740 | 5,391 | 5,143 | ||||||||||||
Total revenues | 2,300 | 2,140 | 6,752 | 6,292 | ||||||||||||
Depreciation on operating leases | 1,376 | 1,378 | 4,112 | 4,087 | ||||||||||||
Interest expense | 303 | 229 | 870 | 651 | ||||||||||||
Net revenues | 621 | 533 | 1,770 | 1,554 | ||||||||||||
Gain on disposition of lease vehicles | 24 | 8 | 118 | 71 | ||||||||||||
Other income | 19 | 14 | 51 | 41 | ||||||||||||
Total net revenues | 664 | 555 | 1,939 | 1,666 | ||||||||||||
Expenses: | ||||||||||||||||
General and administrative expenses | 109 | 106 | 338 | 325 | ||||||||||||
Provision for credit losses | 75 | 65 | 181 | 187 | ||||||||||||
Early termination loss on operating leases | 22 | 22 | 78 | 81 | ||||||||||||
Loss on lease residual values | — | 1 | — | 2 | ||||||||||||
(Gain)/Loss on derivative instruments | 106 | (62 | ) | 416 | (436 | ) | ||||||||||
(Gain)/Loss on foreign currency revaluation of debt | (63 | ) | 53 | (337 | ) | 384 | ||||||||||
Total expenses | 249 | 185 | 676 | 543 | ||||||||||||
Income before income taxes | 415 | 370 | 1,263 | 1,123 | ||||||||||||
Income tax expense/(benefit) | 67 | (3,000 | ) | 320 | (2,717 | ) | ||||||||||
Net income | 348 | 3,370 | 943 | 3,840 | ||||||||||||
Less: Net income attributable to noncontrolling interest | 22 | 21 | 74 | 78 | ||||||||||||
Net income attributable to American Honda Finance Corporation | $ | 326 | $ | 3,349 | $ | 869 | $ | 3,762 |
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(U.S. dollars in millions)
Three months ended December 31, | Nine months ended December 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
Net income | $ | 348 | $ | 3,370 | $ | 943 | $ | 3,840 | ||||||||
Other comprehensive income: | ||||||||||||||||
Foreign currency translation adjustment | (103 | ) | (12 | ) | (103 | ) | 94 | |||||||||
Comprehensive income | 245 | 3,358 | 840 | 3,934 | ||||||||||||
Less: Comprehensive income/(loss) attributable to noncontrolling interest | (27 | ) | 16 | 25 | 123 | |||||||||||
Comprehensive income attributable to American Honda Finance Corporation | $ | 272 | $ | 3,342 | $ | 815 | $ | 3,811 |
See accompanying notes to consolidated financial statements.
2
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (UNAUDITED)
(U.S. dollars in millions)
Total | Retained earnings | Accumulated other comprehensive loss | Common stock | Noncontrolling interest | ||||||||||||||||
Balance at March 31, 2017 | $ | 12,786 | $ | 10,787 | $ | (110 | ) | $ | 1,366 | $ | 743 | |||||||||
Net income | 3,840 | 3,762 | — | — | 78 | |||||||||||||||
Other comprehensive income | 94 | — | 49 | — | 45 | |||||||||||||||
Dividends declared | (141 | ) | (141 | ) | — | — | — | |||||||||||||
Balance at December 31, 2017 | $ | 16,579 | $ | 14,408 | $ | (61 | ) | $ | 1,366 | $ | 866 | |||||||||
Balance at March 31, 2018 | $ | 16,596 | $ | 14,449 | $ | (85 | ) | $ | 1,366 | $ | 866 | |||||||||
Net income | 943 | 869 | — | — | 74 | |||||||||||||||
Other comprehensive loss | (103 | ) | — | (54 | ) | — | (49 | ) | ||||||||||||
Dividends declared | (235 | ) | (235 | ) | — | — | — | |||||||||||||
Balance at December 31, 2018 | $ | 17,201 | $ | 15,083 | $ | (139 | ) | $ | 1,366 | $ | 891 |
See accompanying notes to consolidated financial statements.
3
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(U.S. dollars in millions)
Nine months ended December 31, | ||||||||
2018 | 2017 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 943 | $ | 3,840 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Debt and derivative instrument valuation adjustments | 81 | (44 | ) | |||||
Loss on lease residual values and provision for credit losses | 181 | 189 | ||||||
Early termination loss on operating leases and impairment on operating leases | 78 | 81 | ||||||
Depreciation and amortization | 4,121 | 4,095 | ||||||
Accretion of unearned subsidy income | (1,210 | ) | (1,075 | ) | ||||
Amortization of deferred dealer participation and other deferred costs | 252 | 237 | ||||||
Gain on disposition of lease vehicles and fixed assets | (118 | ) | (71 | ) | ||||
Deferred income taxes | 214 | (2,644 | ) | |||||
Changes in operating assets and liabilities: | ||||||||
Income taxes receivable/payable | 35 | (57 | ) | |||||
Other assets | (40 | ) | (21 | ) | ||||
Accrued interest/discounts on debt | 51 | 51 | ||||||
Other liabilities | 61 | 52 | ||||||
Due to/from Parent and affiliated companies | 16 | 78 | ||||||
Net cash provided by operating activities | 4,665 | 4,711 | ||||||
Cash flows from investing activities: | ||||||||
Finance receivables acquired | (14,368 | ) | (13,899 | ) | ||||
Principal collected on finance receivables | 12,007 | 11,698 | ||||||
Net change in wholesale loans | 150 | 183 | ||||||
Purchase of operating lease vehicles | (11,966 | ) | (11,124 | ) | ||||
Disposal of operating lease vehicles | 6,991 | 6,280 | ||||||
Cash received for unearned subsidy income | 1,490 | 1,350 | ||||||
Other investing activities, net | (4 | ) | (43 | ) | ||||
Net cash used in investing activities | (5,700 | ) | (5,555 | ) |
Statement continues on the next page.
4
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(U.S. dollars in millions)
Nine months ended December 31, | ||||||||
Cash flows from financing activities: | 2018 | 2017 | ||||||
Proceeds from issuance of commercial paper | $ | 23,289 | $ | 26,573 | ||||
Paydown of commercial paper | (22,254 | ) | (25,223 | ) | ||||
Proceeds from issuance of short-term debt | 1,100 | 381 | ||||||
Paydown of short-term debt | (300 | ) | — | |||||
Proceeds from issuance of related party debt | 2,984 | 3,186 | ||||||
Paydown of related party debt | (3,293 | ) | (3,345 | ) | ||||
Proceeds from issuance of medium term notes and other debt | 5,365 | 5,033 | ||||||
Paydown of medium term notes and other debt | (5,492 | ) | (5,474 | ) | ||||
Proceeds from issuance of secured debt | 3,514 | 3,508 | ||||||
Paydown of secured debt | (3,493 | ) | (3,624 | ) | ||||
Dividends paid | (235 | ) | (141 | ) | ||||
Net cash provided by financing activities | 1,185 | 874 | ||||||
Effect of exchange rate changes on cash and cash equivalents | (8 | ) | 3 | |||||
Net increase in cash and cash equivalents | 142 | 33 | ||||||
Cash and cash equivalents and restricted cash at beginning of period | 1,226 | 1,142 | ||||||
Cash and cash equivalents and restricted cash at end of period | $ | 1,368 | $ | 1,175 | ||||
Supplemental disclosures of cash flow information: | ||||||||
Interest paid | $ | 594 | $ | 567 | ||||
Income taxes paid/(received) | $ | 39 | $ | (11 | ) |
The following table provides a reconciliation of cash and cash equivalents and restricted cash from the Consolidated Balance Sheets to the Consolidated Statements of Cash Flows.
December 31, | ||||||||
2018 | 2017 | |||||||
Cash and cash equivalents | $ | 811 | $ | 774 | ||||
Restricted cash included in other assets (1) | 557 | 401 | ||||||
Total | $ | 1,368 | $ | 1,175 |
---------------------------------------------------------
(1) | Restricted cash balances relate primarily to securitization arrangements (Note 9). |
See accompanying notes to consolidated financial statements
5
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
(1) Interim Information
(a) Organizational Structure
American Honda Finance Corporation (AHFC) is a wholly-owned subsidiary of American Honda Motor Co., Inc. (AHM or the Parent). Honda Canada Finance Inc. (HCFI) is a majority-owned subsidiary of AHFC. Noncontrolling interest in HCFI is held by Honda Canada Inc. (HCI), an affiliate of AHFC. AHM is a wholly-owned subsidiary and HCI is an indirect wholly-owned subsidiary of Honda Motor Co., Ltd. (HMC). AHM and HCI are the sole authorized distributors of Honda and Acura products, including motor vehicles, parts and accessories in the United States and Canada.
Unless otherwise indicated by the context, all references to the “Company”, “we”, “us”, and “our” in this report include AHFC and its consolidated subsidiaries, and references to “AHFC” refer solely to American Honda Finance Corporation (excluding AHFC’s subsidiaries).
(b) | Basis of Presentation |
The unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim information, and instructions to the Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X. In the opinion of management, these unaudited interim financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results of operations, cash flows, and financial condition for the interim periods presented. Results for interim periods should not be considered indicative of results for the full year or for any other interim period. These unaudited interim financial statements should be read in conjunction with the Company’s audited consolidated financial statements, significant accounting policies, and the other notes to the consolidated financial statements for the fiscal year ended March 31, 2018 included in the Company’s Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission (SEC) on June 21, 2018. All significant intercompany balances and transactions have been eliminated upon consolidation.
(c) | Recently Adopted Accounting Standards |
Effective April 1, 2018, the Company adopted Accounting Standard Update (ASU) 2014-09 and the subsequent ASUs that modified ASU 2014-09, which have been codified in Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers, and ASC 610-20, Gains and Losses from the Derecognition of Nonfinancial Assets. The guidance in this ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The Company’s primary sources of revenue are from lease and loan contracts, which are not within the scope of ASC 606 as they are within the scope of other accounting standards. All of the Company’s other revenue sources that are within the scope of ASC 606 are insignificant, with the exception of revenue from Vehicle Service Contract Administration. The adoption of this standard did not change the timing or amount of revenue from Vehicle Service Contract Administration, see Note 6—Transactions Involving Related Parties. Gains or losses related to the sale of lease vehicles are within the scope of ASC 610-20. The adoption of this standard did not have an impact on the timing or amount of gains or losses from the disposition of lease vehicles. ASU 2014-09 was adopted using the modified retrospective transition method. The adoption of this standard did not require any adjustments to opening retained earnings as of April 1, 2018.
Effective April 1, 2018, the Company adopted ASU 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments address certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The adoption of this standard did not have a material impact on the consolidated financial statements.
Effective April 1, 2018, the Company adopted ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice on how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The adoption of this standard did not have a material impact on the consolidated statements of cash flows.
6
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
Effective April 1, 2018, the Company adopted ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The amendments address diversity in practice that exists in the classification and presentation of changes in restricted cash and require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash or restricted cash equivalents, and that an entity disclose information about the nature of such restricted amounts. The Company’s restricted cash consists primarily of reserve funds and yield supplement accounts held in securitization trusts. Net changes in these restricted cash balances are currently reported within investing activities in the Company’s consolidated statements of cash flows. Under the amended guidance, transfers between restricted and unrestricted cash accounts are not reported as cash flows. The amendments in this update require that amounts classified as restricted cash and restricted cash equivalents be included within the beginning-of-period and end-of-period amounts along with cash and cash equivalents on the statement of cash flows. The amendments were applied retrospectively to all periods presented within the consolidated statements of cash flows.
(d) | Recently Issued Accounting Standards |
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which supersedes the guidance in ASC 840, Leases. The new standard will require the Company to record right-of-use assets and lease liabilities for the current operating leases as a lessee. The Company anticipates that adoption of this standard will require the present value of all future minimum lease payments to be made by the Company to be included in the Company’s consolidated balance sheets. The Company has $72 million of future minimum lease payments to be made as of December 31, 2018. The Company is identifying contracts that are or may contain lease arrangements as a lessee and continues to evaluate the application of this standard to those contracts. Lessor accounting remains largely unchanged from current GAAP. The Company continues to evaluate the application of this standard as a lessor. The FASB has also issued other updates to ASU 2016-02 with targeted improvements and clarification. All the amendments are effective for the Company beginning April 1, 2019. Early adoption is permitted. The Company plans to adopt the new guidance effective April 1, 2019.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The Company is currently assessing the impact of this standard on the consolidated financial statements. In general, the allowance for credit losses is expected to increase when changing from an incurred loss to expected loss methodology. The models and methodologies that are currently used in estimating the allowance for credit losses are being evaluated to identify the changes necessary to meet the requirements of the new standard. The amendments are effective for the Company beginning April 1, 2020, with early adoption permitted as of April 1, 2019. The Company plans to adopt the new guidance effective April 1, 2020.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which addresses better alignment between an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The amendments are effective for the Company beginning April 1, 2019. Early adoption is permitted, including adoption in an interim period. The Company is currently assessing the impact of this standard on the consolidated financial statements. The Company plans to adopt the new guidance effective April 1, 2019.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. The amendments modify the disclosure requirements on fair value measurements in Topic 820, based on FASB Concepts Statement, Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements. Certain disclosure requirements were removed, modified and added in Topic 820. The amendments are effective for the Company beginning April 1, 2020. Early adoption is permitted. The Company is currently assessing the impact of this standard on the consolidated financial statements. The Company plans to adopt the new guidance effective April 1, 2020.
7
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
(2) Finance Receivables
Finance receivables consisted of the following:
December 31, 2018 | ||||||||||||||||
Lease | Retail | Dealer | Total | |||||||||||||
(U.S. dollars in millions) | ||||||||||||||||
Finance receivables | $ | 44 | $ | 34,873 | $ | 5,451 | $ | 40,368 | ||||||||
Allowance for credit losses | �� | (188 | ) | (8 | ) | (196 | ) | |||||||||
Write-down of lease residual values | (3 | ) | — | — | (3 | ) | ||||||||||
Unearned interest income and fees | — | — | — | — | ||||||||||||
Deferred dealer participation and other deferred costs | — | 430 | — | 430 | ||||||||||||
Unearned subsidy income | (1 | ) | (1,094 | ) | — | (1,095 | ) | |||||||||
Finance receivables, net | $ | 40 | $ | 34,021 | $ | 5,443 | $ | 39,504 | ||||||||
March 31, 2018 | ||||||||||||||||
Lease | Retail | Dealer | Total | |||||||||||||
(U.S. dollars in millions) | ||||||||||||||||
Finance receivables | $ | 154 | $ | 33,140 | $ | 5,495 | $ | 38,789 | ||||||||
Allowance for credit losses | — | (179 | ) | — | (179 | ) | ||||||||||
Write-down of lease residual values | (9 | ) | — | — | (9 | ) | ||||||||||
Unearned interest income and fees | (2 | ) | — | — | (2 | ) | ||||||||||
Deferred dealer participation and other deferred costs | — | 396 | — | 396 | ||||||||||||
Unearned subsidy income | (2 | ) | (1,037 | ) | — | (1,039 | ) | |||||||||
Finance receivables, net | $ | 141 | $ | 32,320 | $ | 5,495 | $ | 37,956 |
Finance receivables include retail loans with a principal balance of $9.3 billion and $9.1 billion as of December 31, 2018 and March 31, 2018, respectively, which have been transferred to securitization trusts and are considered to be legally isolated but do not qualify for sale accounting treatment. These finance receivables are restricted as collateral for the payment of the related secured debt obligations. Refer to Note 9 for additional information.
The uninsured portions of the direct financing lease residual values were $12 million and $35 million at December 31, 2018 and March 31, 2018, respectively. Included in the gain or loss on disposition of lease vehicles are end of term charges on both direct financing and operating leases of $12 million and $13 million for the three months ended December 31, 2018 and 2017, respectively, and $52 million and $46 million for the nine months ended December 31, 2018 and 2017, respectively.
Credit Quality of Financing Receivables
Credit losses are an expected cost of extending credit. The majority of the credit risk is with consumer financing and to a lesser extent with dealer financing. Credit risk on consumer finance receivables can be affected by general economic conditions. Adverse changes such as a rise in unemployment can increase the likelihood of defaults. Declines in used vehicle prices can reduce the amount of recoveries on repossessed collateral. Credit risk on dealer loans is affected primarily by the financial strength of the dealers within the portfolio, the value of collateral securing the financings, and economic and market factors that could affect the creditworthiness of dealers. Exposure to credit risk is managed through purchasing standards, pricing of contracts for expected losses, focusing collection efforts to minimize losses, and ongoing reviews of the financial condition of dealers.
Allowance for Credit Losses
The allowance for credit losses is management’s estimate of probable losses incurred on finance receivables, which requires significant judgment and assumptions that are inherently uncertain. The allowance is based on management’s evaluation of many factors, including the Company’s historical credit loss experience, the value of the underlying collateral, delinquency trends, and economic conditions.
8
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
Consumer finance receivables in the retail loan and direct financing lease portfolio segments are collectively evaluated for impairment. Delinquencies and losses are monitored on an ongoing basis and the historical experience provides the primary basis for estimating the allowance. Management utilizes various methodologies when estimating the allowance for credit losses, including models which incorporate vintage loss and delinquency migration analysis. These models take into consideration attributes of the portfolio including loan-to-value ratios, internal and external credit scores, collateral types, and loan terms. Market and economic factors such as used vehicle prices, unemployment, and consumer debt service burdens are also incorporated into these models.
Dealer loans are individually evaluated for impairment when specifically identified as impaired. Dealer loans are considered impaired when it is probable that the Company will be unable to collect the amounts due according to the terms of the contract. The Company’s determination of whether dealer loans are impaired is based on evaluations of dealership payment history, financial condition, ability to perform under the terms of the loan agreements, and collateral values as applicable. Dealer loans that have not been specifically identified as impaired are collectively evaluated for impairment.
There were no modifications to dealer loans that constituted troubled debt restructurings during the nine months ended December 31, 2018 and 2017.
The Company generally does not grant concessions on consumer finance receivables that are considered troubled debt restructurings other than modifications of retail loans in reorganization proceedings pursuant to the U.S. Bankruptcy Code. Retail loans modified under bankruptcy protection were not material to the Company’s consolidated financial statements during the nine months ended December 31, 2018 and 2017. The Company does allow payment deferrals on consumer finance receivables. However, these payment deferrals are not considered troubled debt restructurings since the deferrals are deemed insignificant and interest continues to accrue during the deferral period.
9
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
The following is a summary of the activity in the allowance for credit losses of finance receivables, excluding the provisions related to past due operating leases:
Three and nine months ended December 31, 2018 | ||||||||||||||||
Lease | Retail | Dealer | Total | |||||||||||||
(U.S. dollars in millions) | ||||||||||||||||
Beginning balance, October 1, 2018 | $ | — | $ | 191 | $ | — | $ | 191 | ||||||||
Provision | — | 56 | 8 | 64 | ||||||||||||
Charge-offs | — | (80 | ) | — | (80 | ) | ||||||||||
Recoveries | — | 21 | — | 21 | ||||||||||||
Effect of translation adjustment | — | — | — | — | ||||||||||||
Ending balance, December 31, 2018 | $ | — | $ | 188 | $ | 8 | $ | 196 | ||||||||
Beginning balance, April 1, 2018 | $ | — | $ | 179 | $ | — | $ | 179 | ||||||||
Provision | — | 143 | 7 | 150 | ||||||||||||
Charge-offs | — | (200 | ) | — | (200 | ) | ||||||||||
Recoveries | — | 66 | 1 | 67 | ||||||||||||
Effect of translation adjustment | — | — | — | — | ||||||||||||
Ending balance, December 31, 2018 | $ | — | $ | 188 | $ | 8 | $ | 196 | ||||||||
Allowance for credit losses – ending balance: | ||||||||||||||||
Individually evaluated for impairment | $ | — | $ | — | $ | 8 | $ | 8 | ||||||||
Collectively evaluated for impairment | — | 188 | — | 188 | ||||||||||||
Finance receivables – ending balance: | ||||||||||||||||
Individually evaluated for impairment | $ | — | $ | — | $ | 178 | $ | 178 | ||||||||
Collectively evaluated for impairment | 43 | 34,209 | 5,273 | 39,525 | ||||||||||||
Three and nine months ended December 31, 2017 | ||||||||||||||||
Lease | Retail | Dealer | Total | |||||||||||||
(U.S. dollars in millions) | ||||||||||||||||
Beginning balance, October 1, 2017 | $ | — | $ | 167 | $ | 2 | $ | 169 | ||||||||
Provision | — | 56 | — | 56 | ||||||||||||
Charge-offs | — | (66 | ) | — | (66 | ) | ||||||||||
Recoveries | — | 19 | — | 19 | ||||||||||||
Effect of translation adjustment | — | — | — | — | ||||||||||||
Ending balance, December 31, 2017 | $ | — | $ | 176 | $ | 2 | $ | 178 | ||||||||
Beginning balance, April 1, 2017 | $ | 1 | $ | 132 | $ | — | $ | 133 | ||||||||
Provision | — | 161 | 2 | 163 | ||||||||||||
Charge-offs | (1 | ) | (175 | ) | — | (176 | ) | |||||||||
Recoveries | — | 57 | — | 57 | ||||||||||||
Effect of translation adjustment | — | 1 | — | 1 | ||||||||||||
Ending balance, December 31, 2017 | $ | — | $ | 176 | $ | 2 | $ | 178 | ||||||||
Allowance for credit losses – ending balance: | ||||||||||||||||
Individually evaluated for impairment | $ | — | $ | — | $ | 2 | $ | 2 | ||||||||
Collectively evaluated for impairment | — | 176 | — | 176 | ||||||||||||
Finance receivables – ending balance: | ||||||||||||||||
Individually evaluated for impairment | $ | — | $ | — | $ | 4 | $ | 4 | ||||||||
Collectively evaluated for impairment | $ | 200 | $ | 32,690 | $ | 4,926 | $ | 37,816 |
10
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
Delinquencies
The following is an aging analysis of past due finance receivables:
30 – 59 days past due | 60 – 89 days past due | 90 days or greater past due | Total past due | Current or less than 30 days past due | Total finance receivables | |||||||||||||||||||
(U.S. dollars in millions) | ||||||||||||||||||||||||
December 31, 2018 | ||||||||||||||||||||||||
Retail loans: | ||||||||||||||||||||||||
New auto | $ | 270 | $ | 66 | $ | 18 | $ | 354 | $ | 28,004 | $ | 28,358 | ||||||||||||
Used and certified auto | 91 | 23 | 6 | 120 | 4,494 | 4,614 | ||||||||||||||||||
Motorcycle and other | 16 | 5 | 3 | 24 | 1,213 | 1,237 | ||||||||||||||||||
Total retail | 377 | 94 | 27 | 498 | 33,711 | 34,209 | ||||||||||||||||||
Direct financing leases | 1 | — | — | 1 | 42 | 43 | ||||||||||||||||||
Dealer loans: | ||||||||||||||||||||||||
Wholesale flooring | 3 | 2 | 18 | 23 | 4,254 | 4,277 | ||||||||||||||||||
Commercial loans | — | — | 16 | 16 | 1,158 | 1,174 | ||||||||||||||||||
Total dealer loans | 3 | 2 | 34 | 39 | 5,412 | 5,451 | ||||||||||||||||||
Total finance receivables | $ | 381 | $ | 96 | $ | 61 | $ | 538 | $ | 39,165 | $ | 39,703 | ||||||||||||
March 31, 2018 | ||||||||||||||||||||||||
Retail loans: | ||||||||||||||||||||||||
New auto | $ | 188 | $ | 35 | $ | 10 | $ | 233 | $ | 27,034 | $ | 27,267 | ||||||||||||
Used and certified auto | 59 | 11 | 2 | 72 | 3,967 | 4,039 | ||||||||||||||||||
Motorcycle and other | 10 | 3 | 2 | 15 | 1,178 | 1,193 | ||||||||||||||||||
Total retail | 257 | 49 | 14 | 320 | 32,179 | 32,499 | ||||||||||||||||||
Direct financing leases | 2 | — | — | 2 | 148 | 150 | ||||||||||||||||||
Dealer loans: | ||||||||||||||||||||||||
Wholesale flooring | 2 | 1 | 2 | 5 | 4,447 | 4,452 | ||||||||||||||||||
Commercial loans | — | — | — | — | 1,043 | 1,043 | ||||||||||||||||||
Total dealer loans | 2 | 1 | 2 | 5 | 5,490 | 5,495 | ||||||||||||||||||
Total finance receivables | $ | 261 | $ | 50 | $ | 16 | $ | 327 | $ | 37,817 | $ | 38,144 |
Credit Quality Indicators
Retail Loan and Direct Financing Lease Portfolio Segments
The Company utilizes proprietary credit scoring systems to evaluate the credit risk of applicants for retail loans and leases. These systems assign internal credit scores based on various factors including the applicant’s credit bureau information and contract terms. The internal credit score provides the primary basis for credit decisions when acquiring retail loan and lease contracts. Internal credit scores are determined only at the time of origination and are not reassessed during the life of the contract.
Subsequent to origination, collection experience provides an indication of the credit quality of consumer finance receivables. The likelihood of accounts charging off is significantly higher once an account becomes 60 days delinquent. Accounts that are current or less than 60 days past due are considered to be performing. Accounts that are 60 days or more past due are considered to be nonperforming. The table below presents the Company’s portfolio of retail loans and direct financing leases by this credit quality indicator:
11
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
Retail new auto loans | Retail used and certified auto loans | Retail motorcycle and other loans | Direct financing lease | Total consumer finance receivables | ||||||||||||||||
(U.S. dollars in millions) | ||||||||||||||||||||
December 31, 2018 | ||||||||||||||||||||
Performing | $ | 28,274 | $ | 4,585 | $ | 1,229 | $ | 43 | $ | 34,131 | ||||||||||
Nonperforming | 84 | 29 | 8 | — | 121 | |||||||||||||||
Total | $ | 28,358 | $ | 4,614 | $ | 1,237 | $ | 43 | $ | 34,252 | ||||||||||
March 31, 2018 | ||||||||||||||||||||
Performing | $ | 27,222 | $ | 4,026 | $ | 1,188 | $ | 150 | $ | 32,586 | ||||||||||
Nonperforming | 45 | 13 | 5 | — | 63 | |||||||||||||||
Total | $ | 27,267 | $ | 4,039 | $ | 1,193 | $ | 150 | $ | 32,649 |
Dealer Loan Portfolio Segment
The Company utilizes an internal risk rating system to evaluate dealer credit risk. Dealerships are assigned an internal risk rating based on an assessment of their financial condition and other factors. Factors including liquidity, financial strength, management effectiveness, and operating efficiency are evaluated when assessing their financial condition. Financing limits and interest rates are based upon these risk ratings. Monitoring activities including financial reviews and inventory inspections are performed more frequently for dealerships with weaker risk ratings. The financial conditions of dealerships are reviewed and their risk ratings are updated at least annually.
The Company’s outstanding portfolio of dealer loans has been divided into two groups in the tables below. Group A includes the loans of dealerships with the strongest internal risk rating. Group B includes the loans of all remaining dealers. Although the likelihood of losses can be higher for dealerships in Group B, the overall risk of losses is not considered significant.
December 31, 2018 | March 31, 2018 | |||||||||||||||||||||||
Wholesale flooring | Commercial loans | Total | Wholesale flooring | Commercial loans | Total | |||||||||||||||||||
(U.S. dollars in millions) | ||||||||||||||||||||||||
Group A | $ | 2,585 | $ | 772 | $ | 3,357 | $ | 2,791 | $ | 684 | $ | 3,475 | ||||||||||||
Group B | 1,692 | 402 | 2,094 | 1,661 | 359 | 2,020 | ||||||||||||||||||
Total | $ | 4,277 | $ | 1,174 | $ | 5,451 | $ | 4,452 | $ | 1,043 | $ | 5,495 |
12
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
(3) Investment in Operating Leases
Investment in operating leases consisted of the following:
December 31, 2018 | March 31, 2018 | |||||||
(U.S. dollars in millions) | ||||||||
Operating lease vehicles | $ | 42,073 | $ | 41,285 | ||||
Accumulated depreciation | (8,375 | ) | (8,169 | ) | ||||
Deferred dealer participation and other deferred costs | 117 | 117 | ||||||
Unearned subsidy income | (1,507 | ) | (1,317 | ) | ||||
Estimated early termination losses | (115 | ) | (99 | ) | ||||
Investment in operating leases, net | $ | 32,193 | $ | 31,817 |
The Company recognized $22 million of estimated early termination losses due to lessee defaults for both the three months ended December 31, 2018 and 2017. Actual net losses realized for the three months ended December 31, 2018 and 2017 totaled $26 million and $22 million, respectively. The Company recognized $78 million and $81 million of estimated early termination losses due to lessee defaults for the nine months ended December 31, 2018 and 2017, respectively. Actual net losses realized for the nine months ended December 31, 2018 and 2017 totaled $62 million and $57 million, respectively.
Included in the provision for credit losses for the three months ended December 31, 2018 and 2017 are provisions related to past due receivables on operating leases in the amounts of $11 million and $9 million, respectively. Included in the provision for credit losses for the nine months ended December 31, 2018 and 2017 are provisions related to past due receivables on operating leases in the amounts of $31 million and $24 million, respectively.
No impairment losses due to declines in estimated residual values were recognized during the three and nine months ended December 31, 2018 and 2017.
13
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
(4) Debt
The Company issues debt in various currencies with both floating and fixed interest rates. Outstanding debt net of discounts and fees, weighted average contractual interest rates and range of contractual interest rates were as follows:
Weighted average contractual interest rate | Contractual interest rate ranges | |||||||||||||||||
December 31, 2018 | March 31, 2018 | December 31, 2018 | March 31, 2018 | December 31, 2018 | March 31, 2018 | |||||||||||||
(U.S. dollars in millions) | ||||||||||||||||||
Unsecured debt: | ||||||||||||||||||
Commercial paper | $ | 6,165 | $ | 5,167 | 2.52 | % | 1.86 | % | 1.86 - 2.76% | 1.07 - 2.21% | ||||||||
Related party debt | 733 | 1,085 | 2.17 | % | 1.64 | % | 1.99 - 2.31% | 1.43 - 1.72% | ||||||||||
Bank loans | 4,939 | 5,419 | 3.16 | % | 2.48 | % | 2.55 - 3.65% | 2.02 - 3.15% | ||||||||||
Private MTN program | 998 | 1,698 | 3.84 | % | 5.40 | % | 3.80 - 3.88% | 3.80 - 7.63% | ||||||||||
Public MTN program | 22,785 | 21,398 | 2.31 | % | 1.92 | % | 0.09 - 3.63% | 0.07 - 3.50% | ||||||||||
Euro MTN programme | 886 | 1,111 | 1.89 | % | 1.95 | % | 1.88 - 2.23% | 1.88 - 2.33% | ||||||||||
Other debt | 3,366 | 3,250 | 2.57 | % | 2.20 | % | 1.63 - 3.44% | 1.63 - 2.76% | ||||||||||
Total unsecured debt | 39,872 | 39,128 | ||||||||||||||||
Secured debt | 8,706 | 8,733 | 2.34 | % | 1.74 | % | 1.16 - 3.30% | 1.04 - 2.83% | ||||||||||
Total debt | $ | 48,578 | $ | 47,861 |
As of December 31, 2018, the outstanding principal balance of long-term debt with floating interest rates totaled $12.9 billion, long-term debt with fixed interest rates totaled $27.5 billion, and short-term debt totaled $8.3 billion. As of March 31, 2018, the outstanding principal balance of long-term debt with floating interest rates totaled $13.2 billion, long-term debt with fixed interest rates totaled $27.8 billion, and short-term debt totaled $7.0 billion.
Commercial Paper
As of December 31, 2018 and March 31, 2018, the Company had commercial paper programs that provide the Company with available funds of up to $8.5 billion and $8.6 billion, respectively, at prevailing market interest rates for terms up to one year. The commercial paper programs are supported by the Keep Well Agreements with HMC described in Note 6.
Outstanding commercial paper averaged $5.5 billion and $5.6 billion during the nine months ended December 31, 2018 and 2017, respectively. The maximum balance outstanding at any month-end during the nine months ended December 31, 2018 and 2017 was $6.2 billion and $6.0 billion, respectively.
Related Party Debt
HCFI issues fixed rate short-term notes to HCI to help fund HCFI’s general corporate operations. HCFI incurred interest expense on these notes totaling $4 million for both the three months ended December 31, 2018 and 2017, and $12 million and $10 million for the nine months ended December 31, 2018 and 2017, respectively.
14
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
Bank Loans
Outstanding bank loans at December 31, 2018 were either short-term or long-term, with floating interest rates, and denominated in U.S. dollars or Canadian dollars. Outstanding bank loans have prepayment options. No outstanding bank loans as of December 31, 2018 were supported by the Keep Well Agreements with HMC described in Note 6. Outstanding bank loans contain certain covenants, including limitations on liens, mergers, consolidations and asset sales.
Medium Term Note (MTN) Programs
Private MTN Program
AHFC no longer issues MTNs under its Rule 144A Private MTN Program. Notes outstanding under the Private MTN Program as of December 31, 2018 were long-term, with fixed interest rates, and denominated in U.S. dollars. Notes under this program were issued pursuant to the terms of an issuing and paying agency agreement which contains certain covenants, including negative pledge provisions.
Public MTN Program
In August 2016, AHFC filed a registration statement with the SEC under which it may issue from time to time up to $30 billion aggregate principal amount of Public MTNs. The aggregate principal amount of MTNs offered under this program may be increased from time to time. Notes outstanding under this program as of December 31, 2018 were either long-term or short-term, with either fixed or floating interest rates, and denominated in U.S. dollars, Euro or Sterling. Notes under this program are issued pursuant to an indenture which contains certain covenants, including negative pledge provisions and limitations on mergers, consolidations and asset sales.
Euro MTN Programme
The Euro MTN Programme was retired in August 2014. Notes under this program that are currently listed on the Luxembourg Stock Exchange will remain listed through their maturities. Notes outstanding under this program as of December 31, 2018 were long-term with fixed interest rates. Notes under this program were issued pursuant to the terms of an agency agreement which contains certain covenants, including negative pledge provisions.
The MTN programs are supported by the Keep Well Agreement with HMC described in Note 6.
Other Debt
The outstanding balances as of December 31, 2018 consisted of private placement debt issued by HCFI which are long-term, with either fixed or floating interest rates, and denominated in Canadian dollars. Private placement debt is supported by the Keep Well Agreement with HMC described in Note 6. The notes are issued pursuant to the terms of an indenture which contains certain covenants, including negative pledge provisions.
Secured Debt
The Company issues notes through financing transactions that are secured by assets held by issuing securitization trusts. Notes outstanding as of December 31, 2018 were long-term and short-term with either fixed or floating interest rates, and denominated in U.S. dollars or Canadian dollars. Repayment of the notes is dependent on the performance of the underlying receivables. Refer to Note 9 for additional information on the Company’s secured financing transactions.
Credit Agreements
Syndicated Bank Credit Facilities
AHFC maintains a $3.5 billion 364-day credit agreement, which expires on March 1, 2019, a $2.1 billion three-year credit agreement, which expires on March 3, 2021, and a $1.4 billion five-year credit agreement, which expires on March 3, 2023. As of December 31, 2018, no amounts were drawn upon under the AHFC credit agreements. AHFC intends to renew or replace these credit agreements prior to or on their respective expiration dates.
15
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
HCFI maintains a $1.2 billion credit agreement, which provides that HCFI may borrow up to $587 million on a one-year and up to $587 million on a five-year revolving basis. The one-year tranche of the credit agreement expires on March 24, 2019 and the five-year tranche of the credit agreement expires on March 24, 2023. As of December 31, 2018, no amounts were drawn upon under the HCFI credit agreement. HCFI intends to renew or replace the credit agreement prior to or on the expiration date of each respective tranche.
The credit agreements contain customary covenants, including limitations on liens, mergers, consolidations and asset sales.
Other Credit Agreements
AHFC maintains other committed lines of credit that allow the Company access to an additional $1 billion in unsecured funding with multiple banks. The credit agreements contain customary covenants, including limitations on liens, mergers, consolidations and asset sales. As of December 31, 2018, no amounts were drawn upon under these agreements. These agreements expire in September 2019.
(5) Derivative Instruments
The notional balances and fair values of the Company’s derivatives are presented below. The derivative instruments are presented on a gross basis in the Company’s consolidated balance sheets. Refer to Note 13 regarding the valuation of derivative instruments.
December 31, 2018 | March 31, 2018 | |||||||||||||||||||||||
Notional balances | Assets | Liabilities | Notional balances | Assets | Liabilities | |||||||||||||||||||
(U.S. dollars in millions) | ||||||||||||||||||||||||
Interest rate swaps | $ | 55,249 | $ | 357 | $ | 270 | $ | 56,043 | $ | 465 | $ | 342 | ||||||||||||
Cross currency swaps | 4,310 | 98 | 231 | 4,310 | 285 | 72 | ||||||||||||||||||
Gross derivative assets/liabilities | 455 | 501 | 750 | 414 | ||||||||||||||||||||
Counterparty netting adjustment and collateral | (333 | ) | (331 | ) | (372 | ) | (371 | ) | ||||||||||||||||
Net derivative assets/liabilities | $ | 122 | $ | 170 | $ | 378 | $ | 43 |
The income statement impact of derivative instruments is presented below. There were no derivative instruments designated as part of a hedge accounting relationship during the periods presented.
Three months ended December 31, | Nine months ended December 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
(U.S. dollars in millions) | ||||||||||||||||
Interest rate swaps | $ | (25 | ) | $ | 23 | $ | (5 | ) | $ | 87 | ||||||
Cross currency swaps | (81 | ) | 39 | (411 | ) | 349 | ||||||||||
Total gain/(loss) on derivative instruments | $ | (106 | ) | $ | 62 | $ | (416 | ) | $ | 436 |
The fair value of derivative instruments is subject to the fluctuations in market interest rates and foreign currency exchange rates. Since the Company has elected not to apply hedge accounting, the volatility in the changes in fair value of these derivative instruments is recognized in earnings. All settlements of derivative instruments are presented within cash flows from operating activities in the consolidated statements of cash flows.
These derivative instruments also contain an element of credit risk in the event the counterparties are unable to meet the terms of the agreements. However, the Company minimizes the risk exposure by limiting the counterparties to major financial institutions that meet established credit guidelines. In the event of default, all counterparties are subject to legally enforceable master netting agreements. In Canada, HCFI is a party to credit support agreements that require posting of cash collateral to mitigate counterparty credit risk on derivative positions.
16
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
(6) Transactions Involving Related Parties
The following tables summarize the income statement and balance sheet impact of transactions with the Parent and affiliated companies:
Three months ended December 31, | Nine months ended December 31, | |||||||||||||||
Income Statement | 2018 | 2017 | 2018 | 2017 | ||||||||||||
(U.S. dollars in millions) | ||||||||||||||||
Revenue: | ||||||||||||||||
Subsidy income | $ | 414 | $ | 369 | $ | 1,204 | $ | 1,067 | ||||||||
Interest expense: | ||||||||||||||||
Related party debt | 4 | 4 | 12 | 10 | ||||||||||||
Other income, net: | ||||||||||||||||
VSC administration fees | 28 | 28 | 82 | 81 | ||||||||||||
Support Service Fee | (9 | ) | (7 | ) | (26 | ) | (21 | ) | ||||||||
General and administrative expenses: | ||||||||||||||||
Support Compensation Agreement fees | 6 | 5 | 17 | 16 | ||||||||||||
Benefit plan expenses | 3 | 3 | 8 | 8 | ||||||||||||
Shared services | 13 | 15 | 50 | 46 |
Balance Sheet | December 31, 2018 | March 31, 2018 | ||||||
(U.S. dollars in millions) | ||||||||
Assets: | ||||||||
Finance receivables, net: | ||||||||
Unearned subsidy income | $ | (1,086 | ) | $ | (1,030 | ) | ||
Investment in operating leases, net: | ||||||||
Unearned subsidy income | (1,503 | ) | (1,313 | ) | ||||
Due from Parent and affiliated companies | 158 | 139 | ||||||
Liabilities: | ||||||||
Debt: | ||||||||
Related party debt | $ | 733 | $ | 1,085 | ||||
Due to Parent and affiliated companies | 125 | 87 | ||||||
Accrued interest expense: | ||||||||
Related party debt | 2 | 3 | ||||||
Other liabilities: | ||||||||
VSC unearned administrative fees | 393 | 396 | ||||||
Accrued benefit expenses | 63 | 71 |
Support Agreements
HMC and AHFC are parties to a Keep Well Agreement, effective as of September 9, 2005. This Keep Well Agreement provides that HMC will (1) maintain (directly or indirectly) at least 80% ownership in AHFC’s voting stock and not pledge (directly or indirectly), or in any way encumber or otherwise dispose of, any such stock of AHFC that it is required to hold (or permit any of HMC’s subsidiaries to do so), (2) cause AHFC to have a positive consolidated tangible net worth with tangible net worth defined as (a) stockholder’s equity less (b) any intangible assets, determined on a consolidated basis in accordance with GAAP, and (3) ensure that AHFC has sufficient liquidity to meet its payment obligations for debt HMC has confirmed in writing is covered by this Keep Well Agreement, in accordance with its terms, or where necessary make available to AHFC, or HMC shall procure for AHFC, sufficient funds to enable AHFC to meet such obligations in accordance with such terms. This Keep Well Agreement is not a guarantee by HMC.
17
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
HMC and HCFI are parties to a Keep Well Agreement effective as of September 26, 2005. This Keep Well Agreement provides that HMC will (1) maintain (directly or indirectly) at least 80% ownership in HCFI’s voting stock and not pledge (directly or indirectly), or in any way encumber or otherwise dispose of, any such stock of HCFI that it is required to hold (or permit any of HMC’s subsidiaries to do so), (2) cause HCFI to have a positive consolidated tangible net worth with tangible net worth defined as (a) stockholder’s equity less (b) any intangible assets, determined on a consolidated basis in accordance with generally accepted accounting principles in Canada, and (3) ensure that HCFI has sufficient liquidity to meet its payment obligations for debt HMC has confirmed in writing is covered by this Keep Well Agreement, in accordance with its terms, or where necessary make available to HCFI, or HMC shall procure for HCFI, sufficient funds to enable HCFI to meet such obligations in accordance with such terms. This Keep Well Agreement is not a guarantee by HMC.
Debt programs supported by the Keep Well Agreements consist of the Company’s commercial paper programs, Private MTN Program, Public MTN Program, Euro MTN Programme, and HCFI’s private placement debt. In connection with the above agreements, AHFC and HCFI have entered into separate Support Compensation Agreements, where each has agreed to pay HMC a quarterly fee based on the amount of outstanding debt that benefit from the Keep Well Agreements. Support Compensation Agreement fees are recognized in general and administrative expenses.
Incentive Financing Programs
The Company receives subsidy payments from AHM and HCI, which supplement the revenues on financing products offered under incentive programs. Subsidy payments received on retail loans and leases are deferred and recognized as revenue over the term of the related contracts. The unearned balance is recognized as reductions to the carrying value of finance receivables and investment in operating leases. Subsidy payments on dealer loans are received as earned.
Related Party Debt
HCFI issues short-term notes to HCI to fund HCFI’s general corporate operations. Interest rates are based on prevailing rates of debt with comparable terms. Refer to Note 4 for additional information.
Vehicle Service Contract (VSC) Administration
AHFC performs administrative services for VSCs issued by certain subsidiaries of AHM. AHFC’s performance obligations for the services are satisfied over the term of the underlying contracts and revenue is recognized proportionate to the anticipated amount of services to be performed. Contract terms range between 2 to 8 years with the majority of contracts having original terms between 6 and 8 years. The majority of the administrative service revenue is recognized during the latter years of the underlying contracts as this is the period in which the majority of VSC claims are processed. AHFC receives fees for performing the administrative services when the contracts are acquired. Unearned VSC administration fees represents AHFC’s contract liabilities and are included in other liabilities (Note 11). VSC administration income is recognized in other income (Note 12). HCFI receives fees for marketing VSCs issued by HCI. These fees are also recognized in other income.
AHFC pays fees to AHM for services provided in support of AHFC’s performance of VSC administrative services. The support fees are recognized as an expense within other income, net (Note 12).
Shared Services
The Company shares certain common expenditures with AHM, HCI, and related parties including information technology services and facilities. The allocated costs for shared services are included in general and administrative expenses.
Benefit Plans
The Company participates in various employee benefit plans that are sponsored by AHM and HCI. The allocated benefit plan expenses are included in general and administrative expenses.
Income taxes
The Company’s U.S. income taxes are recognized on a modified separate return basis pursuant to an intercompany income tax allocation agreement with AHM. Income tax related items are not included in the tables above. Refer to Note 7 for additional information.
18
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
Other
AHM periodically sponsors programs that allow lessees to terminate their lease contracts prior to the contractual maturity date. AHM compensates the Company for rental payments that were waived under these programs. During both the three months ended December 31, 2018 and 2017, the Company recognized $3 million, and during the nine months ended December 31, 2018 and 2017, the Company recognized $12 million and $14 million, respectively, under these programs which were reflected as proceeds on the disposition of the returned lease vehicles.
The majority of the amounts due from the Parent and affiliated companies at December 31, 2018 and March 31, 2018 related to incentive financing program subsidies. The majority of the amounts due to the Parent and affiliated companies at December 31, 2018 and March 31, 2018 related to wholesale flooring payable to the Parent. These receivable and payable accounts are non-interest-bearing and short-term in nature and are expected to be settled in the normal course of business.
In April 2017, the Company sold all issued and outstanding common stock of its wholly-owned subsidiary American Honda Service Contract Corporation (AHSCC) to AHM for $36 million, which was equal to AHSCC’s total equity as of March 31, 2017. AHSCC was not material to the Company’s operations.
In July 2018 and July 2017, AHFC declared and paid cash dividends of $235 million and $141 million, respectively, to its parent, AHM.
(7) Income Taxes
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (Tax Act). The primary impact on the effective tax rate is the reduction of the U.S. federal corporate tax rate from 35% to 21%, effective January 1, 2018.
The Company adopted Staff Accounting Bulletin No. 118 (SAB 118) which provides guidance on accounting for the tax effects of the Tax Act in the Company’s interim quarter ended December 31, 2017 to record re-measurement of deferred taxes and a one-time deemed repatriation transition tax (Transition Tax). As of March 31, 2018, the Company completed the accounting for the effect of re-measurement of deferred taxes at the new 21% tax rate. At March 31, 2018, the Company provisionally accrued a total of $52 million for the Transition Tax. Upon further analysis, the Company completed its accounting for the Transition Tax, and reduced the provisional estimate as of March 31, 2018 by $19 million in the quarter ended December 31, 2018, for a final amount of $33 million, inclusive of associated unrecognized tax benefits. The adjustment was attributed primarily to the availability of new information, which led to further analysis on key inputs to the Transition Tax calculation. The measurement period adjustment in the current fiscal year decreased the Company's effective tax rate by approximately 4.7% and 1.5% for the three and nine months ended December 31, 2018, respectively. The Company has elected not to record deferred taxes for a Global Intangible Low-Taxed Income (GILTI) related book-tax differences, and will treat taxes due on future U.S. inclusions in taxable income related to GILTI as a current period expense when incurred. Other domestic and international effects of the Tax Act to the total tax expense are immaterial as of December 31, 2018.
The Company’s effective tax rate was 16.1% and (810.8)% for the three months ended December 31, 2018 and 2017, respectively, and 25.3% and (241.9)% for the nine months ended December 31, 2018 and 2017, respectively. The increase in the effective tax rate for the three and nine months ended December 31, 2018 was primarily due to the impact of the U.S. federal corporate tax rate reduction from 35% to 21% recorded in fiscal year 2018, partially offset by the net effects of tax credits, uncertain tax positions, the adjustment to the Transition Tax and state taxes.
Prior to the passage of the Tax Act, foreign undistributed earnings were generally subject to U.S. taxation when repatriated and were generally offset by foreign tax credits. The Tax Act imposes a one-time Transition Tax on the previously untaxed Earnings and Profits (E&P) as of December 31, 2017 and generally eliminates future U.S. federal income taxes on dividends from foreign subsidiaries. The Company completed its calculations of the Transition Tax liability within the SAB 118 measurement period. The Company has not provided for income taxes on its share of the undistributed earnings of HCFI which are intended to be indefinitely reinvested outside the United States. At December 31, 2018, $923 million of accumulated undistributed earnings of HCFI were intended to be so reinvested. If the undistributed earnings as of December 31, 2018 were to be distributed, the tax liability associated with these indefinitely reinvested earnings would be $71 million.
The Company recorded unrecognized tax benefits related to current and prior year's tax positions in the current fiscal year. The Company does not expect any material changes in the amounts of unrecognized tax benefits during the remainder of the fiscal year ending March 31, 2019.
19
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
As of December 31, 2018, the Company is subject to examination by U.S. federal and state tax jurisdictions for returns filed for the taxable years ended March 31, 2008 through 2017, with the exception of one state which is subject to departmental review for returns filed for the taxable years ended March 31, 2001 through 2007. The Company’s Canadian subsidiary, HCFI, is subject to examination for returns filed for the taxable years ended March 31, 2012 through 2018 federally, and returns filed for the taxable years ended March 31, 2009 through 2018 provincially. The Company believes appropriate provision has been made for all outstanding issues for all open years.
(8) Commitments and Contingencies
The Company leases certain premises and equipment on a long-term basis under noncancelable leases. Some of these leases require the Company to pay property taxes, insurance, and other expenses. Lease expense was $3 million for both the three months ended December 31, 2018 and 2017, and $8 million and $6 million for the nine months ended December 31, 2018 and 2017, respectively.
The Company extends commercial revolving lines of credit to dealerships to support their business activities including facilities refurbishment and general working capital requirements. The amounts borrowed are generally secured by the assets of the borrowing entity. The majority of the lines have annual renewal periods. The unused balance of commercial revolving lines of credit was $227 million as of December 31, 2018. The Company also has commitments to finance the construction of auto dealership facilities. The remaining unfunded balance for these construction loans was $21 million as of December 31, 2018.
Legal Proceedings and Regulatory Matters
The Company establishes accruals for legal claims when payments associated with the claims become probable and the costs can be reasonably estimated. When able, the Company will determine estimates of reasonably possible loss or range of loss, whether in excess of any related accrued liability or where there is no accrued liability. Given the inherent uncertainty associated with legal matters, the actual costs of resolving legal claims and associated costs of defense may be substantially higher or lower than the amounts for which accruals have been established.
The Company is involved, in the ordinary course of business, in various legal proceedings including claims of individual customers and purported class action lawsuits. Certain of these actions are similar to suits filed against other financial institutions and captive finance companies. Most of these proceedings concern customer allegations of wrongful repossession or defamation of credit. The Company is also subject to governmental reviews and inquiries from time to time. Based on available information and established accruals, management does not believe it is reasonably possible that the results of these proceedings, in the aggregate, will have a material adverse effect on the Company’s consolidated financial statements.
(9) Securitizations and Variable Interest Entities (VIE)
The trusts utilized for on-balance sheet securitizations are VIEs, which are required to be consolidated by their primary beneficiary. The Company is considered to be the primary beneficiary of these trusts due to (i) the power to direct the activities of the trusts that most significantly impact the trusts’ economic performance through its role as servicer, and (ii) the obligation to absorb losses or the right to receive residual returns that could potentially be significant to the trusts through the subordinated certificates and residual interest retained. The debt securities issued by the trusts to third-party investors along with the assets of the trusts are included in the Company’s consolidated financial statements.
During the nine months ended December 31, 2018 and 2017, the Company issued notes through asset-backed securitizations, which were accounted for as secured financing transactions totaling $3.5 billion for both periods. The notes were secured by receivables with an initial principal balance of $4.3 billion and $4.1 billion, respectively.
20
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
The table below presents the carrying amounts of assets and liabilities of consolidated securitization trusts as they are reported in the Company’s consolidated balance sheets. All amounts exclude intercompany balances, which have been eliminated upon consolidation. The assets of the trusts can only be used to settle the obligations of the trusts and investors in the notes issued by a trust only have recourse to the assets of such trust and do not have recourse to the assets of AHFC, HCFI, or our other subsidiaries or to other trusts.
December 31, 2018 | March 31, 2018 | |||||||
(U.S. dollars in millions) | ||||||||
Assets: | ||||||||
Finance receivables | $ | 9,280 | $ | 9,112 | ||||
Unamortized costs and subsidy income, net | (254 | ) | (203 | ) | ||||
Allowance for credit losses | (14 | ) | (14 | ) | ||||
Finance receivables, net | 9,012 | 8,895 | ||||||
Vehicles held for disposition | 4 | 4 | ||||||
Restricted cash (1) | 557 | 443 | ||||||
Accrued interest receivable (1) | 9 | 9 | ||||||
Total assets | $ | 9,582 | $ | 9,351 | ||||
Liabilities: | ||||||||
Secured debt | $ | 8,719 | $ | 8,745 | ||||
Unamortized discounts and fees | (13 | ) | (12 | ) | ||||
Secured debt, net | 8,706 | 8,733 | ||||||
Accrued interest expense | 8 | 6 | ||||||
Total liabilities | $ | 8,714 | $ | 8,739 |
(i) | Included with other assets in the Company’s consolidated balance sheets (Note 10). |
In their role as servicers, AHFC and HCFI collect principal and interest payments on the underlying receivables on behalf of the securitization trusts. Cash collected during a calendar month is required to be remitted to the trusts in the following month. AHFC and HCFI are not restricted from using the cash collected for their general purposes prior to the remittance to the trusts. As of December 31, 2018 and March 31, 2018, AHFC and HCFI had combined cash collections of $415 million and $466 million, respectively, which were required to be remitted to the trusts.
21
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
(10) Other Assets
Other assets consisted of the following:
December 31, 2018 | March 31, 2018 | |||||||
(U.S. dollars in millions) | ||||||||
Interest receivable and other assets | $ | 103 | $ | 84 | ||||
Other receivables | 124 | 144 | ||||||
Deferred expense | 120 | 122 | ||||||
Software, net of accumulated amortization of $151 and $146 as of December 31, 2018 and March 31, 2018, respectively | 29 | 33 | ||||||
Property and equipment, net of accumulated depreciation of $21 and $20 as of December 31, 2018 and March 31, 2018, respectively | 5 | 6 | ||||||
Restricted cash | 557 | 443 | ||||||
Other miscellaneous assets | 98 | 102 | ||||||
Total | $ | 1,036 | $ | 934 |
Depreciation and amortization are computed on a straight-line basis over the estimated useful lives of the related assets, which range from 3 to 5 years. General and administrative expenses include depreciation and amortization expense of $3 million for both the three months ended December 31, 2018 and 2017, and $9 million and $8 million for the nine months ended December 31, 2018 and 2017, respectively.
(11) Other Liabilities
Other liabilities consisted of the following:
December 31, 2018 | March 31, 2018 | |||||||
(U.S. dollars in millions) | ||||||||
Dealer payables | $ | 167 | $ | 174 | ||||
Accounts payable and accrued expenses | 363 | 363 | ||||||
Lease security deposits | 82 | 78 | ||||||
VSC unearned administrative fees (Note 6) | 393 | 396 | ||||||
Unearned income, operating lease | 350 | 347 | ||||||
Uncertain tax positions | 43 | 10 | ||||||
Other liabilities | 16 | 14 | ||||||
Total | $ | 1,414 | $ | 1,382 |
22
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
(12) Other Income, net
Other income consisted of the following:
Three months ended December 31, | Nine months ended December 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
(U.S. dollars in millions) | ||||||||||||||||
VSC administration (Note 6) | $ | 28 | $ | 28 | $ | 82 | $ | 81 | ||||||||
Other, net | (9 | ) | (14 | ) | (31 | ) | (40 | ) | ||||||||
Total | $ | 19 | $ | 14 | $ | 51 | $ | 41 |
(13) Fair Value Measurements
Fair value is defined 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. The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Level 1 inputs are quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are those other than quoted prices included within Level 1 that are observable for the asset or liability. Level 3 inputs are unobservable inputs for the asset or liability. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Nonperformance risk is also required to be reflected in the fair value measurement, including an entity’s own credit standing when measuring the fair value of a liability.
23
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
Recurring Fair Value Measurements
The following tables summarize the fair value hierarchy of assets and liabilities measured at fair value on a recurring basis:
December 31, 2018 | ||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||
(U.S. dollars in millions) | ||||||||||||
Assets: | ||||||||||||
Derivative instruments: | ||||||||||||
Interest rate swaps | — | 357 | — | 357 | ||||||||
Cross currency swaps | — | 98 | — | 98 | ||||||||
Total assets | — | 455 | — | 455 | ||||||||
Liabilities: | ||||||||||||
Derivative instruments: | ||||||||||||
Interest rate swaps | — | 270 | — | 270 | ||||||||
Cross currency swaps | — | 231 | — | 231 | ||||||||
Total liabilities | — | 501 | — | 501 | ||||||||
March 31, 2018 | ||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||
(U.S. dollars in millions) | ||||||||||||
Assets: | ||||||||||||
Derivative instruments: | ||||||||||||
Interest rate swaps | — | 465 | — | 465 | ||||||||
Cross currency swaps | — | 285 | — | 285 | ||||||||
Total assets | — | 750 | — | 750 | ||||||||
Liabilities: | ||||||||||||
Derivative instruments: | ||||||||||||
Interest rate swaps | — | 342 | — | 342 | ||||||||
Cross currency swaps | — | 72 | — | 72 | ||||||||
Total liabilities | — | 414 | — | 414 |
The valuation techniques used in measuring assets and liabilities at fair value on a recurring basis are described below:
Derivative Instruments
The Company’s derivatives are transacted in over-the-counter markets and quoted market prices are not readily available. The Company uses third-party developed valuation models to value derivative instruments. These models estimate fair values using discounted cash flow modeling techniques, which utilize the contractual terms of the derivative instruments and market-based inputs, including interest rates and foreign exchange rates. Discount rates incorporate counterparty and HMC specific credit default spreads to reflect nonperformance risk.
The Company’s derivative instruments are classified as Level 2 since all significant inputs are observable and do not require management judgment. There were no transfers between fair value hierarchy levels during the nine months ended December 31, 2018 and 2017. Refer to Note 5 for additional information on derivative instruments.
24
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
Nonrecurring Fair Value Measurements
The following tables summarize nonrecurring fair value measurements recognized for assets still held at the end of the reporting periods presented:
Level 1 | Level 2 | Level 3 | Total | Lower-of-cost or fair value adjustment | |||||||||||
(U.S. dollars in millions) | |||||||||||||||
December 31, 2018 | |||||||||||||||
Vehicles held for disposition | — | — | 156 | 156 | 32 | ||||||||||
December 31, 2017 | |||||||||||||||
Vehicles held for disposition | — | — | 177 | 177 | 33 |
The following describes the methodologies and assumptions used in nonrecurring fair value measurements, which relate to the application of lower of cost or fair value accounting on long-lived assets.
Vehicles Held for Disposition
Vehicles held for disposition consist of returned and repossessed vehicles. They are valued at the lower of their carrying value or estimated fair value, less estimated disposition costs. The fair value is based on current average selling prices of like vehicles at wholesale used vehicle auctions.
Fair Value of Financial Instruments
The following tables summarize the carrying values and fair values of the Company’s financial instruments except for those measured at fair value on a recurring basis. Certain financial instruments and all nonfinancial assets and liabilities are excluded from fair value disclosure requirements including the Company’s direct financing lease receivables and investment in operating leases.
25
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
December 31, 2018 | ||||||||||||||||||||
Carrying | Fair value | |||||||||||||||||||
value | Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||
(U.S. dollars in millions) | ||||||||||||||||||||
Assets: | ||||||||||||||||||||
Cash and cash equivalents | $ | 811 | $ | 811 | $ | — | $ | — | $ | 811 | ||||||||||
Dealer loans, net | 5,443 | — | — | 5,170 | 5,170 | |||||||||||||||
Retail loans, net | 34,021 | — | — | 34,028 | 34,028 | |||||||||||||||
Restricted cash | 557 | 557 | — | — | 557 | |||||||||||||||
Liabilities: | ||||||||||||||||||||
Commercial paper | $ | 6,165 | $ | — | $ | 6,165 | $ | — | $ | 6,165 | ||||||||||
Related party debt | 733 | — | 733 | — | 733 | |||||||||||||||
Bank loans | 4,939 | — | 4,956 | — | 4,956 | |||||||||||||||
Medium term note programs | 24,669 | — | 24,568 | — | 24,568 | |||||||||||||||
Other debt | 3,366 | — | 3,341 | — | 3,341 | |||||||||||||||
Secured debt | 8,706 | — | 8,684 | — | 8,684 | |||||||||||||||
March 31, 2018 | ||||||||||||||||||||
Carrying | Fair value | |||||||||||||||||||
value | Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||
(U.S. dollars in millions) | ||||||||||||||||||||
Assets: | ||||||||||||||||||||
Cash and cash equivalents | $ | 783 | $ | 783 | $ | — | $ | — | $ | 783 | ||||||||||
Dealer loans, net | 5,495 | — | — | 5,299 | 5,299 | |||||||||||||||
Retail loans, net | 32,320 | — | — | 32,295 | 32,295 | |||||||||||||||
Restricted cash | 443 | 443 | — | — | 443 | |||||||||||||||
Liabilities: | ||||||||||||||||||||
Commercial paper | $ | 5,167 | $ | — | $ | 5,167 | $ | — | $ | 5,167 | ||||||||||
Related party debt | 1,085 | — | 1,085 | — | 1,085 | |||||||||||||||
Bank loans | 5,419 | — | 5,480 | — | 5,480 | |||||||||||||||
Medium term note programs | 24,207 | — | 24,176 | — | 24,176 | |||||||||||||||
Other debt | 3,250 | — | 3,229 | — | 3,229 | |||||||||||||||
Secured debt | 8,733 | — | 8,683 | — | 8,683 |
Fair value information presented in the tables above is based on information available at December 31, 2018 and March 31, 2018. Although the Company is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been updated since those dates, and therefore, the current estimates of fair value at dates subsequent to those dates may differ significantly from the amounts presented herein.
26
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
(14) Segment Information
The Company’s reportable segments are based on the two geographic regions where operating results are measured and evaluated by management: the United States and Canada.
Segment performance is evaluated using an internal measurement basis, which differs from the Company’s consolidated results prepared in accordance with GAAP. Segment performance is evaluated on a pre-tax basis before the effect of valuation adjustments on derivative instruments and revaluations of foreign currency denominated debt. Since the Company does not elect to apply hedge accounting, the impact to earnings resulting from these valuation adjustments as reported under GAAP is not representative of segment performance as evaluated by management. Realized gains and losses on derivative instruments, net of realized gains and losses on foreign currency denominated debt, are included in the measure of net revenues when evaluating segment performance.
No adjustments are made to segment performance to allocate any revenues or expenses. Financing products offered throughout the United States and Canada are substantially similar. Segment revenues from the various financing products are reported on the same basis as GAAP consolidated results.
Financial information for the three and nine months ended December 31, 2018 and 2017 is summarized in the following tables:
27
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
United States | Canada | Valuation adjustments and reclassifications | Consolidated Total | |||||||||||||
(U.S. dollars in millions) | ||||||||||||||||
Three months ended December 31, 2018 | ||||||||||||||||
Revenues: | ||||||||||||||||
Direct financing leases | $ | — | $ | — | $ | — | $ | — | ||||||||
Retail | 363 | 52 | — | 415 | ||||||||||||
Dealer | 54 | 5 | — | 59 | ||||||||||||
Operating leases | 1,507 | 319 | — | 1,826 | ||||||||||||
Total revenues | 1,924 | 376 | — | 2,300 | ||||||||||||
Depreciation on operating leases | 1,120 | 256 | — | 1,376 | ||||||||||||
Interest expense | 258 | 45 | — | 303 | ||||||||||||
Realized (gains)/losses on derivatives and foreign currency denominated debt | 9 | (5 | ) | (4 | ) | — | ||||||||||
Net revenues | 537 | 80 | 4 | 621 | ||||||||||||
Gain on disposition of lease vehicles | 16 | 8 | — | 24 | ||||||||||||
Other income | 18 | 1 | — | 19 | ||||||||||||
Total net revenues | 571 | 89 | 4 | 664 | ||||||||||||
Expenses: | ||||||||||||||||
General and administrative expenses | 97 | 12 | — | 109 | ||||||||||||
Provision for credit losses | 74 | 1 | — | 75 | ||||||||||||
Early termination loss on operating leases | 21 | 1 | — | 22 | ||||||||||||
(Gain)/Loss on derivative instruments | — | — | 106 | 106 | ||||||||||||
(Gain)/Loss on foreign currency revaluation of debt | — | — | (63 | ) | (63 | ) | ||||||||||
Income before income taxes | $ | 379 | $ | 75 | $ | (39 | ) | $ | 415 | |||||||
Nine months ended December 31, 2018 | ||||||||||||||||
Revenues: | ||||||||||||||||
Direct financing leases | $ | — | $ | 3 | $ | — | $ | 3 | ||||||||
Retail | 1,035 | 154 | — | 1,189 | ||||||||||||
Dealer | 154 | 15 | — | 169 | ||||||||||||
Operating leases | 4,460 | 931 | — | 5,391 | ||||||||||||
Total revenues | 5,649 | 1,103 | — | 6,752 | ||||||||||||
Depreciation on operating leases | 3,365 | 747 | — | 4,112 | ||||||||||||
Interest expense | 742 | 128 | — | 870 | ||||||||||||
Realized (gains)/losses on derivatives and foreign currency denominated debt | 9 | (12 | ) | 3 | — | |||||||||||
Net revenues | 1,533 | 240 | (3 | ) | 1,770 | |||||||||||
Gain on disposition of lease vehicles | 93 | 25 | — | 118 | ||||||||||||
Other income | 45 | 6 | — | 51 | ||||||||||||
Total net revenues | 1,671 | 271 | (3 | ) | 1,939 | |||||||||||
Expenses: | ||||||||||||||||
General and administrative expenses | 299 | 39 | — | 338 | ||||||||||||
Provision for credit losses | 176 | 5 | — | 181 | ||||||||||||
Early termination loss on operating leases | 75 | 3 | — | 78 | ||||||||||||
(Gain)/Loss on derivative instruments | — | — | 416 | 416 | ||||||||||||
(Gain)/Loss on foreign currency revaluation of debt | — | — | (337 | ) | (337 | ) | ||||||||||
Income before income taxes | $ | 1,121 | $ | 224 | $ | (82 | ) | $ | 1,263 | |||||||
December 31, 2018 | ||||||||||||||||
Finance receivables, net | $ | 35,201 | $ | 4,303 | $ | — | $ | 39,504 | ||||||||
Investment in operating leases, net | 27,189 | 5,004 | — | 32,193 | ||||||||||||
Total assets | 64,900 | 9,469 | — | 74,369 |
28
AMERICAN HONDA FINANCE CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
United States | Canada | Valuation adjustments and reclassifications | Consolidated Total | |||||||||
(U.S. dollars in millions) | ||||||||||||
Three months ended December 31, 2017 | ||||||||||||
Revenues: | ||||||||||||
Direct financing leases | — | 3 | — | 3 | ||||||||
Retail | 304 | 49 | — | 353 | ||||||||
Dealer | 39 | 5 | — | 44 | ||||||||
Operating leases | 1,461 | 279 | — | 1,740 | ||||||||
Total revenues | 1,804 | 336 | — | 2,140 | ||||||||
Depreciation on operating leases | 1,149 | 229 | — | 1,378 | ||||||||
Interest expense | 194 | 35 | — | 229 | ||||||||
Realized (gains)/losses on derivatives and foreign currency denominated debt | (1 | ) | (2 | ) | 3 | — | ||||||
Net revenues | 462 | 74 | (3 | ) | 533 | |||||||
Gain on disposition of lease vehicles | 2 | 6 | — | 8 | ||||||||
Other income | 12 | 2 | — | 14 | ||||||||
Total net revenues | 476 | 82 | (3 | ) | 555 | |||||||
Expenses: | ||||||||||||
General and administrative expenses | 92 | 14 | — | 106 | ||||||||
Provision for credit losses | 62 | 3 | — | 65 | ||||||||
Early termination loss on operating leases | 21 | 1 | — | 22 | ||||||||
Loss on lease residual values | — | 1 | — | 1 | ||||||||
(Gain)/Loss on derivative instruments | — | — | (62 | ) | (62 | ) | ||||||
(Gain)/Loss on foreign currency revaluation of debt | — | — | 53 | 53 | ||||||||
Income before income taxes | 301 | 63 | 6 | 370 | ||||||||
Nine months ended December 31, 2017 | ||||||||||||
Revenues: | ||||||||||||
Direct financing leases | — | 11 | — | 11 | ||||||||
Retail | 871 | 139 | — | 1,010 | ||||||||
Dealer | 115 | 13 | — | 128 | ||||||||
Operating leases | 4,359 | 784 | — | 5,143 | ||||||||
Total revenues | 5,345 | 947 | — | 6,292 | ||||||||
Depreciation on operating leases | 3,441 | 646 | — | 4,087 | ||||||||
Interest expense | 561 | 90 | — | 651 | ||||||||
Realized (gains)/losses on derivatives and foreign currency denominated debt | (11 | ) | 2 | 9 | — | |||||||
Net revenues | 1,354 | 209 | (9 | ) | 1,554 | |||||||
Gain on disposition of lease vehicles | 50 | 21 | — | 71 | ||||||||
Other income | 36 | 5 | — | 41 | ||||||||
Total net revenues | 1,440 | 235 | (9 | ) | 1,666 | |||||||
Expenses: | ||||||||||||
General and administrative expenses | 283 | 42 | — | 325 | ||||||||
Provision for credit losses | 182 | 5 | — | 187 | ||||||||
Early termination loss on operating leases | 78 | 3 | — | 81 | ||||||||
Loss on lease residual values | — | 2 | — | 2 | ||||||||
(Gain)/Loss on derivative instruments | — | — | (436 | ) | (436 | ) | ||||||
(Gain)/Loss on foreign currency revaluation of debt | — | — | 384 | 384 | ||||||||
Income before income taxes | 897 | 183 | 43 | 1,123 | ||||||||
December 31, 2017 | ||||||||||||
Finance receivables, net | 32,851 | 4,781 | — | 37,632 | ||||||||
Investment in operating leases, net | 27,367 | 4,852 | — | 32,219 | ||||||||
Total assets | 62,892 | 9,822 | — | 72,714 |
29
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Our primary focus, in collaboration with AHM and HCI, is to provide support for the sale of Honda and Acura products and maintain customer and dealer satisfaction and loyalty. To deliver this support effectively, we seek to maintain competitive cost of funds, efficient operations, and effective risk and compliance management. The primary factors influencing our results of operations, cash flows, and financial condition include the volume of Honda and Acura sales and the portion of those sales that we finance, our cost of funds, competition from other financial institutions, consumer credit defaults, and used motor vehicle prices.
A substantial portion of our consumer financing business is acquired through incentive financing programs sponsored by AHM and HCI. The volume of these incentive financing programs and the allocation of those programs between retail loans and leases may vary from fiscal period to fiscal period depending upon the respective marketing strategies of AHM and HCI. AHM and HCI’s marketing strategies are based in part on their business planning and control, in which we do not participate. Therefore, we cannot predict the level of incentive financing programs AHM and HCI may sponsor in the future. Our consumer financing acquisition volumes are substantially dependent on the extent to which incentive financing programs are offered. Increases in incentive financing programs generally increase our financing penetration rates, which typically results in increased financing acquisition volumes for us. The amount of subsidy payments we receive from AHM and HCI is dependent on the terms of the incentive financing programs and the interest rate environment. Subsidy payments are received upon acquisition and recognized in revenue throughout the life of the loan or lease; therefore, a significant change in the level of incentive financing programs in a fiscal period typically only has a limited impact on our results of operations for that period. The amount of subsidy income we recognize in a fiscal period is dependent on the cumulative level of subsidized contracts outstanding that were acquired through incentive financing programs.
We seek to maintain high quality consumer and dealer account portfolios, which we support with strong underwriting standards, risk-based pricing, and effective collection practices. Our cost of funds is facilitated by the diversity of our funding sources, and effective interest rate and foreign currency exchange risk management. We manage expenses to support our profitability, including adjusting staffing needs based upon our business volumes and centralizing certain functions. Additionally, we use risk and compliance management practices to optimize credit and residual value risk levels and maintain compliance with our pricing, underwriting and servicing policies at the United States, Canadian, state and provincial levels.
In our business operations, we incur costs related to funding, credit loss, residual value loss, and general and administrative expenses, among other expenses.
We analyze our operations in two business segments defined by geography: the United States and Canada. We measure the performance of our United States and Canada segments on a pre-tax basis before the effect of valuation adjustments on derivative instruments and revaluations of foreign currency denominated debt. For additional information regarding our segments, see Note 14—Segment Information of Notes to Consolidated Financial Statements. The following tables and the related discussion are presented based on our geographically segmented consolidated financial statements.
References in this report to our “fiscal year 2019” and “fiscal year 2018” refer to our fiscal year ending March 31, 2019 and our fiscal year ended March 31, 2018, respectively.
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Results of Operations
The following table presents our income before income taxes:
Three months ended December 31, | Nine months ended December 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
(U.S. dollars in millions) | ||||||||||||||||
Income before income taxes: | ||||||||||||||||
United States segment | $ | 352 | $ | 309 | $ | 1,051 | $ | 900 | ||||||||
Canada segment | 63 | 61 | 212 | 223 | ||||||||||||
Total income before income taxes | $ | 415 | $ | 370 | $ | 1,263 | $ | 1,123 |
Comparison of the Three Months Ended December 31, 2018 and 2017
Our consolidated income before income taxes was $415 million during the third quarter of fiscal year 2019 compared to $370 million during the same period in fiscal year 2018. This increase of $45 million, or 12%, was due to the following differences:
Three months ended December 31, | |||||||||||||||
2018 | 2017 | Difference | % Change | ||||||||||||
(U.S. dollars in millions) | |||||||||||||||
Net revenues: | |||||||||||||||
Retail | $ | 415 | $ | 353 | $ | 62 | 18 | % | |||||||
Dealer | 59 | 44 | 15 | 34 | % | ||||||||||
Operating lease, net of depreciation | 450 | 362 | 88 | 24 | % | ||||||||||
Interest expense | (303 | ) | (229 | ) | (74 | ) | 32 | % | |||||||
Gain on disposition of lease vehicles | 24 | 8 | 16 | 200 | % | ||||||||||
Other | 19 | 17 | 2 | 12 | % | ||||||||||
Total net revenues | 664 | 555 | 109 | 20 | % | ||||||||||
Expenses: | |||||||||||||||
(Gain)/Loss on derivative instruments | 106 | (62 | ) | 168 | n/m | ||||||||||
(Gain)/Loss on foreign currency revaluation of debt | (63 | ) | 53 | (116 | ) | n/m | |||||||||
Other | 206 | 194 | 12 | 6 | % | ||||||||||
Total expenses | 249 | 185 | 64 | 35 | % | ||||||||||
Total income before income taxes | $ | 415 | $ | 370 | $ | 45 | 12 | % |
n/m = not meaningful
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Comparison of the Nine Months Ended December 31, 2018 and 2017
Our consolidated income before income taxes was $1,263 million during the first nine months of fiscal year 2019 compared to $1,123 million during the same period in fiscal year 2018. This increase of $140 million, or 12%, was due to the following differences:
Nine months ended December 31, | |||||||||||||||
2018 | 2017 | Difference | % Change | ||||||||||||
(U.S. dollars in millions) | |||||||||||||||
Net revenues: | |||||||||||||||
Retail | $ | 1,189 | $ | 1,010 | $ | 179 | 18 | % | |||||||
Dealer | 169 | 128 | 41 | 32 | % | ||||||||||
Operating lease, net of depreciation | 1,279 | 1,056 | 223 | 21 | % | ||||||||||
Interest expense | (870 | ) | (651 | ) | (219 | ) | 34 | % | |||||||
Gain on disposition of lease vehicles | 118 | 71 | 47 | 66 | % | ||||||||||
Other | 54 | 52 | 2 | 4 | % | ||||||||||
Total net revenues | 1,939 | 1,666 | 273 | 15 | % | ||||||||||
Expenses: | |||||||||||||||
(Gain)/Loss on derivative instruments | 416 | (436 | ) | 852 | n/m | ||||||||||
(Gain)/Loss on foreign currency revaluation of debt | (337 | ) | 384 | (721 | ) | n/m | |||||||||
Other | 597 | 595 | 2 | — | % | ||||||||||
Total expenses | 676 | 543 | 133 | 24 | % | ||||||||||
Total income before income taxes | $ | 1,263 | $ | 1,123 | $ | 140 | 12 | % |
n/m = not meaningful
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Segment Results—Comparison of the Three Months Ended December 31, 2018 and 2017
Results of operations for the United States segment and the Canada segment are summarized below:
United States Segment | Canada Segment | Consolidated | ||||||||||||||||||||||
Three months ended December 31, | Three months ended December 31, | Three months ended December 31, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||
(U.S. dollars in millions) | ||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||
Direct financing leases | $ | — | $ | — | $ | — | $ | 3 | $ | — | $ | 3 | ||||||||||||
Retail | 363 | 304 | 52 | 49 | 415 | 353 | ||||||||||||||||||
Dealer | 54 | 39 | 5 | 5 | 59 | 44 | ||||||||||||||||||
Operating leases | 1,507 | 1,461 | 319 | 279 | 1,826 | 1,740 | ||||||||||||||||||
Total revenues | 1,924 | 1,804 | 376 | 336 | 2,300 | 2,140 | ||||||||||||||||||
Depreciation on operating leases | 1,120 | 1,149 | 256 | 229 | 1,376 | 1,378 | ||||||||||||||||||
Interest expense | 258 | 194 | 45 | 35 | 303 | 229 | ||||||||||||||||||
Net revenues | 546 | 461 | 75 | 72 | 621 | 533 | ||||||||||||||||||
Gain on disposition of lease vehicles | 16 | 2 | 8 | 6 | 24 | 8 | ||||||||||||||||||
Other income | 18 | 12 | 1 | 2 | 19 | 14 | ||||||||||||||||||
Total net revenues | 580 | 475 | 84 | 80 | 664 | 555 | ||||||||||||||||||
Expenses: | ||||||||||||||||||||||||
General and administrative expenses | 97 | 92 | 12 | 14 | 109 | 106 | ||||||||||||||||||
Provision for credit losses | 74 | 62 | 1 | 3 | 75 | 65 | ||||||||||||||||||
Early termination loss on operating leases | 21 | 21 | 1 | 1 | 22 | 22 | ||||||||||||||||||
Loss on lease residual values | — | — | — | 1 | — | 1 | ||||||||||||||||||
(Gain)/Loss on derivative instruments | 99 | (62 | ) | 7 | — | 106 | (62 | ) | ||||||||||||||||
(Gain)/Loss on foreign currency revaluation of debt | (63 | ) | 53 | — | — | (63 | ) | 53 | ||||||||||||||||
Income before income taxes | $ | 352 | $ | 309 | $ | 63 | $ | 61 | $ | 415 | $ | 370 |
Revenues
Revenue from retail loans in the United States segment increased by $59 million, or 19%, during the third quarter of fiscal year 2019 compared to the same period in fiscal year 2018. The increase in revenue was attributable to higher yields due to the rising interest rate environment and the increase in volume of retail loans with longer terms which typically have higher interest rates, and higher average outstanding balances. Revenue from retail loans in the Canada segment increased by $3 million, or 6%, during the third quarter of fiscal year 2019 compared to the same period in fiscal year 2018. The increase in revenue was attributable to higher yields due to the rising interest rate environment.
Operating lease revenue in the United States segment increased by $46 million, or 3%, during the third quarter of fiscal year 2019 compared to the same period in fiscal year 2018. The increase was attributable to higher net revenue on more recently acquired operating lease assets due to the rising interest rate environment. Operating lease revenue in the Canada segment increased by $40 million, or 14%, during the third quarter of fiscal year 2019 compared to the same period in fiscal year 2018. The increase in revenue was attributable to higher net revenue on more recently acquired operating lease assets due to the rising interest rate environment and higher average outstanding operating lease assets.
Direct financing lease revenue, which is generated only in Canada, declined by $3 million, or 100%, during the third quarter of fiscal year 2019 compared to the same period in fiscal year 2018 due to the run-off of direct financing lease assets.
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Revenue from dealer loans in the United States segment increased by $15 million, or 38%, during the third quarter of fiscal year 2019 compared to the same period in fiscal year 2018. The increase was primarily attributable to higher yields due to the rising interest rate environment and higher average outstanding balances. Revenue from dealer loans in the Canada segment was flat compared to the same period in fiscal year 2018.
Consolidated subsidy income from AHM and HCI sponsored incentive programs increased by $45 million, or 12%, to $414 million during the third quarter of fiscal year 2019 compared to $369 million during the same period in fiscal year 2018 primarily due to the increase in average subsidy payments received. As a result of the rising interest rate environment, the average amount of subsidy payments necessary for us to realize market yields on incentive programs has also been rising.
Depreciation on operating leases
Depreciation on operating leases in the United States segment decreased by $29 million, or 3%, during the third quarter of fiscal year 2019 compared to the same period in fiscal year 2018. The decrease in depreciation was primarily due to improvements in expected used vehicle values during the third quarter of fiscal year 2019 as compared to the same period in fiscal year 2018. Depreciation on operating lease assets in the Canada segment increased by $27 million, or 12%, due to higher average outstanding operating lease assets.
Operating lease revenue, net of depreciation in the United States segment increased by $75 million, or 24%, during the third quarter of fiscal year 2019 compared to the same period in fiscal year 2018. The increase in operating lease revenue, net of depreciation was attributable to higher net revenue on more recently acquired operating lease assets due to the rising interest rate environment and a decrease in depreciation due to improvements in expected used vehicle values. Operating lease revenue, net of depreciation in the Canada segment increased by $13 million, or 26%, during the third quarter of fiscal year 2019 compared to the same period in fiscal year 2018. The increase in operating lease revenue, net of depreciation was attributable to higher net revenue on more recently acquired operating lease assets due to the rising interest rate environment and higher average outstanding operating lease assets.
Interest expense
Interest expense in the United States segment increased by $64 million, or 33%, during the third quarter of fiscal year 2019 compared to the same period in fiscal year 2018 primarily due to higher average interest rates and an increase in average outstanding debt. Interest expense in the Canada segment increased by $10 million, or 29%, due to higher average interest rates. See “—Liquidity and Capital Resources” below for more information.
Gain on disposition of lease vehicles
The gain on disposition of lease vehicles in the United States segment increased by $14 million during the third quarter of fiscal year 2019 compared to the same period in fiscal year 2018. The gain on disposition of lease vehicles in the Canada segment increased by $2 million, or 33%. The increases in gains for both segments were primarily the result of a higher volume of units with more favorable disposition proceeds than the assumptions that were reflected in their estimated residual values including, with respect to the United States segment, proceeds from AHM sponsored lease termination programs. See “—Financial Condition—Lease Residual Value Risk” below for more information.
Provision for credit losses
The provision for credit losses in the United States segment increased by $12 million, or 19%, during the third quarter of fiscal year 2019 compared to the same period in fiscal year 2018 primarily due to an increase in the provision for impaired dealer loans. The provision for credit losses in the Canada segment decreased by $2 million, or 67% during the third quarter of fiscal year 2019 compared to the same period in fiscal year 2018. The decrease in the provision was due to the decline in charge-offs and reduction in the allowance for credit losses to reflect improving credit performance. See “—Financial Condition—Credit Risk” below for more information.
Early termination loss on operating leases
Early termination losses on operating leases in both the United States and Canada segments were flat during the third quarter of fiscal year 2019 compared to the same period in fiscal year 2018. See “—Financial Condition—Credit Risk” below for more information.
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Gain/loss on derivative instruments
In the United States segment, we recognized a loss on derivative instruments of $99 million during the third quarter of fiscal year 2019 compared to a gain of $62 million during the same period in fiscal year 2018. The loss in the third quarter of fiscal year 2019 was attributable to a loss on pay fixed interest rate swaps of $162 million and cross currency swaps of $81 million, partially offset by gains on pay float interest rate swaps of $144 million. The loss on cross currency swaps during the third quarter of fiscal year 2019 was primarily attributable to the U.S. dollar strengthening against the Euro and Sterling during the period. The losses on pay fixed interest rate swaps and gains on pay float interest rate swaps during the third quarter of fiscal year 2019 were primarily due to the decrease in applicable swap rates during the period. In the Canada segment, we recognized a loss on derivative instruments of $7 million during the third quarter of fiscal year 2019 compared to a gain of less than $1 million during the same period in fiscal year 2018. The loss in the third quarter of fiscal year 2019 was due to a decline in applicable swap rates during the period. See “—Derivatives” below for more information.
Gain/loss on foreign currency revaluation of debt
In the United States segment, we recognized a gain on the revaluation of foreign currency denominated debt of $63 million during the third quarter of fiscal year 2019 compared to a loss of $53 million during the same period in fiscal year 2018. The gain during the third quarter of fiscal year 2019 was primarily due to the U.S. dollar strengthening against the Euro and Sterling during the period.
Income tax expense
The consolidated effective tax rate was 16.1% for the third quarter of fiscal year 2019 and (810.8)% for the same period in fiscal year 2018. The increase in the effective tax rate for the third quarter of fiscal year 2019 was primarily due to the impact of the U.S. federal corporate tax rate reduction from 35% to 21% recorded in fiscal year 2018, partially offset by the net effects of tax credits, uncertain tax positions, the adjustment to the Transition Tax and state taxes. For additional information regarding income taxes, see Note 7—Income Taxes of Notes to Consolidated Financial Statements (Unaudited).
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Segment Results—Comparison of the Nine Months Ended December 31, 2018 and 2017
Results of operations for the United States segment and the Canada segment are summarized below:
United States Segment | Canada Segment | Consolidated | ||||||||||||||||||||||
Nine months ended December 31, | Nine months ended December 31, | Nine months ended December 31, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||
(U.S. dollars in millions) | ||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||
Direct financing leases | $ | — | $ | — | $ | 3 | $ | 11 | $ | 3 | $ | 11 | ||||||||||||
Retail | 1,035 | 871 | 154 | 139 | 1,189 | 1,010 | ||||||||||||||||||
Dealer | 154 | 115 | 15 | 13 | 169 | 128 | ||||||||||||||||||
Operating leases | 4,460 | 4,359 | 931 | 784 | 5,391 | 5,143 | ||||||||||||||||||
Total revenues | 5,649 | 5,345 | 1,103 | 947 | 6,752 | 6,292 | ||||||||||||||||||
Depreciation on operating leases | 3,365 | 3,441 | 747 | 646 | 4,112 | 4,087 | ||||||||||||||||||
Interest expense | 742 | 561 | 128 | 90 | 870 | 651 | ||||||||||||||||||
Net revenues | 1,542 | 1,343 | 228 | 211 | 1,770 | 1,554 | ||||||||||||||||||
Gain on disposition of lease vehicles | 93 | 50 | 25 | 21 | 118 | 71 | ||||||||||||||||||
Other income | 45 | 36 | 6 | 5 | 51 | 41 | ||||||||||||||||||
Total net revenues | 1,680 | 1,429 | 259 | 237 | 1,939 | 1,666 | ||||||||||||||||||
Expenses: | ||||||||||||||||||||||||
General and administrative expenses | 299 | 283 | 39 | 42 | 338 | 325 | ||||||||||||||||||
Provision for credit losses | 176 | 182 | 5 | 5 | 181 | 187 | ||||||||||||||||||
Early termination loss on operating leases | 75 | 78 | 3 | 3 | 78 | 81 | ||||||||||||||||||
Loss on lease residual values | — | — | — | 2 | — | 2 | ||||||||||||||||||
(Gain)/Loss on derivative instruments | 416 | (398 | ) | — | (38 | ) | 416 | (436 | ) | |||||||||||||||
(Gain)/Loss on foreign currency revaluation of debt | (337 | ) | 384 | — | — | (337 | ) | 384 | ||||||||||||||||
Income before income taxes | $ | 1,051 | $ | 900 | $ | 212 | $ | 223 | $ | 1,263 | $ | 1,123 |
Revenues
Revenue from retail loans in the United States segment increased by $164 million, or 19%, during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018. The increase in revenue was attributable to higher yields due to the rising interest rate environment and the increase in volume of retail loans with longer terms which typically have higher interest rates, and higher average outstanding balances. Revenue from retail loans in the Canada segment increased by $15 million, or 11%, during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018. The increase in revenue was attributable to higher yields due to the rising interest rate environment and higher average outstanding balances.
Operating lease revenue in the United States segment increased by $101 million, or 2%, during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018. The increase was primarily attributable to higher net revenue on more recently acquired operating lease assets due to the rising interest rate environment. Operating lease revenue in the Canada segment increased by $147 million, or 19%, during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018. The increase in revenue was attributable to higher net revenue on more recently acquired operating lease assets due to the rising interest rate environment and higher average outstanding operating lease assets.
Direct financing lease revenue, which is generated only in Canada, declined by $8 million, or 73%, during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018 due to the run-off of direct financing lease assets.
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Revenue from dealer loans in the United States segment increased by $39 million, or 34%, during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018. The increase was primarily attributable to higher yields due to the rising interest rate environment and higher average outstanding balances. Revenue from dealer loans in the Canada segment increased by $2 million, or 15%, primarily due to higher yields and higher average outstanding balances.
Consolidated subsidy income from AHM and HCI sponsored incentive programs increased by $137 million, or 13%, to $1,204 million during the first nine months of fiscal year 2019 compared to $1,067 million during the same period in fiscal year 2018 primarily due to the increase in average subsidy payments received. As a result of the rising interest rate environment, the average amount of subsidy payments necessary for us to realize market yields on incentive programs has also been rising.
Depreciation on operating leases
Depreciation on operating leases in the United States segment decreased by $76 million, or 2%, during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018. The decrease in depreciation was primarily due to improvements in expected used vehicle values during the first nine months of fiscal year 2019 as compared to the same period in fiscal year 2018. Depreciation on operating lease assets in the Canada segment increased by $101 million, or 16%, due to higher average outstanding operating lease assets.
Operating lease revenue, net of depreciation in the United States segment increased by $177 million, or 19%, during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018. The increase in operating lease revenue, net of depreciation was attributable to higher net revenue on more recently acquired operating lease assets due to the rising interest rate environment and decrease in depreciation due to improvements in expected used vehicle values. Operating lease revenue, net of depreciation in the Canada segment increased by $46 million, or 33%, during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018. The increase in operating lease revenue, net of depreciation was attributable to higher net revenue on more recently acquired operating lease assets due to the rising interest rate environment and higher average outstanding operating lease assets.
Interest expense
Interest expense in the United States segment increased by 181 million, or 32%, during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018 primarily due to higher average interest rates and an increase in average outstanding debt. Interest expense in the Canada segment increased by $38 million, or 42%, due to higher average interest rates and the increase in average outstanding debt. See “—Liquidity and Capital Resources” below for more information.
Gain on disposition of lease vehicles
The gain on disposition of lease vehicles in the United States segment increased by $43 million, or 86%, during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018. The gain on disposition of lease vehicles in the Canada segment increased by $4 million, or 19%. The increases in gains for both segments were primarily the result of a higher volume of units with more favorable disposition proceeds than the assumptions that were reflected in their estimated residual values including, with respect to the United States segment, proceeds from AHM sponsored lease termination programs in the United States. See “—Financial Condition—Lease Residual Value Risk” below for more information.
Provision for credit losses
The provision for credit losses in the United States segment decreased by $6 million, or 3%, during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018 due to a smaller increase in the allowance for credit losses for retail loans during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018 which was partially offset by increases in the provision for past due operating lease rental payments and provision for impaired dealer loans. The provision for credit losses in the Canada segment were flat during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018. See “—Financial Condition—Credit Risk” below for more information.
Early termination loss on operating leases
Early termination losses on operating leases in the United States segment decreased by $3 million, or 4%, during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018 due to a smaller increase to estimated early termination losses during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018. Early termination losses on operating leases in the Canada segment were flat during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018. See “—Financial Condition—Credit Risk” below for more information.
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Gain/loss on derivative instruments
In the United States segment, we recognized a loss on derivative instruments of $416 million during the first nine months of fiscal year 2019 compared to a gain of $398 million during the same period in fiscal year 2018. The loss in the first nine months of fiscal year 2019 was attributable to a loss on cross currency swaps of $411 million and pay fixed interest rate swaps of $63 million, partially offset by gains on pay float interest rate swaps of $58 million. The loss on cross currency swaps during the first nine months of fiscal year 2019 was primarily attributable to the U.S. dollar strengthening against the Euro and Sterling during the period. The losses on pay fixed interest rate swaps and gains on pay float interest rate swaps during the first nine months of fiscal year 2019 were primarily due to the decrease in applicable swap rates during the period. In the Canada segment, we recognized a loss on derivative instruments of less than $1 million during the first nine months of fiscal year 2019 compared to a gain of $38 million during the same period in fiscal year 2018. The losses during fiscal year 2019 were due to the decrease in applicable swap rates during the period. See “—Derivatives” below for more information.
Gain/loss on foreign currency revaluation of debt
In the United States segment, we recognized a gain on the revaluation of foreign currency denominated debt of $337 million during the first nine months of fiscal year 2019 compared to a loss of $384 million during the same period in fiscal year 2018. The gain during the first nine months of fiscal year 2019 was primarily due to the U.S. dollar strengthening against the Euro and Sterling during the period.
Income tax expense
The consolidated effective tax rate was 25.3% for the first nine months of fiscal year 2019 and (241.9)% for the same period in fiscal year 2018. The increase in the effective tax rate for the first nine months of fiscal year 2019 was primarily due to the impact of the U.S. federal corporate tax rate reduction from 35% to 21% recorded in fiscal year 2018, partially offset by the net effects of tax credits, uncertain tax positions, the adjustment to the Transition Tax and state taxes. For additional information regarding income taxes, see Note 7—Income Taxes of Notes to Consolidated Financial Statements (Unaudited).
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Financial Condition
Consumer Financing
Consumer Financing Acquisition Volumes
The following table summarizes the number of retail loans and leases we acquired and the number of such loans and leases acquired through incentive financing programs sponsored by AHM and HCI:
Three months ended December 31, | Nine months ended December 31, | |||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||||||||||
Acquired | Sponsored (2) | Acquired | Sponsored (2) | Acquired | Sponsored (2) | Acquired | Sponsored (2) | |||||||||||||||||
(Units (1) in thousands) | ||||||||||||||||||||||||
United States Segment | ||||||||||||||||||||||||
Retail loans: | ||||||||||||||||||||||||
New auto | 109 | 70 | 126 | 77 | 362 | 237 | 371 | 249 | ||||||||||||||||
Used auto | 26 | 4 | 30 | 14 | 92 | 18 | 79 | 23 | ||||||||||||||||
Motorcycle | 17 | 1 | 19 | 2 | 54 | 4 | 58 | 8 | ||||||||||||||||
Other | — | — | — | — | 1 | — | 1 | — | ||||||||||||||||
Total retail loans | 152 | 75 | 175 | 93 | 509 | 259 | 509 | 280 | ||||||||||||||||
Leases | 105 | 91 | 102 | 74 | 356 | 315 | 353 | 289 | ||||||||||||||||
Canada Segment | ||||||||||||||||||||||||
Retail loans: | ||||||||||||||||||||||||
New auto | 15 | 14 | 17 | 17 | 52 | 51 | 59 | 58 | ||||||||||||||||
Used auto | 1 | — | 1 | 1 | 3 | 1 | 7 | 5 | ||||||||||||||||
Motorcycle | 1 | 1 | 2 | 1 | 6 | 5 | 7 | 6 | ||||||||||||||||
Total retail loans | 17 | 15 | 20 | 19 | 61 | 57 | 73 | 69 | ||||||||||||||||
Leases | 21 | 21 | 20 | 20 | 74 | 74 | 69 | 68 | ||||||||||||||||
Consolidated | ||||||||||||||||||||||||
Retail loans: | ||||||||||||||||||||||||
New auto | 124 | 84 | 143 | 94 | 414 | 288 | 430 | 307 | ||||||||||||||||
Used auto | 27 | 4 | 31 | 15 | 95 | 19 | 86 | 28 | ||||||||||||||||
Motorcycle | 18 | 2 | 21 | 3 | 60 | 9 | 65 | 14 | ||||||||||||||||
Other | — | — | — | — | 1 | — | 1 | — | ||||||||||||||||
Total retail loans | 169 | 90 | 195 | 112 | 570 | 316 | 582 | 349 | ||||||||||||||||
Leases | 126 | 112 | 122 | 94 | 430 | 389 | 422 | 357 |
(1) | A unit represents one retail loan or lease contract, as noted, that was originated in the United States and acquired by AHFC or its subsidiaries, or that was originated in Canada and acquired by HCFI, in each case during the period shown. |
(2) | Represents the number of retail loans and leases acquired through incentive financing programs sponsored by AHM and/or HCI and only those contracts with subsidy payments. Excludes contracts where contractual rates met or exceeded AHFC’s yield requirements and subsidy payments were not required. |
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Consumer Financing Penetration Rates
The following table summarizes the percentage of AHM and/or HCI sales of new automobiles and motorcycles that were financed with either retail loans or leases that we acquired:
Three months ended December 31, | Nine months ended December 31, | |||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||
United States Segment | ||||||||||||
New auto | 54 | % | 56 | % | 58 | % | 57 | % | ||||
Motorcycle | 36 | % | 38 | % | 36 | % | 38 | % | ||||
Canada Segment | ||||||||||||
New auto | 88 | % | 89 | % | 82 | % | 82 | % | ||||
Motorcycle | 31 | % | 35 | % | 31 | % | 33 | % | ||||
Consolidated | ||||||||||||
New auto | 57 | % | 59 | % | 60 | % | 60 | % | ||||
Motorcycle | 36 | % | 38 | % | 35 | % | 37 | % |
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Consumer Financing Asset Balances
The following table summarizes our outstanding retail loan and lease asset balances and units:
December 31, 2018 | March 31, 2018 | December 31, 2018 | March 31, 2018 | |||||||||||
(U.S. dollars in millions) | (Units (1) in thousands) | |||||||||||||
United States Segment | ||||||||||||||
Retail loans: | ||||||||||||||
New auto | $ | 24,814 | $ | 23,700 | 1,563 | 1,590 | ||||||||
Used auto | 4,332 | 3,685 | 306 | 268 | ||||||||||
Motorcycle | 1,083 | 1,028 | 196 | 193 | ||||||||||
Other | 50 | 46 | 4 | 4 | ||||||||||
Total retail loans | $ | 30,279 | $ | 28,459 | 2,069 | 2,055 | ||||||||
Securitized retail loans (2) | $ | 7,746 | $ | 7,633 | 666 | 691 | ||||||||
Investment in operating leases | $ | 27,189 | $ | 27,040 | 1,300 | 1,301 | ||||||||
Canada Segment | ||||||||||||||
Retail loans: | ||||||||||||||
New auto | $ | 3,417 | $ | 3,463 | 258 | 245 | ||||||||
Used auto | 236 | 309 | 30 | 36 | ||||||||||
Motorcycle | 86 | 86 | 20 | 19 | ||||||||||
Other | 3 | 3 | 2 | 2 | ||||||||||
Total retail loans | $ | 3,742 | $ | 3,861 | 310 | 302 | ||||||||
Securitized retail loans (2) | $ | 1,266 | $ | 1,262 | 97 | 89 | ||||||||
Direct financing leases | $ | 40 | $ | 141 | 5 | 15 | ||||||||
Investment in operating leases | $ | 5,004 | $ | 4,777 | 288 | 259 | ||||||||
Consolidated | ||||||||||||||
Retail loans: | ||||||||||||||
New auto | $ | 28,231 | $ | 27,163 | 1,821 | 1,835 | ||||||||
Used auto | 4,568 | 3,994 | 336 | 304 | ||||||||||
Motorcycle | 1,169 | 1,114 | 216 | 212 | ||||||||||
Other | 53 | 49 | 6 | 6 | ||||||||||
Total retail loans | $ | 34,021 | $ | 32,320 | 2,379 | 2,357 | ||||||||
Securitized retail loans (2) | $ | 9,012 | $ | 8,895 | 763 | 780 | ||||||||
Direct financing leases | $ | 40 | $ | 141 | 5 | 15 | ||||||||
Investment in operating leases | $ | 32,193 | $ | 31,817 | 1,588 | 1,560 |
(1) | A unit represents one retail loan or lease contract, as noted, that was outstanding as of the date shown. |
(2) | Securitized retail loans represent the portion of total retail loans that have been sold in securitization transactions but continue to be recognized on our balance sheet. Securitized retail loans are included in the amounts for total retail loans. |
In the United States segment, retail loan acquisition volumes were flat during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018. Lease acquisition volumes increased by 1% during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018 due to the increase in incentive program volumes.
In the Canada segment, retail loan acquisition volumes declined by 16% during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018 primarily due to decline in retail loan incentive volumes. Lease acquisition volumes increased by 7% during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018 due the increase in incentive program volumes. Outstanding direct financing lease assets continued to decline and operating lease assets continued to increase during the first nine months of fiscal year 2019 as the result of our remaining direct financing leases maturing and all newly acquired leases being classified as operating leases.
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Dealer Financing
Wholesale Flooring Financing Penetration Rates
The following table summarizes the number of dealerships with wholesale flooring financing agreements as a percentage of total Honda and Acura dealerships in the United States and/or Canada, as applicable:
December 31, 2018 | March 31, 2018 | |||||
United States Segment | ||||||
Automobile | 30 | % | 28 | % | ||
Motorcycle | 98 | % | 98 | % | ||
Other | 20 | % | 21 | % | ||
Canada Segment | ||||||
Automobile | 35 | % | 36 | % | ||
Motorcycle | 95 | % | 95 | % | ||
Other | 94 | % | 95 | % | ||
Consolidated | ||||||
Automobile | 31 | % | 30 | % | ||
Motorcycle | 97 | % | 97 | % | ||
Other | 23 | % | 23 | % |
Wholesale Flooring Financing Percentage of Sales
The following table summarizes the percentage of AHM unit sales in the United States and/or HCI unit sales in Canada, as applicable, that we financed through wholesale flooring loans with dealerships:
Three months ended December 31, | Nine months ended December 31, | |||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||
United States Segment | ||||||||||||
Automobile | 27 | % | 29 | % | 28 | % | 29 | % | ||||
Motorcycle | 98 | % | 98 | % | 98 | % | 98 | % | ||||
Other | 6 | % | 9 | % | 8 | % | 11 | % | ||||
Canada Segment | ||||||||||||
Automobile | 32 | % | 31 | % | 32 | % | 31 | % | ||||
Motorcycle | 94 | % | 96 | % | 92 | % | 94 | % | ||||
Other | 97 | % | 91 | % | 97 | % | 94 | % | ||||
Consolidated | ||||||||||||
Automobile | 28 | % | 29 | % | 28 | % | 29 | % | ||||
Motorcycle | 97 | % | 98 | % | 97 | % | 97 | % | ||||
Other | 8 | % | 12 | % | 12 | % | 14 | % |
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Dealer Financing Asset Balances
The following table summarizes our outstanding dealer financing asset balances and units:
December 31, 2018 | March 31, 2018 | December 31, 2018 | March 31, 2018 | |||||||||||
(U.S. dollars in millions) | (Units (1) in thousands) | |||||||||||||
United States Segment | ||||||||||||||
Wholesale flooring loans: | ||||||||||||||
Automobile | $ | 3,094 | $ | 3,075 | 110 | 113 | ||||||||
Motorcycle | 665 | 738 | 85 | 100 | ||||||||||
Other | 52 | 60 | 44 | 67 | ||||||||||
Total wholesale flooring loans | $ | 3,811 | $ | 3,873 | 239 | 280 | ||||||||
Commercial loans | $ | 1,111 | $ | 978 | ||||||||||
Canada Segment | ||||||||||||||
Wholesale flooring loans: | ||||||||||||||
Automobile | $ | 373 | $ | 452 | 15 | 18 | ||||||||
Motorcycle | 59 | 98 | 8 | 13 | ||||||||||
Other | 26 | 29 | 24 | 31 | ||||||||||
Total wholesale flooring loans | $ | 458 | $ | 579 | 47 | 62 | ||||||||
Commercial loans | $ | 63 | $ | 65 | ||||||||||
Consolidated | ||||||||||||||
Wholesale flooring loans: | ||||||||||||||
Automobile | $ | 3,467 | $ | 3,527 | 125 | 131 | ||||||||
Motorcycle | 724 | 836 | 93 | 113 | ||||||||||
Other | 78 | 89 | 68 | 98 | ||||||||||
Total wholesale flooring loans | $ | 4,269 | $ | 4,452 | 286 | 342 | ||||||||
Commercial loans | $ | 1,174 | $ | 1,043 |
(1) | A unit represents one automobile, motorcycle, power equipment, or marine engine, as applicable, financed through a wholesale flooring loan that was outstanding as of the date shown. |
Credit Risk
Credit losses are an expected cost of extending credit. The majority of our credit risk is in consumer financing and to a lesser extent in dealer financing. Credit risk of our portfolio of consumer finance receivables can be affected by general economic conditions. Adverse changes such as a rise in unemployment can increase the likelihood of defaults. Declines in used vehicle prices can reduce the amount of recoveries on repossessed collateral. We manage our exposure to credit risk in retail loans and direct financing leases by monitoring and adjusting our underwriting standards, which affect the level of credit risk that we assume, pricing contracts for expected losses, and focusing collection efforts to minimize losses.
We are also exposed to credit risk on our portfolio of operating lease assets. We expect a portion of our operating leases to terminate prior to their scheduled maturities when lessees default on their contractual obligations. Losses are generally realized upon the disposition of the repossessed operating lease vehicles. The factors affecting credit risk on our operating leases and our management of the risk are similar to that of our retail loans and direct financing leases.
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Credit risk on dealer loans is affected primarily by the financial strength of the dealers within the portfolio, the value of collateral securing the financings, and economic and market factors that could affect the creditworthiness of dealers. We manage our exposure to credit risk in dealer financing by performing comprehensive reviews of dealers prior to establishing financing arrangements and monitoring the payment performance and creditworthiness of these dealers on an ongoing basis. In the event of default by a dealer, we seek all available legal remedies pursuant to related dealer agreements, guarantees, security interests on collateral, or liens on dealership assets. Additionally, we have agreements with AHM and HCI that provide for their repurchase of new, unused, undamaged and unregistered vehicles or equipment that have been repossessed from dealers who defaulted under the terms of its wholesale flooring agreement.
An allowance for credit losses is maintained for management’s estimate of probable losses incurred on finance receivables. We also maintain an estimate for early termination losses on operating lease assets due to lessee defaults and an allowance for credit losses for estimated probable losses incurred on past due operating lease rental payments.
Additional information regarding credit losses is provided in the discussion of “—Critical Accounting Policies—Credit Losses” below.
The following table presents information with respect to our allowance for credit losses and credit loss experience of our finance receivables and losses related to lessee defaults on our operating leases:
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As of or for the three months ended December 31, | As of or for the nine months ended December 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
(U.S. dollars in millions) | ||||||||||||||||
United States Segment | ||||||||||||||||
Finance receivables: | ||||||||||||||||
Allowance for credit losses at beginning of period | $ | 184 | $ | 161 | $ | 173 | $ | 124 | ||||||||
Provision for credit losses | 64 | 54 | 146 | 159 | ||||||||||||
Charge-offs, net of recoveries | (58 | ) | (45 | ) | (129 | ) | (113 | ) | ||||||||
Allowance for credit losses at end of period | $ | 190 | $ | 170 | $ | 190 | $ | 170 | ||||||||
Allowance as a percentage of ending receivable balance (1) | 0.53 | % | 0.51 | % | ||||||||||||
Charge-offs as a percentage of average receivable balance (1), (4) | 0.65 | % | 0.54 | % | 0.49 | % | 0.46 | % | ||||||||
Delinquencies (60 or more days past due): | ||||||||||||||||
Delinquent amount (2) | $ | 133 | $ | 94 | ||||||||||||
As a percentage of ending receivable balance (1), (2) | 0.37 | % | 0.28 | % | ||||||||||||
Operating leases: | ||||||||||||||||
Early termination loss on operating leases | $ | 21 | $ | 21 | $ | 75 | $ | 78 | ||||||||
Provision for past due operating lease rental payments (3) | 10 | 8 | 30 | 23 | ||||||||||||
Canada Segment | ||||||||||||||||
Finance receivables: | ||||||||||||||||
Allowance for credit losses at beginning of period | $ | 7 | $ | 8 | $ | 6 | $ | 9 | ||||||||
Provision for credit losses | — | 2 | 4 | 4 | ||||||||||||
Charge-offs, net of recoveries | (1 | ) | (2 | ) | (4 | ) | (6 | ) | ||||||||
Effect of translation adjustment | — | — | — | 1 | ||||||||||||
Allowance for credit losses at end of period | $ | 6 | $ | 8 | $ | 6 | $ | 8 | ||||||||
Allowance as a percentage of ending receivable balance (1) | 0.14 | % | 0.16 | % | ||||||||||||
Charge-offs as a percentage of average receivable balance (1), (4) | 0.11 | % | 0.17 | % | 0.11 | % | 0.16 | % | ||||||||
Delinquencies (60 or more days past due): | ||||||||||||||||
Delinquent amount (2) | $ | 7 | $ | 9 | ||||||||||||
As a percentage of ending receivable balance (1), (2) | 0.15 | % | 0.18 | % | ||||||||||||
Operating leases: | ||||||||||||||||
Early termination loss on operating leases | $ | 1 | $ | 1 | $ | 3 | $ | 3 | ||||||||
Provision for past due operating lease rental payments (3) | 1 | 1 | 1 | 1 | ||||||||||||
Consolidated | ||||||||||||||||
Finance receivables: | ||||||||||||||||
Allowance for credit losses at beginning of period | $ | 191 | $ | 169 | $ | 179 | $ | 133 | ||||||||
Provision for credit losses | 64 | 56 | 150 | 163 | ||||||||||||
Charge-offs, net of recoveries | (59 | ) | (47 | ) | (133 | ) | (119 | ) | ||||||||
Effect of translation adjustment | — | — | — | 1 | ||||||||||||
Allowance for credit losses at end of period | $ | 196 | $ | 178 | $ | 196 | $ | 178 | ||||||||
Allowance as a percentage of ending receivable balance (1) | 0.49 | % | 0.46 | % | ||||||||||||
Charge-offs as a percentage of average receivable balance (1), (4) | 0.59 | % | 0.50 | % | 0.45 | % | 0.42 | % | ||||||||
Delinquencies (60 or more days past due): | ||||||||||||||||
Delinquent amount (2) | $ | 140 | $ | 103 | ||||||||||||
As a percentage of ending receivable balance (1), (2) | 0.35 | % | 0.27 | % | ||||||||||||
Operating leases: | ||||||||||||||||
Early termination loss on operating leases | $ | 22 | $ | 22 | $ | 78 | $ | 81 | ||||||||
Provision for past due operating lease rental payments (3) | 11 | 9 | 31 | 24 |
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(1) | Ending and average receivable balances exclude the allowance for credit losses, write-down of lease residual values, unearned subvention income related to our incentive financing programs and deferred origination costs. Average receivable balances are calculated based on the average of each month’s ending receivables balance for each respective period. |
(2) | For the purposes of determining whether a contract is delinquent, payment is generally considered to have been made, in the case of (i) dealer finance receivables, upon receipt of 100% of the payment when due and (ii) consumer finance receivables, upon receipt of 90% of the sum of the current monthly payment plus any overdue monthly payments. Delinquent amounts presented are the aggregated principal balances of delinquent finance receivables. |
(3) | Provisions for past due operating lease rental payments are also included in total provision for credit losses in our consolidated statements of income. |
(4) | Percentages for the three and nine months ended December 31, 2018 and 2017 have been annualized. |
In the United States segment, the provision for credit losses on our finance receivables was $146 million during the first nine months of fiscal year 2019 compared to $159 million during the same period in fiscal year 2018. The decline in the provision was due to a smaller increase in the allowance for credit losses for retail loans during the first nine months of fiscal year 2019 compared to the same period in fiscal year 2018. Although net charge-offs of retail loans during the first nine months of fiscal year 2019 were higher compared to the same period in fiscal year 2018, which continues the trend of increasing charge-offs that we have been experiencing since fiscal year 2016, the rate of increase was lower than prior years. The increasing trend in charge-offs was primarily due to the increase in the volume of retail loans with longer terms which typically have higher loan-to-value ratios and, as a result, higher loss severities. The increasing trend in charge-offs was also the result of higher charge-off frequencies due to the increase in the volume of retail loans in our lowest credit grade tier and used auto loans. The decline in the provision for retail loans was partially offset by an increase in the provision for impaired dealer loans. We recognized early termination losses on operating lease assets of $75 million during the first nine months of fiscal year 2019 compared to $78 million during the same period in fiscal year 2018. Although the actual net losses we have been realizing during the first nine months of the current fiscal year continued to increase compared to prior years, the rate of increase has slowed. As a result, the increase to the estimated early termination losses we recognized during the first nine months of fiscal year 2019 was lower compared to the same period in fiscal year 2018. During the first nine months of fiscal year 2019, there was an increase in the frequency of lessee defaults which was partially offset by lower loss severities on early terminations. The increase in lessee defaults contributed to the increase in provision for credit losses on past due rental payments.
In the Canada segment, the provision for credit losses on our finance receivables was $4 million during the first nine months of fiscal year 2019, which was flat compared to the same period in fiscal year 2018. Early termination losses on operating lease assets was $3 million during the first nine months of fiscal year 2019, which was flat compared to the same period in fiscal year 2018.
Lease Residual Value Risk
Contractual residual values of lease vehicles are determined at lease inception based on expectations of future used vehicle values, taking into consideration external industry data and our own historical experience. Lease customers have the option at the end of the lease term to return the vehicle to the dealer or to buy the vehicle at the contractual residual value (or if purchased prior to lease maturity, for the outstanding contractual balance). Returned lease vehicles can be purchased by the grounding dealer at the contractual residual value (or if purchased prior to lease maturity, for the outstanding contractual balance) or for a market based price. Returned lease vehicles that are not purchased by the grounding dealers are sold through online and physical auctions. We are exposed to risk of loss on the disposition of returned lease vehicles when the proceeds from the sale of the vehicles are less than the contractual residual values.
We assess our estimates for end of lease term market values of leased vehicles, at minimum, on a quarterly basis. The primary factors affecting the estimates are the percentage of leased vehicles that we expect to be returned by the lessee at the end of lease term and expected loss severities. Factors considered in this evaluation include, among other factors, economic conditions, historical trends, and market information on new and used vehicles. Our leasing volumes and those across the automotive industry have increased significantly in recent years. As a result, the supply of off-lease vehicles will continue to increase over the next several years, which could negatively impact used vehicle prices. For operating leases, adjustments to estimated residual values are made on a straight-line basis over the remaining term of the lease and recognized as depreciation expense. For direct financing leases, downward adjustments for declines in estimated residual values deemed other-than-temporary are recognized as a loss on lease residual values in the period in which the estimate changed. Additional information regarding lease residual values is provided in the discussion of “—Critical Accounting Policies—Determination of Lease Residual Values” below.
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We also review our investment in operating leases for impairment whenever events or changes in circumstances indicate that the carrying values may not be recoverable. If impairment conditions are met, impairment losses are measured by the amount the carrying values exceed their fair values. We did not recognize impairment losses due to declines in estimated residual values during the first nine months of fiscal year 2019 or the same period in fiscal year 2018.
The following table summarizes our number of lease terminations and the method of disposition:
Three months ended December 31, | Nine months ended December 31, | |||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||
(Units (1) in thousands) | ||||||||||||
United States Segment | ||||||||||||
Termination units: | ||||||||||||
Sales at outstanding contractual balances (2) | 68 | 62 | 231 | 203 | ||||||||
Sales through auctions and dealer direct programs (3) | 25 | 33 | 114 | 124 | ||||||||
Total termination units | 93 | 95 | 345 | 327 | ||||||||
Canada Segment | ||||||||||||
Termination units: | ||||||||||||
Sales at outstanding contractual balances (2) | 15 | 13 | 49 | 38 | ||||||||
Sales through auctions and dealer direct programs (3) | 2 | 1 | 5 | 5 | ||||||||
Total termination units | 17 | 14 | 54 | 43 | ||||||||
Consolidated | ||||||||||||
Termination units: | ||||||||||||
Sales at outstanding contractual balances (2) | 83 | 75 | 280 | 241 | ||||||||
Sales through auctions and dealer direct programs (3) | 27 | 34 | 119 | 129 | ||||||||
Total termination units | 110 | 109 | 399 | 370 |
(1) | A unit represents one terminated lease by their method of disposition during the period shown. Unit counts do not include leases that were terminated due to lessee defaults. |
(2) | Includes vehicles purchased by lessees or dealers for the contractual residual value at lease maturity or the outstanding contractual balance if purchased prior to lease maturity. |
(3) | Includes vehicles sold through online auctions and market based pricing options under our dealer direct programs or through physical auctions. |
Liquidity and Capital Resources
Our liquidity strategy is to fund current and future obligations through our cash flows from operations and our diversified funding programs in a cost and risk effective manner. Our cash flows are generally impacted by cash requirements related to the volume of finance receivable and operating lease acquisitions and various operating and funding costs incurred, which are largely funded through payments received on our assets and our funding sources outlined below. As noted, the levels of incentive financing sponsored by AHM and HCI can impact our financial results and liquidity from period to period. Increases or decreases in incentive financing programs typically increase or decrease our financing penetration rates, respectively, which result in increased or decreased acquisition volumes and increased or decreased liquidity needs, respectively. At acquisition, we receive the subsidy payments, which reduce the cost of consumer loan and lease contracts acquired, and we recognize such payments as revenue over the term of the loan or lease.
In an effort to minimize liquidity risk and interest rate risk and the resulting negative effects on our margins, results of operations and cash flows, our funding strategy incorporates investor diversification and the utilization of multiple funding sources including commercial paper, medium term notes, bank loans and asset-backed securities. We incorporate a funding strategy that takes into consideration factors such as the interest rate environment, domestic and foreign capital market conditions, maturity profiles, and economic conditions. We believe that our funding sources, combined with cash provided by operating and investing activities, will provide sufficient liquidity for us to meet our debt service and working capital requirements over the next twelve months.
47
The summary of outstanding debt presented in the tables below in this section “—Liquidity and Capital Resources” as of December 31, 2018 and March 31, 2018 includes foreign currency denominated debt, which was translated into U.S. dollars using the relevant exchange rates as of December 31, 2018 and March 31, 2018, as applicable. Additionally, the amounts in this section that are presented in “C$” (Canadian dollar) were converted into U.S. dollars solely for the reader’s convenience based on the exchange rate on December 31, 2018 of 1.3637 per U.S. dollar. These translations should not be construed as representations that the converted amounts actually represent such U.S. dollar amounts or that they could be converted into U.S. dollars at the rates indicated.
Summary of Outstanding Debt
The table below presents a summary of our outstanding debt by various funding sources:
Weighted average contractual interest rate | ||||||||||||||
December 31, 2018 | March 31, 2018 | December 31, 2018 | March 31, 2018 | |||||||||||
(U.S. dollars in millions) | ||||||||||||||
United States Segment | ||||||||||||||
Unsecured debt: | ||||||||||||||
Commercial paper | $ | 5,454 | $ | 4,437 | 2.58 | % | 1.91 | % | ||||||
Bank loans | 3,895 | 4,393 | 3.25 | % | 2.52 | % | ||||||||
Private MTN program | 998 | 1,698 | 3.84 | % | 5.40 | % | ||||||||
Public MTN program | 22,785 | 21,398 | 2.31 | % | 1.92 | % | ||||||||
Euro MTN programme | 886 | 1,111 | 1.89 | % | 1.95 | % | ||||||||
Total unsecured debt | 34,018 | 33,037 | ||||||||||||
Secured debt | 7,503 | 7,521 | 2.28 | % | 1.68 | % | ||||||||
Total debt | $ | 41,521 | $ | 40,558 | ||||||||||
Canada Segment | ||||||||||||||
Unsecured debt: | ||||||||||||||
Commercial paper | $ | 711 | $ | 730 | 2.09 | % | 1.55 | % | ||||||
Related party debt | 733 | 1,085 | 2.17 | % | 1.64 | % | ||||||||
Bank loans | 1,044 | 1,026 | 2.81 | % | 2.27 | % | ||||||||
Other debt | 3,366 | 3,250 | 2.57 | % | 2.20 | % | ||||||||
Total unsecured debt | 5,854 | 6,091 | ||||||||||||
Secured debt | 1,203 | 1,212 | 2.72 | % | 2.09 | % | ||||||||
Total debt | $ | 7,057 | $ | 7,303 | ||||||||||
Consolidated | ||||||||||||||
Unsecured debt: | ||||||||||||||
Commercial paper | $ | 6,165 | $ | 5,167 | 2.52 | % | 1.86 | % | ||||||
Related party debt | 733 | 1,085 | 2.17 | % | 1.64 | % | ||||||||
Bank loans | 4,939 | 5,419 | 3.16 | % | 2.48 | % | ||||||||
Private MTN program | 998 | 1,698 | 3.84 | % | 5.40 | % | ||||||||
Public MTN program | 22,785 | 21,398 | 2.31 | % | 1.92 | % | ||||||||
Euro MTN programme | 886 | 1,111 | 1.89 | % | 1.95 | % | ||||||||
Other debt | 3,366 | 3,250 | 2.57 | % | 2.20 | % | ||||||||
Total unsecured debt | 39,872 | 39,128 | ||||||||||||
Secured debt | 8,706 | 8,733 | 2.34 | % | 1.74 | % | ||||||||
Total debt | $ | 48,578 | $ | 47,861 |
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Commercial Paper
As of December 31, 2018, we had commercial paper programs in the United States of $7.0 billion and in Canada of C$2.0 billion ($1.5 billion). Interest rates on the commercial paper are fixed at the time of issuance. During the nine months ended December 31, 2018, consolidated commercial paper month-end outstanding principal balances ranged from $4.9 billion to $6.2 billion.
Related Party Debt
HCFI issues fixed rate notes to HCI to help fund HCFI’s general corporate operations. Interest rates are based on prevailing rates of debt with comparable terms. Generally, the term of these notes is less than 120 days.
Bank Loans
During the nine months ended December 31, 2018, AHFC did not enter into any term loan agreements and HCFI entered into a C$350 million ($257 million) two-year term loan agreement. As of December 31, 2018, we had bank loans denominated in U.S. dollars and Canadian dollars with floating interest rates, in principal amounts ranging from $37 million to $600 million. As of December 31, 2018, the remaining maturities of all bank loans outstanding ranged from 325 days to approximately 5.7 years. The weighted average remaining maturities on all bank loans was 2.2 years as of December 31, 2018.
Our bank loans contain customary restrictive covenants, including limitations on liens, mergers, consolidations and asset sales, and a financial covenant that requires us to maintain positive consolidated tangible net worth. In addition to other customary events of default, the bank loans include cross-default provisions and provisions for default if HMC does not maintain ownership, whether directly or indirectly, of at least 80% of the outstanding capital stock of AHFC or HCFI, as applicable. All of these covenants and events of default are subject to important limitations and exceptions under the agreements governing the bank loans. As of December 31, 2018, management believes that AHFC and HCFI were in compliance with all covenants contained in our bank loans.
Medium Term Note (MTN) Programs
Private MTN Program
AHFC no longer issues MTNs under its Rule 144A Private MTN Program. As of December 31, 2018, the remaining maturities of Private MTNs outstanding did not exceed 2.7 years. Private MTNs were issued pursuant to the terms of an issuing and paying agency agreement, which requires AHFC to comply with certain covenants, including negative pledge provisions, and includes customary events of defaults. As of December 31, 2018, management believes that AHFC was in compliance with all covenants contained in the Private MTNs.
Public MTN Program
AHFC is a well-known seasoned issuer under SEC rules and issues Public MTNs pursuant to a registration statement on Form S-3 filed with the SEC. In August 2016, AHFC filed a registration statement with the SEC under which it may issue from time to time up to $30.0 billion aggregate principal amount of Public MTNs. During fiscal year 2016, AHFC began issuing foreign currency denominated notes into international markets under this program. The aggregate principal amount of MTNs offered under this program may be increased from time to time.
The Public MTNs may have original maturities of 9 months or more from the date of issue, may be interest bearing with either fixed or floating interest rates, or may be discounted notes. During the nine months ended December 31, 2018, AHFC issued $3.0 billion aggregate principal amount of U.S. dollar denominated floating rate MTNs and $2.4 billion aggregate principal amount of U.S. dollar denominated fixed rate notes, with original maturities between 10 months and 5.0 years. The weighted average remaining maturities of all Public MTNs was 2.3 years as of December 31, 2018.
The Public MTNs are issued pursuant to an indenture, which requires AHFC to comply with certain covenants, including negative pledge provisions and restrictions on AHFC’s ability to merge, consolidate or transfer substantially all of its assets or the assets of its subsidiaries, and includes customary events of default. As of December 31, 2018, management believes that AHFC was in compliance with all covenants under the indenture.
49
Euro MTN Programme
The Euro MTN Programme was retired in August 2014. Notes under this program that are currently listed on the Luxembourg Stock Exchange will remain listed through their maturities. As of December 31, 2018, the remaining maturities of Euro MTNs outstanding under this program did not exceed 4.1 years. Euro MTNs were issued pursuant to the terms of an agency agreement which requires AHFC to comply with certain covenants, including negative pledge provisions, and includes customary events of default. As of December 31, 2018, management believes that AHFC was in compliance with all covenants contained in the Euro MTNs.
The table below presents a summary of outstanding debt issued under our MTN Programs by currency:
December 31, 2018 | March 31, 2018 | |||||||
(U.S. dollars in millions) | ||||||||
U.S. dollar | $ | 20,510 | $ | 19,717 | ||||
Euro | 3,370 | 3,623 | ||||||
Sterling | 762 | 839 | ||||||
Japanese yen | 27 | 28 | ||||||
Total | $ | 24,669 | $ | 24,207 |
Other Debt
HCFI issues privately placed Canadian dollar denominated notes, with either fixed or floating interest rates. During the nine months ended December 31, 2018, HCFI entered into private placement transactions for C$1.1 billion ($770 million). As of December 31, 2018, the remaining maturities of all of HCFI’s Canadian notes outstanding ranged from 50 days to approximately 6.4 years. The weighted average remaining maturities of these notes was 3.1 years as of December 31, 2018.
The notes are issued pursuant to the terms of an indenture, which requires HCFI to comply with certain covenants, including negative pledge provisions, and includes customary events of default. As of December 31, 2018, management believes that HCFI was in compliance with all covenants contained in the privately placed notes.
Secured Debt
Asset-Backed Securities
We enter into securitization transactions for funding purposes. Securitization transactions involve transferring pools of retail loans to trusts. The trusts are special-purpose entities that we establish to accommodate securitization structures. Securitization trusts have the limited purpose of acquiring assets, issuing asset-backed securities, and making payments on the securities. Assets transferred to securitization trusts are considered legally isolated from us and the claims of our creditors. We continue to service the retail loans transferred to the trusts. Investors in the notes issued by a trust only have recourse to the assets of such trust and do not have recourse to the assets of AHFC, HCFI, or our other subsidiaries or to other trusts.
Our securitizations are structured to provide credit enhancements to investors in the notes issued by the trusts. Credit enhancements can include the following:
• | Subordinated certificates— which are securities issued by the trusts that are retained by us and are subordinated in priority of payment to the notes. |
• | Overcollateralization— which occurs when the principal balance of securitized assets exceed the balance of securities issued by the trust. |
• | Excess interest— which allows excess interest collections to be used to cover losses on defaulted loans. |
• | Reserve funds— which are restricted cash accounts held by the trusts to cover shortfalls in payments of interest and principal required to be paid on the notes. |
• | Yield supplement accounts— which are restricted cash accounts held by the trusts to supplement interest payments on notes. |
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The risk retention regulations in Regulation RR of the Securities Exchange Act of 1934, as amended (Exchange Act), require the sponsor to retain an economic interest in the credit risk of the securitized receivables, either directly or through one or more majority-owned affiliates. Standard risk retention options allow the sponsor to retain either an eligible vertical interest, an eligible horizontal residual interest, or a combination of both. AHFC has satisfied this obligation by retaining an eligible vertical interest of an amount equal to at least 5% of the principal amount of each class of note and certificate issued for the securitization transaction that was subject to this rule but may choose to use other structures in the future.
We are required to consolidate the securitization trusts in our financial statements, which results in the securitizations being accounted for as on-balance sheet secured financings. The securitized receivables remain on our consolidated balance sheet along with the notes issued by the trusts. The notes are secured solely by the assets of the applicable trust and not by any of our other assets or those of other trusts. The assets of a trust are the only source of funds for repayment on the notes of such trust.
During the nine months ended December 31, 2018, we issued notes through asset-backed securitizations totaling $3.5 billion, which were secured by consumer finance receivables with an initial principal balance of $4.3 billion.
Credit Agreements
Syndicated Bank Credit Facilities
AHFC maintains a $3.5 billion 364-day credit agreement, which expires on March 1, 2019, a $2.1 billion three-year credit agreement, which expires on March 3, 2021, and a $1.4 billion five-year credit agreement, which expires on March 3, 2023. As of December 31, 2018, no amounts were drawn upon under the AHFC credit agreements. AHFC intends to renew or replace these credit agreements prior to or on their respective expiration dates.
HCFI maintains a C$1.6 billion ($1.2 billion) credit agreement which provides that HCFI may borrow up to C$800 million ($587 million) on a one-year and up to C$800 million ($587 million) on a five-year revolving basis. The one-year tranche of the credit agreement expires on March 24, 2019 and the five-year tranche of the credit agreement expires on March 24, 2023. As of December 31, 2018, no amounts were drawn upon under the HCFI credit agreement. HCFI intends to renew or replace the credit agreement prior to or on the expiration date of each respective tranche.
The credit agreements contain customary conditions to borrowing and customary restrictive covenants, including limitations on liens and limitations on mergers, consolidations and asset sales. The credit agreements also require AHFC and HCFI, respectively, to maintain a positive consolidated tangible net worth as defined in their respective credit agreements. The credit agreements, in addition to other customary events of default, include cross-default provisions and provisions for default if HMC does not maintain ownership, whether directly or indirectly, of at least 80% of the outstanding capital stock of AHFC or HCFI, as applicable. In addition, the AHFC and HCFI credit agreements contain provisions for default if HMC’s obligations under the HMC-AHFC Keep Well Agreement or the HMC-HCFI Keep Well Agreement, as applicable, become invalid, voidable, or unenforceable. All of these conditions, covenants and events of default are subject to important limitations and exceptions under the agreements governing the credit agreements. As of December 31, 2018, management believes that AHFC and HCFI were in compliance with all covenants contained in the respective credit agreements.
Other Credit Agreements
AHFC maintains other committed lines of credit that allow the Company access to an additional $1.0 billion in unsecured funding with multiple banks. The credit agreements contain customary covenants, including limitations on liens, mergers, consolidations and asset sales and a requirement for AHFC to maintain a positive consolidated tangible net worth. As of December 31, 2018, no amounts were drawn upon under these agreements. These agreements expire in September 2019.
Keep Well Agreements
HMC has entered into separate Keep Well Agreements with AHFC and HCFI. Pursuant to the Keep Well Agreements, HMC has agreed to, among other things:
• | own and hold, at all times, directly or indirectly, at least 80% of each of AHFC’s and HCFI’s issued and outstanding shares of voting stock and not pledge, directly or indirectly, encumber, or otherwise dispose of any such shares or permit any of HMC’s subsidiaries to do so, except to HMC or wholly-owned subsidiaries of HMC; |
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• | cause each of AHFC and HCFI to, on the last day of each of AHFC’s and HCFI’s respective fiscal years, have a positive consolidated tangible net worth (with “tangible net worth” meaning (a) shareholders’ equity less (b) any intangible assets, as determined in accordance with GAAP with respect to AHFC and generally accepted accounting principles in Canada with respect to HCFI); and |
• | ensure that, at all times, each of AHFC and HCFI has sufficient liquidity and funds to meet their payment obligations under any Debt (with “Debt” defined as AHFC’s or HCFI’s debt, as applicable, for borrowed money that HMC has confirmed in writing is covered by the respective Keep Well Agreement) in accordance with the terms of such Debt, or where necessary, HMC will make available to AHFC or HCFI, as applicable, or HMC will procure for AHFC or HCFI, as applicable, sufficient funds to enable AHFC or HCFI, as applicable, to pay its Debt in accordance with its terms. AHFC or HCFI Debt does not include the notes issued by securitization trusts in connection with AHFC’s or HCFI’s secured financing transactions, any related party debt or any indebtedness outstanding as of December 31, 2018 under AHFC’s and HCFI’s bank loan agreements. |
As consideration for HMC’s obligations under the Keep Well Agreements, we have agreed to pay HMC a quarterly fee based on the amount of outstanding Debt pursuant to support compensation agreements, dated October 1, 2005. We incurred expenses of $6 million and $5 million during the three months ended December 31, 2018 and 2017, respectively, and $17 million and $16 million during the nine months ended December 31, 2018 and 2017, respectively, pursuant to these support compensation agreements.
Indebtedness of Consolidated Subsidiaries
As of December 31, 2018, AHFC and its consolidated subsidiaries had $57.1 billion of outstanding indebtedness and other liabilities, including current liabilities, of which $15.9 billion consisted of indebtedness and liabilities of our consolidated subsidiaries. None of AHFC’s consolidated subsidiaries had any outstanding preferred equity.
Derivatives
We utilize derivative instruments to mitigate exposures to fluctuations in interest rates and foreign currency exchange rates. The types of derivative instruments include interest rate swaps, basis swaps, and cross currency swaps. Interest rate and basis swap agreements are used to mitigate the effects of interest rate fluctuations of our floating rate debt relative to our fixed rate finance receivables and operating lease assets. Cross currency swap agreements are used to manage currency and interest rate risk exposure on foreign currency denominated debt. The derivative instruments contain an element of credit risk in the event the counterparties are unable to meet the terms of the agreements.
All derivative financial instruments are recorded on our consolidated balance sheet as assets or liabilities, and carried at fair value. Changes in the fair value of derivatives are recognized in our consolidated statements of income in the period of the change. Since we do not elect to apply hedge accounting, the impact to earnings resulting from these valuation adjustments as reported under GAAP is not representative of our results of operations as evaluated by management. Realized gains and losses on derivative instruments, net of realized gains and losses on foreign currency denominated debt, are included in the measure of net revenues when we evaluate segment performance. Refer to Note 14—Segment Information of Notes to Consolidated Financial Statements (Unaudited) for additional information about segment information and Note 5—Derivative Instruments of Notes to Consolidated Financial Statements (Unaudited) for additional information on derivative instruments.
Off-Balance Sheet Arrangements
We are not a party to off-balance sheet arrangements.
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Contractual Obligations
The following table summarizes our contractual obligations, excluding lending commitments to dealers and derivative obligations, for the periods indicated:
Payments due for the twelve month periods ending December 31, | ||||||||||||||||||||||||||||
Total | 2019 | 2020 | 2021 | 2022 | 2023 | Thereafter | ||||||||||||||||||||||
(U.S. dollars in millions) | ||||||||||||||||||||||||||||
Unsecured debt obligations (1) | $ | 39,954 | $ | 15,706 | $ | 8,263 | $ | 6,947 | $ | 3,955 | $ | 2,570 | $ | 2,513 | ||||||||||||||
Secured debt obligations (1) | 8,719 | 4,591 | 2,540 | 1,280 | 258 | 50 | — | |||||||||||||||||||||
Interest payments on debt (2) | 2,473 | 942 | 642 | 406 | 211 | 127 | 145 | |||||||||||||||||||||
Operating lease obligations | 72 | 9 | 10 | 10 | 9 | 8 | 26 | |||||||||||||||||||||
Total | $ | 51,218 | $ | 21,248 | $ | 11,455 | $ | 8,643 | $ | 4,433 | $ | 2,755 | $ | 2,684 |
(1) | Debt obligations reflect the remaining principal obligations of our outstanding debt and do not reflect unamortized debt discounts and fees. Repayment schedule of secured debt reflects payment performance assumptions on underlying receivables. Foreign currency denominated debt principal is based on exchange rates as of December 31, 2018. |
(2) | Interest payments on floating rate and foreign currency denominated debt based on the applicable floating rates and/or exchange rates as of December 31, 2018. |
The obligations in the above table do not include certain lending commitments to dealers since the amount and timing of future payments is uncertain. Refer to Note 8—Commitments and Contingencies of Notes to Consolidated Financial Statements (Unaudited) for additional information on these commitments.
Our contractual obligations on derivative instruments are also excluded from the table above because our future cash obligations under these contracts are inherently uncertain. We recognize all derivative instruments on our consolidated balance sheet at fair value. The amounts recognized as fair value do not represent the amounts that will be ultimately paid or received upon settlement under these contracts. Refer to Note 5—Derivative Instruments of Notes to Consolidated Financial Statements (Unaudited) for additional information on derivative instruments.
New Accounting Standards
Refer to Note 1(c)—Recently Adopted Accounting Standards and Note 1(d)—Recently Issued Accounting Standards of Notes to Consolidated Financial Statements (Unaudited).
Critical Accounting Policies
Critical accounting policies are those accounting policies that require the application of our most difficult, subjective, or complex judgments, often requiring us to make estimates about the effects of matters that are inherently uncertain and may change in subsequent periods, or for which the use of different estimates that could have reasonably been used in the current period would have had a material impact on the presentation of our financial condition, cash flows, and results of operations. The impact and any associated risks related to these estimates on our financial condition, cash flows, and results of operations are discussed throughout “Management’s Discussion and Analysis of Financial Condition and Results of Operation” where such estimates affect reported and expected financial results. Different assumptions or changes in economic circumstances could result in additional changes to the determination of the allowance for credit losses and the determination of lease residual values.
Credit Losses
We maintain an allowance for credit losses for management’s estimate of probable losses incurred on our finance receivables. We also maintain an estimate for early termination losses on operating lease assets due to lessee defaults and an allowance for credit losses on past due operating lease rental payments. These estimates are evaluated by management, at minimum, on a quarterly basis.
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Consumer finance receivables are collectively evaluated for impairment. Delinquencies and losses are monitored on an ongoing basis and this historical experience provides the primary basis for estimating the allowance. Management utilizes various methodologies when estimating the allowance for credit losses including models which incorporate vintage loss and delinquency migration analysis. These models take into consideration attributes of the portfolio, including loan-to-value ratios, internal and external credit scores, collateral types, and loan terms. Market and economic factors such as used vehicle prices, unemployment, and consumer debt service burdens are also incorporated into these models. Estimated losses on operating leases expected to terminate early due to lessee defaults are also determined collectively, consistent with the methodologies used for consumer finance receivables.
Dealer finance receivables are individually evaluated for impairment when specifically identified as impaired. Dealer finance receivables are considered impaired when it is probable that we will be unable to collect all amounts due according to the original terms of the loan. Our determination of whether dealer loans are impaired is based on evaluations of dealership payment history, financial condition, their ability to perform under the terms of the loans, and collateral values as applicable. Dealer loans that have not been specifically identified as impaired are collectively evaluated for impairment.
Refer to Note 2—Finance Receivables of Notes to Consolidated Financial Statements (Unaudited) for additional information regarding charge-offs or write-downs of contractual balances of retail and dealer finance receivables and operating leases.
Our allowance for credit losses and early termination losses on operating leases requires significant judgment about inherently uncertain factors. The estimates are based on management’s evaluation of many factors, including our historical credit loss experience, the value of the underlying collateral, delinquency trends, and economic conditions. The estimates are based on information available as of each reporting date. Actual losses may differ from the original estimates due to actual results varying from those assumed in our estimates. Refer to Note 3—Investment in Operating Leases of Notes to Consolidated Financial Statements (Unaudited) for additional information.
Sensitivity Analysis
If we had experienced a 10% increase in net charge-offs of finance receivables during the twelve-month period ended December 31, 2018, our provision for credit losses would have increased by approximately $38 million during the period. Similarly, if we had experienced a 10% increase in realized losses on the disposition of repossessed operating lease vehicles during the twelve-month period ended December 31, 2018, we would have recognized an additional $22 million in early termination losses in our consolidated statement of income during the period.
Determination of Lease Residual Values
Contractual residual values of lease vehicles are determined at lease inception based on expectations of future used vehicle values, taking into consideration external industry data and our own historical experience. Lease customers have the option at the end of the lease term to return the vehicle to the dealer or to buy the vehicle at the contractual residual value (or if purchased prior to lease maturity, for the outstanding contractual balance). Returned lease vehicles can be purchased by the grounding dealer at the contractual residual value (or if purchased prior to lease maturity, for the outstanding contractual balance) or a market based price. Returned lease vehicles that are not purchased by the grounding dealer are sold through online and physical auctions. We are exposed to risk of loss on the disposition of returned lease vehicles when the proceeds from the sale of the vehicles are less than the contractual residual values at the end of lease term. We assess our estimates for end of term market values of the leased vehicles, at minimum, on a quarterly basis. The primary factors affecting the estimates are the percentage of leased vehicles that we expect to be returned by the lessee at the end of lease term and expected loss severities. Factors considered in this evaluation include, among other factors, economic conditions, historical trends and market information on new and used vehicles. Our leasing volumes and those across the automotive industry have increased significantly in recent years. As a result, the supply of off-lease vehicles will continue to increase over the next several years which could negatively impact used vehicle prices.
For operating leases, adjustments to estimated residual values are made on a straight-line basis over the remaining term of each lease and recognized as depreciation expense. For direct financing leases, downward adjustments for declines in estimated residual values deemed other-than-temporary are recognized as a loss on lease residual values in the period in which the estimate changed.
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Sensitivity Analysis
If future estimated auction values for all outstanding operating leases as of December 31, 2018 were to decrease by $100 per unit from our current estimates, the total impact would be an increase of approximately $72 million in depreciation expense, which would be recognized over the remaining lease terms. If future return rates for all operating leases were to increase by one percentage point from our current estimates, the total impact would be an increase of approximately $13 million in depreciation expense, which would be recognized over the remaining lease terms. This sensitivity analysis may be asymmetric and is specific to the conditions in effect as of December 31, 2018. Additionally, any declines in auction values are likely to have a negative effect on return rates which could affect the severity of the impact on our results of operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We have omitted this section pursuant to General Instruction H(2) of Form 10-Q.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our Principal Executive Officer and Principal Financial Officer have performed an evaluation of our disclosure controls and procedures, as that term is defined in Rule 13a-15(e) of the Exchange Act, as of December 31, 2018, and each has concluded that such disclosure controls and procedures are effective, at the reasonable assurance level, to ensure that information required to be disclosed in our periodic reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms, and such information is accumulated and communicated to management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosures. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Changes in Internal Control over Financial Reporting
There were no changes in the internal control over financial reporting during the quarter ended December 31, 2018, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II – OTHER INFORMATION
Item 1. Legal Proceedings
For information on our legal proceedings, see Note 8—Commitments and Contingencies—Legal Proceedings and Regulatory Matters of Notes to Consolidated Financial Statements (Unaudited), which is incorporated by reference herein.
Item 1A. Risk Factors
There are no material changes to the risk factors set forth under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended March 31, 2018, which was filed with the SEC on June 21, 2018.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
We have omitted this section pursuant to General Instruction H(2) of Form 10-Q.
Item 3. Defaults Upon Senior Securities
We have omitted this section pursuant to General Instruction H(2) of Form 10-Q.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
None.
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Item 6. Exhibits
Exhibit Number | Description | |
3.1(1) | ||
3.2(1) | ||
4.1(1) | ||
4.2 | American Honda Finance Corporation agrees to furnish to the Securities and Exchange Commission upon request a copy of each instrument with respect to issues of long-term debt of American Honda Finance Corporation and its subsidiaries, the authorized principal amount of which does not exceed 10% of the consolidated assets of the American Honda Finance Corporation and its subsidiaries. | |
4.3(2) | ||
4.4 | ||
4.5(5) | ||
4.6(6) | ||
4.7 | ||
31.1(9) | ||
31.2(9) | ||
32.1(10) | ||
32.2(10) | ||
101.INS(9) | XBRL Instance Document | |
101.SCH(9) | XBRL Taxonomy Extension Schema Document | |
101.CAL(9) | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.LAB(9) | XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE(9) | XBRL Taxonomy Extension Presentation Linkbase Document | |
101.DEF(9) | XBRL Taxonomy Extension Definition Linkbase Document | |
1. | Incorporated herein by reference to the same numbered Exhibit filed with our registration statement on Form 10, dated June 28, 2013. |
2. | Incorporated herein by reference to the same numbered Exhibit filed with our registration statement on Form 10, amendment No. 1, dated August 7, 2013. |
3. | Incorporated herein by reference to Exhibit number 4.5 filed with our registration statement on Form 10, amendment No. 1, dated August 7, 2013. |
4. | Incorporated herein by reference to the same numbered Exhibit filed with our quarterly report on Form 10-Q, dated February 12, 2015. |
5. | Incorporated herein by reference to Exhibit number 4.1 filed with our registration statement on Form S-3, dated September 5, 2013. |
6. | Incorporated herein by reference to Exhibit number 4.6 filed with our quarterly report on Form 10-Q, dated February 8, 2018. |
7. | Incorporated herein by reference to Exhibit number 4.1 filed with our current report on Form 8-K, dated February 12, 2014. |
8. | Incorporated herein by reference to Exhibit number 4.2 filed with our current report on Form 8-K, dated August 10, 2016. |
9. | Filed herewith. |
10. | Furnished herewith. |
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Signature
Pursuant to the requirements 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.
Dated: February 7, 2019
AMERICAN HONDA FINANCE CORPORATION | ||||
By: | /s/ Paul C. Honda | |||
Paul C. Honda | ||||
Vice President and Assistant Secretary (Principal Accounting Officer) |
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