Cautionary Statement Regarding Forward-Looking Information
Certain statements contained in this Form 10-Q are "forward looking statements"
within the meaning of the Private Securities Litigation Reform Act of
1995. These statements are based on current expectations and currently available
information. However, since these statements are based on factors that involve
risks and uncertainties, our performance and results may differ materially from
those described or implied by such forward-looking statements. Words such as
"believe," "anticipate," "expect," "estimate," "project," "should," "intend,"
"will," "may" or words or phrases of similar meaning are intended to identify
forward-looking statements. We caution that the forward-looking statements
involve known and unknown risks, uncertainties and other important factors that
may cause actual results to differ materially from those in the forward-looking
statements, including, without limitation, the risk factors set forth in "Part
II. Other Information - Item 1A. Risk Factors" and "Item 1A. Risk Factors" of
our Annual Report on Form 10-K ("Form 10-K") for the fiscal year ended March 31,
2022 ("fiscal 2022"), including the following:
• Risks related to health epidemics and other outbreaks;
• Changes in general business, economic, and geopolitical conditions,
including trade policy, as well as in consumer demand and the competitive
environment in the automotive markets in
• A decline in
label sales volume and the level of TMNA or any private label sponsored
subvention, cash, and contractual residual value support incentive
programs;
• Extreme weather conditions, natural disasters, changes in fuel prices,
manufacturing disruptions and production suspensions of
private label vehicles and related parts supply;
• Increased competition from other financial institutions seeking to
increase their share of financing Toyota , Lexus, and private label
vehicles;
• Changes in consumer behavior;
• Recalls announced by TMNA or private label companies and the perceived
quality ofToyota , Lexus, and any private label vehicles; • Availability and cost of financing;
• Failure or interruption in our operations, including our communications
and information systems, or as a result of our failure to retain existing
or to attract new key personnel;
• Increased cost, credit and operating risk exposure, or our failure to
realize the anticipated benefits, from our private label financial
services to third-party automotive and mobility companies, including Mazda
andBass Pro Shops ;
• Changes in our credit ratings and those of our ultimate parent,
• Changes in our financial position and liquidity, or changes or disruptions
in our funding sources or access to the global capital markets;
• Revisions to the estimates and assumptions for our allowance for credit
losses;
• Flaws in the design, implementation and use of quantitative models and
revisions to the estimates and assumptions that are used to determine the
value of certain assets;
• Fluctuations in the value or market prices of our investment securities;
• Changes in prices of used vehicles and their effect on residual values of
our off-lease vehicles and return rates;
• Failure of our customers or dealers to meet the terms of any contract with
us, or otherwise perform as agreed; • Fluctuations in interest rates and foreign currency exchange rates;
• Failure or changes in commercial soundness of our counterparties and other
financial institutions;
• Insufficient establishment of reserves, or the failure of a reinsurer to
meet its obligations, in our voluntary protection operations;
• Changes to existing, or adoption of new, accounting standards;
• A security breach or a cyber-attack;
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• Failure to maintain compliant enterprise data practices, including the
collection, use, sharing, and security of personally identifiable and
financial information of our customers and employees;
• Compliance with current laws and regulations or becoming subject to more
stringent laws, regulatory requirements and regulatory scrutiny; and
• Changes in the economies and applicable laws in the states where we have
concentration risk.
Forward-looking statements speak only as of the date they are made. We will not
update the forward-looking statements to reflect actual results or changes in
the factors affecting the forward-looking statements.
38
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OVERVIEW
Key Performance Indicators and Factors Affecting Our Business
In our finance operations, we generate revenue, income, and cash flows by providing retail, lease, and dealer financing to dealers and their customers. We measure the performance of our finance operations using the following metrics: financing volume, market share, Net financing revenues, Operating and administrative expense, residual value and credit loss metrics. In our voluntary protection operations, we generate revenue primarily through marketing, underwriting, and providing claims administration for products that cover certain risks of customers. We measure the performance of our voluntary protection operations using the following metrics: issued contract volume, average number of contracts in force, loss metrics and investment income. Our financial results are affected by a variety of economic and industry factors including, but not limited to, new and used vehicle markets,Toyota , Lexus, and private label new vehicle production volume, vehicle inventory levels, vehicle sales and incentive programs, consumer behavior, employment levels, our ability to respond to changes in interest rates with respect to both contract pricing and funding, the actual or perceived quality, safety or reliability ofToyota , Lexus, and private label vehicles, the financial health of the dealers we finance, and competitive pressure. Our financial results may also be affected by the regulatory environment in which we operate, including as a result of new legislation or changes in regulation and any compliance costs or changes we may be required to make to our business practices. All of these factors can influence consumer contract and dealer financing volume, the number of consumer contracts and dealers that default and the loss per occurrence, our inability to realize originally estimated contractual residual values on leased vehicles, the volume and performance of our voluntary protection operations, and our Net financing revenues on consumer and dealer financing volume. Changes in the volume of vehicle sales, sales of our voluntary protection products, or the level of voluntary protection expenses and insurance losses could materially and adversely impact our voluntary protection operations. Additionally, our funding programs and related costs are influenced by changes in the global capital markets, prevailing interest rates, and our credit ratings and those of our parent companies, which may affect our ability to obtain cost effective funding to support earning asset growth. 39 --------------------------------------------------------------------------------
Fiscal 2023 First Three Months Operating Environment
During the first quarter of the fiscal year endingMarch 31, 2023 ("fiscal 2023"),the United States ("U.S.") economy continued to be impacted by the global coronavirus and related variants ("COVID-19") pandemic and the governmental measures intended to slow its spread, in addition to inflationary pressures and higher interest rates. The ongoing challenging economic conditions caused by the COVID-19 pandemic and the current conflict inUkraine , including production halts and supply shortages affecting the automotive industry and additional delays affecting the supply chain and logistics networks, have resulted in a decrease in the availability of new vehicles from pre-pandemic levels. The lack of availability of new vehicles resulted in decreases in industry-wide vehicle sales and sales incentives in theU.S. the first quarter of fiscal 2023, compared to the same period in fiscal 2022. For more information regarding the potential impact of current market conditions, refer to Part I. Item 1A. Risk Factors in our Form 10-K for the fiscal year endedMarch 31, 2022 . Average used vehicle values in the first quarter of fiscal 2023 remained elevated compared to historical levels, primarily due to the lack of availability of new vehicles. Future declines in used vehicle values resulting from increases in the supply of new and used vehicles and increases in new vehicle sales incentives could unfavorably impact return rates, residual values, depreciation expense and credit losses in the future. During the first quarter of fiscal 2023, the global capital markets experienced periods of heightened volatility in response to the ongoing conflict inUkraine , increases in the inflation rate, and uncertainty regarding the path ofU.S. monetary policy.U.S. benchmark interest rates and credit spreads both increased during the quarter. While we continue to maintain broad global access to both domestic and international markets, these events could lead to further disruptions in the capital markets and increases in our funding costs. Future changes in interest rates in theU.S. and foreign markets could result in volatility in our interest expense, which could affect our results of operations. 40 --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
The following table summarizes total net income by our reportable operating
segments:
Three months ended
June 30,
(Dollars in millions) 2022 2021
Net income:
Finance operations 1 $ 390 $ 781
Voluntary protection operations 1 (220 ) 140
Total net income
$ 170 $ 921
1 Refer to Note 13 – Segment Information of the Notes to Consolidated Financial
Statements for the total asset balances of our finance and voluntary protection
operations.
Our consolidated net income was$170 million for the first quarter of fiscal 2023, compared to$921 million for the same period in fiscal 2022. The decrease in net income for the first quarter of fiscal 2023, compared to the same period in fiscal 2022, was primarily due to a$462 million decrease in investment and other income, net, a$277 million increase in interest expense, a$168 million decrease in total financing revenues, and a$81 million increase in provision for credit losses, partially offset by a$216 million decrease in provision for income taxes, and a$32 million decrease in depreciation on operating leases. Our overall capital position increased$0.1 billion , bringing total shareholder's equity to$18.2 billion atJune 30, 2022 as compared to$18.1 billion atMarch 31, 2022 . Our debt increased to$110.4 billion atJune 30, 2022 from$109.2 billion atMarch 31, 2022 . Our debt-to-equity ratio increased to 6.1 atJune 30, 2022 from 6.0 atMarch 31, 2022 . 41 --------------------------------------------------------------------------------
Finance Operations
The following table summarizes key results of our finance operations:
Three months ended
June 30, Percentage
(Dollars in millions) 2022 2021 change
Financing revenues:
Operating lease $ 1,900 $ 2,120 (10 )%
Retail 845 791 7 %
Dealer 86 88 (2 )%
Total financing revenues 2,831 2,999 (6 )%
Depreciation on operating leases 1,409 1,441 (2 )%
Interest expense 563 286 97 %
Net financing revenues 859 1,272 (32 )%
Investment and other income, net 33 19 74 %
Net financing and other revenues 892 1,291 (31 )%
Expenses:
Provision for credit losses 78 (3 ) (2700 )%
Operating and administrative 299 292 2 %
Total expenses 377 289 30 %
Income before income taxes 515 1,002 (49 )%
Provision for income taxes 125 221 (43 )%
Net income from finance operations $ 390 $ 781 (50 )%
Our finance operations reported net income of $390 million for the first quarter
of fiscal 2023, compared to $781 million for the same period in fiscal 2022. The
decrease in net income from finance operations for first quarter of fiscal 2023,
compared to the same period in fiscal 2022 was due to a $277 million increase in
interest expense, a $168 million decrease in total financing revenues, and a $81
million increase in provision for credit losses, partially offset by a $96
million decrease in provision for income taxes, and a $32 million decrease in
depreciation on operating leases.
Financing Revenues
Total financing revenues decreased 6 percent during the first quarter of fiscal
2023, as compared to the same period in fiscal 2022 due to the following:
• Operating lease revenues decreased 10 percent for first quarter of fiscal
2023, compared to the same period in fiscal 2022, due lower average
outstanding earning asset balances and lower yields.
• Retail financing revenues increased 7 percent for the first quarter of
fiscal 2023, as compared to the same period in fiscal 2022, due to higher
average outstanding earning asset balances partially offset by lower
yields.
• Dealer financing revenues decreased 2 percent for the first quarter of
fiscal 2023, as compared to the same period in fiscal 2022, due to lower
average outstanding earning asset balances from lower average inventory
levels partially offset by higher yields.
As a result of the above, our total portfolio yield, which includes operating
lease, retail and dealer financing revenues, was 4.68 percent for the first
quarter of fiscal 2023, compared to 5.15 percent for the same period in fiscal
2022.
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Depreciation on Operating Leases
We recorded depreciation on operating leases of$1,409 million for the first quarter of fiscal 2023, compared to$1,441 million for the same period in fiscal 2022, primarily due to lower average operating lease units outstanding, partially offset by higher expectations of residual value losses. The ongoing challenging economic conditions have resulted in a decrease in the availability of new vehicles from pre-pandemic levels. The lower levels of new vehicle inventory and higher off-lease vehicle purchases by dealers have led to historically high levels of average used vehicle values. Declines in used vehicle values resulting from increases in the supply of new vehicles and increases in new vehicle sales incentives could unfavorably impact return rates, residual values, and depreciation expense in the future. 43 --------------------------------------------------------------------------------
Interest Expense
Our liabilities consist mainly of fixed and variable rate debt, denominated inU.S. dollars and various other currencies, which we issue in the global capital markets, while our assets consist primarily ofU.S. dollar denominated, fixed rate receivables. We enter into interest rate swaps and foreign currency swaps to economically hedge the interest rate and foreign currency risks that result from the different characteristics of our assets and liabilities. The following table summarizes the components of interest expense: Three months ended June 30, (Dollars in millions) 2022 2021 Interest expense on debt$ 446 $ 389 Interest (income) expense on derivatives (62 )
66
Interest expense on debt and derivatives 384
455
(Gains) losses on debt denominated in foreign currencies (591 )
10
Losses on foreign currency swaps 712
25
Losses (gains) on U.S. dollar interest rate swaps 58 (204 ) Total interest expense$ 563 $ 286 During the first quarter of fiscal 2023, total interest expense increased to$563 million from$286 million for the same period in fiscal 2022. The increase is attributable to losses onU.S. dollar interest rate swaps and losses on foreign currency swaps net of gains from debt denominated in foreign currencies, partially offset by a decrease in interest expense on debt and derivatives combined. Interest expense on debt and derivatives primarily represents contractual net interest settlements and changes in accruals on secured and unsecured notes and loans payable and derivatives, and includes amortization of discounts, premiums, and debt issuance costs. During the first quarter of fiscal 2023, interest expense on debt and derivatives combined decreased to$384 million from$455 million for the same period in fiscal 2022. The decrease in interest expense on derivatives is primarily due to a decrease in interest expense on pay-fixed swaps, partially offset by a decrease in net interest income on pay-float swaps. The increase in interest expense on debt is primarily due to an increase in weighted average interest rates. Gains or losses on debt denominated in foreign currencies represent the impact of translation adjustments. We use foreign currency swaps to economically hedge the debt denominated in foreign currencies. During the first quarter of fiscal 2023 and 2022, we recorded net losses of$121 million and$35 million , respectively, primarily due to increases in foreign currency swap rates across the various currencies in which our debt is denominated. Gains or losses onU.S. dollar interest rate swaps represent the change in the valuation of interest rate swaps. During the first quarter of fiscal 2023, we recorded losses of$58 million , as losses on pay-float swaps exceeded gains on pay-fixed swaps, primarily due to increases inU.S. dollar swap rates. During the first quarter of fiscal 2022, we recorded gains of$204 million , primarily due to the impact from net interest income on our pay-fixed swaps. Future changes in interest and foreign currency exchange rates could result in significant volatility in our interest expense, thereby affecting our results of operations. 44 --------------------------------------------------------------------------------
Investment and Other Income, Net
We recorded investment and other income, net of$33 million for the first quarter of fiscal 2023, compared to$19 million for the same period in fiscal 2022. The increase in investment and other income, net for the first quarter of fiscal 2023, compared to the same period in fiscal 2022, was primarily due to higher yields on our investment in marketable securities portfolio.
Provision for Credit Losses
We recorded a provision for credit losses of$78 million for the first quarter of fiscal 2023, compared to a benefit for credit losses of$3 million for the same period in fiscal 2022. The increase in the provision for credit losses for the first quarter of fiscal 2023, compared to the same period in fiscal 2022, was due to the expected credit losses in our retail loan portfolio, partially offset by the continued improved dealer financial performance.
Operating and Administrative Expenses
We recorded operating and administrative expenses of$299 million for the first quarter of fiscal 2023, compared to$292 million for the same period in fiscal 2022. 45 --------------------------------------------------------------------------------
Voluntary Protection Operations
The following table summarizes key results of our voluntary protection
operations:
Three months ended
June 30, Percentage
2022 2021 change
Contracts (units in thousands)
Issued 770 824 (7 )%
Average in force 10,240 9,816 4 %
(Dollars in millions)
Voluntary protection contract revenues
and insurance earned premiums $ 259 $ 249 4 %
Investment and other (loss) income, net (339 ) 137 (347 )%
Revenues from voluntary protection
operations (80 ) 386 (121 )%
Expenses:
Voluntary protection contract expenses
and insurance losses 107 108 (1 )% Operating and administrative 107 92 16 % Total expenses 214 200 7 % (Loss) income before income taxes (294 ) 186 (258 )% (Benefit) provision for income taxes (74 ) 46 (261 )% Net (loss) income from voluntary protection operations$ (220 ) $ 140 (257 )% Our voluntary protection operations reported net loss of$220 million for the first quarter of fiscal 2023, compared to net income of$140 million for the same period in fiscal 2022. The decrease in net income from voluntary protection operations for the first quarter of fiscal 2023, compared to the same period in fiscal 2022, was primarily due to a$476 million decrease in investment and other (loss) income, net, and a$15 million increase in operating and administrative expenses, partially offset by a$120 million decrease in provision for income taxes. Contracts issued decreased 7 percent in the first quarter of fiscal 2023, compared to the same period in fiscal 2022, primarily due to a decrease in financing contract volumes as a result of lower new vehicles inventory levels. The average number of contracts in force increased 4 percent for the first quarter of fiscal 2023, compared to the same period in fiscal 2022, due to net growth in the voluntary protection portfolio compared to prior years, most notably in prepaid maintenance, vehicle services, and guaranteed auto protection contracts.
Revenue from Voluntary Protection Operations
Our voluntary protection operations reported voluntary protection contract revenues and insurance earned premiums of$259 million for the first quarter of fiscal 2023, compared to$249 million for the same period in fiscal 2022. Voluntary protection contract revenues and insurance earned premiums represent revenues from in force contracts and are affected by issuances as well as the level of coverage, age, and mix of in force contracts. Voluntary protection contract revenues and insurance earned premiums are recognized over the term of the contracts in relation to the timing and level of anticipated claims. The increase in voluntary protection contract revenues and insurance earned premiums for the first quarter of fiscal 2023, compared to the same period in fiscal 2022, was primarily due to an increase in our average in force contracts resulting from net growth in the voluntary protection portfolio compared to prior years. 46 --------------------------------------------------------------------------------
Investment and Other (Loss) Income, Net
Our voluntary protection operations reported investment and other loss, net of$339 million for the first quarter of fiscal 2023, compared to investment and other income, net of$137 million for the same period in fiscal 2022. Investment and other (loss) income, net, consists primarily of dividend and interest income, realized gains and losses on investments in marketable securities, changes in fair value from equity and available-for-sale debt securities for which the fair value option was elected, and credit loss expense on available-for-sale debt securities, if any. The decrease in investment and other (loss) income, net for the first quarter of fiscal 2023, compared to the same period in fiscal 2022, was primarily due to losses from changes in fair value on our equity investments and available-for-sale debt securities for which the fair value option was elected and losses from sales of marketable securities as a result of market volatility. Should market volatility persist or become more severe, it could continue to negatively impact results from voluntary protection operations.
Voluntary Protection Contract Expenses and Insurance Losses
Our voluntary protection operations reported voluntary protection contract expenses and insurance losses of$107 million for the first quarter of fiscal 2023, compared to$108 million for the same period in fiscal 2022. Voluntary protection contract expenses and insurance losses incurred are a function of the amount of covered risks, the frequency and severity of claims associated with in force contracts and the level of risk retained by our voluntary protection operations. Voluntary protection contract expenses and insurance losses include amounts paid and accrued for reported losses, estimates of losses incurred but not reported, and any related claim adjustment expenses.
Operating and Administrative Expenses
Our voluntary protection operations operating and administrative expenses increased to$107 million for the first quarter of fiscal 2023, compared to$92 million for the same period in fiscal 2022. The increase in operating and administrative expenses for the first quarter of fiscal 2023, compared to the same period in fiscal 2022, was primarily attributable to higher product expenses driven by the continued growth of our voluntary protection product business as well as higher dealer back-end expenses. Dealer back-end program expenses are incentives or expense reduction programs we offer to dealers based on certain performance criteria. 47 --------------------------------------------------------------------------------
Provision for Income Taxes
We recorded a provision for income taxes of$51 million for the first quarter of fiscal 2023, compared to$267 million for the same period in fiscal 2022. Our effective tax rate was 23 percent for the first quarter of fiscal 2023, compared to 22 percent for the same period in fiscal 2022. The decrease in the provision for income taxes for the first quarter of fiscal 2023, compared to the same period in fiscal 2022, was primarily due to the decrease in income before income taxes. The higher effective tax rate for the first quarter of fiscal 2023, compared to the same period in fiscal 2022, was primarily attributable to the larger impact of permanent differences between book and tax on lower income before income taxes in the current period, partially offset by a lower state effective tax rate. 48
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FINANCIAL CONDITION
Vehicle Financing Volume and Net Earning Assets
The composition of our vehicle contract volume and market share is summarized
below:
Three months ended
June 30, Percentage
(units in thousands): 2022 2021 change
Vehicle financing volume 1:
New retail contracts 175 192 (9 )%
Used retail contracts 124 126 (2 )%
Lease contracts 63 154 (59 )%
Total 362 472 (23 )%
TMNA subvened vehicle financing volume 2:
New retail contracts 93 54 72 %
Used retail contracts 8 6 33 %
Lease contracts 36 101 (64 )%
Total 137 161 (15 )%
Market share of TMNA sales 3: 53.5 % 55.9 %
1 Total financing volume was comprised of approximately 67 percent
percent Lexus, 10 percent Mazda, and 8 percent non-
first quarter of fiscal 2023. Total financing volume was comprised of
approximately 64 percent
percent non-
2 TMNA subvened volume units are included in the total vehicle financing. Units
exclude third-party subvened units.
3 Represents the percentage of total domestic TMNA sales of new
vehicles financed by us, excluding sales under dealer rental car and commercial
fleet programs, sales of a privateToyota distributor and private label vehicles financed. Vehicle Financing Volume The volume of our retail and lease contracts, which are acquired primarily fromToyota , Lexus, and private label dealers, is dependent upon TMNA and private label sales volume, the level of TMNA, private label, and third-party sponsored subvention and other incentive programs, as well as TMCC competitive rate and other incentive programs. Our financing volume decreased 23 percent for the first quarter of fiscal 2023, compared to the same period in fiscal 2022, primarily due to lower new vehicles inventory levels and lower total levels of incentives and subvention. The ongoing challenging economic conditions, including production halts and supply shortages affecting the automotive industry and additional delays affecting the supply chain and logistics networks, have resulted in a decrease in the availability of new vehicles from pre-pandemic levels. Our market share of TMNA sales decreased approximately 2 percentage points for the first quarter of fiscal 2023, compared to the same period in fiscal 2022, due to increased competition from other financial institutions. 49 --------------------------------------------------------------------------------
The composition of our net earning assets is summarized below:
June 30, March 31, Percentage (Dollars in millions) 2022 2022 change Net Earning Assets Finance receivables, net Retail finance receivables, net$ 74,278 $ 72,185 3 % Dealer financing, net 1 10,544 10,247 3 % Total finance receivables, net 84,822 82,432 3 % Investments in operating leases, net 33,703 35,455 (5 )% Net earning assets$ 118,525 $ 117,887 1 % Dealer Financing (Number of dealers serviced) Toyota, Lexus, and private label dealers1 1,118 966 16 % Dealers outside of theToyota /Lexus/private label dealer network 393 399 (2 )% Total number of dealers receiving wholesale financing 1,511 1,365 11 % Dealer inventory outstanding (units in thousands) 73 64 14 %
1 Includes wholesale and other credit arrangements in which we participate as
part of a syndicate of lenders.
Retail Contract Volume and Earning Assets
Our new retail contract volume decreased 9 percent for the first quarter of fiscal 2023, compared to the same period in fiscal 2022. Despite higher levels of incentives and subvention, our new retail contracts have decreased due to lower vehicles inventory levels and increased competition from other financial institutions. Our used retail contracts decreased by 2 percent for the first quarter of fiscal 2023, compared to same period in fiscal 2022, due to increased competition in the used vehicle marketplace caused by the reduction in new vehicle inventory levels.
Our retail finance receivables, net increased 3 percent at
compared to
average amount financed.
Lease Contract Volume and Earning Assets
Our lease contract volume decreased 59 percent for the first quarter of fiscal 2023, compared to the same period in fiscal 2022, primarily due to the decrease in the availability of new vehicles and lower levels of incentive and subvention programs. Our investments in operating leases, net, decreased 5 percent atJune 30, 2022 , as compared toMarch 31, 2022 due to lower average operating lease units outstanding, offset by higher vehicle values.
Dealer Financing and Earning Assets
Dealer financing, net increased 3 percent atJune 30, 2022 , as compared toMarch 31, 2022 , primarily due to an increase in revolving credit financing as well as the new inventory financing volume we gained from the launch of our private label financial services toBass Pro Shops onApril 1, 2022 .
The ongoing challenging economic conditions, including production halts and
supply shortages affecting the automotive industry and additional delays
affecting the supply chain and logistics networks, have resulted in a temporary
decrease in dealer new vehicle inventory levels.
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Residual Value Risk
The primary factors affecting our exposure to residual value risk are the levels at which residual values are established at lease inception, current economic conditions and outlook, projected end-of-term market values, and the resulting impact on depreciation expense and lease return rates. Higher average operating lease units outstanding and the resulting increase in maturities, a higher supply of used vehicles, as well as deterioration in actual and expected used vehicle values forToyota , Lexus, and private label vehicles could unfavorably impact return rates, residual values, and depreciation expense. On a quarterly basis, we review the estimated end-of-term market values of leased vehicles to assess the appropriateness of our carrying values. To the extent the estimated end-of-term market value of a leased vehicle is lower than the residual value established at lease inception, the residual value of the leased vehicle is adjusted downward so that the carrying value at lease end will approximate the estimated end-of-term market value. For investments in operating leases, adjustments are made on a straight-line basis over the remaining terms of the lease contracts and are included in Depreciation on operating leases in our Consolidated Statements of Income as a change in accounting estimate.
Depreciation on Operating Leases
Depreciation on operating leases and average operating lease units outstanding
are as follows:
Three months ended
June 30, Percentage
2022 2021 change
Depreciation on operating leases
(dollars in millions)$ 1,409 $ 1,441 (2 )% Average operating lease units outstanding (in thousands) 1,219 1,342 (9 )%
Depreciation expense on operating leases decreased 2 percent for the first
quarter of fiscal 2023, as compared to the same period in fiscal 2022, primarily
due to lower average operating lease units outstanding, partially offset by
higher expectations of residual value losses.
The ongoing challenging economic conditions have resulted in a decrease in the
availability of new vehicles from pre-pandemic levels. The lower levels of new
vehicle inventory and higher off-lease vehicle purchases by dealers have led to
historically high levels of average used vehicle values. Declines in used
vehicle values resulting from increases in the supply of new vehicles and
increases in new vehicle sales incentives could unfavorably impact return rates,
residual values, and depreciation expense in the future.
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Origination, Credit Loss, and Delinquency Experience
Our credit loss experience may be affected by a number of factors including the
economic environment, our purchasing, servicing and collections practices, used
vehicle market conditions and subvention. Changes in the economy that impact the
consumer such as increasing interest rates, and a rise in the unemployment rate
as well as higher debt balances, coupled with deterioration in actual and
expected used vehicle values, could increase our credit losses. In addition, a
decline in the effectiveness of our collection practices could also increase our
credit losses. We continuously evaluate and refine our purchasing practices and
collection efforts to minimize risk. In addition, subvention contributes to our
overall portfolio quality, as subvened contracts typically have higher credit
scores than non-subvened contracts.
The following table provides information related to our origination experience:
June 30, March 31, June 30,
2022 2022 2021
Average consumer portfolio
origination FICO score 742 742 740
Average retail loan origination term
(months) 1 69 69 69
1 Retail loan origination greater than or equal to 78 months was 10% as of June
30, 2022, 10% as of
While we have included the average origination FICO score to illustrate
origination trends, we also use a proprietary credit scoring system to evaluate
an applicant’s risk profile. Refer to Part I. Item 1. Business “Finance
Operations” in our fiscal 2022 Form 10-K for further discussion of the
proprietary manner in which we evaluate risk.
The following table provides information related to our consumer finance
receivables and investment in operating leases:
June 30 , March 31 ,
2022 2022
2021
Net charge-offs as a percentage of average finance receivables 1, 5 0.33 % 0.22 % 0.19 % Default frequency as a percentage of outstanding finance receivables contracts 1 0.83 % 0.72 % 0.85 % Average finance receivables loss severity per unit 2$ 10,588 $ 9,012
Aggregate balances for accounts 60 or more days past due as a percentage of earning assets 3, 4, 5 Finance receivables 0.49 % 0.43 % 0.32 % Operating leases 0.30 % 0.26 % 0.19 %
1 The ratio for net charge-offs and the ratio for default frequency have been
annualized using three month results for the periods ended
2021. Net charge-off includes the write-offs of accounts deemed to be
uncollectable and accounts greater than 120 days past due.
2 Average loss per unit upon disposition of repossessed vehicles or charge-off
prior to repossession.
3 Substantially all retail receivables do not involve recourse to the dealer in
the event of customer default.
4 Includes accounts in bankruptcy and excludes accounts for which vehicles have
been repossessed.
5 Excludes accrued interest from average finance receivables.
Management considers historical credit loss information when assessing the allowance for credit losses. Historical credit losses are primarily driven by two factors: default frequency and loss severity. Our net charge-offs as a percentage of average finance receivables for the first quarter of fiscal 2023 increased to 0.33 percent from 0.19 percent for the same period in fiscal 2022. Our average finance receivables loss severity per unit for the first quarter of fiscal 2023 increased to$10,588 from$8,417 in the first quarter of fiscal 2022. The increase in net charge-offs and loss severity per unit were due to higher average amounts financed, a higher percentage of used vehicles financed, and higher delinquencies. Our default frequency as a percentage of outstanding finance receivable contracts was relatively consistent at 0.83 percent for the first quarter of fiscal 2023, compared to 0.85 percent in the same period in fiscal 2022. Our aggregate balances for accounts 60 or more days past due as a percentage of finance receivables was 0.49 percent atJune 30, 2022 , compared to 0.32 percent atJune 30, 2021 , and 0.43 percent atMarch 31, 2022 . Our aggregate balances for accounts 60 or more days past due as a percentage of operating leases was 0.30 percent atJune 30, 2022 , compared to 0.19 percent atJune 30, 2021 , and 0.26 percent atMarch 31, 2022 . Our delinquencies increased atJune 30, 2022 , compared toJune 30, 2021 andMarch 31, 2022 due to the ongoing challenging economic conditions. 52 --------------------------------------------------------------------------------
Allowance for Credit Losses
We maintain an allowance for credit losses which is measured by an impairment
model that reflects lifetime expected losses.
The allowance for credit losses for our retail consumer portfolio is measured on a collective basis when loans have similar risk characteristics such as loan-to-value ratio, book payment-to-income ratio, FICO score at origination, collateral type, contract term, and other relevant factors. We use statistical models to estimate lifetime expected credit losses of our retail loan portfolio segment by applying probability of default and loss given default to the exposure at default on a loan level basis. Probability of default models are developed from internal risk scoring models which consider variables such as delinquency status, historical default frequency, and other credit quality indicators. Other credit quality indicators include loan-to-value ratio, book payment-to-income ratio, FICO score at origination, collateral type (new or used, Lexus,Toyota , or private label), and contract term. Loss given default models forecast the extent of losses given that a default has occurred and consider variables such as collateral, trends in recoveries, historical loss severity, and other contract structure variables. Exposure at default represents the expected outstanding principal balance, including the effects of expected prepayment when applicable. The lifetime expected credit losses incorporate the probability-weighted forward-looking macroeconomic forecasts for baseline, favorable, and adverse scenarios. The loan lifetime is regarded by management as the reasonable and supportable period. We use macroeconomic forecasts from a third party and update such forecasts quarterly. On an ongoing basis, we review our models, including macroeconomic factors, the selection of macroeconomic scenarios and their weighting to ensure they reflect the risk of the portfolio. For the allowance for credit losses for our dealer portfolio, an allowance for credit losses is established for both outstanding dealer finance receivables and certain unfunded off-balance sheet lending commitments. The allowance for credit losses is measured on a collective basis when loans have similar risk characteristics such as dealer group internal risk rating and loan-to-value ratios. We measure lifetime expected credit losses of our dealer products portfolio segment by applying probability of default and loss given default to the exposure at default on a loan level basis. Probability of default is primarily established based on internal risk assessments. The probability of default model also considers qualitative factors related to macroeconomic outlooks. Loss given default is established based on the nature and market value of the collateral, loan-to-value ratios and other credit quality indicators. Exposure at default represents the expected outstanding principal balance. The lifetime of the loan or lending commitment is regarded by management as the reasonable and supportable period. On an ongoing basis, we review our models, including macroeconomic outlooks, to ensure they reflect the risk of the portfolio.
If management does not believe the models reflect lifetime expected credit
losses, a qualitative adjustment is made to reflect management judgment
regarding observable changes in recent or expected economic trends and
conditions, portfolio composition, and other relevant factors.
The following table provides information related to our allowance for credit
losses for finance receivables and certain off-balance sheet lending
commitments:
Three months ended
June 30,
2022 2021
Allowance for credit losses at beginning of period $ 1,272 $ 1,215
Charge-offs (91 ) (33 )
Recoveries 15 17
Provision for credit losses 78
(3 )
Allowance for credit losses at end of period 1
1 Ending balance as of
losses related to off-balance-sheet commitments of
respectively, which is included in Other liabilities on the Consolidated
Balance Sheet.
Our allowance for credit losses increased by$78 million from$1,196 million atJune 30, 2021 to$1,274 million atJune 30, 2022 , due to the increase in size of our retail loan portfolio and an increase in delinquencies, partially offset by the continued improved dealer financial performance in fiscal 2023. Future changes in the economy that impact the consumer and consumer confidence such as increasing interest rates and a rise in the unemployment rate as well as higher debt balances, coupled with deterioration in actual and expected used vehicle values, could result in further increases to our allowance for credit losses. In addition, a decline in the effectiveness of our collection practices could also increase our allowance for credit losses. 53 --------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
Cash Requirements
Our primary material cash requirements include the acquisition of finance receivables and investment in operating leases from dealers, providing various financing to dealers, payments related to debt and swaps, operating expenses, voluntary protection contract expenses, income taxes, and dividend payments.
Liquidity
Liquidity risk is the risk relating to our ability to meet our financial obligations when they come due. Our liquidity strategy is to ensure that we maintain the ability to fund assets and repay liabilities in a timely and cost-effective manner, even in adverse market conditions. Our strategy includes raising funds via the global capital markets and through loans, credit facilities, and other transactions as well as generating liquidity from our earning assets. This strategy has led us to develop a diversified borrowing base that is distributed across a variety of markets, geographies, investors and financing structures. Liquidity management involves forecasting and maintaining sufficient capacity to meet our cash needs, including unanticipated events. To ensure adequate liquidity through a full range of potential operating environments and market conditions, we conduct our liquidity management and business activities in a manner that will preserve and enhance funding stability, flexibility and diversity. Key components of this operating strategy include a strong focus on developing and maintaining direct relationships with commercial paper investors and wholesale market funding providers and maintaining the ability to sell certain assets when and if conditions warrant. We develop and maintain contingency funding plans and regularly evaluate our liquidity position under various operating circumstances, allowing us to assess how we will be able to operate through a period of stress when access to normal sources of capital is constrained. The plans project funding requirements during a potential period of stress, specify and quantify sources of liquidity, and outline actions and procedures for effectively managing through the problem period. In addition, we monitor the ratings and credit exposure of the lenders that participate in our credit facilities to ascertain any issues that may arise with potential draws on these facilities if that contingency becomes warranted. We maintain broad access to a variety of domestic and global markets and may choose to realign our funding activities depending upon market conditions, relative costs, and other factors. We believe that our funding sources, combined with operating and investing activities, provide sufficient liquidity to meet future funding requirements and business growth. For liquidity purposes, we hold cash in excess of our immediate funding needs. These excess funds are invested in short-term, highly liquid and investment grade money market instruments as well as certain available-for-sale debt securities, which provide liquidity for our short-term funding needs and flexibility in the use of our other funding sources. We maintained excess funds ranging from$7.3 billion to$12.2 billion with an average balance of$10.1 billion during the quarter endedJune 30, 2022 . The amount of excess funds we hold may fluctuate, depending on market conditions and other factors. We also have access to liquidity under the$5.0 billion credit facility withToyota Motor Sales U.S.A., Inc. ("TMS"), which as ofJune 30, 2022 , was not drawn upon and had no outstanding balance as further described in Note 7 - Debt and Credit Facilities of the Notes to the Consolidated Financial Statements. We believe we have sufficient capacity to meet our short-term funding requirements and manage our liquidity. Credit support is provided to us by our indirect parentToyota Financial Services Corporation ("TFSC"), and, in turn to TFSC by TMC. Taken together, these credit support agreements provide an additional source of liquidity to us, although we do not rely upon such credit support in our liquidity planning and capital and risk management. The credit support agreements are not a guarantee by TMC or TFSC of any securities or obligations of TFSC or TMCC, respectively. The fees paid pursuant to these agreements are disclosed in Note 11 - Related Party Transactions of the Notes to Consolidated Financial Statements. TMC's obligations under its credit support agreement with TFSC rank pari passu with TMC's senior unsecured debt obligations. Refer to Part II. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations "Liquidity and Capital Resources" in our fiscal 2022 Form 10-K for further discussion. We routinely monitor global financial conditions and our financial exposure to our global counterparties, particularly in those countries experiencing significant economic, fiscal or political strain, and the corresponding likelihood of default. As ofJune 30, 2022 , our exposure to foreign sovereign and non-sovereign counterparties was not significant. Refer to the "Liquidity and Capital Resources - Credit Facilities and Letters of Credit" section and Part I, Item 1A. Risk Factors - "The failure or commercial soundness of our counterparties and other financial institutions may have an effect on our liquidity, results of operations or financial condition" in our fiscal 2022 Form 10-K for further discussion. 54
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Funding
The following table summarizes the components of our outstanding debt which
includes unamortized premiums, discounts, debt issuance costs and the effects of
foreign currency translation adjustments:
June 30, 2022 March 31, 2022
Weighted average Weighted average
Carrying contractual Carrying contractual
(Dollars in millions) Face value value interest rates
Face value value interest rates Unsecured notes and loans payable Commercial paper$ 17,483 $ 17,429 1.27 %$ 16,896 $ 16,876 0.43 %
("MTN") program 46,202 46,049 1.89 % 46,387 46,235 1.55 %
Euro medium term note
("EMTN") program 13,183 13,115 1.55 % 13,891 13,813 1.54 %
Other debt 4,951 4,948 2.42 % 5,368 5,364 1.28 %
Total Unsecured notes
and loans
payable 81,819 81,541 1.73 % 82,542 82,288 1.30 %
Secured notes and loans
payable 28,933 28,882 1.54 % 26,907 26,864 1.01 %
Total debt $ 110,752 $ 110,423 1.68 % $ 109,449 $ 109,152 1.23 %
Unsecured notes and loans payable
The following table summarizes the significant activities by program of our
Unsecured notes and loans payable:
Total
Unsecured
notes and
Commercial loans
(Dollars in millions) paper 1 MTNs EMTNs Other payable
Balance at March 31, 2022 $ 16,896 $ 46,387 $ 13,891 $ 5,368 $ 82,542
Issuances 587 3,000 - - 3,587
Maturities and terminations - (3,185 ) (125 ) (417 ) (3,727 )
Non-cash changes in foreign
currency rates - - (583 ) - (583 )
Balance at June 30, 2022 $ 17,483 $ 46,202 $ 13,183 $ 4,951 $ 81,819
1 Changes in Commercial paper are shown net due to its short duration.
Commercial paper
Short-term funding needs are met through the issuance of commercial paper in theU.S. Commercial paper outstanding under our commercial paper programs ranged from approximately$16.9 billion to$17.9 billion during the quarter endedJune 30, 2022 , with an average outstanding balance of$17.2 billion . Our commercial paper programs are supported by the credit facilities discussed under the heading "Credit Facilities and Letters of Credit." We believe we have sufficient capacity to meet our short-term funding requirements and manage our liquidity.
MTN program
We maintain a shelf registration statement with theSecurities and Exchange Commission ("SEC") to provide for the issuance of debt securities in theU.S. capital markets to retail and institutional investors. We currently qualify as a well-known seasoned issuer underSEC rules, which allows us to issue under our registration statement an unlimited amount of debt securities during the three-year period endingJanuary 2024 . Debt securities issued under theU.S. shelf registration statement are issued pursuant to the terms of an indenture which requires TMCC to comply with certain covenants, including negative pledge and cross-default provisions. We are currently in compliance with these covenants. 55 --------------------------------------------------------------------------------
EMTN program
Our EMTN program, shared with our affiliatesToyota Motor Finance (Netherlands) B.V .,Toyota Credit Canada Inc. andToyota Finance Australia Limited (TMCC and such affiliates, the "EMTN Issuers"), provides for the issuance of debt securities in the international capital markets. InSeptember 2021 , the EMTN Issuers renewed the EMTN program for a one-year period. The maximum aggregate principal amount authorized under the EMTN Program to be outstanding at any time is €60.0 billion or the equivalent in other currencies, of which €27.8 billion was available for issuance atJune 30, 2022 . The authorized amount is shared among all EMTN Issuers. The authorized aggregate principal amount under the EMTN program may be increased from time to time. Debt securities issued under the EMTN program are issued pursuant to the terms of an agency agreement. Certain debt securities issued under the EMTN program are subject to negative pledge provisions. We are currently in compliance with these covenants. We may issue other debt securities through the global capital markets or enter into other unsecured financing arrangements, including those in which we agree to use the proceeds solely to acquire retail or lease contracts financing newToyota and Lexus vehicles of specified "green" models. The terms of these "green" bond transactions have been consistent with the terms of other similar transactions except that the proceeds we receive are included in Restricted cash and cash equivalents on our Consolidated Balance Sheets, when applicable.
Other debt
TMCC has entered into term loan agreements with various banks. These term loan agreements contain covenants and conditions customary in transactions of this nature, including negative pledge provisions, cross-default provisions and limitations on certain consolidations, mergers and sales of assets. We are currently in compliance with these covenants and conditions. We may borrow from affiliates on terms based upon a number of business factors such as funds availability, cash flow timing, relative cost of funds, and market access capabilities. Amounts borrowed from affiliates are recorded in Other liabilities on our Consolidated Balance Sheets and are therefore excluded from Debt amounts.
Secured Notes and Loans Payable
Asset-backed securitization of our earning asset portfolio provides us with an
alternative source of funding. We regularly execute public or private
securitization transactions.
The following table summarizes the significant activities of our Secured notes
and loans payable:
Secured
notes and
loans
(Dollars in millions) payable
Balance at March 31, 2022 $ 26,907
Issuances 5,629
Maturities and terminations (3,603 )
Balance at June 30, 2022 $ 28,933
We securitize finance receivables and beneficial interests in investments in
operating leases ("Securitized Assets") using a variety of structures. Our
securitization transactions involve the transfer of Securitized Assets to
bankruptcy-remote special purpose entities. These bankruptcy-remote entities are
used to ensure that the Securitized Assets are isolated from the claims of
creditors of TMCC and that the cash flows from these assets are available solely
for the benefit of the investors in these asset-backed securities. Investors in
asset-backed securities do not have recourse to our other assets, and neither
TMCC nor our affiliates guarantee these obligations. We are not required to
repurchase or make reallocation payments with respect to the Securitized Assets
that become delinquent or default after securitization. As seller and servicer
of the Securitized Assets, we are required to repurchase or make a reallocation
payment with respect to the underlying assets that are subsequently discovered
not to have met specified eligibility requirements. This repurchase obligation
is customary in securitization transactions. With the exception of our revolving
asset-backed securitization program, funding obtained from our securitization
transactions is repaid as the underlying Securitized Assets amortize.
We service the Securitized Assets in accordance with our customary servicing
practices and procedures. Our servicing duties include collecting payments on
Securitized Assets and submitting them to a trustee for distribution to security
holders and other interest holders. We prepare monthly servicer certificates on
the performance of the Securitized Assets, including collections, investor
distributions, delinquencies, and credit losses. We also perform administrative
services for the special purpose entities.
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Our use of special purpose entities in securitizations is consistent with
conventional practice in the securitization market. None of our officers,
directors, or employees hold any equity interests or receive any direct or
indirect compensation from our special purpose entities. These entities do not
own our stock or the stock of any of our affiliates. Each special purpose entity
has a limited purpose and generally is permitted only to purchase assets, issue
asset-backed securities, and make payments to the security holders, other
interest holders and certain service providers as required under the terms of
the transactions.
Our securitizations are structured to provide credit enhancement to reduce the
risk of loss to security holders and other interest holders in the asset-backed
securities. Credit enhancement may include some or all of the following:
• Overcollateralization: The principal of the Securitized Assets that exceeds
the principal amount of the related secured debt.
• Excess spread: The expected interest collections on the Securitized Assets
that exceed the expected fees and expenses of the special purpose entity,
including the interest payable on the debt, net of swap settlements, if any.
• Cash reserve funds: A portion of the proceeds from the issuance of
asset-backed securities may be held by the securitization trust in a
segregated reserve fund and may be used to pay principal and interest to
security holders and other interest holders if collections on the underlying
receivables are insufficient.
• Yield supplement arrangements: Additional overcollateralization may be
provided to supplement the future contractual interest payments from
securitized receivables with relatively low contractual interest rates.
• Subordinated notes: The subordination of principal and interest payments on
subordinated notes may provide additional credit enhancement to holders of
senior notes.
In addition to the credit enhancement described above, we may enter into interest rate swaps with our special purpose entities that issue variable rate debt. Under the terms of these swaps, the special purpose entities are obligated to pay TMCC a fixed rate of interest on payment dates in exchange for receiving a floating rate of interest on notional amounts equal to the outstanding balance of the secured notes and loans payable. This arrangement enables the special purpose entities to mitigate the interest rate risk inherent in issuing variable rate debt that is secured by fixed rate Securitized Assets. Securitized Assets and the related debt remain on our Consolidated Balance Sheets. We recognize financing revenue on the Securitized Assets. We also recognize interest expense on the secured notes and loans payable issued by the special purpose entities and maintain an allowance for credit losses on the Securitized Assets to cover estimated lifetime expected credit losses using a methodology consistent with that used for our non-securitized asset portfolio. The interest rate swaps between TMCC and the special purpose entities are considered intercompany transactions and therefore are eliminated in our consolidated financial statements. We periodically enter into term securitization transactions whereby we agree to use the proceeds solely to acquire retail and lease contracts financing newToyota and Lexus vehicles of certain specified "green" models. The terms of these "green" securitization transactions have been consistent with the terms of our other similar transactions except that the proceeds we receive are included in Restricted cash and cash equivalents on our Consolidated Balance Sheets, when applicable. Our secured notes also include a revolving asset-backed securitization program backed by a revolving pool of finance receivables and cash collateral. Cash flows from these receivables during the revolving period in excess of what is needed to pay certain expenses of the securitization trust and contractual interest payments on the related secured notes may be used to purchase additional receivables, provided that certain conditions are met following the purchase. The secured notes feature a scheduled revolving period, with the ability to repay the secured notes in full, after which an amortization period begins. The revolving period may also end with the amortization period beginning upon the occurrence of certain events that include certain segregated account balances falling below their required levels, credit losses or delinquencies on the pool of assets supporting the secured notes exceeding specified levels, the adjusted pool balance falling to less than 50% of the initial principal amount of the secured notes, or interest not being paid on the secured notes.
Public Securitization
We maintain a shelf registration statement with theSEC to provide for the issuance of securities backed by Securitized Assets in theU.S. capital markets during the three-year period endingDecember 2024 . We regularly sponsor public securitization trusts that issue securities backed by retail finance receivables, including registered securities that we retain. None of these securities have defaulted, experienced any events of default or failed to pay principal in full at maturity. As ofJune 30, 2022 andMarch 31, 2022 , we did not have any outstanding lease securitization transactions registered with theSEC . 57 --------------------------------------------------------------------------------
Credit Facilities and Letters of Credit
For additional liquidity purposes, we maintain credit facilities, which may be
used for general corporate purposes, as described below:
364-Day Credit Agreement, Three-Year Credit Agreement and Five-Year Credit
Agreement
TMCC,Toyota Credit de Puerto Rico Corp. ("TCPR"), and otherToyota affiliates are party to a$5.0 billion 364-day syndicated bank credit facility, a$5.0 billion three-year syndicated bank credit facility, and a$5.0 billion five-year syndicated bank credit facility, expiring in fiscal 2023, 2025 and 2027, respectively. The ability to make draws is subject to covenants and conditions customary in transactions of this nature, including negative pledge provisions, cross-default provisions and limitations on certain consolidations, mergers and sales of assets. These agreements were not drawn upon and had no outstanding balances as ofJune 30, 2022 andMarch 31, 2022 . We are currently in compliance with the covenants and conditions of the credit agreements described above.
Committed Revolving Asset-backed Facility
We are party to a 364-day revolving securitization facility with certain bank-sponsored asset-backed conduits and other financial institutions expiring in fiscal 2023. Under the terms and subject to the conditions of this facility, the committed lenders under the facility have committed to make advances up to a facility limit of$8.0 billion backed by eligible retail finance receivables transferred by us to a special-purpose entity acting as borrower. We utilized$2.8 billion and$3.2 billion of this facility as ofJune 30, 2022 andMarch 31, 2022 , respectively.
Other Unsecured Credit Agreements
TMCC is party to additional unsecured credit facilities with various banks. As
of
billion
mature in fiscal 2023, 2024, 2025, and 2026, respectively.
These credit agreements contain covenants and conditions customary in transactions of this nature, including negative pledge provisions, cross-default provisions and limitations on certain consolidations, mergers and sales of assets. These credit facilities were not drawn upon and had no outstanding balances as ofJune 30, 2022 andMarch 31, 2022 . We are currently in compliance with the covenants and conditions of the credit agreements described above.
TMCC is party to a
expiring in fiscal 2025. This credit facility was not drawn upon and had no
outstanding balance as of
From time to time, we may borrow from affiliates based upon a number of business factors such as funds availability, cash flow timing, relative cost of funds, and market access capabilities.
Credit Ratings
The cost and availability of unsecured financing is influenced by credit ratings, which are intended to be an indicator of the creditworthiness of a particular company, security, or obligation. Lower ratings generally result in higher borrowing costs as well as reduced access to capital markets. Credit ratings are not recommendations to buy, sell, or hold securities, and are subject to revision or withdrawal at any time by the assigning credit rating organization. Each credit rating organization may have different criteria for evaluating risk, and therefore ratings should be evaluated independently for each organization. Our credit ratings depend in part on the existence of the credit support agreements of TFSC and TMC. Refer to "Part I, Item 1A. Risk Factors - Our borrowing costs and access to the unsecured debt capital markets depend significantly on the credit ratings of TMCC and its parent companies and our credit support arrangements" in our fiscal 2022 Form 10-K.
Derivative Instruments
Our liabilities consist mainly of fixed and variable rate debt, denominated inU.S. dollars and various other currencies, which we issue in the global capital markets, while our assets consist primarily ofU.S. dollar denominated, fixed rate receivables. We enter into interest rate swaps and foreign currency swaps to economically hedge the interest rate and foreign currency risks that result from the different characteristics of our assets and liabilities. Our use of derivative transactions is intended to reduce long-term fluctuations in the fair value of assets and liabilities caused by market movements. All of our derivative activities are authorized and monitored by our management and our Asset-Liability Committee which provides a framework for financial controls and governance to manage market risk. Refer to Note 6 - Derivatives, Hedging Activities and Interest Expense of the Notes to Consolidated Financial Statements for further discussion and disclosure on derivative instruments. 58 --------------------------------------------------------------------------------
LIBOR TRANSITION
The publication of non-U.S. dollar LIBOR rates on a representative basis, as well as the publication of the lesser used 1-week and 2-monthU.S. dollar LIBOR tenors, ceased as of the end ofDecember 2021 . While the most commonly usedU.S. dollar LIBOR tenors are expected to continue to be published untilJune 30, 2023 ,U.S. banking agencies issued guidance that financial institutions should cease usingU.S. dollar LIBOR as a reference rate in new contracts afterDecember 31, 2021 . We are exposed to LIBOR-based financial instruments, including through our dealer financing activities, derivative contracts, secured and unsecured debt, and investment securities. To facilitate an orderly transition from LIBOR to alternative reference rates ("ARRs"), we have established an initiative led by senior management, with Board and committee oversight, to assess, monitor and mitigate risks associated with the expected discontinuation of LIBOR, to achieve operational readiness and engage impacted borrowers and counterparties in connection with the transition to ARRs. Our efforts under this initiative include monitoring developments and the usage of ARRs, monitoring the regulatory and financial reporting guidance, as well as reviewing and updating current legal contracts, internal systems and processes to accommodate the use of ARRs. For example, we have committed to using Secured Overnight Financing Rate ("SOFR") linked rates in connection with various borrowing arrangements and Prime in connection with various lending arrangements and we continue to evaluate other alternatives as potential ARRs to LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized byU.S. Treasury securities, and is based on directly observableU.S. Treasury -backed repurchase transactions. We are also continuously assessing how the expected discontinuation of LIBOR will impact accounting and financial reporting. Refer to Part I, Item 1A. Risk Factors - "Uncertainty about the transition away from the London Interbank Offered Rate ("LIBOR") and the adoption of alternative reference rates could adversely impact our business and results of operations" in our fiscal 2022 Form 10-K for further discussion. 59 --------------------------------------------------------------------------------
NEW ACCOUNTING STANDARDS
Refer to Note 1 – Interim Financial Data of the Notes to Consolidated Financial
Statements.
CRITICAL ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted inthe United States of America (U.S. GAAP) requires management to make certain estimates which affect reported financial results. The evaluation of the factors used in determining each of our critical accounting estimates involves significant assumptions, complex analyses, and management judgment. Changes in the evaluation of these factors may have a significant impact on the consolidated financial statements. Additionally, due to inherent uncertainties in making estimates, actual results could differ from those estimates, and those differences could be material. The critical accounting estimates that affect the consolidated financial statements and the judgment and assumptions used are consistent with those described in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations, Critical Accounting Estimates" in our fiscal 2022 Form 10-K.
OFF-BALANCE SHEET ARRANGEMENTS
Guarantees
TMCC has guaranteed the payments of principal and interest with respect to the bond obligations that were issued byPutnam County, West Virginia andGibson County, Indiana to finance the construction of pollution control facilities at manufacturing plants of certain TMCC affiliates. Refer to Note 9 - Commitments and Contingencies of the Notes to Consolidated Financial Statements for further discussion. Commitments A description of our lending commitments is included under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, Off-Balance Sheet Arrangements" and Note 12 - Related Party Transactions of the Notes to Consolidated Financial Statements in our fiscal 2022 Form 10-K, as well as in Note 9 - Commitments and Contingencies of the Notes to Consolidated Financial Statements.
Indemnification
Refer to Note 9 - Commitments and Contingencies of the Notes to Consolidated
Financial Statements for a description of agreements containing indemnification
provisions.
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