Item 1. Business
Overview
CNH Industrial Capital LLC (together with its consolidated subsidiaries, “CNH Industrial Capital,” the “Company” or “we”) is an indirect wholly-owned subsidiary of CNH Industrial N.V. (“CNHI” and together with its consolidated subsidiaries, “CNH Industrial”) and is headquartered in Racine, Wisconsin. As a captive finance company, our primary business is to underwrite and manage financing products for end-use customers and dealers of CNH Industrial America LLC (“CNH Industrial America”) and CNH Industrial Canada Ltd. (collectively, “CNH Industrial North America”) and provide other related financial products and services to support the sale of agricultural and construction equipment sold by CNH Industrial North America. We also provide wholesale and retail financing related to new and used equipment manufactured by entities other than CNH Industrial North America. We are often able to offer financing to customers at advantageous interest rates or other terms (such as longer contract terms, longer warranty terms or parts and service incentives), due to our participation in subsidized financing programs sponsored by CNH Industrial North America, which reimburses us for some or all of the cost of such terms. The primary operating subsidiaries of CNH Industrial Capital LLC include CNH Industrial Capital America LLC (“CNH Industrial Capital America”), New Holland Credit Company, LLC (“New Holland Credit”) and CNH Industrial Capital Canada Ltd. (“CNH Industrial Capital Canada”). CNH Industrial Capital America is the primary financing and business entity of CNH Industrial Capital for the United States that enters into retail and wholesale financing arrangements with end-use customers and equipment dealers, and CNH Industrial Capital Canada performs the same functions in Canada, while New Holland Credit acts as the servicer for retail and wholesale receivables originated by CNH Industrial Capital America.
CNH Industrial is the company formed by the merger, completed September 29, 2013, between Fiat Industrial S.p.A. (“Fiat Industrial”) and CNH Global N.V. (“CNH Global”), the former indirect parents of CNH Industrial Capital. As a result of the merger, CNH Industrial Capital LLC and its primary operating subsidiaries, including CNH Industrial Capital America, New Holland Credit and CNH Industrial Capital Canada, are indirect wholly-owned subsidiaries of CNHI (with all of the equity interests in CNH Industrial Capital LLC owned by CNHI through intermediate companies, through which CNHI exercises indirect control over CNH Industrial Capital LLC). CNHI is incorporated in and under the laws of The Netherlands. CNHI has its corporate seat in Amsterdam, The Netherlands, and its principal office in London, England.
CNH Industrial Capital offers retail loan and lease financing to end-use customers for the purchase of new and used equipment and components, as well as other financial services. CNH Industrial Capital also provides wholesale financing to CNH Industrial North America equipment dealers and distributors (all of which are independently owned and operated). Wholesale financing consists primarily of dealer floorplan financing and gives dealers the ability to maintain a representative inventory of new products. In addition, CNH Industrial Capital provides financing to dealers for used equipment taken in trade, equipment utilized in dealer-owned rental yards, parts inventory, working capital and other financing needs. CNH Industrial Capital Canada purchases short-term wholesale receivables at a discount (“wholesale factoring”) from Iveco Argentina S.A. (“Iveco Argentina”), an indirect wholly-owned subsidiary of CNHI, from time to time. The purchase is consistent with factoring arrangements between CNHI’s industrial and financial services companies. As a holding company, CNH Industrial Capital LLC generally does not conduct operations of its own, but relies on its subsidiaries for the generation and distribution of profits.
CNH Industrial Capital’s revenue is primarily generated through the income of its portfolio and the income generated through marketing programs with CNH Industrial North America. The size of the portfolio is in part related to the level of equipment sales by CNH Industrial North America. The portfolio profitability is linked to the difference between lending and borrowing rates, the credit quality of the borrowers and the value of collateral. For each of the years ended December 31, 2018 and 2017, the percentage of revenue derived by us from CNH Industrial North America and other CNH Industrial subsidiaries was 39% and 42%, respectively.
Our retail borrowers are generally commercial entities and, in many cases, have had a previous borrowing relationship with CNH Industrial Capital. Retail receivables are secured by the purchased equipment, which generally
has a longer useful life than the term of the receivable. Wholesale financings are likewise secured by the equipment purchased by the dealer.
CNH Industrial Capital funds its operations and lending activity through a combination of term receivables securitizations, secured and unsecured facilities, commercial paper, unsecured bonds, affiliate borrowings and retained earnings. CNH Industrial Capital’s current funding strategy is to maintain sufficient liquidity and flexible access to a wide variety of financial instruments and funding options.
To help fund its retail and wholesale financing business, CNH Industrial Capital participates in the asset backed securitization (“ABS”) markets. CNH Industrial Capital periodically transfers retail and wholesale receivables originated from end-use customers and dealers to special purpose entities, in exchange for cash proceeds from asset backed securities issued by these special purpose entities. Investors in these asset backed securities in turn receive payments on their securities based on the cash flows from the transferred receivables. CNH Industrial Capital continues to service the transferred receivables and maintains a cash reserve account, which provides security to investors in the event that cash collections from the receivables are not sufficient to permit principal and interest payments to the holders of the securities. These special purpose entities and the investors in the asset backed securities have no recourse, beyond the applicable cash reserve account, for failure of any end-use customers or dealers to make payments on the transferred receivables when due.
In addition to portfolio quality and funding costs, CNH Industrial Capital’s long-term profitability is also dependent on service levels and operational effectiveness. CNH Industrial Capital performs billing and collection services, customer support, repossession and remarketing functions, reporting and data management operations and marketing activities.
As of December 31, 2018, CNH Industrial Capital had total assets of $12.9 billion and total stockholder’s equity of $1.4 billion. For the year ended December 31, 2018, CNH Industrial Capital had total revenues of $878.4 million and net income of $156.8 million. As of December 31, 2018, CNH Industrial Capital had outstanding debt (excluding debt owed to affiliates) of $10.6 billion, approximately 63% of which represented secured debt as of such date.
Relationship with CNH Industrial
CNH Industrial organizes its operations into five operating segments: Agricultural Equipment, Construction Equipment, Commercial Vehicles, Powertrain and Financial Services. CNH Industrial’s five segments design, produce, market, sell and finance agricultural and construction equipment, trucks, commercial vehicles, buses and specialty vehicles for firefighting, defense and other uses, as well as engines, transmissions and axles for those vehicles and engines for marine and power generation applications. CNH Industrial has industrial and financial services companies located in 44 countries and a commercial presence in approximately 180 countries around the world.
CNH Industrial’s Agricultural Equipment segment designs, manufactures and distributes a full line of farm machinery and implements, including two-wheel and four-wheel drive tractors, crawler tractors (Quadtrac®), combines, cotton pickers, grape and sugar cane harvesters, hay and forage equipment, planting and seeding equipment, soil preparation and cultivation implements and material handling equipment. Agricultural equipment is sold in North America under the New Holland Agriculture and Case IH Agriculture brands, as well as the Steyr brand in Europe and the Miller brand, primarily in North America and Australia. Following the acquisition of the grass and soil implement business of Kongskilde Industries in February 2017, certain agricultural equipment products have been sold under the Kongskilde, Överum, and JF brands.
CNH Industrial’s Construction Equipment segment designs, manufactures and distributes a full line of construction equipment including excavators, crawler dozers, graders, wheel loaders, backhoe loaders, skid steer loaders, compact track loaders and telehandlers. Construction equipment is sold in North America under the New Holland Construction and Case Construction Equipment brands.
As of December 31, 2018 and 2017, CNH Industrial had total assets of $46.1 billion and $48.3 billion and total equity of $5.1 billion and $4.2 billion, respectively.
For the years ended December 31, 2018 and 2017, CNH Industrial had total revenues of $29.7 billion and $27.7 billion, respectively, and net income attributable to CNH Industrial N.V. of $1.1 billion and $272 million,
respectively. For the year ended December 31, 2018, CNH Industrial’s net sales of agricultural equipment and net sales of construction equipment generated in NAFTA (United States, Canada and Mexico) were $4.0 billion and $1.5 billion, respectively, representing increases of 13% and 17% from the same period in 2017, respectively.
CNH Industrial Capital is a key financing source for CNH Industrial North America’s end-use customers and dealers. CNH Industrial North America offers subsidized financing programs such as low-rate, interest-free or interest-only periods and other sales incentive programs. We participate in and receive reimbursement for these programs, which allow us to offer financing to customers at advantageous terms.
Although our primary focus is to finance CNH Industrial North America equipment, we also provide retail and wholesale financing related to new and used agricultural and construction equipment manufactured by entities other than CNH Industrial North America. We are dependent on CNH Industrial North America for substantially all of our business, with revenues related to financing provided to CNH Industrial North America dealers and retail customers purchasing and/or leasing from CNH Industrial North America and its dealers accounting for over 90% of our total revenues for the year ended December 31, 2018, and with loan portfolios attributable to such financing accounting for over 90% of our total managed receivables as of December 31, 2018.
The size of our lending portfolio is related in part to the level of equipment sales by CNH Industrial North America, which is driven by the strength of the agricultural and construction markets. The credit quality of our portfolio reflects the underwriting standards of CNH Industrial Capital, which are developed internally and independent of the sales volume goals of CNH Industrial North America.
We borrow from our affiliates as one of the funding sources for our operations and lending activity. As of December 31, 2018 and 2017, we had outstanding affiliate borrowings of $276.3 million and $445.8 million, respectively, representing 2.5% and 3.9% of our total indebtedness.
CNH Industrial North America also provides us with other types of operational and administrative support, such as payroll and other human resource services. For the years ended December 31, 2018 and 2017, we incurred fees charged by our affiliates of $47.5 million and $46.4 million, respectively, representing 13% and 11% of our total administrative and operating expenses.
Effective as of September 29, 2013, in connection with the merger of CNH Global with and into CNHI, CNHI assumed all of CNH Global’s obligations under a support agreement, pursuant to which CNHI has agreed to, among other things, (a) make cash capital contributions to us, to the extent necessary to cause our ratio of net earnings available for fixed charges to fixed charges to be not less than 1.05 for each fiscal quarter (with such ratio determined, on a consolidated basis and in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), for such fiscal quarter and the immediately preceding three fiscal quarters taken as a whole), (b) generally maintain an ownership of at least 51% of the voting equity interests in us and (c) cause us to have, as of the end of any fiscal quarter, a consolidated tangible net worth of at least $50 million. The support agreement is not intended to be and is not a guarantee by CNHI of our indebtedness or other obligations. The obligations of CNHI to us pursuant to this support agreement are to us only and do not run to, and are not enforceable directly by, any creditor of ours, including holders of our notes or the trustee under the indenture governing our notes. The support agreement may be modified, amended or terminated, at CNHI’s election, upon thirty days’ prior written notice to us and the rating agencies, if (a) the modification, amendment or termination would not result in a downgrade of our rated indebtedness; (b) the modification, amendment or notice of termination provides that the support agreement will continue in effect with respect to our rated indebtedness then outstanding; or (c) we have no long-term rated indebtedness outstanding.
Products and Services
CNH Industrial Capital’s financing products and services fall into the following main categories:
Retail (69.5% of managed portfolio as of December 31, 2018): CNH Industrial Capital provides and administers retail financing to end-use customers for the purchase or lease of new and used CNH Industrial North America equipment or other agricultural and construction equipment sold primarily through CNH Industrial North America dealers and distributors. Retail financing products primarily include retail installment sales contracts, finance leases and operating leases to end-use customers. The terms of retail contracts, finance leases and operating leases generally
range from two to six years, and interest rates vary depending on prevailing market interest rates and certain incentive programs offered by CNH Industrial North America.
CNH Industrial Capital utilizes a proprietary credit scoring model as part of the retail credit approval and review process. CNH Industrial Capital also provides servicing and collection operations generally performed through its subsidiary, New Holland Credit, for the retail financing products.
Wholesale (30.5% of managed portfolio as of December 31, 2018): CNH Industrial Capital provides wholesale financing to dealers to finance purchases of new and used agricultural and construction equipment and parts. In addition, CNH Industrial Capital extends credit to dealers for working capital and other financing needs. Currently, credit is extended to approximately 900 CNH Industrial North America dealers (with each being a separate legal entity) with approximately 1,700 locations in North America.
The dealer financing agreements provide CNH Industrial Capital with a first priority security interest in the equipment and parts financed and possibly other collateral. A majority of dealers also provide a personal or corporate guarantee (from an affiliate of the dealer). The amount of credit extended is primarily based upon the dealer’s expected annual sales, effective net worth, utilization of existing credit lines and inventory turnover. CNH Industrial Capital evaluates and assesses dealers on an ongoing basis as to their credit worthiness and conducts audits of dealer equipment inventories on a regular basis. The amounts of credit made available to dealers are reviewed on a regular basis, which is usually annually, and such amounts are adjusted when deemed appropriate by CNH Industrial Capital.
Wholesale Factoring (0.0% of managed portfolio as of December 31, 2018): CNH Industrial Capital Canada purchases short-term receivables from Iveco Argentina from time to time.
CNH Industrial Capital finances other products, including insurance and equipment protection products underwritten through a third-party insurer.
Competition
CNH Industrial Capital’s financing products and services are intended to be competitive with those available from third parties. CNH Industrial North America sponsors certain marketing programs that allow us to offer financing to customers at competitive or advantageous interest rates or other terms (such as longer contract terms, longer warranty terms or parts and service incentives). Under these programs, including our low-rate financing programs or interest waiver programs, we are compensated by CNH Industrial North America for some or all of the cost of such terms. This support from CNH Industrial North America provides a material competitive advantage in offering financing to customers of CNH Industrial North America’s products.
We compete primarily with banks, equipment finance and leasing companies, and other financial institutions. Typically, this competition is based upon financial products and services offered, customer service, financial terms and interest rates charged. In addition, some of our competitors may be eligible to participate in government programs providing access to capital at more favorable rates, which may create a competitive disadvantage for CNH Industrial Capital. CNH Industrial Capital believes that its strong, long-term relationship with the dealers and end-use customers and the ease-of-use of our products provides a competitive edge over other third-party financing options. In addition, the marketing programs offered by CNH Industrial North America have a positive influence on the proportion of CNH Industrial North America’s equipment sales financed by CNH Industrial Capital.
Employees
As of December 31, 2018, CNH Industrial Capital had approximately 390 employees, none of which were represented by unions.
Item 1A.
Item 1A. Risk Factors
CNH Industrial Capital LLC is an indirect wholly-owned subsidiary of CNHI. The results of operations of the Company are primarily affected by its relationships with CNH Industrial North America.
The following risks are considered the most significant to the Company’s business based upon current knowledge, information and assumptions. This discussion of risk factors should be considered in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations beginning on page 15 and the other risks described in the Cautionary Note Regarding Forward-Looking Statements beginning on page 26. These risks may affect our operating results and, individually or in the aggregate, could cause our actual results to differ materially from past and projected future results. Except as may be required by law, we undertake no obligation to publicly update these risks or any forward-looking statements, whether as a result of new information, future events, or otherwise.
Risks Related to Our Indebtedness and Liquidity
Credit rating changes could affect our access to funding and our cost of funds, which could in turn adversely affect our financial position and results of operations.
Our ability to access the capital markets or other forms of financing and our funding costs are highly dependent on, among other things, our credit ratings and those of CNHI and our ABS transactions. Rating agencies may review and revise their ratings from time to time, and any downgrade or other negative action with respect to our credit ratings by one or more rating agencies may increase our funding costs, limit our access to sources of financing and/or adversely affect our financial position and results of operations. A lack of funding could result in our inability to meet customer demand for equipment financing, while increased funding costs could lead to deteriorating margins, decreased profits and could result in our inability to meet customer demand at attractive interest rates, which in turn may adversely affect our financial position and results of operations.
We have significant outstanding indebtedness, which may limit our ability to obtain additional funding and may limit our financial and operating flexibility.
As of December 31, 2018, we had an aggregate of $10.9 billion of consolidated indebtedness and our equity was $1.4 billion.
The extent of our indebtedness could have important consequences on our operations and financial results, including:
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we may not be able to secure additional funds for working capital, capital expenditures, debt service requirements or general corporate purposes;
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we may need to use a portion of our projected future cash flow from operations to pay principal and interest on our indebtedness, which may reduce the amount of funds available to us for other purposes;
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we may be more financially leveraged than some of our competitors, which could put us at a competitive disadvantage;
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we may not be able to invest in the development or introduction of new products or new business opportunities;
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we may not be able to adjust rapidly to changing market conditions, which may make us more vulnerable to a downturn in general economic conditions; and
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we may not be able to access the capital markets on favorable terms, which may adversely affect our ability to provide competitive retail and wholesale financing programs.
Restrictive covenants in our debt agreements could limit our financial and operating flexibility.
The agreements governing our outstanding debt securities and other credit agreements to which we are a party from time to time contain, or may contain, covenants that restrict our ability and/or that of our subsidiaries to, among other things:
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incur additional indebtedness;
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make certain investments;
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enter into certain types of transactions with affiliates;
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sell or acquire certain assets or merge with or into other companies;
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use assets as security in other transactions; and/or
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enter into sale and leaseback transactions.
These restrictive covenants could limit our financial and operating flexibility. For example:
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limits on incurring additional debt and using assets as security in other transactions could materially limit our future business prospects by restricting us from financing as many customers as we otherwise would, particularly if our traditional funding sources (including principally the ABS markets) were not available;
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limits on investments could result in a return on assets lower than that of our competitors; and
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limits on the sale of assets or merger with or into other companies could deny us a future business opportunity despite the benefits that could be realized from such a transaction.
In addition, we are required to maintain a certain coverage level for leverage; our leverage ratio, defined as the ratio of total net debt to equity, is required not to exceed 9.00:1.
Although we do not believe any of these covenants materially restrict our operations currently, a breach of one or more of the covenants could result in adverse consequences that could negatively impact our businesses, results of operations and financial position. These consequences may include the acceleration of amounts outstanding under certain of our credit facilities, triggering an obligation to redeem certain debt securities, termination of existing unused commitments by our lenders, refusal by our lenders to extend further credit under one or more of the facilities or to enter into new facilities or the lowering or modification of CNHI’s or our credit ratings. We cannot assure you that we will continue to comply with each restrictive covenant at all times, particularly if we were to encounter challenging and volatile market conditions.
Risks Related to Our Business, Strategy and Operations
Reduced demand for agricultural and construction equipment would reduce the opportunities for us to finance equipment.
Our business is largely dependent upon the demand for CNH Industrial North America’s products and its customers’ willingness to enter into financing or leasing arrangements with respect thereto. A significant and prolonged decrease in demand for CNH Industrial North America’s products could have a material adverse effect on our business, financial position, results of operations and cash flows. Our primary business is to provide retail and wholesale financing alternatives for CNH Industrial North America’s products to CNH Industrial North America’s customers and dealers. The demand for CNH Industrial North America’s products and our financing products and services is influenced, in particular, by factors such as:
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the price of agricultural commodities and the relative level of inventories;
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the profitability of agricultural enterprises, farmers’ income and their capitalization;
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the demand for food products;
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CNH Industrial North America’s ability to produce products that meet the quality, performance and price expectations of customers;
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agricultural policies, including aid and subsidies to agricultural enterprises provided by governments and/or supranational organizations as well as alternative fuel mandates;
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withdrawal from or change in trade agreements or trade terms, negotiation of new trade agreements and the imposition of new (and retaliatory) tariffs against certain countries or covering certain products or raw materials;
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change in or uncertainty surrounding global trade policies;
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unfavorable climatic conditions, especially during the spring, a particularly important period for generating CNH Industrial North America’s sales orders;
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public infrastructure spending;
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new residential and non-residential construction;
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capital spending in oil and gas and, to a lesser extent, in mining; and
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changes in currency exchange rates and interest rates.
In the equipment industry, changes in demand can occur suddenly, resulting in imbalances in inventories, product capacity, and prices for new and used equipment. If fewer pieces of equipment are sold, CNH Industrial Capital will be presented with fewer opportunities to finance equipment.
A decrease in government incentives may adversely affect our results.
Government initiatives that are intended to stimulate demand for products sold by CNH Industrial North America, such as changes in tax treatment or purchase incentives for new equipment, can substantially influence the timing and level of our revenues. The terms, size and duration of such government actions are unpredictable and outside of our control. Any adverse change in government policy relating to those initiatives could have a material adverse effect on our business, results of operations and financial condition.
Change in support from CNH Industrial North America could limit our ability to offer competitively priced financing, which may have a material adverse effect on our business, financial position, results of operations and cash flows.
CNH Industrial North America sponsors certain marketing programs that allow us to offer financing to customers at advantageous interest rates or other terms (such as longer contract terms, longer warranty terms or parts and service incentives). This support from CNH Industrial North America provides a material competitive advantage in offering financing to customers of CNH Industrial North America’s products. Any elimination or reduction of these marketing programs, which affects our ability to offer competitively priced financing to customers, could in turn reduce the percentage of CNH Industrial North America’s products financed by us and could have a material adverse effect on our business, financial condition, results of operations and cash flows. For the years ended December 31, 2018, 2017 and 2016, the revenues recognized by us from CNH Industrial North America for marketing programs were $333.8 million, $392.9 million and $398.4 million, respectively, representing 38%, 42% and 42% , respectively, of our total revenues.
CNH Industrial North America also provides us with other types of operational and administrative support, such as payroll and other human resource services. For the years ended December 31, 2018, 2017 and 2016, we incurred fees charged by our affiliates of $47.5 million, $46.4 million and $45.2 million, respectively, representing 13%, 11% and 13%, respectively, of our total administrative and operating expenses.
An increase in customer credit risk may result in higher delinquencies and defaults, and deterioration in collateral valuation may reduce our collateral recoveries, which could increase losses on our receivables and operating leases and adversely affect our financial position and results of operations.
Fundamental to any organization that extends credit is the credit risk associated with its customers/borrowers. The creditworthiness of each customer, rates of delinquency and default, repossessions and net losses on customer receivables are impacted by many factors, including:
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relevant industry and general economic conditions (in particular, those conditions most directly affecting the agricultural and construction industries);
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the availability of capital;
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the terms and conditions applicable to extensions of credit;
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interest rates (and changes in the applicable interest rates);
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the experience and skills of the customer’s management team;
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commodity prices;
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political events;
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the weather; and
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the value of the collateral securing the extension of credit.
Deterioration in the quality of our financial assets, an increase in delinquencies or defaults, or a reduction in collateral recovery rates could have an adverse impact on our financial performance. These risks become more acute in an economic slowdown or recession due to decreased demand for (or availability of) credit, declining asset values, changes in government subsidies, reductions in collateral to receivable balance ratios, and an increase in delinquencies, defaults, insolvencies, foreclosures and losses. In such circumstances, our receivable servicing and litigation costs may also increase. In addition, governments may pass laws, or implement regulations, that modify rights and obligations under existing agreements, or which prohibit or limit the exercise of contractual rights.
When a borrower defaults on a receivable and we repossess collateral securing the repayment of the receivable, our ability to recover or mitigate losses by selling the collateral is subject to the current market value of such collateral. Those values are affected by levels of new and used inventory of agricultural and construction equipment on the market. They are also dependent upon the strength or weakness of market demand for new and used agricultural and construction equipment, which is affected by the strength of the general economy. In addition, repossessed collateral may be in poor condition, which would reduce its value. Finally, relative pricing of used equipment, compared with new equipment, can affect levels of market demand and the resale of repossessed equipment. An industry-wide decrease in demand for agricultural or construction equipment could result in lower resale values for repossessed equipment, which could increase losses on receivables and operating leases, adversely affecting our financial position and results of operations.
Changes in interest rates, exchange rates and market liquidity could have a material adverse effect on our earnings and cash flows.
Because a significant number of our receivables are generated at fixed interest rates, our business is subject to fluctuations in interest rates. Although we seek to match fund our assets, with approximately 64% of our receivables and approximately 77% of our funding at a fixed rate, respectively, as of December 31, 2018, changes in market interest rates may influence our financing costs, returns on financial investments and the valuation of derivative contracts and could reduce our earnings and/or cash flow.
We are subject to currency exchange risk to the extent that our costs are denominated in currencies other than those in which we earn revenues. In addition, the reporting currency for the consolidated financial statements is the U.S. dollar. Certain of our assets, liabilities, expenses and revenues are denominated in other currencies. Those assets, liabilities, expenses and revenues are translated into the U.S. dollar at the applicable exchange rates to prepare our consolidated financial statements. Therefore, increases or decreases in exchange rates between the U.S. dollar and
those other currencies affect the value of those items reflected in the consolidated financial statements, even if their value remains unchanged in the original currency. Changes in currency exchange rates between the U.S. dollar and other currencies could adversely affect our financial position and results of operations.
We also rely on the capital markets and a variety of funding programs to provide liquidity for our operations, including committed asset backed and unsecured facilities and the issuance of secured and unsecured debt. Significant changes in market liquidity conditions could affect our access to funding and the associated funding costs and reduce our earnings and cash flow.
Although we manage interest rate, exchange rate and market liquidity risks with a variety of techniques, including a match funding program, the selective use of derivatives and a diversified funding program, there can be no assurance that fluctuations in interest rates, exchange rates and market liquidity conditions will not have a material adverse effect on our earnings and cash flow. If any of the variety of instruments and strategies we use to hedge our exposure to these various types of risk is ineffective, we may incur losses.
The transition from LIBOR as an interest rate benchmark could subject the Company to financial risks.
The London Interbank Offered Rate (“LIBOR”) is a widely accepted interest rate benchmark and is the reference rate in a number of financial instruments and contracts, including in a number of our wholesale receivables agreements. In July 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR announced that it intends to stop compelling banks to submit LIBOR rates after 2021. In April 2018, the Federal Reserve Bank of New York commenced publication of three reference rates based on overnight United States Treasury repurchase agreement transactions, including the Secured Overnight Financing Rate (“SOFR”), which has been recommended as an alternative to United States dollar LIBOR by the Alternative Reference Rates Committee. Uncertainty exists as to the transition process and acceptance of SOFR as the primary alternative to LIBOR. The transition from LIBOR to SOFR or another benchmark rate could have adverse effects on our financial position, results of operations and cash flows.
Changes in government monetary or fiscal policies may negatively impact our results.
Governments may implement measures designed to slow the economic growth rate (e.g., higher interest rates, reduced bank lending and other anti-inflation measures). Rising interest rates could have a dampening effect on the overall economic activity and/or the financial condition of our customers, either or both of which could negatively affect demand for our products and our customers’ ability to repay obligations to us. Central banks and other policy arms of many countries may take actions to vary the amount of liquidity and credit available in an economy. The impact from a change in liquidity and credit policies could negatively affect the customers and markets we serve, which could adversely impact our business, results of operations and financial condition.
If we are unable to obtain funding, in particular through the ABS market and committed asset-backed facilities, at competitive rates, our ability to conduct our financing business may be severely impaired and our financial position, results of operations and cash flows may be materially and adversely affected.
We have traditionally relied upon the ABS market and committed asset-backed facilities as a primary source of funding and liquidity. Access to funding at competitive rates is essential to our business. An inability to access the ABS market or a significant reduction in liquidity in the secondary market for ABS transactions could adversely affect our ability to sell receivables on a favorable or timely basis. Such conditions could have an adverse impact on our access to funding, financial position and results of operations.
If we breach our representations and warranties in connection with our ABS transactions, we may be required to repurchase non-conforming receivables from the securitization vehicles, which could have an adverse effect on our financial position, results of operations and cash flows.
In connection with our ABS transactions, we make customary representations and warranties regarding the assets being securitized, as disclosed in the relevant offering documents. While no recourse provisions exist that allow holders of asset-backed securities issued by our ABS trusts to require us to repurchase those securities, a breach of these representations and warranties could give rise to an obligation to repurchase non-conforming receivables from
the trusts. Any obligation to make future repurchases could have an adverse effect on our financial position, results of operations and cash flows.
Certain of our operations are subject to supervision and regulation by governmental authorities and changes in applicable laws or regulations may adversely impact our ability to engage in related business activities or increase the cost of our operations, thus adversely affecting our business, financial position and results of operations.
Our operations are subject to extensive, complex and frequently changing rules, regulations and legal interpretations from various governmental authorities, which among other things:
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regulate credit granting activities, including establishing licensing requirements;
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establish maximum interest rates, finance and other charges;
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regulate customers’ insurance coverage;
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require disclosures to customers;
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govern secured and unsecured transactions;
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set collection, foreclosure, repossession and claims handling procedures and other trade practices;
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prohibit discrimination in the extension of credit and administration of loans; and
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regulate the use, handling and reporting of information related to applicants and borrowers.
As applicable laws are amended or construed differently, new laws are adopted to expand the scope of regulation imposed upon us, or existing laws prohibit interest rates we charge from rising to a level commensurate with risk and market conditions, such events could adversely affect our business and our financial position and results of operations.
New regulations or changes in financial services regulations could adversely affect us.
Our operations are highly regulated by governmental authorities which can impose significant additional costs and/or restrictions on our business. For example, the requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), including its implementing regulations, may substantially affect our origination, servicing and securitization programs. The Dodd-Frank Act also strengthens the regulatory oversight of these securities and related capital market activities by the SEC and increases the regulation of the ABS markets through, among other things, a mandated risk retention requirement for securitizers and a direction to regulate credit rating agencies. Other future regulations may affect our ability to engage in funding these capital market activities or increase the effective cost of such transactions, which could adversely affect our financial position, results of operations and cash flows.
Our business may be affected by unfavorable weather conditions, climate change or other calamities.
Poor, severe or unusual weather conditions caused by climate change or other factors, particularly during the planting and early growing season, can significantly affect the purchasing decisions of CNH Industrial North America’s agricultural equipment customers. The timing and quantity of rainfall are two of the most important factors in agricultural production. Insufficient levels of rain prevent farmers from planting crops or may cause growing crops to die, resulting in lower yields. Excessive rain or flooding can also prevent planting or harvesting from occurring at optimal times and may cause crop loss through increased disease or mold growth. Temperature affects the rate of growth, crop maturity, crop quality and yield. Temperatures outside normal ranges can cause crop failure or decreased yields, and may also affect disease incidence. Natural disasters such as floods, hurricanes, storms and droughts can have a negative impact on agricultural production. The resulting negative impact on farm income can strongly affect demand for CNH Industrial North America’s agricultural equipment in any given period.
In addition, natural disasters, pandemic illness, terrorist attacks or violence, equipment failures, power outages, disruptions to our information technology systems and networks or other unexpected events could result in physical damage to and complete or partial closure of one or more of CNH Industrial’s manufacturing facilities or distribution centers, temporary or long-term disruption in the supply of parts or component products, disruption in the transport
of CNH Industrial North America’s products to dealers and customers and delay in delivery of products to distribution centers. In the event such events occur, our financial results might be negatively impacted. Our existing insurance arrangements may not protect against all costs that may arise from such events.
Furthermore, the potential physical impacts of climate change on CNH Industrial North America’s facilities, suppliers and customers and therefore on its operations are highly uncertain and will be particular to the circumstances developing in various geographical regions. These may include long-term changes in temperature levels and water availability. These potential physical effects may adversely impact the demand for CNH Industrial North America’s products and the cost, production, sales and financial performance of its operations and as a result could adversely affect our financial position, results of operations and cash flows.
Changes in demand for food and alternate energy sources could impact our revenues.
Changing worldwide demand for farm outputs to meet the world’s growing food and alternative energy demands, driven in part by government policies and a growing world population, are likely to result in fluctuating agricultural commodity prices, which affect sales of agricultural equipment. While higher commodity prices will benefit our crop producing agricultural equipment customers, higher commodity prices also result in greater feed costs for livestock and poultry producers, which in turn may result in lower levels of equipment purchased by these customers. Lower commodity prices directly affect farm income, which could negatively affect sales of agricultural equipment. Moreover, changing alternative energy demands may cause farmers to change the types or quantities of the crops they grow, with corresponding changes in equipment demands. Finally, changes in governmental policies regulating bio-fuel utilization could affect demand for CNH Industrial North America’s equipment and result in higher research and development costs related to equipment fuel standards.
Competitive activity or failure by us to respond to actions by our competitors could adversely affect our results of operations, in particular due to a cost of funds disparity between us and some of our competitors.
We operate in a highly competitive environment, with financing for owners or operators of CNH Industrial North America equipment available through a variety of sources, such as banks, finance companies and other financial institutions, including government sponsored entities. Some of our competitors enjoy certain regulatory, government support or credit rating advantages over CNH Industrial Capital today, which often enable them to access capital on favorable terms, among other things. Such cost of funds disparities between us and our competitors, or any additional regulatory, government support or credit rating changes that enhance the competitive position of our competitors, could result in our inability to effectively compete.
The success of our business also depends on our ability to identify emerging industry changes and develop and market new products and services that meet the evolving needs of existing and potential customers. Increasing competition may adversely affect our business if we are unable to match the products and services of our competitors. If we are unable to effectively compete, our business, financial position and results of operations will suffer.
A decrease in the value of the equipment that we lease or higher than expected return volumes of our leased equipment could adversely affect our results.
We estimate the expected residual values of leased equipment at the inception of the lease, which is the estimated future value of leased equipment at the time of the expiration of the lease term. The residual values are reviewed quarterly. Changes in residual value assumptions would affect the amount of depreciation expense and the net amount of equipment on operating leases. If estimated future values significantly decline due to economic factors, obsolescence, the overall industry volume of lease returns, or other adverse circumstances, we may not realize such residual values, which could reduce our earnings.
Actual proceeds realized by us upon the sale of returned leased equipment at lease termination may be lower than the amount projected. Among the factors that can affect the value of returned lease equipment are the volume of equipment returned (primarily affected by contractual lease-end values relative to prevailing market values and marketing programs for new equipment), any significant trends in the used equipment market and any new product trends. Each of these factors, alone or in combination, has the potential to adversely affect our profitability if actual results were to differ significantly from our estimates.
As of December 31, 2018, our total operating lease residual values were $1.4 billion.
Our results of operations may be adversely impacted by various types of claims, lawsuits, and other contingent obligations.
We are involved in various lawsuits and other legal proceedings that arise in the ordinary course of our business. The ultimate outcome of the legal matters pending against us or our subsidiaries is uncertain. Furthermore, we could in the future become subject to judgments or enter into settlements of lawsuits and claims that could have a material adverse effect on our results of operations in any particular period. In addition, while we maintain insurance coverage with respect to certain risks, we may not be able to obtain such insurance on acceptable terms in the future, if at all, and any such insurance may not provide adequate coverage against claims under such policies.
Our affiliates may cease to provide us with financing support.
During the capital markets crisis, which had a material adverse effect on the ABS markets, we relied more heavily upon financing provided by CNH Industrial and its predecessors. In the event of a repeat of the severe downturn in the ABS markets, we would need to look to alternative funding sources, including CNH Industrial, though CNH Industrial would have no obligation to provide such financing (other than the obligations assumed by CNHI under the support agreement, dated November 4, 2011). To the extent CNH Industrial does not provide such financing to us when needed, we could suffer from a lack of funding and/or incur increased funding costs if funding is obtained through other third-party sources.
Our participation in cash management pools exposes us to CNH Industrial credit risk, which, in the event of a bankruptcy or insolvency of certain CNH Industrial entities, could render us unable to recover our deposits and in turn materially and adversely affect our financial position and results of operations.
We participate in a group-wide cash management system with other companies within CNH Industrial, including CNH Industrial America and CNH Industrial Canada Ltd. Our positive cash deposits with CNH Industrial, if any, are either invested by CNH Industrial treasury subsidiaries in highly rated, highly liquid money market instruments or bank deposits, or may be applied by CNH Industrial treasury subsidiaries to meet the financial needs of other CNH Industrial entities and vice versa. While we believe participation in such CNH Industrial treasury subsidiaries’ cash management pools provides us with financial benefits, it exposes us to CNH Industrial credit risk.
In the event of a bankruptcy or insolvency of CNHI (or any other CNH Industrial entity, including CNH Industrial America and CNH Industrial Canada Ltd., in the jurisdictions with set off agreements) or in the event of a bankruptcy or insolvency of the CNH Industrial entity in whose name the deposit is pooled, we may be unable to secure the return of such funds to the extent they belong to us, and we may be viewed as a creditor of such CNH Industrial entity with respect to such deposits. It is possible that our claims as a creditor could be subordinated to the rights of third-party creditors in certain situations. If we are not able to recover our deposits, our financial position and results of operations may be materially and adversely impacted.
Our financial statements may be adversely impacted by changes in accounting standards.
Our financial statements are prepared in accordance with U.S. GAAP, which are periodically revised. At times, we are required to adopt new or revised accounting standards issued by recognized bodies. It is possible such changes could have a material adverse effect on our reported results of operations or financial position. See “Note 2: Summary of Significant Accounting Policies” to our audited consolidated financial statements for the year ended December 31, 2018 for additional information on the adoption of new accounting guidance.
A cybersecurity breach could interfere with our operations, compromise confidential information, negatively impact our corporate reputation and expose us to liability.
We rely upon information technology systems and networks, some of which are managed by third parties, in connection with a variety of our business activities. We use information technology systems to record, process and summarize financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting, legal and tax requirements. Additionally, we collect and store sensitive data, including intellectual property, proprietary business information and the proprietary information of CNH Industrial North America’s dealers, as well as personally identifiable information of our dealers, customers and our employees, in data centers and on information technology networks. Operating these information technology systems and networks,
and processing and maintaining this data, in a secure manner, are critical to our business operations and strategy. Increased information technology security threats and more sophisticated computer crime pose a risk to the security of our systems and networks and the confidentiality, availability and integrity of our data.
While we actively manage information technology security risks within our control through security measures, business continuity plans and employee training around phishing and other cyber risks, there can be no assurance that such actions will be sufficient to mitigate all potential risks to our systems, networks, data and products. Furthermore, third parties on which we rely, including internet, mobile communications technology and cloud service providers, could be sources of information security risk to us.
A failure or breach in security, whether of our systems and networks or those of third parties on which we rely, could expose us and our customers and dealers to risks of misuse of information or systems, the compromising of confidential information, loss of financial resources, manipulation and destruction of data and operations disruptions, which in turn could adversely affect our reputation, competitive position, businesses and results of operations. Security breaches could also result in litigation, regulatory action, unauthorized release of confidential or otherwise protected information and corruption of data, as well as remediation costs and higher operational and other costs of implementing further data protection measures. In addition, as security threats continue to evolve we may need to invest additional resources to protect the security of our systems and data. The amount of insurance coverage we maintain may be inadequate to cover claims or liabilities relating to a cybersecurity attack.
Changes in privacy laws could disrupt our business. We are also subject to various laws regarding privacy and the protection of personal information.
The regulatory framework for privacy and data security issues is rapidly evolving and is likely to remain uncertain for the foreseeable future. We may be required to incur significant costs to comply with privacy and data security laws, rules and regulations. Any inability to adequately address privacy and security concerns or comply with applicable privacy and data security laws, rules and regulations could have an adverse effect on our business prospects, results of operations and/or financial position.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Our principal executive offices are located at 5729 Washington Avenue, Racine, WI 53406. We maintain the following offices:
Item 3.
Item 3. Legal Proceedings
CNH Industrial Capital is party to various litigation matters and claims arising from its operations. Management believes that the outcome of these proceedings, individually and in the aggregate, will not have a material adverse effect on CNH Industrial Capital’s financial position or results of operations.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
All of CNH Industrial Capital LLC’s limited liability company interests are owned by CNH Industrial America, which is indirectly wholly-owned by CNHI. There is currently no established trading market for CNH Industrial Capital LLC’s limited liability company interests. CNH Industrial Capital LLC paid cash dividends of $130 million, $285 million and $290 million to CNH Industrial America in 2018, 2017 and 2016, respectively.
Item 6.
Item 6. Selected Financial Data
Omitted pursuant to General Instruction I of Form 10-K.
Item 7.
Item 7. Managements’ Discussion and Analysis of Financial Condition and Results of Operations
Overview
Organization
We offer a range of financial products and services to the dealers and customers of CNH Industrial North America. The principal products offered are retail financing for the purchase or lease of new and used CNH Industrial North America equipment and wholesale financing to CNH Industrial North America dealers. Wholesale financing consists primarily of floor plan financing as well as financing equipment used in dealer-owned rental yards, parts inventory and working capital needs. In addition, we purchase equipment from dealers that is leased to retail customers under operating lease agreements.
Trends and Economic Conditions
Our business is closely related to the agricultural and construction equipment industries because we offer financing products for such equipment. For the year ended December 31, 2018, CNH Industrial’s net sales of agricultural equipment and net sales of construction equipment generated in NAFTA were $4.0 billion and $1.5 billion, respectively, representing increases of 13% and 17% from the same period in 2017, respectively.
In general, our receivable mix between agricultural and construction equipment financing directionally reflects the mix of equipment sales by CNH Industrial North America. As such, changes in the agricultural industry or with respect to our agricultural equipment borrowers may affect the majority of our portfolio.
Net income was $156.8 million for the year ended December 31, 2018, compared to $250.5 million for the year ended December 31, 2017. The decrease in net income was primarily due to a one-time, positive income tax adjustment in the fourth quarter of 2017 with the enactment of the Tax Cuts and Jobs Act (“U.S. Tax Act”) and a reduced net interest margin, partially offset by lower depreciation of equipment on operating lease, and decreased provisions for credit losses. The receivables balance greater than 30 days past due as a percentage of managed receivables was 0.6%, 0.8% and 0.7% at December 31, 2018, 2017 and 2016, respectively.
Macroeconomic issues for us include the uncertainty of governmental actions in respect to monetary, fiscal and legislative policies, the global economic recovery, changes in demand and pricing for used equipment, capital market disruptions, trade agreements, and financial regulatory reform. Significant volatility in the price of certain commodities could also impact CNH Industrial North America’s and our results.
Results of Operations
Year Ended December 31, 2018 Compared to Year Ended December 31, 2017
Revenues
Revenues for the years ended December 31, 2018 and 2017 were as follows (dollars in thousands):
Revenues totaled $878.4 million for the year ended December 31, 2018 compared to $938.9 million for the year ended December 31, 2017. A lower average managed portfolio drove the year-over-year decrease in total revenues. The average yield for the managed portfolio was 7.3% for the year ended December 31, 2018, compared to 7.4% for the year ended December 31, 2017.
Interest income on retail notes and finance leases for the year ended December 31, 2018 was $201.3 million, flat compared to the year ended December 31, 2017, as the unfavorable impact from lower average earning assets was offset by a favorable impact from higher interest rates.
Interest income on wholesale notes for the year ended December 31, 2018 was $66.9 million, representing an increase of $1.2 million from the year ended December 31, 2017. The increase was primarily due to a $2.0 million favorable impact from higher average earning assets, partially offset by a $0.8 million unfavorable impact from lower interest rates.
Interest and other income from affiliates for the year ended December 31, 2018 was $345.9 million, compared to $398.3 million for the year ended December 31, 2017. Compensation from CNH Industrial North America for retail low-rate financing programs and interest waiver programs offered to customers was $149.4 million and $157.5 million for the years ended December 31, 2018 and 2017, respectively. The decrease was primarily due to lower average retail receivables. For the year ended December 31, 2018, compensation from CNH Industrial North America for wholesale marketing programs was $123.6 million compared to $166.4 million for the prior year. The decrease was primarily due to pricing initiatives. For select operating leases, compensation from CNH Industrial North America for the difference between market rental rates and the amounts paid by customers was $60.8 million and $69.0 million for the years ended December 31, 2018 and 2017, respectively. The decrease was primarily due to lower average earning assets. Also included in interest and other income from affiliates was $10.9 million of wholesale factoring income for the year ended December 31, 2018 compared to $5.2 million for the year ended December 31, 2017.
Rental income on operating leases for the year ended December 31, 2018 was $241.6 million, representing a decrease of $10.0 million from the year ended December 31, 2017. The decrease was primarily due to a $15.5 million unfavorable impact from lower average earning assets, partially offset by a $5.5 million favorable impact from higher interest rates.
Other income for the year ended December 31, 2018 was $22.7 million, representing an increase of $0.9 million from the year ended December 31, 2017.
Expenses
Expenses for the years ended December 31, 2018 and 2017 were as follows (dollars in thousands):
Interest expense totaled $325.3 million for the year ended December 31, 2018 compared to $322.6 million for the year ended December 31, 2017. The increase was primarily due to a $23.9 million unfavorable impact from higher average interest rates, partially offset by a $21.2 million favorable impact from lower average total debt. The average debt cost was 3.0% for the year ended December 31, 2018 compared to 2.8% for the year ended December 31, 2017.
The provision for credit losses was $31.7 million for the year ended December 31, 2018 compared to a provision of $40.9 million for the year ended December 31, 2017. The decrease in 2018 was primarily due to lower retail losses.
Depreciation of equipment on operating leases decreased by $49.0 million for the year ended December 31, 2018 compared to the year ended December 31, 2017, primarily due to updated depreciation estimates and a smaller operating lease portfolio.
Other expenses decreased by $1.0 million for the year ended December 31, 2018 compared to the prior year, primarily due to lower losses on equipment held for sale and foreign exchange.
The effective tax rate for the year ended December 31, 2018 was a provision of 20.9%, compared to a benefit of 23.1% for the year ended December 31, 2017, reflecting the impact from the enactment of the U.S. Tax Act.
Receivables and Equipment on Operating Leases Originated and Held
Receivables and equipment on operating lease originations for the years ended December 31, 2018 and 2017 were as follows (dollars in thousands):
The year-over-year increase in retail, wholesale and equipment on operating lease originations was primarily due to an increase in unit sales of CNH Industrial North America agricultural equipment.
Total receivables and equipment on operating leases held as of December 31, 2018 and 2017 were as follows (dollars in thousands):
The total retail receivables balance greater than 30 days past due as a percentage of the retail receivables was 0.8% and 1.1% at December 31, 2018 and 2017, respectively. The total wholesale receivables balance greater than 30 days past due as a percentage of the wholesale receivables was not significant at December 31, 2018 or 2017. Total retail receivables on nonaccrual status, which represent receivables for which we have ceased accruing finance income, were $28.5 million and $43.5 million at December 31, 2018 and 2017, respectively. Total wholesale receivables on nonaccrual status were $23.0 million and $43.5 million at December 31, 2018 and 2017, respectively.
Total receivable write-off amounts and recoveries, by product, for the years ended December 31, 2018 and 2017 were as follows (dollars in thousands):
Our allowance for credit losses on all receivables financed totaled $74.4 million at December 31, 2018 and $79.2 million at December 31, 2017.
The allowance is subject to a quarterly evaluation based on many quantitative and qualitative factors, including historical loss experience by product category, portfolio duration, delinquency trends, economic conditions (in particular, those conditions directly affecting the profitability and financial strength of our customers), collateral value and credit risk quality. No single factor determines the adequacy of the allowance. Different assumptions or changes in economic conditions would result in changes to the allowance for credit losses and the provision for credit losses. These qualitative factors are subjective and require a degree of management judgment.
We believe our allowance is sufficient to provide for losses in our receivable portfolio as of December 31, 2018.
Year Ended December 31, 2017 Compared to Year Ended December 31, 2016
Revenues
Revenues for the years ended December 31, 2017 and 2016 were as follows (dollars in thousands):
Revenues totaled $938.9 million for the year ended December 31, 2017 compared to $946.7 million for the year ended December 31, 2016. A lower average managed portfolio drove the year-over-year decrease in total revenues. The average yield for the managed portfolio was 7.4% for the year ended December 31, 2017, compared to 7.0% for the year ended December 31, 2016.
Interest income on retail notes and finance leases for the year ended December 31, 2017 was $201.5 million, representing a decrease of $10.0 million from the year ended December 31, 2016. The decrease was primarily due to a $17.1 million unfavorable impact from lower average earning assets, partially offset by a $7.1 million favorable impact from higher interest rates.
Interest income on wholesale notes for the year ended December 31, 2017 was $65.7 million, representing a decrease of $3.2 million from the year ended December 31, 2016. The decrease was primarily due to a $7.9 million unfavorable impact from lower average earning assets, partially offset by a $4.7 million favorable impact from higher interest rates.
Interest and other income from affiliates for the year ended December 31, 2017 was $398.3 million, flat compared to the prior year. Compensation from CNH Industrial North America for retail low-rate financing programs and interest waiver programs offered to customers was $157.5 million and $170.4 million for the years ended December 31, 2017 and 2016, respectively. The decrease was primarily due to lower average retail receivables. For the year ended December 31, 2017, compensation from CNH Industrial North America for wholesale marketing programs was $166.4 million compared to $156.7 million for the prior year. The increase was primarily due to the mix of programs and products. For select operating leases, compensation from CNH Industrial North America for the difference between market rental rates and the amounts paid by customers was $69.0 million and $70.1 million for the years ended December 31, 2017 and 2016, respectively.
Rental income on operating leases for the year ended December 31, 2017 was $251.6 million, representing an increase of $8.1 million from the year ended December 31, 2016. The increase was primarily due to higher interest rates.
Other income for the year ended December 31, 2017 was $21.8 million, representing a decrease of $2.6 million from the year ended December 31, 2016.
Expenses
Expenses for the years ended December 31, 2017 and 2016 were as follows (dollars in thousands):
Interest expense totaled $322.6 million for the year ended December 31, 2017 compared to $305.1 million for the year ended December 31, 2016. The increase was primarily due to a $37.1 million unfavorable impact from higher average interest rates, partially offset by a $19.6 million favorable impact from lower average total debt. The average debt cost was 2.8% for the year ended December 31, 2017 compared to 2.5% for the year ended December 31, 2016.
The provision for credit losses was $40.9 million for the year ended December 31, 2017 compared to a provision of $30.8 million for the year ended December 31, 2016. The increase in 2017 was primarily due to higher losses.
Depreciation of equipment on operating leases increased by $33.3 million for the year ended December 31, 2017 compared to the year ended December 31, 2016, primarily due to updated depreciation estimates.
Other expenses increased by $8.5 million for the year ended December 31, 2017 compared to the prior year, primarily due to higher losses on equipment held for sale and foreign exchange.
The effective tax rate for the year ended December 31, 2017 was a benefit of 23.1%, compared to a provision of 33.5% for the year ended December 31, 2016, reflecting the impact from the enactment of the U.S. Tax Act.
Receivables and Equipment on Operating Leases Originated and Held
Receivables and equipment on operating lease originations for the years ended December 31, 2017 and 2016 were as follows (dollars in thousands):
The year-over-year decrease in retail, wholesale and equipment on operating lease originations was primarily due to a decrease in unit sales of CNH Industrial North America agricultural equipment.
Total receivables and equipment on operating leases held as of December 31, 2017 and 2016 were as follows (dollars in thousands):
The total retail receivables balance greater than 30 days past due as a percentage of the retail receivables was 1.1% and 1.0% at December 31, 2017 and 2016, respectively. The total wholesale receivables balance greater than 30 days past due as a percentage of the wholesale receivables was not significant at December 31, 2017 or 2016. Total retail receivables on nonaccrual status, which represent receivables for which we have ceased accruing finance income, were $43.5 million and $50.3 million at December 31, 2017 and 2016, respectively. Total wholesale receivables on nonaccrual status were $43.5 million and $43.4 million at December 31, 2017 and 2016, respectively.
Total receivable write-offs and recoveries, by product, for the years ended December 31, 2017 and 2016 were as follows (dollars in thousands):
Our allowance for credit losses on all receivables financed totaled $79.2 million at December 31, 2017 and $84.9 million at December 31, 2016.
The allowance is subject to a quarterly evaluation based on many quantitative and qualitative factors, including historical loss experience by product category, portfolio duration, delinquency trends, economic conditions (in particular, those conditions directly affecting the profitability and financial strength of our customers), collateral
value and credit quality. No single factor determines the adequacy of the allowance. Different assumptions or changes in economic conditions would result in changes to the allowance for credit losses and the provision for credit losses. These qualitative factors are subjective and require a degree of management judgment.
We believe our allowance is sufficient to provide for losses in our receivable portfolio as of December 31, 2017.
Liquidity and Capital Resources
The following discussion of liquidity and capital resources principally focuses on our statements of cash flows, balance sheets and capitalization. CNH Industrial Capital’s current funding strategy is to maintain sufficient liquidity and flexible access to a wide variety of financial instruments and funding options.
In the past, securitization has been one of our most economical sources of funding and, therefore, the majority of our originated receivables are securitized, with the cash generated from such receivables utilized to repay the related debt or purchase new receivables.
In addition, we have secured and unsecured facilities, commercial paper, unsecured bonds, affiliate borrowings and cash to fund our liquidity needs. To add more diversity to our funding structure, we established a commercial paper program during 2017 and continued to access the unsecured bond market. As of December 31, 2018, our outstanding commercial paper totaled $389 million and our outstanding unsecured senior notes totaled $3.0 billion. We expect continued changes to our funding profile, with less reliance on the securitization market.
Cash Flows
For the years ended December 31, 2018, 2017 and 2016, our cash flows were as follows (dollars in thousands):
Operating activities in the year ended December 31, 2018 generated cash of $363 million, resulting primarily from net income of $157 million, adjusted by depreciation and amortization of $234 million, provision for credit losses of $32 million, and $28 million in deferred income tax expense, partially offset by changes in working capital of $88 million. The decrease in cash provided by operating activities in 2018 compared to 2017 was primarily due to $205 million related to changes in working capital, a $94 million decrease in net income, a $49 million decrease in depreciation and amortization expense, and a $9 million decrease in provision for credit losses, partially offset by a $109 million change in deferred income tax. Operating activities in 2017 generated cash of $610 million, resulting primarily from net income of $250 million, adjusted by depreciation and amortization of $283 million, cash from changes in working capital of $117 million, and provision for credit losses of $41 million, partially offset by $81 million in deferred income tax benefit. The decrease in cash provided by operating activities in 2017 compared to 2016 was primarily due to a $119 million increase in net deferred income tax benefit and a $62 million reduction in cash from changes in working capital, partially offset by a $63 million increase in net income, a $33 million increase in depreciation and amortization expense, and $10 million increase in provision for credit losses. Operating activities in 2016 generated cash of $685 million, resulting primarily from net income of $188 million, adjusted by depreciation and amortization of $249 million, cash from changes in working capital of $179 million, deferred income tax expense of $38 million and provision for credit losses of $31 million.
Investing activities in the year ended December 31, 2018 generated cash of $53 million, resulting primarily from a net reduction in receivables of $270 million, partially offset by $212 million in net expenditures for equipment on operating leases and $5 million in net expenditures for property, equipment and software. The decrease in cash provided by investing activities in 2018 compared to 2017 was primarily due to a $221 million lower net reduction in receivables, a $12 million increase in net expenditures for equipment on operating leases and a $4 million increase in net expenditures on property, equipment and software. Investing activities in 2017 generated cash of $290 million,
resulting primarily from a net reduction in receivables of $491 million, partially offset by $200 million in net expenditures for equipment on operating leases. The decrease in cash provided in investing activities in 2017 compared to 2016 was primarily due to a $252 million lower net reduction in receivables, partially offset by a $162 million reduction in net expenditures for equipment on operating leases. Investing activities in 2016 generated cash of $381 million, resulting primarily from a net collection of receivables of $743 million, partially offset by $361 million in net expenditures for equipment on operating leases and $1 million in net expenditures for property, equipment and software.
Financing activities in the year ended December 31, 2018 used cash of $492 million, resulting primarily from net cash paid on long-term debt and affiliated debt of $390 million and $154 million, respectively, and $130 million in dividends paid to CNH Industrial America, partially offset by net cash received on short-term borrowings of $182 million. The decrease in cash used in financing activities in 2018 compared to 2017 was primarily due to a decrease in net cash paid on long-term debt of $825 million and lower dividends of $155 million paid to CNH Industrial America, partially offset by increases in net cash paid on affiliated debt and short-term borrowings of $443 million and $127 million, respectively. Financing activities in 2017 used cash of $902 million, resulting primarily from net cash paid on long-term debt of $1,215 million and $285 million in dividends paid to CNH Industrial America, partially offset by net cash received on short-term borrowings and affiliated debt of $309 million and $289 million, respectively. The decrease in cash used in financing activities in 2017 compared to 2016 was primarily due to decreases in net cash paid on short-term borrowings and affiliated debt of $645 million and $179 million, respectively, and lower dividends of $5 million paid to CNH Industrial America, partially offset by a $444 million increase in net cash paid on long-term debt. Financing activities in 2016 used cash of $1,287 million, resulting primarily from net cash paid on long-term debt and short-term borrowings of $771 million and $336 million, respectively, and $290 million dividends paid to CNH Industrial America, partially offset by $110 million in net cash received on affiliated debt.
Securitization
CNH Industrial Capital and its predecessor entities have been securitizing receivables since 1992. This market is a cost-effective financing source and allows access to a wide investor base. CNH Industrial Capital has approximately $4.8 billion of public and private asset-backed securities outstanding in both the U.S. and Canada as of December 31, 2018. Our securitizations are treated as financing arrangements for accounting purposes.
Committed Asset-Backed Facilities
CNH Industrial Capital has committed asset-backed facilities with several banks or through their commercial paper conduit programs. Committed asset-backed facilities for the U.S. and Canada totaled $2.8 billion at December 31, 2018, with original borrowing maturities of up to two years. The unused availability under the facilities varies during the year, depending on origination volume and the refinancing of receivables with term securitization transactions and/or other financing. At December 31, 2018, approximately $0.9 billion of funding was available for use under these facilities.
Unsecured Facilities and Debt
As of December 31, 2018, we had fully-drawn uncommitted credit lines totaling $195 million with final maturities in June 2019 and July 2020.
In addition, committed unsecured facilities with banks as of December 31, 2018 totaled $826 million. These credit facilities, which are eligible for renewal at various future dates, are used primarily for working capital and other general corporate purposes. As of December 31, 2018, we had $330 million outstanding under these credit facilities. Included in the remaining available credit commitments is $389 million maintained primarily to provide backup liquidity for commercial paper borrowings.
In 2017, we established a commercial paper program to issue short-term, unsecured, unsubordinated commercial paper notes on a private placement basis. As of December 31, 2018, the aggregate principal amount of notes outstanding was $389 million.
As of December 31, 2018, our outstanding unsecured senior notes were as follows (dollars in thousands):
These notes, which are senior unsecured obligations of CNH Industrial Capital LLC, are guaranteed by CNH Industrial Capital America and New Holland Credit.
On April 16, 2018, we repaid $600 million of our 3.625% unsecured notes due 2018.
On August 14, 2018, we completed an offering of $500 million in aggregate principal amount of our 4.200% unsecured notes due 2024, issued at a price to the public of 99.701%.
Credit Ratings
Our ability to obtain funding is affected by credit ratings of our debt, which are closely related to the outlook for and the financial condition of CNHI, and the nature and availability of our support agreement with CNHI.
To access public debt capital markets, we rely on credit rating agencies to assign short-term and long-term credit ratings to our securities as an indicator of credit quality for fixed income investors. A credit rating agency may change or withdraw our ratings based on its assessment of our current and future ability to meet interest and principal repayment obligations. Each agency’s rating should be evaluated independently of any other rating. Lower credit ratings generally result in higher borrowing costs, including costs of derivative transactions, and reduced access to debt capital markets.
The senior long-term and short-term debt ratings and outlook currently assigned to our unsecured debt securities by the rating agencies engaged by us are the same as those for CNHI. Those ratings as of December 31, 2018 were as follows:
Affiliate Sources
CNH Industrial Capital borrows, as needed, from CNH Industrial. This source of funding is primarily used to finance various assets and provides additional flexibility when evaluating market conditions and potential third-party financing options. We had affiliated debt of $276 million and $446 million as of December 31, 2018 and 2017, respectively.
Equity Position
Our equity position also supports our ability to access various funding sources. Our stockholder’s equity at December 31, 2018 and 2017 was $1.4 billion. During 2018, CNH Industrial Capital LLC paid cash dividends of $130 million to CNH Industrial America.
Liquidity
The majority of CNH Industrial Capital’s debt is self-liquidating from the cash generated by the underlying receivables. Normally, additional liquidity should not be necessary for the repayment of such debt. New originations of retail receivables are usually warehoused in committed asset-backed facilities until being refinanced in the term ABS market or with other third party debt. The majority of new wholesale receivables are financed through a master trust and funded by variable funding notes.
The liquidity available for use varies due to: (a) changes in origination volumes, reflecting the financing needs of our customers, and is influenced by the timing of any refinancing of underlying receivables; and (b) the execution of our funding strategy of maintaining a sufficient level of liquidity and flexible access to a wide variety of financial instruments including both committed and uncommitted, unsecured facilities.
Debt
Our consolidated debt as of December 31, 2018 and 2017 is set forth in the table below (dollars in thousands):
Cash, Cash Equivalents and Restricted Cash
The following table shows cash and cash equivalents and restricted cash as of December 31, 2018 and 2017 (dollars in thousands):
Cash and cash equivalents and restricted cash are comprised of highly liquid investments with short-term original maturities. See “Liquidity and Capital Resources - Cash Flows” for a further discussion of the change in our cash position.
Restricted cash is principally held by depository banks in order to comply with securitization contractual agreements, such as providing cash reserve accounts for the benefit of securitization investors.
Off-Balance Sheet Arrangements
For additional information, see “Note 13: Commitments and Contingencies” to our consolidated financial statements for the year ended December 31, 2018.
Contractual Obligations
The following table sets forth the aggregate amounts of our contractual obligations and commitments as of December 31, 2018 with definitive payment terms that will require significant cash outlays in the future (dollars in thousands).
(1)
Short-term debt shown as less than one year includes current maturities of long-term debt of $2,511,226.
(2)
The interest funding requirements are based on the year-end 2018 interest rates.
(3)
Minimum rental commitments.
See “Liquidity and Capital Resources - Debt” for information relating to our consolidated debt as of December 31, 2018.
Other Data
(1)
Delinquency means managed receivables that are past due over 30 days, expressed as a percentage of the managed receivables as of the end of the respective period.
(2)
Net credit losses on the managed receivables means write-offs, net of recoveries, for the preceding 12 months expressed as a percentage of the respective average managed receivables.
(3)
Yield on retail and wholesale receivables.
(4)
Net income for the period expressed as a percentage of average managed portfolio.
(5)
2017 and/or 2016 figures have been recast following the retrospective adoption on January 1, 2018 of ASU 2014-09.
Cautionary Note Regarding Forward-Looking Statements
All statements other than statements of historical fact contained in this annual report, including statements regarding our competitive strengths; business strategy; future financial position or operating results; budgets; projections with respect to revenue, income, capital expenditures, dividends, capital structure or other financial items; costs; and plans and objectives of management regarding operations, products and services, are forward-looking statements. These statements may include terminology such as “may,” “will,” “expect,” “could,” “should,” “intend,” “estimate,” “anticipate,” “believe,” “outlook,” “continue,” “remain,” “on track,” “design,” “target,” “objective,” “goal,” “forecast,” “projection,” “prospects,” “plan,” or similar terminology. Forward-looking statements are not guarantees of future performance. Rather, they are based on current views and assumptions and involve known and unknown risks, uncertainties and other factors, many of which are outside our control and are difficult to predict. If any of these risks and uncertainties materialize or other assumptions underlying any of the forward-looking statements prove to be incorrect, the actual results or developments may differ materially from any future results or developments expressed or implied by the forward-looking statements.
Factors, risks and uncertainties that could cause actual results to differ materially from those contemplated by the forward-looking statements include, among others: the many interrelated factors that affect customer confidence and demand for our financing products and services; general economic conditions; changes in government policies regarding banking, monetary and fiscal policies; legislation, particularly relating to capital goods-related issues such as agriculture, the environment, debt relief and subsidy program policies, trade and commerce and infrastructure development; government policies on international trade and investment, including protectionist trade policies such as higher tariffs, sanctions, import quotas, capital controls and new barriers to entry or consequent reactions by other governments against such policies; actions of competitors in the various industries in which CNH Industrial North America competes; interest rates and currency exchange rates; inflation and deflation; energy prices; prices for agricultural commodities; housing starts and other construction activity; our ability to obtain financing or to refinance existing debt; restrictive covenants in our debt agreements; actions by rating agencies concerning the ratings on our debt and asset-backed securities and the credit rating of CNHI; a decline in the price of used equipment; political and civil unrest; volatility and deterioration of capital and financial markets, other similar risks and uncertainties and our success, and CNH Industrial North America’s success, in managing the risks involved in the foregoing.
Forward-looking statements are based upon assumptions relating to the factors described in this annual report, which are sometimes based upon estimates and data received from third parties. Such estimates and data are often revised. Our actual results could differ materially from those anticipated in such forward-looking statements. Forward-looking statements speak only as of the date on which such statements are made, and we undertake no obligation to update or revise publicly our forward-looking statements.
Additional factors which could cause actual results and developments to differ from those expressed or implied by the forward-looking statements are included in the section “Item 1A. Risk Factors” of this annual report.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues and expenses during the reported periods. Actual results may differ from these estimates under different assumptions and conditions. Our critical accounting policies and estimates, which require management assumptions and complex judgments, are summarized below.
Allowance for Credit Losses
The allowance for credit losses is our estimate of losses for receivables owned by us and consists of two components, depending on whether the receivable has been individually identified as being impaired. The first component of the allowance for credit losses covers the receivables specifically reviewed by management for which we have determined it is probable that we will not collect all the principal and interest as per the terms of the contract. Receivables are individually reviewed for impairment based on, among other items, amounts outstanding, days past due and prior collection history. These receivables are subject to impairment measurement at the loan level based either on the fair value of the collateral for collateral-dependent receivables or on the present value of expected future cash flows discounted at the receivables’ effective interest rate.
The second component of the allowance for credit losses covers all receivables that have not been individually reviewed for impairment. The allowance for these receivables is based on aggregated portfolio evaluations, generally by financial product. The allowance for retail and wholesale credit losses is based on loss forecast models that consider a variety of factors that include, but are not limited to, historical loss experience, collateral value, portfolio balance and delinquency. The loss forecast models are updated on a quarterly basis. In addition, qualitative factors that are not fully captured in the loss forecast models, including industry trends, and macroeconomic factors are considered in the evaluation of the adequacy of the allowance for credit losses. These qualitative factors are subjective and require a degree of management judgment.
The total allowance for credit losses at December 31, 2018 and 2017 was $74.4 million and $79.2 million, respectively. Management’s ongoing evaluation of the adequacy of the allowance for credit losses takes into consideration historical loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of underlying collateral and current economic conditions.
While management believes it has exercised prudent judgment and applied reasonable assumptions, there can be no assurance that, in the future, changes in economic conditions or other factors will not cause changes in the financial condition of our customers. If the financial condition of some of our customers deteriorates, the timing and level of payments received could be impacted and, therefore, could result in an increase in losses on the current portfolio.
Equipment on Operating Lease Residual Values
We purchase equipment from our dealers and other independent third parties and lease such equipment to retail customers under operating leases. Income from these operating leases is recognized over the term of the lease. Our decision on whether or not to offer lease financing to customers is based, in part, upon estimated residual values of the leased equipment, which are estimated at the lease inception date and periodically updated. Realization of the residual values, a component in the profitability of a lease transaction, is dependent on our ability to market the equipment at lease termination under the then prevailing market conditions. Equipment model changes and updates, as well as market strength and product acceptance, are monitored and adjustments are made to residual values in accordance with the significance of any such changes. Although realization is not assured, management believes that the estimated residual values are realizable.
Total operating lease residual values at December 31, 2018 and 2017 were $1.4 billion.
Estimates used in determining end-of-lease market values for equipment on operating leases significantly impact the amount and timing of depreciation expense. If future values for this equipment were to decrease 10% from our present estimates, the total impact would be to increase our depreciation expense on equipment on operating leases by approximately $135.5 million. This amount would be charged to depreciation expense during the remaining lease terms such that the net amount of equipment on operating leases at the end of the lease terms would be equal to the revised residual values. Initial lease terms generally range from two to five years.
New Accounting Pronouncements Not Yet Adopted
In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which supersedes ASC 840, Leases (“ASC 840”) Subsequently, the FASB has issued additional ASUs, which further clarify this guidance. The ASU’s most prominent change is the requirement for lessees to recognize leased assets and liabilities classified as operating leases under the previous standard. The ASU does not significantly change the lessee’s recognition, measurement and presentation of expenses and cash flows from the previous accounting standard. Lessors’ accounting under the ASC is largely unchanged from the previous accounting standard. ASU 2016-02 also will require disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. It is effective for annual reporting periods beginning after December 15, 2018 including interim periods within those fiscal years and early adoption is permitted.
The original transition guidance in ASU 2016-02 required a modified retrospective approach. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements (“ASU 2018-11”), an amendment to ASU 2016-02, which provides entities with an additional transition method to adopt the new leases standard. Under
this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. If the transition option in ASU 2018-11 is elected, reporting for the comparative periods presented in the financial statements in which the entity adopts the new leases standard will continue to be in accordance with ASC 840.
We will adopt the new standard effective January 1, 2019, using the modified retrospective approach which requires us to recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption, without recasting prior periods. We will elect certain practical expedients upon transition, including: not to reassess under the new guidance its prior conclusions about lease identification, lease classification and initial direct costs; and, those provided for short-term leases. We do not believe the adoption of the standard will have a material impact on our consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which establishes ASC 326, Financial Instruments - Credit Losses. In November 2018, the FASB issued ASU No. 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses (“ASU 2018-19”), which amended ASC 326. The ASU introduced a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. Additional disclosures about significant estimates and credit quality are also required. ASU 2016-13 is effective for annual periods beginning after December 15, 2019, with early adoption permitted for annual periods beginning after December 15, 2018. We are currently evaluating the impact the adoption of this standard will have on our consolidated financial statements.
In August 2017, the FASB issued ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”) and in October 2018, the FASB issued ASU No. 2018-16, Inclusion of the Secured Overnight Financial Rate (SOFR) Overnight Index Swap Rate (OIS) as a Benchmark Interest Rate for Hedge Accounting Purposes (“ASU 2018-16”), which together amend ASC 815, Derivatives and Hedging. The purpose of this ASU is to better align a company’s risk management activities and financial reporting for hedging relationships, simplify the hedge accounting requirements and improve the disclosures of hedging arrangements. ASU 2017-12 is effective for fiscal years beginning after December 15, 2018, including interim periods within these years. Early adoption is permitted in any interim period or fiscal year before the effective date. We do not believe the adoption of this standard will have a material impact on our consolidated financial statements.
In February 2018, the FASB issued ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”), which amends ASC 202, Income Statement - Reporting Comprehensive Income. In December 2017, the U.S. government enacted new tax legislation (the “U.S. Tax Act”). Included in the provisions of U.S. Tax Act is a reduction of the corporate income tax rate from 35 percent to 21 percent. U.S. GAAP requires that remeasurement of deferred taxes to the new corporate tax rate occur in the period in which the legislation is enacted. The deferred tax adjustment is recorded in the provision for income taxes, including items for which the tax effects were originally recorded in other comprehensive income (“OCI”). This treatment results in the items in OCI reflecting a disproportionate tax rate, a result often referred to as stranded tax effects. This ASU allows a reclassification from accumulated OCI to retained earnings for stranded tax effects resulting from tax reform. ASU 2018-02 is effective for annual reporting periods beginning after December 15, 2018 including interim periods within those fiscal years, and early adoption is permitted. The ASU can be adopted at the beginning of an interim or annual period or retrospectively to each period affected by tax reform. We do not believe the adoption of this standard will have a material impact on our consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”), which amends ASC 820, Fair Value Measurement. This ASU modifies the disclosure requirements for fair value measurements by removing, modifying, or adding certain disclosures. The effective date is the first quarter of fiscal year 2021, with early adoption permitted for the removed disclosures and delayed adoption until fiscal year 2021 permitted for the new disclosures. The removed and modified disclosures will be adopted on a retrospective basis and the new disclosures will be adopted on a prospective basis. We are currently evaluating the impact the adoption of this standard will have on our consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement (“ASU 2018-15”), which expands upon the guidance set forth in ASU 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. ASU 2018-15 aligns the requirements for capitalization of implementation costs in a cloud computing service contract with those requirements for capitalization of implementation costs incurred for an internal-use software license. ASU 2018-15 is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years, and early adoption is permitted in any interim period for which financial statements have not been issued. ASU 2018-15 may be applied prospectively from the date the guidance is first applied or retrospectively. We are currently evaluating the impact the adoption of this standard will have on our consolidated financial statements.
In August 2018, the SEC adopted a final rule that amends certain disclosure requirements that have become duplicative, overlapping, or outdated in light of other SEC disclosure requirements, U.S. GAAP, or changes in the information environment. However, the guidance also added requirements for registrants to include in their interim financial statements a reconciliation of changes in stockholders’ equity for each period for which an income statement is required (both year-to-date and quarterly periods). The final rule is effective for all filings made on or after November 5, 2018. However, the SEC staff said it would not object to a registrant waiting to comply with the new interim disclosure requirement until the filing for the quarter that begins after the effective date. As a result, we plan to adopt the new interim disclosure requirement in our Form 10-Q for the three months ended March 31, 2019. We are currently evaluating the impact compliance with this rule will have on our consolidated financial statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to a variety of market risks, primarily changes in interest rates. We monitor our exposure to these risks, and manage the underlying economic exposures on transactions using financial instruments such as forward contracts, interest rate swaps, interest rate caps and forward starting swaps. We do not hold or issue derivatives or other financial instruments for speculative purposes or to hedge translation risks. See “Note 10: Financial Instruments” in the notes to our consolidated financial statements for the year ended December 31, 2018, for a description of our risk management strategy and the methods and assumptions used to determine the fair values of financial instruments.
Interest Rate Risk
We are exposed to market risk from changes in interest rates. We monitor our exposure to this risk and manage the underlying exposure both through the matching of financial assets and liabilities and through the use of financial instruments, including swaps, caps, and forward starting swaps for the net exposure. The instruments aim to stabilize funding costs by managing the exposure created by the differing maturities and interest rate structures of our financial assets and liabilities. We do not hold or issue derivative or other financial instruments for speculative purposes.
We monitor interest rate risk to achieve a predetermined level of matching between the interest rate structure of our financial assets and liabilities. Fixed-rate financial instruments, including receivables, debt and other investments, are segregated from floating-rate instruments in evaluating the potential impact of changes in applicable interest rates. A sensitivity analysis was performed to compute the impact on fair value which would be caused by a hypothetical 10% change in the interest rates used to discount each category of financial assets and liabilities. The net impact on the fair value of the financial instruments and derivative instruments held as of December 31, 2018 and 2017, resulting from a hypothetical 10% change in interest rates, would be approximately $12.6 million and $30.2 million, respectively. For the sensitivity analysis the financial instruments are grouped according to the currency in which financial assets and liabilities are denominated and the applicable interest rate index. As a result, our interest rate risk sensitivity model may overstate the impact of interest rate fluctuations for such financial instruments, as consistently unfavorable movements of all interest rates are unlikely.
Item 8.
Item 8. Financial Statements and Supplementary Data
Our consolidated financial statements are included in this annual report beginning on page.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
Under the supervision, and with the participation, of our management, including our President and Chief Financial Officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of December 31, 2018. Based on that evaluation, our President and Chief Financial Officer concluded that the disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in our Exchange Act filings is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our President and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during the three months ended December 31, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2018, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework (2013). Based on this assessment, management believes that, as of December 31, 2018, our internal control over financial reporting was effective.
This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this annual report.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Omitted pursuant to General Instruction I of Form 10-K.
Item 11.
Item 11. Executive Compensation
Omitted pursuant to General Instruction I of Form 10-K.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Omitted pursuant to General Instruction I of Form 10-K.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Omitted pursuant to General Instruction I of Form 10-K.
Item 14.
Item 14. Principal Accounting Fees and Services
For the years ended December 31, 2018 and 2017, Ernst & Young LLP, the member firms of Ernst & Young and their respective affiliates (collectively, the “Ernst & Young Entities”) were appointed to serve as our independent registered public accounting firm.
We incurred the following fees for professional services performed by the Ernst & Young Entities for the years ended December 31, 2018 and 2017, respectively:
“Audit Fees” are the aggregate fees billed for the audit of our consolidated annual financial statements, reviews of interim financial statements and attestation services that are provided in connection with statutory and regulatory filings or engagements. “Audit-related fees” are fees charged for assurance and related services that are reasonably related to the performance of the audit or review of our financial statements and are not reported under “Audit Fees.” This category is comprised of fees for agreed-upon procedure engagements and other attestation services subject to regulatory and funding requirements. There were no fees billed for professional services in connection with tax compliance, tax advice, tax planning or other fees not included above for the years ended December 31, 2018 and 2017.
Audit Committee’s Pre-Approval Policies and Procedures
As a wholly-owned subsidiary of CNHI, audit and non-audit services provided by our independent registered public accounting firm are subject to CNHI’s Audit Committee pre-approval policies and procedures. During the year ended December 31, 2018, all audit and non-audit services provided by our independent registered public accounting firm were pre-approved in accordance with such policies and procedures.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
The following documents are filed as part of this report:
1.Financial Statements
2.Financial Statement Schedules
See table of contents to financial statement and schedules immediately preceding the financial statements and schedules to the consolidated financial statements.
3.Exhibits.
† These certifications are deemed not filed for purposes of section 18 of the Exchange Act, or otherwise subject to the liability of that section; nor shall they be deemed incorporated by reference into any filing under the Securities Act of 1933 or the Exchange Act.
Pursuant to Item 601(b)(4)(iii) of Regulation S-K, copies of instruments defining the rights of holders of certain long-term debt have not been filed. The registrant will furnish copies thereof to the SEC upon request.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Brett D. Davis
Chairman, President and Director
March 1, 2019
Brett D. Davis
(Principal Executive Officer)
/s/ Douglas MacLeod
Chief Financial Officer and Assistant Treasurer
March 1, 2019
Douglas MacLeod
(Principal Financial Officer and Principal Accounting Officer)
/s/ Leandro Lecheta
Director
March 1, 2019
Leandro Lecheta
			 		
INDEX TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
CNH INDUSTRIAL CAPITAL LLC AND SUBSIDIARIES
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholder and Board of Directors of CNH Industrial Capital LLC
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of CNH Industrial Capital LLC and subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, changes in stockholder’s equity and cash flows for each of the three years in the period ended December 31, 2018, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ ERNST & YOUNG LLP
We have served as the Company’s auditor since 2011.
Milwaukee, WI
March 1, 2019
CNH INDUSTRIAL CAPITAL LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016
(Dollars in thousands)
The accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.
CNH INDUSTRIAL CAPITAL LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016
(Dollars in thousands)
The accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.
CNH INDUSTRIAL CAPITAL LLC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2018 AND 2017
(Dollars in thousands)
The accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.
CNH INDUSTRIAL CAPITAL LLC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Continued)
AS OF DECEMBER 31, 2018 AND 2017
(Dollars in thousands)
The following table presents certain assets and liabilities of consolidated variable interest entities (“VIEs”), which are included in the consolidated balance sheets. The assets in the table include those assets that can only be used to settle obligations of consolidated VIEs. The liabilities in the table include third-party liabilities of the consolidated VIEs, for which creditors do not have recourse to the general credit of CNH Industrial Capital LLC.
The accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.
CNH INDUSTRIAL CAPITAL LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016
(Dollars in thousands)
Notes:
(*)2017 and 2016 figures have been recast following the retrospective adoption on January 1, 2018 of the updated accounting standard for cash flow presentation (ASU 2016-18).
The accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.
			 		
CNH INDUSTRIAL CAPITAL LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER’S EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 AND 2016
(Dollars in thousands)
The accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.
			 		
CNH INDUSTRIAL CAPITAL LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands)
NOTE 1: NATURE OF OPERATIONS
CNH Industrial Capital LLC and its primary operating subsidiaries, including New Holland Credit Company, LLC (“New Holland Credit”), CNH Industrial Capital America LLC (“CNH Industrial Capital America”) and CNH Industrial Capital Canada Ltd. (“CNH Industrial Capital Canada”) (collectively, “CNH Industrial Capital” or the “Company”), are each a subsidiary of CNH Industrial America LLC (“CNH Industrial America”), which is an indirect wholly-owned subsidiary of CNH Industrial N.V. (“CNHI” and, together with its consolidated subsidiaries, “CNH Industrial”). CNH Industrial America and CNH Industrial Canada Ltd. (collectively, “CNH Industrial North America”) design, manufacture, and sell agricultural and construction equipment. CNH Industrial Capital provides financial services for CNH Industrial North America dealers and end-use customers primarily located in the United States and Canada.
CNHI is incorporated in and under the laws of The Netherlands. CNHI has its corporate seat in Amsterdam, The Netherlands, and its principal office in London, England. The common shares of CNHI are listed on the New York Stock Exchange under the symbol “CNHI,” as well as on the Mercato Telematico Azionario managed by Borsa Italiana S.p.A.
To support CNH Industrial North America’s sales of agricultural and construction equipment products, the Company offers retail financing to end-use customers and wholesale financing to CNH Industrial North America equipment dealers, all of which are independently owned. The Company provides and administers retail financing, primarily retail installment sales contracts, finance leases and operating leases to end-use customers for the purchase or lease of new and used CNH Industrial North America equipment and other agricultural and construction equipment sold primarily through CNH Industrial North America dealers and distributors. In addition, the Company purchases equipment from dealers that is leased to retail customers under operating lease agreements. Wholesale financing consists primarily of dealer floorplan financing, which allows dealers the ability to maintain a representative inventory of products. In addition, the Company provides financing to dealers for equipment used in dealer-owned rental yards, parts inventory, working capital, and other financing needs. CNH Industrial Capital Canada purchases short-term wholesale receivables at a discount (“wholesale factoring”) from Iveco Argentina S.A. (“Iveco Argentina”), an indirect wholly-owned subsidiary of CNHI, from time to time. The purchase is consistent with factoring arrangements between CNHI’s industrial and financial services companies. The Company also finances other products, including insurance and equipment protection products underwritten through a third-party insurer. As a captive finance company, the Company is reliant on the operations of CNH Industrial North America, its dealers and end-use customers.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation
The Company has prepared the accompanying consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The consolidated financial statements include the Company and its consolidated subsidiaries. The consolidated financial statements are expressed in U.S. dollars. The consolidated financial statements include the accounts of the Company’s subsidiaries in which the Company has a controlling financial interest and reflect the noncontrolling interests of the minority owners of the subsidiaries that are not fully owned for the periods presented, as applicable. A controlling financial interest may exist based on ownership of a majority of the voting interest of a subsidiary, or based on the Company’s determination that it is the primary beneficiary of a variable interest entity (“VIE”). The primary beneficiary of a VIE is the party that has the power to direct the activities that most significantly impact the economic performance of the entity and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the entity. The Company assesses whether it is the primary beneficiary on an ongoing basis, as prescribed by the accounting guidance
CNH INDUSTRIAL CAPITAL LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
on the consolidation of VIEs. The consolidated status of the VIEs with which the Company is involved may change as a result of such reassessments.
Certain prior period balances have been reclassified to conform to the current year presentation.
Use of Estimates in the Preparation of Financial Statements
The preparation of consolidated financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities and reported amounts of revenues and expenses. Significant estimates in these consolidated financial statements include the allowance for credit losses and residual values of equipment on operating leases. Actual results could differ from those estimates.
Revenue Recognition
Finance and interest income on retail notes and finance leases and on wholesale notes is recorded using the effective yield method. Deferred costs on the origination of financing receivables are recognized as a reduction in finance revenue over the expected lives of the receivables using the effective yield method. Recognition of income on receivables is suspended when management determines that collection of future income is not probable or when an account becomes 120 days delinquent, whichever occurs earlier. Income accrual is resumed if the receivable becomes contractually current and collection doubts are removed. Previously suspended income is recognized at that time. The Company applies cash received on nonaccrual financing receivables to first reduce any unrecognized interest and then the recorded investment and any other fees. Receivables are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Delinquency is reported on receivables greater than 30 days past due. Charge-offs of principal amounts of receivables outstanding are deducted from the allowance at the point when it is estimated that amounts due are deemed uncollectible.
A substantial portion of the Company’s interest income arises from retail sales programs offered by CNH Industrial North America on which finance charges are waived or below-market rate financing programs are offered. When the Company acquires retail installment sales contracts and finance leases subject to below-market interest rates, including waived interest rate financing, the Company receives compensation from CNH Industrial North America based on the Company’s estimated costs and a targeted return on equity. This amount is initially recognized as an unearned finance charge and is recognized as interest income over the term of the retail notes and finance leases, and is included in “Interest and other income from affiliates” in the accompanying consolidated statements of income.
For selected wholesale receivables, CNH Industrial North America compensates the Company based on the Company’s estimated costs and a targeted return on equity. These amounts are included in “Interest and other income from affiliates” in the accompanying consolidated statements of income.
The Company is also compensated for lending funds to CNH Industrial North America. The amounts earned are included in “Interest and other income from affiliates” in the accompanying consolidated statements of income.
Income from operating leases is recognized over the term of the lease on a straight-line basis. For selected operating leases, CNH Industrial North America compensates the Company based on the Company’s estimated costs and a targeted return on equity. The amounts from CNH Industrial North America recognized as rental income on operating leases are included in “Interest and other income from affiliates.”
Foreign Currency Translation
The Company’s non-U.S. subsidiaries maintain their books and accounting records using local currency as the functional currency. Assets and liabilities of these non-U.S. subsidiaries are translated into U.S. dollars at period-end exchange rates, and net exchange gains or losses resulting from such translation are included in “Accumulated other
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
comprehensive income” in the accompanying consolidated balance sheets. Income and expense accounts of these non-U.S. subsidiaries are translated at the average exchange rates for the period, and gains and losses from foreign currency transactions are included in net income in the period that they arise.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with an original maturity of three months or less. The carrying value of cash equivalents approximates fair value because of the short maturity of these investments.
Restricted Cash
Restricted cash includes principal and interest payments from retail notes and wholesale receivables owned by the consolidated VIEs that are payable to the VIEs’ investors, and cash pledged as a credit enhancement to the same investors. These amounts are held by depository banks in order to comply with contractual agreements.
Receivables
Receivables are recorded at amortized cost, net of allowances for credit losses and deferred fees and costs. Periodically, the Company sells or transfers retail and wholesale receivables to funding facilities or in securitization transactions. In accordance with the accounting guidance regarding transfers of financial assets and the consolidation of VIEs, the majority of the retail and wholesale receivables sold in securitizations do not qualify as sales and are recorded as secured borrowings with no gains or losses recognized at the time of securitization. Receivables associated with these securitization transactions and receivables that the Company has the ability and intent to hold for the foreseeable future are classified as held for investment. The substantial majority of the Company’s receivables, which include unrestricted receivables and restricted receivables for securitization investors, are classified as held for investment.
Allowance for Credit Losses
The allowance for credit losses is the Company’s estimate of losses on receivables owned by the Company and consists of two components, depending on whether the receivable has been individually identified as being impaired. The first component of the allowance for credit losses covers the receivables specifically reviewed by management for which the Company has determined it is probable that it will not collect all the principal and interest payments as per the terms of the contract. Receivables are individually reviewed for impairment based on, among other items, amounts outstanding, days past due and prior collection history. These receivables are subject to impairment measurement at the loan level based either on the fair value of the collateral for collateral dependent receivables or on the present value of expected future cash flows discounted at the receivables’ effective interest rate.
The second component of the allowance for credit losses covers all receivables that have not been individually reviewed for impairment. The allowance for these receivables is based on aggregated portfolio evaluations, generally by financial product. The allowance for retail and wholesale credit losses is based on loss forecast models that consider a variety of factors that include, but are not limited to, historical loss experience, collateral value, portfolio balance and delinquency. The loss forecast models are updated on a quarterly basis. In addition, qualitative factors that are not fully captured in the loss forecast models, including industry trends, and macroeconomic factors, are considered in the evaluation of the adequacy of the allowance for credit losses. These qualitative factors are subjective and require a degree of management judgment.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Equipment on Operating Leases
The Company purchases leases and equipment from CNH Industrial North America dealers and other independent third parties that have leased equipment to retail customers under operating leases. The Company’s investment in operating leases is based on the purchase price paid for the equipment. Income from these operating leases is recognized over the term of the lease. The equipment is depreciated on a straight-line basis over the term of the lease to the estimated residual value at lease termination. Residual values are estimated at the inception of the lease and are reviewed quarterly. Realization of the residual values is dependent on the Company’s future ability to re-market the equipment under then prevailing market conditions. Equipment model changes and updates, as well as market strength and product acceptance, are monitored and adjustments are made to residual values in accordance with the significance of any such changes. Management believes that the estimated residual values are realizable. Expenditures for maintenance and repairs are the responsibility of the lessee.
The Company evaluates the carrying amount of equipment on operating leases for potential impairment when it determines a triggering event has occurred. When a triggering event occurs, a test for recoverability is performed comparing projected undiscounted future cash flows to the carrying amount of the asset. If the test for recoverability identifies a possible impairment, the asset’s fair value is measured in accordance with the fair value measurement framework. An impairment charge would be recognized for the amount by which the carrying amount of the asset exceeds its estimated fair value.
Equipment returned to the Company upon termination of leases and held for subsequent sale or lease is recorded at the lower of net book value or estimated fair value of the equipment, less cost to sell, and is not depreciated.
Goodwill and Intangible Assets
Goodwill represents the excess of the aggregate purchase price over the fair value of the net assets acquired. Goodwill is deemed to have an indefinite useful life and is reviewed for impairment at least annually. During 2018 and 2017, the Company performed its annual impairment review as of December 31, and concluded that there was no impairment in either year. Other intangible assets consist of software and are being amortized on a straight-line basis over five years.
Income Taxes
The provision for income taxes is determined using the asset and liability method. The Company recognizes a current tax liability or asset for the estimated taxes payable or refundable on tax returns for the current year and tax contingencies estimated to be settled with taxing authorities within one year. A deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and tax loss carryforwards. The measurement of current and deferred tax liabilities and assets is based on provisions of enacted tax law. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized based on available evidence.
Derivatives
The Company’s policy is to enter into derivative transactions to manage exposures that arise in the normal course of business and not for trading or speculative purposes. The Company records derivative financial instruments in the consolidated balance sheets as either an asset or liability measured at fair value. The fair value of the Company’s interest rate derivatives is based on discounting expected cash flows, using market interest rates, over the remaining term of the instrument. The fair value of the Company’s foreign exchange derivatives is based on market exchange rates, adjusted for the respective interest rate differentials (premiums or discounts). Changes in the fair value of derivative financial instruments are recognized in current income unless specific hedge accounting criteria are met.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
For derivative financial instruments designated to hedge exposure to changes in the fair value of a recognized asset or liability, the gain or loss is recognized in income in the period of change together with the offsetting loss or gain on the related hedged item. For derivative financial instruments designated to hedge exposure to variable cash flows of a forecasted transaction, the effective portion of the derivative financial instrument’s gain or loss is initially reported in accumulated other comprehensive income and is subsequently reclassified into income when the forecasted transaction affects income. The ineffective portion of the gain or loss is recorded in income immediately. For derivative financial instruments that are not designated as hedges but held as economic hedges, the gain or loss is recognized immediately in income.
For derivative financial instruments designated as hedges, the Company formally documents the hedging relationship to the hedged item and its risk management strategy. This includes linking all derivatives that are designated as fair value hedges to specific assets and liabilities contained in the consolidated balance sheets and linking cash flow hedges to specific forecasted transactions or variability of cash flow. The Company assesses the effectiveness of its hedging instruments both at inception and on an ongoing basis. If a derivative is determined not to be highly effective as a hedge, or the underlying hedged transaction is no longer probable of occurring, or the derivative is terminated, the hedge accounting described above is discontinued and the derivative is marked to fair value and recorded in income through the remainder of its term.
New Accounting Pronouncements Adopted in 2018
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (ASC 606) (“ASU 2014-09”), which supersedes existing revenue recognition guidance under current U.S. GAAP. The new standard requires an entity to recognize revenue upon transfer of control of goods or services to a customer at an amount that reflects the consideration that the entity expects to receive. This new revenue recognition model defines a five-step process to achieve this objective. The new standard also requires additional disclosures to enable users to understand the nature, amount, timing and uncertainty of revenue and cash flow arising from contracts with customers. Entities have the option to apply the new guidance under a retrospective approach to each prior reporting period presented, and the cumulative effect of applying the standard would be recognized at the earliest period shown or a modified retrospective approach with the cumulative effect of initially applying the new guidance recognized at the date of initial application within the consolidated statement of changes in equity.
The Company has adopted this standard effective January 1, 2018. The adoption did not impact the timing or measurement of the Company’s revenue recognition as it is consistent with its current accounting treatment for contracts within the scope of the new ASU.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”) that changes the presentation of restricted cash and cash equivalents on the statement of cash flows. Restricted cash and restricted cash equivalents will be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the statement of cash flows. ASU 2016-18 is effective for annual reporting periods beginning after December 15, 2017, and early adoption is permitted. The Company adopted ASU 2016-18 on a retrospective basis as of January 1, 2018. The impact to the consolidated statement of cash flows for the years ended December 31, 2017 and 2016 was to increase cash flows from changes in accounts payable and other accrued liabilities by $7,643 and $3,300, respectively, eliminate cash flows from changes in restricted cash of $71,876 and $86,176, respectively, and to decrease cash, cash equivalents and restricted cash by $64,233 and $82,876, respectively.
In March 2017, the FASB issued ASU No. 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (“ASU 2017-07”). The amendments in this update require that an employer disaggregate the service cost component from the other components of net benefit cost. The amendments also provide explicit guidance on how to present the service cost
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(Dollars in thousands)
component and the other components of net benefit cost in the income statement and allow only the service cost component of net benefit cost to be eligible for capitalization. ASU 2017-07 is effective for annual reporting periods beginning after December 15, 2017, and early adoption is permitted. The Company adopted this standard on January 1, 2018, which did not have a material impact on its consolidated financial statements.
In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”), which amends ASC 825-10, Financial Instruments - Overall. This ASU changes the treatment for available-for-sale equity investments by recognizing unrealized fair value changes directly in net income, and no longer in other comprehensive income. ASU 2016-01 is effective January 1, 2018, with the cumulative-effect adjustment from initially applying the new standard recognized in the consolidated statement of financial position as of January 1, 2018. The Company adopted this standard on January 1, 2018, which did not have a material impact on its consolidated financial statements.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). This standard provides guidance clarification to reduce diversity in classification of certain cash flow payments and receipts in the statement of cash flows. ASU 2016-15 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017 on a retrospective transition basis to each period presented, and may be early adopted. The Company adopted this standard on January 1, 2018, which did not have a material impact on its consolidated financial statements.
New Accounting Pronouncements Not Yet Adopted
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which supersedes ASC 840, Leases (“ASC 840”) Subsequently, the FASB has issued additional ASUs, which further clarify this guidance. The ASU’s most prominent change is the requirement for lessees to recognize leased assets and liabilities classified as operating leases under the previous standard. The ASU does not significantly change the lessee’s recognition, measurement and presentation of expenses and cash flows from the previous accounting standard. Lessors’ accounting under the ASC is largely unchanged from the previous accounting standard. ASU 2016-02 also will require disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. It is effective for annual reporting periods beginning after December 15, 2018 including interim periods within those fiscal years and early adoption is permitted.
The original transition guidance in ASU 2016-02 required a modified retrospective approach. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements (“ASU 2018-11”), an amendment to ASU 2016-02, which provides entities with an additional transition method to adopt the new leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. If the transition option in ASU 2018-11 is elected, reporting for the comparative periods presented in the financial statements in which the entity adopts the new leases standard will continue to be in accordance with ASC 840.
The Company will adopt the new standard effective January 1, 2019, using the modified retrospective approach which requires it to recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption, without recasting prior periods. The Company will elect certain practical expedients upon transition, including: not to reassess under the new guidance its prior conclusions about lease identification, lease classification and initial direct costs; and, those provided for short-term leases. The Company does not believe the adoption of the standard will have a material impact on its consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which establishes ASC 326, Financial Instruments - Credit Losses. In November 2018, the FASB issued ASU No. 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses (“ASU 2018-19”), which amended ASC 326. The ASU introduced a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. Additional disclosures about significant
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
estimates and credit quality are also required. ASU 2016-13 is effective for annual periods beginning after December 15, 2019, with early adoption permitted for annual periods beginning after December 15, 2018. The Company is currently evaluating the impact the adoption of this standard will have on its consolidated financial statements.
In August 2017, the FASB issued ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”) and in October 2018, the FASB issued ASU No. 2018-16, Inclusion of the Secured Overnight Financial Rate (SOFR) Overnight Index Swap Rate (OIS) as a Benchmark Interest Rate for Hedge Accounting Purposes (“ASU 2018-16”), which together amend ASC 815, Derivatives and Hedging. The purpose of this ASU is to better align a company’s risk management activities and financial reporting for hedging relationships, simplify the hedge accounting requirements and improve the disclosures of hedging arrangements. ASU 2017-12 is effective for fiscal years beginning after December 15, 2018, including interim periods within these years. Early adoption is permitted in any interim period or fiscal year before the effective date. The Company does not believe the adoption of this standard will have a material impact on its consolidated financial statements.
In February 2018, the FASB issued ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”), which amends ASC 202, Income Statement - Reporting Comprehensive Income. In December 2017, the U.S. government enacted new tax legislation (the “U.S. Tax Act”). Included in the provisions of U.S. Tax Act is a reduction of the corporate income tax rate from 35 percent to 21 percent. U.S. GAAP requires that remeasurement of deferred taxes to the new corporate tax rate occur in the period in which the legislation is enacted. The deferred tax adjustment is recorded in the provision for income taxes, including items for which the tax effects were originally recorded in other comprehensive income (“OCI”). This treatment results in the items in OCI reflecting a disproportionate tax rate, a result often referred to as stranded tax effects. This ASU allows a reclassification from accumulated OCI to retained earnings for stranded tax effects resulting from tax reform. ASU 2018-02 is effective for annual reporting periods beginning after December 15, 2018 including interim periods within those fiscal years, and early adoption is permitted. The ASU can be adopted at the beginning of an interim or annual period or retrospectively to each period affected by tax reform. The Company does not believe the adoption of this standard will have a material impact on its consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”), which amends ASC 820, Fair Value Measurement. This ASU modifies the disclosure requirements for fair value measurements by removing, modifying, or adding certain disclosures. The effective date is the first quarter of fiscal year 2021, with early adoption permitted for the removed disclosures and delayed adoption until fiscal year 2021 permitted for the new disclosures. The removed and modified disclosures will be adopted on a retrospective basis and the new disclosures will be adopted on a prospective basis. The Company is currently evaluating the impact the adoption of this standard will have on its consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement (“ASU 2018-15”), which expands upon the guidance set forth in ASU 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. ASU 2018-15 aligns the requirements for capitalization of implementation costs in a cloud computing service contract with those requirements for capitalization of implementation costs incurred for an internal-use software license. ASU 2018-15 is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years, and early adoption is permitted in any interim period for which financial statements have not been issued. ASU 2018-15 may be applied prospectively from the date the guidance is first applied or retrospectively. The Company is currently evaluating the impact the adoption of this standard will have on its consolidated financial statements.
In August 2018, the SEC adopted a final rule that amends certain disclosure requirements that have become duplicative, overlapping, or outdated in light of other SEC disclosure requirements, U.S. GAAP, or changes in the information environment. However, the guidance also added requirements for registrants to include in their interim financial statements a reconciliation of changes in stockholders’ equity for each period for which an income statement
CNH INDUSTRIAL CAPITAL LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
is required (both year-to-date and quarterly periods). The final rule is effective for all filings made on or after November 5, 2018. However, the SEC staff said it would not object to a registrant waiting to comply with the new interim disclosure requirement until the filing for the quarter that begins after the effective date. As a result, the Company plans to adopt the new interim disclosure requirement in its Form 10-Q for the three months ended March 31, 2019. The Company is currently evaluating the impact compliance with this rule will have on its consolidated financial statements.
NOTE 3: ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income (“AOCI”) includes net income plus other comprehensive income, which includes foreign currency translation gains and losses, certain changes in pension plans and changes in fair value of certain derivatives designated as cash flow hedges.
The following table summarizes the change in the components of the Company’s AOCI balance and related tax effects for the year ended December 31, 2018:
The following table summarizes the change in the components of the Company’s AOCI balance and related tax effects for the year ended December 31, 2017:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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The reclassifications out of AOCI and the location on the consolidated statements of income for the years ended December 31, 2018 and 2017 are as follows:
NOTE 4: RECEIVABLES
A summary of receivables included in the consolidated balance sheets as of December 31, 2018 and 2017 is as follows:
The Company provides and administers financing for retail purchases of new and used equipment sold through CNH Industrial North America’s dealer network. The terms of retail and other notes and finance leases generally range from two to six years, and interest rates vary depending on prevailing market interest rates and certain incentive programs offered by CNH Industrial North America.
Wholesale receivables arise primarily from the financing of the sale of goods to dealers and distributors by CNH Industrial North America, and to a lesser extent, the financing of dealer operations. Under the standard terms of the wholesale receivable agreements, these receivables typically have interest-free periods of up to twelve months and stated original maturities of up to twenty-four months, with repayment accelerated upon the sale of the underlying equipment by the dealer. During the interest-free period, the Company is compensated by CNH Industrial North America based on market interest rates. After the expiration of any interest-free period, interest is charged to dealers on outstanding balances until the Company receives payment in full. The interest-free periods are determined based on the type of equipment sold and the time of year of the sale. Interest rates are set based on market factors and the prime rate or LIBOR. The Company evaluates and assesses dealers on an ongoing basis as to their creditworthiness. CNH Industrial North America may be obligated to repurchase the dealer’s equipment upon cancellation or termination of the dealer’s contract for such causes as change in ownership, closeout of the business, or default. There were no significant losses in 2018, 2017 and 2016 relating to the termination of dealer contracts.
Wholesale factoring receivables represent short-term receivables purchased from Iveco Argentina.
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(Dollars in thousands)
Maturities of receivables as of December 31, 2018, are as follows:
It has been the Company’s experience that substantial portions of retail receivables are repaid before their contractual maturity dates. As a result, the above table should not be regarded as a forecast of future cash collections. Retail, finance lease and wholesale receivables have significant concentrations of credit risk in the agricultural and construction business sectors. Short-term receivables purchased from Iveco Argentina have significant concentrations of credit risk in the agricultural and commercial vehicles business sectors in Argentina. On a geographic basis, there is not a disproportionate concentration of credit risk in any area of the United States, Canada or Argentina. The Company typically retains, as collateral, a security interest in the equipment associated with retail notes and wholesale receivables.
Restricted Receivables and Securitization
As part of its overall funding strategy, the Company periodically transfers certain receivables into VIEs that are special purpose entities (“SPEs”) as part of its asset-backed securitization (“ABS”) programs.
SPEs utilized in the securitization programs differ from other entities included in the Company’s consolidated financial statements because the assets they hold are legally isolated from the Company’s assets. For bankruptcy analysis purposes, the Company has sold the receivables to the SPEs in a true sale and the SPEs are separate legal entities. Upon transfer of the receivables to the SPEs, the receivables and certain cash flows derived from them become restricted for use in meeting obligations to the SPEs’ creditors. The SPEs have ownership of cash balances that also have restrictions for the benefit of the SPEs’ investors. The Company’s interests in the SPEs’ receivables are subordinate to the interests of third-party investors. None of the receivables that are directly or indirectly sold or transferred in any of these transactions are available to pay the Company’s creditors until all obligations of the SPE have been fulfilled or the receivables are removed from the SPE.
The secured borrowings related to the restricted receivables are obligations that are payable as the receivables are collected. The following table summarizes the restricted receivables as of December 31, 2018 and 2017:
Retail Receivables Securitizations
Within the U.S. retail receivables securitization programs, qualifying retail receivables are sold to limited purpose, bankruptcy-remote SPEs. In turn, these SPEs establish separate trusts to which the receivables are transferred in exchange for proceeds from asset-backed securities issued by the trusts. In Canada, the receivables are transferred directly to the trusts. These trusts were determined to be VIEs. In its role as servicer, the Company has the power to direct the trusts’ activities. Through its retained interests, the Company has an obligation to absorb certain losses, or the right to receive certain benefits, that could potentially be significant to the trusts. Consequently, the Company has consolidated these retail trusts.
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During the years ended December 31, 2018 and 2017, the Company executed $2,250,399 and $2,989,014, respectively, in term retail asset-backed transactions in the U.S. and Canada. The securities in these transactions are backed by agricultural and construction equipment retail receivable contracts originated through CNH Industrial North America’s dealer network. As of December 31, 2018 and 2017, $4,808,679 and $5,567,786, respectively, of asset-backed securities issued to investors were outstanding with weighted average remaining maturities of 30 months and 31 months, respectively. The Company believes that it is probable that it will continue to regularly utilize the term ABS markets.
The Company may retain all or a portion of the subordinated interests in the SPEs. No recourse provisions exist that allow holders of the asset-backed securities issued by the trusts to put those securities back to the Company although the Company provides customary representations and warranties that could give rise to an obligation to repurchase from the trusts any receivables for which there is a breach of the representations and warranties. Moreover, the Company does not guarantee any securities issued by the trusts. The trusts have a limited life and generally terminate upon final distribution of amounts owed to investors or upon exercise of a cleanup-call option by the Company, in its role as servicer.
The Company also has $1,566,870 in committed asset-backed facilities through which it may sell on a monthly basis retail receivables generated in the United States and Canada. The Company has utilized these facilities in the past to fund the origination of receivables and has later repurchased and resold the receivables in the term ABS markets or found alternative financing for the receivables. The U.S. and Canadian facilities had an original funding term of two years and are renewable in September 2020 and December 2020, respectively. To the extent these facilities are not renewed, they will be repaid according to the amortization of the underlying receivables.
Wholesale Receivables Securitizations
With regard to the wholesale receivable securitization programs, the Company sells eligible receivables on a revolving basis to structured master trust facilities which are limited-purpose, bankruptcy-remote SPEs. As of December 31, 2018, debt issued through the U.S. master trust facility consists of two short-term facilities renewable at the discretion of the investors: $500,000 and $300,000.
The Canadian master trust facility consists of a C$585,750 ($429,788) facility renewable December 2020 at the discretion of the investor.
These trusts were determined to be VIEs. In its role as servicer, CNH Industrial Capital has the power to direct the trusts’ activities. Through its retained interests, the Company provides security to investors in the event that cash collections from the receivables are not sufficient to make principal and interest payments on the securities. Consequently, CNH Industrial Capital has consolidated these wholesale trusts.
Each of the facilities contains minimum payment rate thresholds that, if breached, could preclude the Company from selling additional receivables originated on a prospective basis and could force an early amortization of the debt.
Allowance for Credit Losses
The Company’s allowance for credit losses is segregated into three portfolio segments: retail, wholesale and wholesale factoring. A portfolio segment is the level at which the Company develops a systematic methodology for determining its allowance for credit losses. The retail segment includes retail notes and finance lease receivables. The wholesale segment includes wholesale financing to CNH Industrial North America dealers and the wholesale factoring segment represents the short-term receivables purchased from Iveco Argentina.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Further, the Company evaluates its retail and wholesale portfolio segments by class of receivable: United States and Canada. Typically, the Company’s receivables within a geographic area have similar risk profiles and methods for assessing and monitoring risk. These classes align with management reporting.
Allowance for credit losses activity for the year ended December 31, 2018 is as follows:
Allowance for credit losses activity for the year ended December 31, 2017 is as follows:
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Allowance for credit losses activity for the year ended December 31, 2016 is as follows:
Utilizing an internal credit scoring model, which considers customers’ attributes, prior credit history and each retail transaction’s attributes, the Company assigns a credit quality rating to each retail customer, by specific transaction, as part of the retail underwriting process. This rating is used in setting the terms on the transaction, including the interest rate. A description of the general characteristics of the customers’ risk grades is as follows:
Titanium - Customers from whom the Company expects no loss or collection effort.
Platinum - Customers from whom the Company expects minimal, if any, loss or collection effort.
Gold, Silver, Bronze - Customers defined as those with the potential for loss and collection effort.
A breakdown of the retail portfolio by the customer’s risk grade at the time of origination as of December 31, 2018 and 2017 is as follows:
As part of the ongoing monitoring of the credit quality of the wholesale portfolio, the Company utilizes an internal credit scoring model that assigns a risk grade for each dealer. The scoring model considers the strength of the dealer’s financial condition and payment history. The Company considers the dealers’ ratings in the quarterly credit allowance analysis. A description of the general characteristics of the dealer risk grades is as follows:
Grades A and B - Includes receivables due from dealers that have significant capital strength, moderate leverage, stable earnings and growth, and excellent payment performance.
Grade C - Includes receivables due from dealers with moderate credit risk. Dealers of this grade are differentiated from higher grades on a basis of leverage or payment performance.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Grade D - Includes receivables due from dealers with additional credit risk. These dealers require additional monitoring due to their weaker financial condition or payment performance.
A breakdown of the wholesale portfolio by its credit quality indicators as of December 31, 2018 and 2017 is as follows:
The following tables present information at the level at which management assesses and monitors its credit risk. Receivables are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Delinquency is reported on receivables greater than 30 days past due.
The aging of receivables as of December 31, 2018 and 2017 is as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Impaired receivables are receivables for which the Company has determined it will not collect all the principal and interest payments as per the terms of the contract. As of December 31, 2018 and 2017, the Company’s recorded investment in impaired receivables individually evaluated for impairment and the related unpaid principal balances, allowances and average recorded investment (based on a thirteen-month average) are as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
As of December 31, 2018 and 2017, the Company’s impaired receivables individually evaluated for impairment without an allowance were immaterial. Interest income recognized on impaired receivables for the years ended December 31, 2018 and 2017 was immaterial.
Recognition of income is generally suspended when management determines that collection of future finance income is not probable or when an account becomes 120 days delinquent, whichever occurs first. Interest accrual is resumed if the receivable becomes contractually current and collection becomes probable. Previously suspended income is recognized at that time.
The receivables on nonaccrual status as of December 31, 2018 and 2017 are as follows:
Troubled Debt Restructurings
A restructuring of a receivable constitutes a troubled debt restructuring (“TDR”) when the lender grants a concession it would not otherwise consider to a borrower that is experiencing financial difficulties. As a collateral-based lender, the Company typically will repossess collateral in lieu of restructuring receivables. As such, for retail receivables, concessions are typically provided based on bankruptcy court proceedings. For wholesale receivables, concessions granted may include extended contract maturities, inclusion of interest-only periods, modification of a contractual interest rate to a below market interest rate and waiving of interest and principal.
TDRs are reviewed along with other receivables as part of management’s ongoing evaluation of the adequacy of the allowance for credit losses. The allowance for credit losses attributable to TDRs is based on the most probable source of repayment, which is normally the liquidation of the collateral. In determining collateral value, the Company estimates the current fair market value of the equipment collateral and considers credit enhancements such as additional collateral and third-party guarantees.
Before removing a receivable from TDR classification, a review of the borrower is conducted. If concerns exist about the future ability of the borrower to meet its obligations based on a credit review, the TDR classification is not removed from the receivable.
As of December 31, 2018, the Company had 254 retail and finance lease contracts classified as TDRs where a court has determined the concession. The pre-modification value of these contracts was $8,118 and the post-modification value was $7,272. Additionally, the Company had 371 accounts with a balance of $17,129 undergoing bankruptcy proceedings where a concession has not yet been determined. As of December 31, 2017, the Company had 272 retail and finance lease contracts classified as TDRs where a court has determined the concession. The pre-modification value of these contracts was $8,583 and the post-modification value was $7,710. Additionally, the Company had 423 accounts with a balance of $23,750 undergoing bankruptcy proceedings where a concession has not yet been determined. As the outcome of the bankruptcy cases is determined by the court based on available assets, subsequent re-defaults are unusual and were not material for retail and finance lease contracts that were modified in a TDR during the previous 12 months ended December 31, 2018 and 2017.
As of December 31, 2018 and 2017, the Company’s wholesale TDRs were immaterial.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
NOTE 5: EQUIPMENT ON OPERATING LEASES
A summary of equipment on operating leases as of December 31, 2018 and 2017 is as follows:
Depreciation expense totaled $231,805, $280,765 and $247,438 for the years ended December 31, 2018, 2017 and 2016, respectively.
Lease payments owed to the Company for equipment under non-cancelable operating leases (excluding deferred operating lease subsidy of $106,817) as of December 31, 2018 are as follows:
NOTE 6: GOODWILL AND INTANGIBLE ASSETS
Changes in the carrying amount of goodwill for the years ended December 31, 2018 and 2017 are as follows:
Goodwill is tested for impairment at least annually. During 2018, 2017 and 2016, the Company performed its annual impairment review as of December 31 and concluded that there were no impairments in any year.
As of December 31, 2018 and 2017, the Company’s intangible asset and related accumulated amortization for its software is as follows:
The Company recorded amortization expense of $2,114, $2,112 and $1,998 during 2018, 2017 and 2016, respectively.
Based on the current amount of software subject to amortization, the estimated annual amortization expense for each of the succeeding five years is as follows: $1,722 in 2019; $1,082 in 2020; $516 in 2021; $241 in 2022; and $55 in 2023.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
NOTE 7: OTHER ASSETS
The components of other assets as of December 31, 2018 and 2017 are as follows:
NOTE 8: CREDIT FACILITIES AND DEBT
The following table summarizes the Company’s debt and credit facilities, borrowings thereunder and availability at December 31, 2018:
(1)
Maturity dates reflect maturities of the credit facility, which may be different than the maturities of the advances under the facility.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
A summary of the minimum annual repayments of long-term debt as of December 31, 2018, for 2020 and thereafter is as follows:
The following table summarizes the Company’s credit facilities, borrowings thereunder and availability at December 31, 2017:
(1)
Maturity dates reflect maturities of the credit facility, which may be different than the maturities of the advances under the facility.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Committed Asset-Backed Facilities
The Company has access to committed asset-backed facilities with several banks through which it may sell its receivables. The Company utilizes retail facilities to fund the origination of retail receivables and has exercised the option to periodically repurchase receivables and resell them in the term ABS markets (shown as “Amortizing retail term ABS - N.A.”) or found alternative financing for the receivables. Under these facilities, the maximum amount of proceeds that can be accessed at one time is $1,566,870. In addition, if the receivables sold are not repurchased by the Company, the related debt is paid only as the underlying receivables are collected. Such receivables have maturities not exceeding seven years. The Company believes it is probable that a majority of these receivables will be repurchased and resold in the ABS markets. Borrowings against these facilities accrue interest based on prevailing money market rates, plus an applicable margin.
The Company finances a portion of its wholesale receivable portfolio with the issue of Variable Funding Notes (“VFNs”) which are privately subscribed by certain banks and asset-backed commercial paper conduits. These notes accrue interest based on prevailing money market rates, plus an applicable margin.
Secured Debt
Secured borrowings bear interest at either floating rates of LIBOR plus an applicable margin or fixed rates.
Unsecured Facilities and Debt
As of December 31, 2018, the Company had fully-drawn uncommitted credit lines totaling $195,386 with final maturities in June 2019 and July 2020.
Committed unsecured facilities with banks as of December 31, 2018 totaled $825,569. These credit facilities, which are eligible for renewal at various future dates, are used primarily for working capital and other general corporate purposes. As of December 31, 2018, the Company had $330,183 outstanding under these credit facilities. Included in the remaining available credit commitments is $389,000 maintained primarily to provide backup liquidity for commercial paper borrowings.
In 2017, the Company established a commercial paper program to issue short-term, unsecured, unsubordinated commercial paper notes on a private placement basis. As of December 31, 2018, the aggregate principal amount of notes outstanding was $389,000.
As of December 31, 2018, the Company’s outstanding unsecured senior notes were as follows:
These notes, which are senior unsecured obligations of CNH Industrial Capital LLC, are guaranteed by CNH Industrial Capital America and New Holland Credit.
On April 16, 2018, the Company repaid $600,000 of its 3.625% unsecured notes due 2018.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
On August 14, 2018, the Company completed an offering of $500,000 in aggregate principal amount of its 4.200% unsecured notes due 2024, issued at a price to the public of 99.701%.
Covenants
The indentures and credit agreements governing the Company’s unsecured funding transactions contain covenants that restrict the Company’s ability and/or that of its subsidiaries to, among other things, incur additional debt, make certain investments, enter into certain types of transactions with affiliates, use assets as security in other transactions, enter into sale or leaseback transactions and/or sell certain assets or merge with or into other companies. In addition, the Company is required to maintain a certain coverage level for leverage.
Interest Rates
The weighted-average interest rate on total short-term debt outstanding at December 31, 2018 and 2017 was 3.0% and 2.2%, respectively. The weighted-average interest rate on total long-term debt (including current maturities of long-term debt) at December 31, 2018 and 2017 was 3.1% and 2.6%, respectively. The average rate is calculated using the actual rates at December 31, 2018 and 2017, weighted by the amount of outstanding borrowings of each debt instrument.
Support Agreement
Effective as of September 29, 2013, in connection with the merger of CNH Global N.V., the former indirect parent of CNH Industrial Capital (“CNH Global”), with and into CNHI, CNHI assumed all of CNH Global’s obligations under the support agreement, pursuant to which CNHI has agreed to, among other things, (a) make cash capital contributions to the Company, to the extent necessary to cause the ratio of net earnings available for fixed charges to fixed charges to be not less than 1.05 for each fiscal quarter (with such ratio determined, on a consolidated basis and in accordance with U.S. GAAP, for such fiscal quarter and the immediately preceding three fiscal quarters taken as a whole), (b) generally maintain an ownership of at least 51% of the voting equity interests in the Company and (c) cause the Company to have, as of the end of any fiscal quarter, a consolidated tangible net worth of at least $50,000. The support agreement is not intended to be and is not a guarantee by CNHI of any indebtedness or other obligation of the Company. The obligations of CNHI to the Company pursuant to this support agreement are to the Company only and do not run to, and are not enforceable directly by, any creditor of the Company. The support agreement may be modified, amended or terminated, at CNHI’s election, upon thirty days’ prior written notice to the Company and the rating agencies, if (a) the modification, amendment or termination would not result in a downgrade of the Company’s rated indebtedness; (b) the modification, amendment or notice of termination provides that the support agreement will continue in effect with respect to the Company’s rated indebtedness then outstanding; or (c) the Company has no long-term rated indebtedness outstanding.
NOTE 9: INCOME TAXES
The income and expenses of the Company and certain of its domestic subsidiaries are included in the consolidated income tax return of CNH Industrial U.S. Holdings, Inc., a wholly-owned subsidiary of CNHI. CNH Industrial U.S. Holdings, Inc. is the new parent of Case New Holland Inc., who remains the parent of CNH Industrial America. The Company’s Canadian subsidiaries file separate income tax returns, as do certain domestic subsidiaries. The Company and certain of its domestic subsidiaries are LLCs and, as a result, incur no income tax liability on a stand-alone basis for tax purposes. However, for financial reporting, all tax accounts have been disclosed and the income tax expense is reflective for all of the companies included in the consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
The sources of income before taxes for the years ended December 31, 2018, 2017, and 2016 are as follows, with foreign defined as any income earned outside the United States:
The provision for income taxes for the years ended December 31, 2018, 2017 and 2016 is as follows:
A reconciliation of CNH’s statutory and effective income tax rate for the years ended December 31, 2018, 2017, and 2016 is as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
The components of the Company’s net deferred tax liability as of December 31, 2018 and 2017 are as follows:
(1)
In the accompanying consolidated balance sheets, the US net deferred tax position in 2018 and 2017 is included in “Accounts payable and other accrued liabilities” while the Canadian net deferred tax position in 2018 and 2017 is included in “Other assets”.
Deferred taxes are provided to reflect timing differences between the financial and tax basis of assets and liabilities and tax carryforwards using currently enacted tax rates and laws. Management believes it is more likely than not the benefit of the deferred tax assets will be realized.
A reconciliation of the gross amounts of tax contingencies at the beginning and end of the year is as follows:
The total amount of unrecognized tax benefits that, if recognized, would affect the annual effective income tax rate is $4,274.
The Company recognizes interest and penalties accrued related to tax contingencies in income tax expense. During the years ended December 31, 2018, 2017 and 2016, the Company recognized approximately $686, $0 and $0, respectively, in interest and penalties. The Company had approximately $686, $0 and $0 for the expected future payment of interest and penalties accrued at December 31, 2018, 2017 and 2016, respectively.
The Company has open tax years from 2012 to 2018. The Company does not believe the resolution of any outstanding tax examinations will have a material adverse effect on the Company’s financial position or its results of operations. On December 22, 2017, the U.S. enacted the U.S. Tax Act which included, among other things, a reduction in the corporate tax rate from 35% to 21% and a tax on deemed repatriation of the undistributed earnings of foreign subsidiaries. As a result, in the fourth quarter of 2017, the Company recorded an estimated net tax benefit of $111,000, which included the revaluation of its net deferred tax liability and the tax charge on the deemed repatriation. In the fourth quarter of 2018, the Company filed its 2017 U.S. corporate income tax return and subsequently booked an additional benefit of $2,739 to reflect the final increment of corporate tax reform, thus resulting in an overall benefit of $113,739. In addition, amongst other items, the U.S. Tax Act enacted a tax upon global intangible low tax income (the “GILTI tax”). The Company has made a policy election to account for the GILTI tax as a current period cost, rather than under the deferred tax method.
At December 31, 2018, there are no material deferred tax liabilities on undistributed earnings of subsidiaries
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
outside of the U.S.
NOTE 10: FINANCIAL INSTRUMENTS
The Company may elect to measure many financial instruments and certain other items at fair value. This fair value option must be applied on an instrument-by-instrument basis with changes in fair value reported in earnings. The election can be made at the acquisition of an eligible financial asset, financial liability, or firm commitment or when certain specified reconsideration events occur. The fair value election may not be revoked once made. The Company did not elect the fair value measurement option for eligible items.
Fair-Value Hierarchy
U.S. GAAP specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s internally-developed market assumptions. These two types of inputs have created the following fair-value hierarchy:
Level 1 - Quoted prices for identical instruments in active markets.
Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
Level 3 - Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
This hierarchy requires the use of observable market data when available.
Determination of Fair Value
When available, the Company uses quoted market prices to determine fair value and classifies such items in Level 1. In some cases where a market price is not available, the Company will make use of observable market-based inputs to calculate fair value, in which case the items are classified in Level 2.
If quoted or observable market prices are not available, fair value is based upon internally developed valuation techniques that use, where possible, current market-based or independently sourced market parameters such as interest rates, currency rates, or yield curves. Items valued using such internally generated valuation techniques are classified according to the lowest level input or value driver that is significant to the valuation. Thus, an item may be classified in Level 3 even though there may be some significant inputs that are readily observable.
The following section describes the valuation methodologies used by the Company to measure various financial instruments at fair value, including an indication of the level in the fair value hierarchy in which each instrument is generally classified. Where appropriate, the description includes details of the valuation models and the key inputs to those models, as well as any significant assumptions.
Derivatives
The Company utilizes derivative instruments to mitigate its exposure to interest rate and foreign currency exposures. Derivatives used as hedges are effective at reducing the risk associated with the exposure being hedged and are designated as a hedge at the inception of the derivative contract. The Company does not hold or issue derivative or other financial instruments for speculative purposes. The credit risk for the interest rate hedges is reduced through diversification among counterparties, utilizing mandatory termination clauses and/or collateral
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
support agreements. Derivative instruments are generally classified in Level 2 or 3 of the fair value hierarchy. The cash flows underlying all derivative contracts were recorded in operating activities in the consolidated statements of cash flows.
Interest Rate Derivatives
The Company has entered into interest rate derivatives in order to manage interest rate exposures arising in the normal course of business. Interest rate derivatives that have been designated in cash flow hedging relationships are being used by the Company to mitigate the risk of rising interest rates related to debt and anticipated issuance of fixed-rate debt in future periods. Gains and losses on these instruments, to the extent that the hedge relationship has been effective, are deferred in accumulated other comprehensive income (loss) and recognized in interest expense over the period in which the Company recognizes interest expense on the related debt. Ineffectiveness recognized related to these hedging relationships was not significant for the years ended December 31, 2018, 2017 and 2016. These amounts are recorded in “Other expenses” in the consolidated statements of income. As of December 31, 2018, the maximum length of time over which the Company is hedging its interest rate exposure through the use of derivative instruments designated in cash flow hedge relationships is 53 months. As of December 31, 2018, the after-tax gains deferred in accumulated other comprehensive income (loss) that will be recognized in interest expense over the next 12 months are approximately $712.
The Company also enters into interest rate derivatives with substantially similar economic terms that are not designated as hedging instruments to mitigate interest rate risk related to the Company’s committed asset-backed facilities. These facilities require the Company to enter into interest rate derivatives. To ensure that these transactions do not result in the Company being exposed to this risk, the Company enters into an offsetting position. Unrealized and realized gains and losses resulting from fair value changes in these instruments are recognized directly in income and were insignificant for the years ended December 31, 2018, 2017 and 2016.
Most of the Company’s interest rate derivatives are considered Level 2. The fair market value of these derivatives is calculated using market data input for forecasted benchmark interest rates and can be compared to actively traded derivatives. If the future notional amount of the Company’s interest rate derivatives is not known in advance, the derivatives are considered Level 3 derivatives. The fair market value of these derivatives is calculated using market data input and a forecasted future notional balance. The total notional amount of the Company’s interest rate derivatives was approximately $2,960,191 and $3,143,737 at December 31, 2018 and 2017, respectively. The thirteen-month average notional amounts as of December 31, 2018 and 2017 were $2,947,318 and $3,246,576, respectively.
Foreign Exchange Contracts
The Company uses forward contracts to hedge certain assets and liabilities denominated in foreign currencies. Such derivatives are considered economic hedges and are not designated as hedging instruments. The changes in the fair value of these instruments are recognized directly as income in “Other expenses” and are expected to offset the foreign exchange gains or losses on the exposures being managed.
All of the Company’s foreign exchange derivatives are considered Level 2 as the fair value is calculated using market data input and can be compared to actively traded derivatives.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Financial Statement Impact of the Company’s Derivatives
The fair values of the Company’s derivatives as of December 31, 2018 and 2017 in the consolidated balance sheets are recorded as follows:
Pre-tax gains (losses) on the consolidated statements of income and comprehensive income related to the Company’s derivatives for the years ended December 31, 2018, 2017 and 2016 are recorded in the following accounts:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Items Measured at Fair Value on a Recurring Basis
The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis as of December 31, 2018 and 2017, all of which are classified as Level 2:
There were no transfers between Level 1, Level 2 and Level 3 hierarchy levels during the periods presented.
Items Measured at Fair Value on a Nonrecurring Basis
The Company may be required, from time to time, to measure certain other financial assets at fair value on a nonrecurring basis in accordance with U.S. GAAP. These adjustments to fair value usually result from application of lower of cost or market accounting or impairment charges of individual assets.
Certain equipment held for sale measured at fair value on a nonrecurring basis at June 30, 2018 and December 31, 2017 was $144,913 and $123,503, respectively. The fair market value of these assets was based on an internal valuation methodology, which used industry guide book values adjusted for recent remarketing history and was classified as Level 3 under the fair value hierarchy. For the years ended December 31, 2018, 2017 and 2016, the Company recorded impairment losses on equipment held for sale of $2,894, $5,646 and $11,400, respectively. In addition, the Company recorded (gains) losses on the sale of the equipment held of $11,018, $9,784 and $(1,690) for the years ended December 31, 2018, 2017 and 2016, respectively. Both the impairment losses and the gains on the sale of equipment held were included in “Other expenses” in the accompanying consolidated statements of income.
Fair Value of Other Financial Instruments
The carrying amount of cash and cash equivalents, restricted cash, floating-rate affiliated accounts and notes receivable, floating-rate short-term debt, interest payable and short-term affiliated debt was assumed to approximate its fair value. Under the fair value hierarchy, cash and cash equivalents and restricted cash are classified as Level 1 and the remainder of the financial instruments listed is classified as Level 2.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
Financial Instruments Not Carried at Fair Value
The carrying amount and estimated fair value of assets and liabilities considered financial instruments as of December 31, 2018 and 2017 are as follows:
*Under the fair value hierarchy, receivables measurements are classified as Level 3 and long-term debt measurements are classified as Level 2.
Financial Assets
The fair value of receivables was determined by discounting the estimated future payments using a discount rate which includes an estimate for credit risk.
Financial Liabilities
The fair values of long-term debt were based on current market quotes for identical or similar borrowings and credit risk.
NOTE 11: GEOGRAPHICAL INFORMATION
Based on how its operations are managed and evaluated by management, the Company is viewed as one operating segment.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
A summary of the Company’s geographical information is as follows:
NOTE 12: RELATED-PARTY TRANSACTIONS
The Company receives compensation from CNH Industrial North America for retail, wholesale and operating lease sales programs offered by CNH Industrial North America on which finance charges are waived or below market rate financing programs are offered. The Company receives compensation from CNH Industrial North America based
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
on the Company’s estimated costs and a targeted return on equity. The Company is also compensated for lending funds to CNH Industrial North America.
In addition, the Company receives income from Iveco Argentina for wholesale factoring receivables purchased at a discount.
The summary of sources included in “Interest and other income from affiliates” in the accompanying consolidated statements of income at December 31, 2018, 2017, and 2016 is as follows:
Interest expense to affiliates was $7,533, $11,442 and $7,218, respectively, for the years ended December 31, 2018, 2017 and 2016. Fees charged by affiliates were $47,475 and $46,431 and $45,225 for the years ended December 31, 2018, 2017 and 2016, respectively, and represents payroll and other human resource services CNH Industrial America performs on behalf of the Company.
As of December 31, 2018 and 2017, the Company had various accounts and notes receivable and debt with the following affiliates:
Included in “Other Assets” in the accompanying balance sheet were tax receivables due from related parties of $39,174 and $3,513 as of December 31, 2018 and 2017, respectively. Accounts payable and other accrued liabilities, including tax payables, of $4,740 and $60,070, respectively, as of December 31, 2018 and 2017, were payable to related parties.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
NOTE 13: COMMITMENTS AND CONTINGENCIES
Legal Matters
The Company is party to various litigation matters and claims arising from its operations. Management believes that the outcome of these proceedings, individually and in the aggregate, will not have a material adverse effect on the Company’s financial position or results of operations.
Guarantees
The Company provides payment guarantees on the financial debt of various foreign financial services subsidiaries of CNHI for approximately $30,000. The guarantees are in effect for the term of the underlying funding facilities.
Commitments
The Company has various agreements to extend credit for the wholesale and dealer financing managed portfolio. At December 31, 2018, the total credit limit available was $5,919,819, of which $3,499,835 was utilized.
NOTE 14: SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION
CNH Industrial Capital America and New Holland Credit, which are 100%-owned subsidiaries of CNH Industrial Capital LLC (the “Guarantor Entities”), guarantee certain indebtedness of CNH Industrial Capital LLC. As the guarantees are full, unconditional, and joint and several and because the Guarantor Entities are 100%-owned by CNH Industrial Capital LLC, the Company has included the following condensed consolidating financial information as of December 31, 2018 and 2017 and for the three years ended December 31, 2018. The condensed consolidating financial information reflects investments in consolidated subsidiaries under the equity method of accounting.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
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(Dollars in thousands)
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(Dollars in thousands)
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(Dollars in thousands)
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NOTE 15: SUPPLEMENTAL QUARTERLY INFORMATION (UNAUDITED)
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands)
NOTE 16: SUBSEQUENT EVENTS
On February 6, 2019, the Company, through a trust, issued $786,040 of amortizing asset-backed notes secured by U.S. retail loan receivables.