ITEM 1. BUSINESS:
The principal business of IBM Credit Corporation (the Company) is the financing of IBM products and services. All of the outstanding capital stock of the Company is owned by International Business Machines Corporation (IBM), a New York corporation. The Company finances the purchase and lease of IBM products and related products and services by customers of IBM in the United States and finances inventory and accounts receivable for dealers and remarketers of IBM and non-IBM products and services.
Pursuant to a Support Agreement between IBM and the Company, IBM has agreed to retain 100 percent of the voting capital stock of the Company, unless required to dispose of any or all such shares of stock pursuant to a court decree or order of any governmental authority that, in the opinion of counsel to IBM, may not be successfully challenged. IBM has also agreed to cause the Company to have a tangible net worth of at least $1.00 at all times.
ITEM 2.
ITEM 2. PROPERTIES:
The Company's principal executive offices are located at an IBM owned facility in White Plains, New York. The executive offices comprise approximately 200,000 square feet of office space. The Company occupies this space under an arrangement with IBM.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS:
None material.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:
Omitted pursuant to General Instruction J.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS:
All shares of the Company's capital stock are owned by IBM, and accordingly, there is no market for such stock. The Company paid IBM cash dividends of $50,000,000 and $45,000,000 during 1997 and 1996, respectively. Dividends are declared by the Board of Directors of the Company.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:
OVERVIEW
Net earnings for 1997 were $283.9 million, yielding a return on average equity of 18.6 percent, as compared with 1996 net earnings of $271.1 million, yielding a return on average equity of 20.7 percent.
FINANCING ORIGINATED
For the year ended December 31, 1997, the Company originated capital equipment financing for end users of $6,950.1 million, a 21 percent increase from $5,750.4 million for 1996. For the year ended December 31, 1997, originations of working capital financing for dealers and remarketers of information industry products increased by 12 percent to $15,005.2 million, from $13,387.0 million for 1996.
The growth in capital equipment financing originated is related to IBM's increase in placements of its products and services in the United States and an increase in the propensity for customers to finance their acquisitions with the Company throughout 1997, compared with 1996.
Capital equipment financings for end users comprised purchases of $3,998.1 million of information handling systems from IBM, financing for IBM software and services of $1,182.9 million, installment and lease financing for state and local government customers of $411.0 million for the account of IBM, financing originated for installment receivables of $285.9 million and other financing of $1,072.2 million for IBM equipment, as well as related non-IBM equipment to meet IBM customers' total solution requirements. The purchases of $3,998.1 million from IBM consisted of $2,252.9 million for capital leases and $1,745.2 million for operating leases.
The Company's capital lease portfolio primarily includes direct financing leases. Direct financing leases consist principally of IBM information handling equipment with terms generally from three to five years. Operating leases consist principally of IBM information handling equipment with terms generally from two to four years.
The growth in working capital financing originations reflects volume increases in IBM's personal system client products for remarketers financed by the Company throughout 1997. Working capital financing receivables arise primarily from secured inventory and accounts receivable financing for dealers and remarketers of IBM and non-IBM products. Payment terms for inventory secured financing generally range from 30 days to 45 days. Payment terms for accounts receivable secured financing generally range from 30 days to 90 days.
REMARKETING ACTIVITIES
In addition to originating new financing, the Company remarkets used IBM equipment. This equipment is primarily sourced from the conclusion of lease transactions and is typically remarketed in cooperation with the IBM sales force. The equipment is generally leased or sold to end users. These transactions may be with existing lessees or, when equipment is returned, with new customers.
Remarketing activities are fully integrated in the Company's financial statements. Remarketing activities comprise income from follow-on capital and operating leases and gross profit on equipment sales, net of write-downs in residual values of certain leased equipment. For the year ended December 31, 1997, the remarketing activities contributed $211.4 million to pretax earnings, an increase of 42 percent compared with $149.2 million for 1996.
At December 31, 1997, the investment in remarketed equipment on capital and operating leases totaled $285.5 million, a decrease of 6 percent from the 1996 year-end investment of $305.3 million.
FINANCIAL CONDITION
ASSETS
Total assets increased to $16.6 billion at December 31, 1997, compared with $12.9 billion at December 31, 1996. This increase is primarily the result of growth in end user and working capital financings originated during 1997. Also contributing to the increase in total assets were factored receivables acquired from IBM, which totaled $824.0 million at December 31, 1997, and the lease portfolio purchased from General Electric Capital Technology Management Services Corporation (GECTMSC), a subsidiary of General Electric Capital Corporation (GECC).
Total financing assets serviced by the Company, at December 31, 1997, were $16.0 billion, compared with $12.7 billion at December 31, 1996. Total financing assets serviced include the remaining balance of financing receivables securitized and sold ($176.8 million in 1997, $324.2 million in 1996), capital and operating leases ($8,514.9 million in 1997, $6,766.2 million in 1996), loans receivable ($2,381.3 million in 1997, $1,846.9 million in 1996), working capital financing receivables ($3,249.3 million in 1997, $2,898.7 million in 1996), subordinated interests in trusts resulting from the securitization and sale of financing receivables ($11.4 million in 1997, $37.0 million in 1996) and other assets ($13.9 million in 1997, $44.6 million in 1996). Also included in total financing assets serviced are state and local government installment and lease financing receivables of IBM ($849.9 million in 1997, $805.9 million in 1996), which are not reflected on the Company's Statement of Financial Position and accounts receivable purchases from selected IBM subsidiaries during 1997 ($824.0 million).
The carrying amount of marketable securities, as reported in the Company's Consolidated Statement of Financial Position, approximates market value. At December 31, 1997, the
marketable securities consisted entirely of debt securities, and were available-for-sale.
FINANCIAL CONDITION (Continued)
LIABILITIES AND STOCKHOLDER'S EQUITY
The assets of the Company were financed with $11,068.3 million of debt at December 31, 1997. Total short-term and long-term debt increased by approximately $2,986.0 million, from $8,082.3 million at December 31, 1996. This increase was the result of increases in short-term notes of $1,826.8 million, short-term debt payable to IBM of $1,014.1 million, long-term debt of $371.3 million and long-term debt payable to IBM of $589.3 million, offset by a decrease in commercial paper outstanding of $815.5 million. Included in the increase in total debt are short-term borrowings associated with accounts receivable purchases from selected IBM subsidiaries during 1997. Included in short-term debt at December 31, 1997, was $539.0 million payable to IBM at market terms and conditions, maturing on January 5, 1998. Included in long-term debt at December 31, 1997, were $407.0 million and $182.3 million payable to IBM at market terms and conditions, maturing on August 21, 2000 and February 26, 2001, respectively. Included in short-term debt at December 31, 1996, was $125.0 million payable to IBM at market terms and conditions, which matured on November 1, 1997.
At December 31, 1997, the Company had available $878.2 million of a shelf registration with the Securities and Exchange Commission (SEC) for the issuance of debt securities. On January 12, 1998, the Company's registration of an additional $5.0 billion of debt securities was filed with the SEC. Currently, the Company has available a total of $4.6 billion on the shelf registration with the SEC for the issuance of debt securities. This allows the Company rapid access to domestic financial markets. The Company intends to continue to issue debt securities under this shelf registration. The Company has no firm commitments for the purchase of debt securities that it may issue from the unused portion of this shelf registration.
The Company has the option, as approved by the Board of Directors on November 1, 1997, to issue and sell up to $5.0 billion of debt securities in domestic and foreign financial markets through December 31, 1998. Included within this $5.0 billion authorization is the option, together with IBM and IBM International Finance, N.V., to issue and sell debt securities in an aggregate nominal amount of up to 3.0 billion in European Currency Units (ECU), or its equivalent in any other currency. At December 31, 1997, there was 1.4 billion in ECU available for the issuance of debt securities under this program. The Company may issue debt securities over the next twelve months under this program, dependent on prevailing market conditions and its need for such funding.
The Company has the option, as approved by the Board of Directors on November 1, 1996, to sell, assign, pledge or transfer up to $3.0 billion of assets to third parties through December 31, 1999. Included within this $3.0 billion authorization is $450.0 million of a separate shelf registration for issuance of asset-backed securities, which a subsidiary of the Company has available. The subsidiary's issuance of any asset-backed securities over the next twelve months under this shelf registration is dependent on prevailing market conditions and its need for such
FINANCIAL CONDITION (Continued)
funding. The Company is an authorized borrower of up to $3.0 billion under a $10.0 billion IBM committed global credit facility, and has a liquidity agreement with IBM for $500.0 million. The Company has no borrowings outstanding under the committed global credit facility or the liquidity agreement. The Company and IBM have also signed master loan agreements providing additional funding flexibility to each other. These agreements allow for short-term (up to 270-day) funding, made available at market terms and conditions, upon the request of either the Company or IBM. The Company had borrowings outstanding under this arrangement of $600.2 million at December 31, 1997. The Company had no borrowings outstanding under this agreement at December 31, 1996. These financing sources, along with the Company's internally generated cash and medium-term note and commercial paper programs, provide flexibility to the Company to grow its lease, working capital financings and loan portfolios, to fund working capital requirements and to service debt.
Amounts due to IBM and affiliates include trade payables arising from purchases of equipment for term leases and installment receivables, working capital financing receivables for dealers and remarketers, and software license fees. Also included in amounts due to IBM and affiliates are income taxes currently payable under the intercompany tax allocation agreement. Amounts due to IBM and affiliates increased by approximately $235.5 million to $2,524.5 million at December 31, 1997, from $2,289.0 million at December 31, 1996. The increase was primarily attributable to a $235.1 million increase in the amount payable for capital equipment purchases during 1997, compared with the same 1996 period.
Total stockholder's equity at December 31, 1997, was $1,668.9 million, up $233.9 million from year-end 1996. The increase in stockholder's equity reflects 1997 net earnings of $283.9 million, offset by the payment of $50.0 million in cash dividends to IBM during 1997.
At December 31, 1997, the Company's debt to equity ratio was 6.6:1, compared with 5.6:1 at December 31, 1996.
TOTAL CASH PROVIDED BEFORE DIVIDENDS
Total cash provided before dividends was $209.6 million in 1997, compared with total cash provided before dividends of $341.0 million in 1996. Total cash provided before dividends reflects $2,410.8 million of cash used in investing and financing activities before dividends, offset by $2,620.4 million of cash provided by operating activities in 1997. For 1996, total cash provided before dividends reflects $2,235.1 million of cash used in investing and financing activities before dividends, offset by $2,576.1 million of cash provided by operating activities. Cash and cash equivalents at December 31, 1997, totaled $792.4 million, an increase of $159.6 million, compared with the balance at December 31, 1996.
FINANCIAL CONDITION (Continued)
MARKET RISK
In the normal course of business, the financial position of the Company is routinely subjected to a variety of risks. In addition to the market risk associated with interest and currency rate movements on outstanding debt and non-U.S. dollar denominated assets and liabilities, other examples of risk include collectibility of accounts receivable and recoverability of residual values on leased assets.
The Company regularly assesses these risks and has established policies and business practices to protect against the adverse effects of these and other potential exposures. As a result, the Company does not anticipate any material losses in these areas. The Company manages this risk, in part, through the use of a variety of financial instruments including derivatives, as explained in Significant Accounting Policies in the Notes to Consolidated Financial Statements on page 21.
For purposes of specific risk analysis, the Company uses sensitivity analysis to determine the impacts that market risk exposures may have on the fair values of the Company's debt and financial instruments.
The financial instruments included in the sensitivity analysis consist of all of the Company's cash and cash equivalents, marketable securities, long-term non-lease receivables, investments, long-term and short-term debt and all derivative financial instruments. Interest rate swaps, interest rate options and foreign currency swaps constitute the Company's portfolio of derivative financial instruments.
To perform sensitivity analysis, the Company assesses the risk of loss in fair values from the impact of hypothetical changes in interest rates and foreign currency exchange rates on market sensitive instruments. The market values for interest and foreign currency exchange risk are computed based on the present value of future cash flows as impacted by the changes in the rates attributable to the market risk being measured. The discount rates used for the present value computations were selected based upon market interest and foreign currency exchange rates in effect at December 31, 1997.
The market values that result from these computations are compared with the market values of these financial instruments at December 31, 1997. The differences in this comparison are the hypothetical gains or losses associated with each type of risk.
The results of the sensitivity analysis at December 31, 1997, are as follows:
INTEREST RATE RISK:
A 10 percent decrease in the levels of interest rates with all other variables held constant would result in a decrease in the fair value of the Company's financial instruments by $34.2 million. A 10 percent increase in the levels of interest rates with all other variables held constant would
result in an increase in the fair value of the Company's financial instruments by $34.9 million.
FINANCIAL CONDITION (Continued)
FOREIGN CURRENCY EXCHANGE RATE RISK:
A 10 percent increase or decrease in the levels of foreign currency exchange rates against the U.S. dollar with all other variables held constant would result in a decrease in the fair value of the Company's financial instruments by $18.5 million or an increase in the fair value of the Company's financial instruments by $18.5 million, respectively.
RESULTS OF OPERATIONS
INCOME FROM LEASES
Income from leases increased 15 percent to $600.8 million for the year ended December 31, 1997, from $524.0 million in 1996. The growth in capital equipment financings for end users under capital and operating leases during 1997 contributed to the overall increase in income from leases. This increase in income from leases was partially offset by a more competitive environment for end user financing. Income from leases includes lease income resulting from remarketing transactions. Lease income from remarketing transactions was $185.5 million in 1997, an increase of 29 percent from 1996.
On a periodic basis, the Company reassesses the future residual values of its portfolio of leases. In accordance with generally accepted accounting principles, anticipated increases in specific future residual values may not be recognized before realization and are thus a source of potential future profits. Anticipated decreases in specific future residual values that are considered to be other than temporary must be recognized currently. A review of the Company's $1,105.6 million residual value portfolio at December 31, 1997, indicated that the overall estimated future value of the portfolio continues to be greater than the value currently recorded, which is the lower of the Company's cost or net realizable value. The Company however, did record a $34.7 million reduction to income from leases during 1997 to recognize decreases in the expected future residual value of specific leased equipment, compared with $36.4 million during 1996.
INCOME FROM WORKING CAPITAL FINANCING
Income from working capital financing decreased 3 percent to $257.6 million in 1997, compared with $265.3 million in 1996. This decrease was primarily due to declines in the average working capital receivables outstanding during 1997, compared with 1996. The year-to-year decline in average working capital financing receivables outstanding was due to an increase in cash collected prior to normal payment terms from the dealer.
INCOME FROM LOANS
Income from loans increased 13 percent to $168.0 million in 1997, compared with $148.8 million in 1996. This increase resulted from higher asset balances, which in turn were
primarily due to an increase in financing originated for software and services during 1996 and 1997.
RESULTS OF OPERATIONS (Continued)
EQUIPMENT SALES
Equipment sales amounted to $442.1 million in 1997, compared with $419.3 million in 1996. Contributing to this increase in equipment sales is the growth of equipment remarketed as sales, rather than as operating leases. The revenue associated with outright sales and sales-type leases is included in equipment sales. Company-owned equipment may be sold or released to existing lessees or, when equipment is returned, to new users of that equipment.
Gross profit on equipment sales in 1997 was $60.6 million, an increase of 19 percent, compared with $50.9 million in 1996. The gross profit margin in 1997 increased to 13.7 percent, compared with 12.1 percent in 1996. The mix of products available for sale and changing market conditions for certain used equipment during the applicable periods are factors contributing to the increase in gross profit margins.
INCOME FROM FACTORED IBM RECEIVABLES
Income from factored IBM receivables was $26.5 million for the 12 months ended December 31, 1997. Refer to Related Company Transactions in the Notes to Consolidated Financial Statements on page 32 for additional details.
OTHER INCOME
Other income decreased 3 percent to $135.9 million in 1997, compared with $140.4 million in 1996. The decrease in other income is primarily attributable to a decline in the fees for the servicing of IBM financing receivables sold, resulting from a decrease in the securitized asset portfolios during 1997, as compared with the same 1996 period. Partially offsetting the decrease in other income is an increase in the Company's interest income earned on cash and cash equivalents during 1997, compared with 1996.
The Company continues to service financing receivables securitized and sold in prior years, and earns a fee, which is included in other income. During 1997 and 1996, there were no securitizations or sales of financing receivables by the Company.
Also included in other income is interest income earned on notes, as well as fees for managing IBM's state and local government installment and lease financing receivables portfolio.
INTEREST EXPENSE
As a result of the growth in end user and working capital financings originated, the Company has experienced an increase in the average outstanding debt balance. This increase in the average outstanding debt balance resulted in a 24 percent growth in interest expense to $538.6 million in 1997, compared with $436.1 million in 1996. The Company's 1997 average cost of debt decreased to 5.7 percent, from 5.8 percent for 1996.
RESULTS OF OPERATIONS (Continued)
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES
Selling, general, and administrative expenses were $228.2 million in 1997, an increase of 13 percent compared with $201.2 million in 1996. This increase is primarily due to planned growth in the Company's resources during 1996 and 1997, resulting in an increase in compensation related expenses.
PROVISION FOR RECEIVABLE LOSSES
The Company's portfolio of capital equipment leases and loans is predominantly with investment grade customers. The Company generally retains ownership or takes a security interest in any underlying equipment financed. The Company provides for receivable losses at the time financings are originated and from time to time for capital equipment as conditions warrant. The portfolio is diversified by geography, industry and individual unaffiliated customer.
The Company provides for working capital financing receivable losses on the basis of actual collection experience and estimated collectibility of the related financing receivables. With the continued growth of the Company's working capital financing business in 1996 and 1997, and with the continuation of the trend toward consolidation in this industry segment, the concentration of such financings for certain large dealers and remarketers of information industry products is significant. At December 31, 1997, and December 31, 1996, approximately 62 percent of the working capital financing receivables outstanding were concentrated in ten working capital accounts. The Company's working capital financing business is predominantly with non-investment grade customers. Such financing receivables are typically collateralized by the inventory and accounts receivable of the dealers and remarketers. The Company did not experience material losses in 1997 or 1996. The Company does not believe that there is a risk of loss in this area that would have a material impact on its financial position or results of operations.
The overall provision for receivable losses decreased to $35.5 million in 1997, compared with $44.9 million in 1996. The decline in the provision for receivable losses was attributable to lower reserve requirements, based upon the Company's historical loss experience, assessment of collectibility of specific receivables and its ability to effectively manage credit risk and contain losses.
INCOME TAXES
Income taxes decreased 7 percent to $163.2 million for the year ended December 31, 1997, from $176.1 million for the same period in 1996. The decrease in the effective tax rate was primarily caused by reestimations made in the current period of tax liabilities established in prior periods.
The Company expects its effective tax rate to approximate the statutory federal (35%) and state (6.4%) income tax rates in future years.
RETURN ON AVERAGE EQUITY
The 1997 results yielded an annualized return on average equity of 18.6 percent, compared with 20.7 percent in 1996.
ACCOUNTING CHANGES
The Company implemented new accounting standards in 1997, and 1995. None of these standards had a material effect on the financial position or results of operations of the Company.
Effective January 1, 1997, the Company implemented SFAS 125, "Accounting for Transfer and Servicing of Financial Assets and Extinguishments of Liabilities." This standard provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. The Company was generally in compliance with this standard prior to adoption.
Effective January 1, 1995, the Company implemented SFAS 114, "Accounting by Creditors for Impairment of a Loan," and SFAS 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures." These standards prescribe impairment measurements and reporting related to certain loans.
In 1995, the Company implemented SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." This standard prescribes the method for asset impairment evaluation for long-lived assets and certain identifiable intangibles that are to be either held and used or intended for disposal. The Company was generally in compliance with this standard prior to adoption.
In 1998, the Company will implement two accounting standards issued by the Financial Accounting Standards Board (FASB) in June of 1997. SFAS 130, "Reporting Comprehensive Income," and SFAS 131, "Disclosures About Segments of an Enterprise and Related Information," will have no effect on the Company's financial position or results of operations as they require only changes to or additions to current disclosures.
CLOSING DISCUSSION
The Company's resources continue to be sufficient to enable it to carry out its mission of offering customers competitive leasing and financing and providing information technology remarketers with inventory and accounts receivable financing, which contributes to the growth and stability of IBM earnings.
FORWARD LOOKING STATEMENTS
Except for the historical information and discussions contained herein, statements contained in this Report on Form 10-K may constitute "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including, but not limited to, the Company's level of equipment financing originations; the propensity for customers to finance their acquisition of IBM products and services with the Company; the competitive environment in which the Company operates; the success of the Company in developing strategies to manage debt levels; non-performance by a customer of contractual requirements; the concentration of credit risk and creditworthiness of the customer; the Company's associated collection and asset management efforts; the Company's determination of residual values; currency fluctuations on the associated debt and liabilities; change in interest rates; non-performance by the counterparty in derivative transactions; the Company's ability to attract and retain key personnel; the Company's ability to manage acquisitions and alliances; legal, political and economic changes and other risks, uncertainties and factors inherent in the Company's business and otherwise discussed in this Form 10-K and in the Company's other filings with the Securities and Exchange Commission.
YEAR 2000
What is commonly known as the "Year 2000 issue" arises because many computer hardware and software systems use only two digits to represent the year. As a result, these systems and programs may not calculate dates beyond 1999, which may cause errors in information or systems failures.
With respect to its internal systems, the Company is taking appropriate steps to remediate the Year 2000 issues and does not expect the costs of these efforts to be material. However, the Year 2000 readiness of the Company's customers and the hardware and software offerings from the Company's suppliers, subcontractors and business partners may vary. The Company is also aware of the potential for claims against it and other companies for damages from products and services that were not Year 2000 ready. The Company believes that any such claims against it will be without merit. While the Company does not believe that the Year 2000 matters discussed above will have a material impact on its business, financial condition or results of operation, it is uncertain whether or to what extent the Company may be affected by such matters.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:
Report of Independent Accountants
To the Stockholder and Board of Directors of IBM Credit Corporation
In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a) 1. on page 40 present fairly, in all material respects, the financial position of IBM Credit Corporation and its subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
Price Waterhouse LLP Stamford, CT January 20, 1998, except as to the Subsequent Event note on page 38, which is as of February 26, 1998
IBM CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation: The consolidated financial statements include the accounts of the Company and those of its subsidiaries that are more than 50 percent owned. Investments in partnerships in which the Company has typically a 20 percent ownership are accounted for using the equity method.
Cash and Cash Equivalents: Time deposits with original maturities generally of three months or less are included in cash and cash equivalents. Cash paid for interest was $523.1 million, $443.2 million and $388.3 million in 1997, 1996 and 1995, respectively.
Marketable Securities: The Company's marketable securities, all of which are debt securities, are available-for-sale. The carrying amount of the debt securities approximates market value.
Finance Income Recognition: Income attributable to direct financing leases and loans receivable is initially recorded as unearned income and subsequently recognized as finance income at level rates of return over the term of the leases or receivables. Income recognized from leveraged leases includes the amortization of unearned finance income and deferred investment and other tax credits over the term of the leases, at level rates of return, during periods when the net investment balance is positive.
Equipment on Operating Leases: Equipment is depreciated on a straight-line basis to its estimated residual value over the lease term.
Equipment Sales Income Recognition: Revenue from equipment sales to existing lessees is recognized at the effective date a purchase provision is exercised. Revenue from sales to parties other than existing lessees is recognized when title transfers.
Allowance for Receivable Losses: The allowance for receivable losses is determined on the basis of actual collection experience and estimated collectibility of the related assets.
Income Taxes: Income tax expense is based on reported earnings before income taxes. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes on a separate company basis. In accordance with Statement of Financial Accounting Standards (SFAS) 109, "Accounting for Income Taxes," these deferred taxes are measured by applying currently enacted tax laws.
SIGNIFICANT ACCOUNTING POLICIES (Continued):
Financial Instruments: The Company uses agreements related to currencies and interest rates to lower costs of funding its business, to diversify sources of funding, or to manage interest rate and currency exposures arising from mismatches between assets and liabilities. The Company enters into such financial instruments solely for hedging purposes. The Company does not enter into such financial instrument transactions for trading or for other speculative purposes. Debt obligations denominated in foreign currencies and subject to foreign currency swap agreements are included in the Consolidated Statement of Financial Position at the contractual rate of exchange in the respective foreign currency swap agreement. Gains and losses on forward contracts and purchased options, designated as hedges, are deferred and included in the settlement of the related transaction. The Company routinely evaluates existing and potential counterparty credit exposures associated with such financial instrument transactions to ensure that these exposures remain within credit guidelines.
Under interest rate swaps, the Company agrees with other parties to exchange, at specified intervals, the difference between interest amounts calculated by reference to a floating index or a fixed rate on an agreed upon notional principal amount. Swap contracts are primarily between one and five years in duration. The Company enters into interest rate cap and floor agreements to reduce the potential impact of changes in interest rates on floating rate debt supporting fixed rate assets. Interest rate agreements generally involve the exchange of interest payments without the exchange of the underlying notional amount on which the interest payments are calculated. The Company enters into currency exchange agreements to hedge debt denominated in foreign currencies. The term of the currency derivatives is generally less than five years. The purpose of the Company's foreign currency hedging activities is to protect itself from the risk that the eventual dollar net cash outflows will be affected by changes in exchange rates. The Company does not anticipate any material adverse effect on its financial position or results of operations resulting from its use of these instruments, nor does it anticipate nonperformance by any of its counterparties.
Use of Estimates: Management uses estimates in preparing the consolidated financial statements, in conformity with generally accepted accounting principles. Significant estimates include collectibility of receivables, recoverability of residual values of equipment on capital and operating leases, and useful economic lives of long-term fixed assets. The Company regularly assesses these estimates, and while actual results may differ from these estimates, management believes that material changes will not occur in the near term.
RELATIONSHIP WITH IBM:
Pursuant to a Support Agreement between IBM and the Company, IBM has agreed to retain 100 percent of the voting capital stock of the Company, unless required to dispose of any or all such shares of stock pursuant to a court decree or order of any governmental authority that in the opinion of counsel to IBM may not be successfully challenged. IBM has also agreed to cause the Company to have a tangible net worth of at least $1.00 at all times. The Support Agreement provides that it shall not be deemed to constitute a guarantee by IBM to any party of the payment of any debt or other obligation, indebtedness or liability of the Company. The Support Agreement may not be modified, amended or terminated while there is outstanding any debt of the Company, unless all holders of such debt have consented in writing.
Pursuant to an operating agreement, IBM provides collection, administration and other services and products for the Company and is reimbursed for the cost of these services and products. The Company is compensated for services performed for IBM, primarily for management of IBM's state and local government installment receivables portfolio, the fees for which are reflected in other income.
The operating agreement with IBM also provides that installment receivables, which include finance charges, may be purchased by the Company at a mutually agreed-upon price. The Company is reimbursed by IBM for any price adjustments and concessions that reduce the amount of receivables previously purchased by the Company.
The operating agreement with IBM also provides that IBM will offer term leases of the Company to creditworthy potential lessees. IBM's sales price of the equipment to the Company will typically be at the purchase price payable by the lessee, unless the Company is participating in IBM product promotions.
The Company also has an indemnification agreement with IBM. IBM reimburses the Company for losses on working capital financing receivables with specific dealers and for specific transactions. Approximately $2.2 million, $10.5 million and $9.3 million of such losses have been reimbursed by IBM in 1997, 1996 and 1995, respectively.
The Company received compensation for services and benefits provided to IBM. Included in income from working capital financing is fee income earned from IBM Personal Systems Group of $73.1 million, $63.1 million and $51.1 million in 1997, 1996 and 1995, respectively. Also included in income from working capital financing is fee income from other IBM divisions of $27.3 million, $15.3 million and $7.1 million in 1997, 1996 and 1995, respectively. Included in other income are fees received for the management of IBM's portfolio of state and local government installment receivables of $51.8 million, $51.0 million and $46.8 million in 1997, 1996 and 1995, respectively.
The Company has a liquidity agreement with IBM International Finance, N.V. (IIF), whereby the Company has agreed to advance funds to IIF as an enhancement to IIF's ability to
carry out business. The amount of the advances is not to exceed the greater of $500.0 million or 5 percent of
RELATIONSHIP WITH IBM (Continued):
the Company's total assets. To support this agreement, the Company has entered into a backup agreement with IBM, whereby IBM has agreed to advance funds to the Company, in an amount not to exceed the greater of $500.0 million or 5 percent of the Company's total assets, if at any time the Company requires such funds to satisfy its agreement with IIF. The Company has neither received nor made any advances with respect to these agreements at December 31, 1997 and 1996.
The Company, together with IBM and IIF, has the option to issue and sell debt securities in an aggregate nominal amount of up to 3.0 billion in European Currency Units, or its equivalent in any other currency. This option is part of a $5.0 billion Board of Directors' authorization the Company has to issue and sell debt securities in domestic and foreign financial markets through December 31, 1998. As previously mentioned, at December 31, 1997, there was 1.4 billion in ECU available for the issuance of debt securities under this program. The Company's intention to issue any debt securities over the next twelve months under this program is dependent on prevailing market conditions and the Company's need for such funding.
From time to time, the Company will either borrow funds from or lend funds to IBM and its affiliates, at prevailing interest rates. During the fourth quarter of 1994, the Company and IBM signed master loan agreements providing additional funding flexibility to each other. These agreements allow for short-term (up to 270-day) funding, made available at market terms and conditions, upon the request of either the Company or IBM. The purpose of these agreements is to finance the borrower's assets, for working capital or for other general corporate purposes. At December 31, 1997, the Company had borrowings outstanding under these agreements of $600.2 million, payable to IBM. These borrowings were repaid on January 5, 1998. At December 31, 1996, the Company had no borrowings outstanding under these agreements.
The Company is an authorized borrower of up to $3.0 billion under a $10.0 billion IBM committed global credit facility and has a liquidity agreement with IBM for $500.0 million. The Company has no borrowings outstanding under the committed global credit facility or the liquidity agreement.
MARKETABLE SECURITIES:
The following is a summary of marketable securities at December 31, 1997 and December 31, 1996 which were available-for-sale. The marketable securities consisted entirely of debt securities. Contractual maturities of marketable debt securities at December 31, 1997 and December 31, 1996, are between one and five years. It is expected that actual maturities will differ from contractual maturities because some borrowers have the right to call or prepay certain obligations, sometimes without call or prepayment penalties.
(Dollars in thousands) 1997 1996
________ _________ Corporate . . . . . . . . . . . . . . . . $ 95,023 $125,138 U.S. federal agency . . . . . . . . . . . 32,824 34,210 _________ _________ Total, which approximates market value. . $127,847 $159,348 ========= =========
NET INVESTMENT IN CAPITAL LEASES:
The Company's capital lease portfolio includes direct financing and leveraged leases. The Company originates financing for customers in a variety of industries and throughout the United States. The Company has a diversified portfolio of capital equipment financings for end users.
Direct financing leases consist principally of IBM information handling equipment with terms generally from three to five years. The components of the net investment in direct financing leases at December 31, 1997 and 1996, are as follows:
(Dollars in thousands) 1997 1996 ___________ ___________ Gross lease payments receivable . . . . . $4,922,989 $4,299,250 Estimated unguaranteed residual values. . 327,239 260,004 Deferred initial direct costs . . . . . . 36,325 30,087 Unearned income . . . . . . . . . . . . . (502,564) (528,830) Allowance for receivable losses . . . . . (52,373) (44,131) ___________ ___________ $4,731,616 $4,016,380 =========== ===========
The scheduled maturities of minimum lease payments outstanding at December 31, 1997, expressed as a percentage of the total, are due approximately as follows:
Within 12 months. . . . . . . . . . . . . . . . . . . . 46% 13 to 24 months . . . . . . . . . . . . . . . . . . . . 34 25 to 36 months . . . . . . . . . . . . . . . . . . . . 15 37 to 48 months . . . . . . . . . . . . . . . . . . . . 4 After 48 months . . . . . . . . . . . . . . . . . . . . 1 ____ 100% ====
Included in the net investment in capital leases are $29.8 million and $55.6 million of seller interest at December 31, 1997 and 1996, respectively, relating to the securitization of such leases.
NET INVESTMENT IN CAPITAL LEASES (Continued):
Leveraged lease investments include coal-fired electric generating facilities, commercial aircraft and other non-IBM manufactured equipment. Leveraged leases have remaining terms ranging from five to twenty-one years. The components of the net investment in leveraged leases at December 31, 1997 and 1996, are as follows:
(Dollars in thousands) 1997 1996 __________ __________ Net rents receivable. . . . . . . . . . $ 254,059 $ 258,022 Estimated unguaranteed residual values. 39,752 39,752 Unearned and deferred income. . . . . . (90,773) (93,296) Allowance for receivable losses . . . . (3,362) (6,036) __________ __________ Investment in leveraged leases. . . . . 199,676 198,442 Less: Deferred income taxes. . . . . . (188,074) (196,460) __________ __________ Net investment in leveraged leases. . . $ 11,602 $ 1,982 ========== ==========
Refer to the note on page 28, Allowance for Receivable Losses, for a reconciliation of the direct financing leases and leveraged leases allowances for receivable losses.
EQUIPMENT ON OPERATING LEASES:
Operating leases consist principally of IBM information handling equipment with terms generally from two to four years. The components of equipment on operating lease at December 31, 1997 and 1996, are as follows:
(Dollars in thousands) 1997 1996 ____________ ____________ Cost. . . . . . . . . . . . . . . . . . . $ 6,640,874 $ 4,839,547 Accumulated depreciation. . . . . . . . . (3,057,233) (2,288,165) ____________ ____________ $ 3,583,641 $ 2,551,382 ============ ============
Minimum future rentals were approximately $3,201.1 million at December 31, 1997. The scheduled maturities of the minimum future rentals at December 31, 1997, expressed as a percentage of the total, are due approximately as follows:
Within 12 months. . . . . . . . . . . . . . . . . . . . 50% 13 to 24 months . . . . . . . . . . . . . . . . . . . . 34 25 to 36 months . . . . . . . . . . . . . . . . . . . . 13 37 to 48 months . . . . . . . . . . . . . . . . . . . . 2 After 48 months . . . . . . . . . . . . . . . . . . . . 1 ____ 100% ====
LOANS RECEIVABLE:
Loans receivable include installment receivables that are principally financings of customer purchases of IBM information handling products. Also included are other financings, comprising primarily IBM software and services. The components of loans receivable at December 31, 1997 and 1996, are as follows:
(Dollars in thousands) 1997 1996 ___________ ___________ Gross loans receivable . . . . . . . $2,736,356 $2,166,019 Deferred initial direct costs. . . . 17,890 13,168 Unearned income. . . . . . . . . . . (301,756) (268,876) Allowance for receivable losses. . . (71,229) (63,364) ___________ ___________ $2,381,261 $1,846,947 =========== ===========
The scheduled maturities of loans receivable outstanding at December 31, 1997, expressed as a percentage of the total, are due approximately as follows:
Within 12 months . . . . . . . . . . . . . . . . . . . 44% 13 to 24 months. . . . . . . . . . . . . . . . . . . . 31 25 to 36 months. . . . . . . . . . . . . . . . . . . . 15 37 to 48 months. . . . . . . . . . . . . . . . . . . . 8 After 48 months. . . . . . . . . . . . . . . . . . . . 2 ____ 100% ====
Included in loans receivable are $17.9 million and $40.0 million at December 31, 1997 and 1996, respectively, that are due from the Company's term lease partnerships. Such loans are secured by the general pool of leases in the partnerships. Also included in loans receivable are $6.2 million and $16.1 million of seller interest at December 31, 1997, and 1996, respectively, relating to the securitization of such loans.
Refer to the note on page 28, Allowance for Receivable Losses, for a reconciliation of the loans receivable allowance for receivable losses.
WORKING CAPITAL FINANCING RECEIVABLES:
Working capital financing receivables arise primarily from secured inventory and accounts receivable financing for dealers and remarketers of IBM and non-IBM products and services. Inventory financing includes the financing of the purchase by these dealers and remarketers of information handling products. As previously discussed in the note on pages 22 and 23, Relationship with IBM, the Company is reimbursed by IBM for certain losses on working capital financing receivables with specific dealers and for specific transactions. Approximately $2.2 million, $10.5 million and $9.3 million of such losses have been reimbursed by IBM in 1997, 1996 and 1995, respectively. With the growth of the Company's working capital financing business in 1997 and 1996, the concentration of such financings for certain large dealers and remarketers of information industry products is significant. However, the Company has a secured position on most of its inventory and accounts receivable financing, which mitigates the amount of potential loss. The Company does not believe that there is a risk of loss that would have a material impact on its financial position or results of operations, and it provides for unsecured exposures based upon historical experience.
Payment terms for inventory-secured financing generally range from 30 days to 45 days. Accounts receivable financing includes the financing of trade accounts receivable for these dealers and remarketers. Payment terms for accounts receivable secured financing typically range from 30 days to 90 days. The components of working capital financing receivables at December 31, 1997, and 1996, are as follows:
(Dollars in thousands) 1997 1996 ___________ ___________ Working capital financing receivables $3,289,860 $2,955,411 Allowance for receivable losses . . . (40,550) (56,723) ___________ ___________ $3,249,310 $2,898,688 =========== ===========
Included in working capital financing receivables are $742.9 million and $608.7 million of seller interest at December 31, 1997, and 1996, respectively, relating to the securitization of such receivables. Additionally, the Company has $2,069.1 million of approved but unused working capital financing credit lines available to customers at December 31, 1997.
Refer to the note on page 28, Allowance for Receivable Losses, for a reconciliation of the working capital financing receivables allowance for receivable losses.
ALLOWANCE FOR RECEIVABLE LOSSES:
The following is a reconciliation of the allowance for receivable losses, by portfolio, for the years ended December 31, 1997, 1996 and 1995:
(Dollars in thousands) Direct Working Financing Leveraged Loans Capital 1997 Total Leases Leases Receivable Fin. Rec. _____________________ _________ _________ __________ __________ _________ Beginning of year . . $170,254 $ 44,131 $ 6,036 $ 63,364 $ 56,723 Provision for receivable losses. . 35,541 22,271 (2,674) 11,800 4,144 Accounts written off (net of recoveries). (46,328) (15,321) - (5,453) (25,554) Transfers from allowance for losses on receivables sold and other, net . . . 8,047 1,292 - 1,518 5,237 _________ _________ __________ __________ _________ End of year . . . . . $167,514 $ 52,373 $ 3,362 $71,229 $40,550 ========= ========= ========== ========== =========
Direct Working Financing Leveraged Loans Capital 1996 Total Leases Leases Receivable Fin. Rec. _____________________ _________ _________ __________ __________ _________ Beginning of year . . $159,543 $ 46,266 $ 6,104 $ 59,369 $ 47,804 Provision for receivable losses. . 44,883 17,940 - 13,260 13,683 Accounts written off (net of recoveries). (40,849) (22,104) - (11,686) (7,059) Transfers (to) from allowance for losses on receivables sold and other, net . . . 6,677 2,029 (68) 2,421 2,295 _________ _________ __________ __________ _________ End of year . . . . . $170,254 $ 44,131 $ 6,036 $ 63,364 $ 56,723 ========= ========= ========== ========== =========
Direct Working Financing Leveraged Loans Capital 1995 Total Leases Leases Receivable Fin. Rec. _____________________ _________ _________ __________ __________ _________ Beginning of year . . $ 89,489 $ 24,389 $ 7,171 $ 41,665 $ 16,264 Provision for receivable losses. . 68,417 16,208 - 21,200 31,009 Accounts written off (net of recoveries). (5,680) 2,967 (1,067) (7,232) (348) Transfers from allowance for losses on receivables sold and other, net . . . 7,317 2,702 - 3,736 879 _________ _________ __________ __________ _________ End of year . . . . . $159,543 $ 46,266 $ 6,104 $ 59,369 $ 47,804 ========= ========= ========== ========== =========
ALLOWANCE FOR RECEIVABLE LOSSES (Continued):
The reconciliation of the allowance for receivable losses, by portfolio, presented on page 28, excludes the allowance for estimated credit losses on receivables sold, which was $1.7 million and $5.1 million at December 31, 1997 and 1996, respectively. Provisions for expected losses, as they relate to receivables sold, are provided during the periods in which the receivables were originated. No material provisions were made for the years ended December 31, 1997 and December 31, 1996.
Also excluded from the reconciliation of the allowance for receivable losses, by portfolio, presented on page 28, is the allowance for estimated credit losses on factored IBM receivables, which was $31.3 million at December 31, 1997. IBM factored receivables written off, net of recoveries, during 1997 were $2.8 million. There were no factored IBM receivables at December 31, 1996. Provisions for expected losses, as they relate to factored IBM receivables, are provide during the periods in which the receivables are purchased.
At December 31, 1997, 1996 and 1995, the allowance for receivable losses approximated 1.3 percent, 1.5 percent and 1.6 percent, respectively, of the Company's portfolio of leases, loans, factored IBM receivables and working capital financing receivables. The decline in this ratio from 1996 to 1997 was due to lower reserve requirements, based upon the Company's historical experience and its ability to effectively manage credit risk and contain losses.
INVESTMENTS AND OTHER ASSETS:
The components of investments and other assets at December 31, 1997, and 1996, are as follows:
(Dollars in thousands) 1997 1996 ________ ________ Receivables from customers . . . . . . . . . $303,077 $259,588 Investments in partnerships and other . . . . 170,994 142,742 Receivables from affiliates . . . . . . . . . 79,121 99,214 Due and deferred from receivable sales. . . . 35,928 63,046 Remarketing inventory . . . . . . . . . . . . 58,383 35,986 Other assets . . . . . . . . . . . . . . . . 34,760 41,542 ________ ________ $682,263 $642,118 ======== ========
Due and deferred from receivable sales are net of the allowance for estimated credit losses on receivables sold and include subordinated interests in trusts, cash deposits held by trustee, receivables from investors and interest in excess servicing cash flows. Due and deferred from receivable sales are restricted assets subject to limited recourse provisions. There were no sales in 1997 and 1996 of financing receivables to investors. The Company acts as servicer for receivables securitized and sold, and is contingently liable for up to $197.8 million in the event of nonperformance, default or other loss relating to the outstanding pool balance at December 31, 1997, of IBM state
and local government installment receivables securitized and sold. Adequate reserves exist to cover
INVESTMENTS AND OTHER ASSETS (Continued):
potential losses. Included in other assets at December 31, 1997, and 1996, are $14.4 million and $10.0 million, respectively, on deposit in restricted accounts, held as security deposits received from customers. Also included in other assets at December 31, 1997 and 1996, respectively, are $4.1 million on deposit in restricted accounts for purposes of credit enhancement. The Company, as servicer, deposited the cash in connection with certain tax-exempt grantor trusts comprised of pools of IBM state and local government installment receivables. The trustee of each grantor trust is entitled to draw upon the amounts in the restricted accounts, in the event of nonperformance, default or other loss relating to such installment receivables.
SHORT-TERM DEBT:
The components of short-term debt at December 31, 1997, and 1996, are as follows:
(Dollars in thousands) 1997 1996 __________ __________ Commercial paper, with rates averaging 5.8% in 1997 and 5.5% in 1996. . . . . . . . . $3,902,029 $4,717,531 Other short-term debt, with rates averaging 5.7% in 1997 and 5.5% in 1996. . . . . . . . . 2,134,245 1,509,994 Current maturities of long-term debt. . . . . . 1,416,394 213,875 __________ __________ 7,452,668 6,441,400 IBM short-term borrowings . . . . . . . . . . . 1,139,113 125,000 __________ __________ $8,591,781 $6,566,400 ========== ==========
The approximate weighted average effective interest rates above, are before the effects of interest rate swap agreements and have been calculated on the basis of rates in effect at December 31, 1997 and 1996. The approximate weighted average stated rates (after the effects of interest rate swap agreements) on commercial paper outstanding at December 31, 1997, and 1996, were 6.2% and 5.6%, respectively. The approximate weighted average stated rates (after the effects of interest rate swap agreements) on other short-term debt outstanding at December 31, 1997, and 1996, were 5.7% and 5.8%, respectively. Other short-term debt primarily includes notes having maturities between nine and twelve months offered through the Company's medium-term note program.
LONG-TERM DEBT:
The components of long-term debt at December 31, 1997, and 1996, are as follows:
(Dollars in thousands) 1997 1996 ___________ ___________ Medium-term notes with original maturities ranging from 1998 to 2008, with rates averaging 6.0% in 1997 and 5.9% in 1996. . . $3,302,600 $1,731,344 IBM loan payable, due 2001. . . . . . . . . . 589,253 - ___________ ___________ 3,891,853 1,731,344 Net unamortized premiums/(discounts). . . . . 1,029 (1,532) ___________ ___________ 3,892,882 1,729,812 Less: Current maturities . . . . . . . . . . 1,416,394 213,875 ___________ ___________ $2,476,488 $1,515,937 =========== ===========
The approximate weighted average effective interest rates above are before the effects of interest rate swap agreements and have been calculated on the basis of rates in effect at December 31, 1997, and 1996. The approximate weighted average stated rates (after the effects of interest rate swap agreements) on medium-term notes outstanding at December 31, 1997, and 1996, were 6.0% and 5.9%, respectively. Discounts and premiums have the effect of modifying the stated rate of interest on long-term debt offerings.
Annual maturity of long-term debt at December 31, 1997, is as follows:
(Dollars in thousands)
1998 . . . . . . . . . . . . . . . . . . . $1,416,394 1999 . . . . . . . . . . . . . . . . . . . 1,216,206 2000 . . . . . . . . . . . . . . . . . . . 191,000 2001 . . . . . . . . . . . . . . . . . . . 185,000 2002 . . . . . . . . . . . . . . . . . . . 50,000 2003 and thereafter . . . . . . . . . . . 244,000 __________ $3,302,600 ==========
RATIO OF EARNINGS TO FIXED CHARGES:
The ratio of earnings to fixed charges calculated in accordance with applicable Securities and Exchange Commission requirements was 1.83, 2.02 and 1.96 for the years ended December 31, 1997, 1996 and 1995, respectively.
RELATED COMPANY TRANSACTIONS:
IBM charged the Company $84.4 million, $64.8 million and $62.6 million in 1997, 1996 and 1995, respectively, representing costs for lease services, employee benefit plans, facilities rental and staff support.
Amounts due to IBM and affiliates include current income taxes payable, as well as amounts for software, services, purchases of receivables and purchases of equipment for term leases. At December 31, 1997, and 1996, amounts due to IBM and affiliates were $2,524.5 million and $2,289.0 million, respectively.
Interest and finance income of $6.7 million, $1.9 million and $6.9 million was earned from loans to IBM and affiliates in 1997, 1996 and 1995, respectively. Interest expense of $29.3 million, $10.6 million and $10.2 million was incurred on loans from IBM and affiliates during 1997, 1996 and 1995, respectively.
The Company also provides equipment financing at market rates to IBM and affiliated companies for both IBM and non-IBM products. The Company originated $1,054.4 million and $682.0 million of such financings during 1997 and 1996, respectively. At December 31, 1997, and 1996, approximately $1,255.0 million and $828.0 million, respectively, of such financings were included in the lease and loan portfolio. Of these amounts, $1,136.1 million and $723.4 million were included in the Company's operating lease portfolio at December 31, 1997, and 1996, respectively. The finance income earned from operating leases to IBM and affiliated companies, net of depreciation expense, was $151.3 million, $107.6 million and $91.9 million in 1997, 1996 and 1995, respectively.
In June 1997, IBM Credit International Factoring Corporation (ICIFC) and IBM Credit EMEA Factoring Co., Ltd (ICEFC), subsidiaries of the Company, entered into factoring agreements with selected IBM subsidiaries. Under these agreements, ICIFC and ICEFC will periodically purchase, without recourse, all the rights, title and interest to certain outstanding IBM customer receivables.
During 1997, ICIFC and ICEFC acquired IBM customer receivables having a nominal value of $4,222.2 million for approximately $4,159.2 million. The receivables acquired are short-term in nature and are denominated in non-U.S. currencies. The purchase was financed by the Company through the issuance of short-term debt. Transactions related to these receivables are fully integrated in the Company's consolidated financial statements.
RELATED COMPANY TRANSACTIONS (Continued):
An intercompany tax allocation agreement (the Agreement) exists between the Company and its parent company, IBM. The Agreement aligns the settlement of federal and state tax benefits and/or obligations with the Company's provision for income taxes determined on a separate company basis. The Company is part of the IBM consolidated federal tax return and files separate state tax returns in selected states. Included in amounts due to IBM and affiliates at December 31, 1997, and 1996, are $27.1 million and $5.5 million, respectively, of current income taxes payable determined in accordance with the Agreement. Cash paid for income taxes to IBM and to states that require separate tax returns in 1997, 1996 and 1995 was $18.4 million, $113.3 million and $339.2 million, respectively.
PROVISION FOR INCOME TAXES:
The components of the provision for income taxes are as follows:
(Dollars in thousands) 1997 1996 1995 _________ __________ __________ Federal: Current . . . . . . . . . . $ 32,401 $ 60,741 $ 114,262 Deferred. . . . . . . . . . 100,332 83,637 9,306 _________ __________ __________ 132,733 144,378 123,568 _________ __________ __________ State and local: Current . . . . . . . . . . 8,575 19,216 23,405 Deferred. . . . . . . . . . 21,907 12,528 2,482 _________ __________ __________ 30,482 31,744 25,887 _________ __________ __________ Total provision . . . . . . $ 163,215 $ 176,122 $ 149,455 ========== ========== ==========
Changes in the deferred tax assets and liabilities resulting from temporary differences between financial and tax reporting are as follows:
(Dollars in thousands) 1997 1996 __________ __________ Deferred tax assets (liabilities):
Provision for receivable losses. . . . . . $ 75,477 $ 90,909 Lease income and depreciation. . . . . . . (1,014,615) (901,514) Other, net . . . . . . . . . . . . . . . . 51,958 49,111 __________ __________ Deferred income taxes . . . . . . . . . . . . $ (887,180) $(761,494) ========== ==========
PROVISION FOR INCOME TAXES (Continued):
The provision for income taxes varied from the U.S. federal statutory income tax rate as follows:
1997 1996 1995 ______ ______ ______ Federal statutory rate. . . . . . . . 35.0% 35.0% 35.0% State and local taxes, net of federal tax benefit . . . . . . . . 4.4 4.4 4.4 Adjustments to prior years' tax liabilities . . . . . . . . . . . . (2.9) - - Other, net. . . . . . . . . . . . . . - - (0.1) ______ ______ ______ Effective income tax rate . . . . . . 36.5% 39.4% 39.3% ====== ====== ======
FINANCIAL INSTRUMENTS:
The Company has used derivative instruments as an element of its risk management strategy for many years. Although derivatives entail risk of non-performance by counterparties, the Company manages this risk by establishing explicit dollar and term limitations that correspond to the credit rating of each carefully selected counterparty. The Company has not sustained a material loss from these instruments nor does it anticipate any material adverse effect on its results of operations or financial position in the future.
The majority of the Company's derivative transactions relate to the matching of liabilities to assets. The Company issues debt, using the most efficient capital markets and products, which may result in a currency or interest rate mismatch with the underlying asset. Interest rate swaps or currency swaps are then used to match the interest rates and currencies of its debt to the related asset. Interest and currency rate differentials accruing under interest rate and currency swap contracts are recognized over the life of the contracts in interest expense. When the terms of the underlying instrument are modified, or if it ceases to exist, all changes to fair value of the swap contract are recognized in income each period until it matures.
The tables on page 35 summarize the notional value, maturity dates, weighted average receive and pay rates and net unrealized gain (loss) of derivative financial instruments by category at December 31, 1997, and 1996. The notional value at December 31 provides an indication of the extent of the Company's involvement in such instruments at that time, but does not represent exposure to market risk.
FINANCIAL INSTRUMENTS (Continued):
(Dollars in thousands)
At December 31, 1997:
Notional Weighted Average Rate Type Amount Maturities Receive Pay ____________________ __________ __________ _____________________ Swap to Fixed $2,675,750 1998-2002 5.68% 6.22% Swap to Floating 2,605,800 1999-2007 6.73% 5.70% Currency Related 435,297 1998-1999 n/a * n/a * Int. Rate Cap/Floor 615,000 1998-1999 n/a * n/a * __________ $6,331,847 ==========
At December 31, 1997 (Continued):
Notional Unrealized Unrealized Net Unrealized Type Amount Gross Gain Gross (Loss) Gain (Loss) ____________________ __________ __________ ____________ ______________ Swap to Fixed $2,675,750 $ 1,027 $(16,557) $(15,530) Swap to Floating 2,605,800 22,500 (483) 22,017 Currency Related 435,297 2,213 (39,024) (36,811) Int. Rate Cap/Floor 615,000 - - - __________ __________ ____________ ______________ $6,331,847 $25,740 $(56,064) $(30,324) ========== ========== ============ ==============
At December 31, 1996:
Notional Weighted Average Rate Type Amount Maturities Receive Pay ____________________ __________ __________ _____________________ Swap to Fixed $2,400,000 1997-2001 5.77% 6.27% Swap to Floating 1,670,800 1997-2001 5.86% 5.58% Currency Related 245,445 1998-1999 n/a * n/a * Int. Rate Cap 500,000 1997-1999 n/a * n/a * __________ $4,816,245 ==========
At December 31, 1996 (Continued):
Notional Unrealized Unrealized Net Unrealized Type Amount Gross Gain Gross (Loss) Gain (Loss) ____________________ __________ __________ ____________ ______________ Swap to Fixed $2,400,000 $ 1,848 $(17,876) $(16,028) Swap to Floating 1,670,800 4,838 (4,413) 425 Currency Related 245,445 961 (19,569) (18,608) Int. Rate Cap 500,000 675 - 675 __________ __________ ____________ ______________ $4,816,245 $ 8,322 $(41,858) $(33,536) ========== ========== ============ ==============
* n/a: not applicable
FINANCIAL INSTRUMENTS (Continued):
At December 31, 1997, approximately 57 percent of the Company's total debt was hedged through the use of currency and interest rate related agreements. Before the effects of such agreements, the Company's debt comprised approximately 27 percent fixed rate debt and 73 percent floating rate debt. After the effects of such agreements, the Company's debt consisted of approximately 41 percent fixed rate debt and 59 percent floating rate debt. At December 31, 1996, about 61 percent of the Company's total debt was hedged through the use of currency and interest rate related agreements. Before the effects of such agreements, the Company's debt comprised approximately 36 percent fixed rate debt and 64 percent floating rate debt. After the effects of such agreements, the Company's debt consisted of approximately 45 percent fixed rate debt and 55 percent floating rate debt.
The approximate weighted average effective interest rates for the commercial paper, other short-term debt, medium-term notes and other long-term debt, as disclosed in the notes on pages 30 and 31, Short-Term Debt and Long-Term Debt, include the effects of interest rate swap agreements.
Fair value is a very subjective and imprecise measurement that is based on numerous estimates and assumptions that require substantial judgment and may be valid only at a particular point in time. As such, fair value can represent only a very general approximation of possible value that may never actually be realized.
The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate.
Cash and cash equivalents: The carrying amount approximates fair value due to the short maturity of these instruments.
Marketable securities: The carrying amount approximates fair value, which is estimated using quoted market prices.
Loans receivable: The fair value is estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings with the same remaining maturities.
Working capital financing receivables: The carrying amount approximates fair value due to the short maturity of most of these instruments.
Due and deferred from receivable sales: The carrying amount approximates fair value.
Short and long-term debt and current maturities of long-term debt: The fair value of these instruments is estimated by discounting the future cash flows using the current rates offered to the Company for debt with the same maturities.
Interest rate related and currency related agreements: The fair value of these instruments has been estimated as the amount the Company would receive or pay to terminate the
agreements, taking into consideration current interest and currency exchange rates.
FINANCIAL INSTRUMENTS (Continued):
Commitments to extend credit: The fair value of commitments to extend credit is estimated as the amount of approved but unused working capital financing credit lines available to customers.
Financial guarantees: The fair value of financial guarantees is estimated as the amounts that would be paid if the Company had to settle the obligations.
The following table summarizes the carrying amount and the estimated fair value of all of the Company's financial instruments:
(Dollars in thousands) Carrying Estimated At December 31, 1997: Amount Fair Value __________ ___________
Cash and cash equivalents $ 792,471 $ 792,471 Marketable securities 127,847 127,847 Loans receivable 2,381,261 2,462,666 Working capital financing receivables 3,249,310 3,249,310 Short-term debt (excluding current maturities of long-term debt) 7,175,387 7,109,671 Long-term debt and current maturities of long-term debt 3,892,882 3,962,879 Off-balance-sheet derivatives: Currency related -- Assets - 2,370 Liabilities - 41,274 Interest rate related -- Assets - 14,385 Liabilities - 22,267 Commitments to extend credit - 2,069,076 Financial guarantees - 8,888
Carrying Estimated At December 31, 1996: Amount Fair Value __________ ___________
Cash and cash equivalents $ 632,834 $ 632,834 Marketable securities 159,348 159,348 Loans receivable 1,846,947 1,899,413 Working capital financing receivables 2,898,688 2,898,688 Short-term debt (excluding current maturities of long-term debt) 6,352,525 6,573,150 Long-term debt and current maturities of long-term debt 1,729,812 1,373,218 Off-balance-sheet derivatives: Currency related -- Assets - 961 Liabilities - 19,569 Interest rate related -- Assets - 7,361 Liabilities - 22,289 Commitments to extend credit - 2,051,496 Financial guarantees - 12,884
TRANSACTIONS WITH GENERAL ELECTRIC CAPITAL CORPORATION:
During the second and third quarters of 1997, the Company entered into agreements to purchase selected assets from the leasing portfolio of General Electric Capital Technology Management Services Corporation (GECTMSC), a subsidiary of General Electric Capital Corporation (GECC). The purchase price of approximately $353.3 million was primarily financed by the Company through short-term and long-term borrowings. The acquired capital and operating lease and loan portfolio consists of both IBM and non-IBM products.
Additionally, the Company entered into an alliance with General Electric Capital Information Technology Solutions Corporation (ITS), a GECC affiliate, wherein the Company will serve as the preferred financing provider for customers of ITS's products and services.
INDUSTRY SEGMENT REPORTING:
The Company operates principally in a single business segment offering customer financing of information industry products and services.
SUBSEQUENT EVENT:
On February 26, 1998, the Company's Board of Directors declared a $25.0 million dividend, payable to IBM on March 19, 1998.
SELECTED QUARTERLY FINANCIAL DATA: (Unaudited)
(Dollars in thousands)
Finance Gross Profit and Other Interest Equipment on Equipment Net Income Expense Sales Sales Earnings ___________ ________ _________ ____________ ________ ____
First Quarter . .$ 365,891* $112,966 $ 86,655 $11,305 $ 79,183 Second Quarter. . 363,110 126,824 85,459 12,566 68,583 Third Quarter . . 421,590 143,749 128,961 18,343 62,439 Fourth Quarter. . 480,304 155,021 141,030 18,360 73,688 ___________ ________ _________ _______ ________ $1,630,895 $538,560 $442,105 $60,574 $283,893 =========== ======== ========= ======= ======== ____
First Quarter . .$ 374,179* $106,280 $106,488 $18,689 $ 73,928 Second Quarter. . 368,114 106,931 101,432 17,626 74,075 Third Quarter . . 359,648 110,362 76,367 7,670 71,610 Fourth Quarter. . 395,859 112,536 135,005 6,951 51,469 ___________ ________ ________ _______ ________ $1,497,800 $436,109 $419,292 $50,936 $271,082 =========== ======== ======== ======= ========
* During the first quarter of 1997 and 1996, the Company recognized a pretax gain of $10.7 million and $9.3 million, respectively, upon the sale of certain restricted securities.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE:
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT: Omitted pursuant to General Instruction J.
ITEM 11. EXECUTIVE COMPENSATION: Omitted pursuant to General Instruction J.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT: Omitted pursuant to General Instruction J.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS: Omitted pursuant to General Instruction J.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K:
(a) The following documents are filed as part of this report:
1. Consolidated Financial Statements included in Part II of this report:
Report of Independent Accountants (page 15).
Consolidated Statement of Financial Position at December 31, 1997 and 1996 (page 16).
Consolidated Statement of Earnings and Retained Earnings for the year ended December 31, 1997, 1996 and (page 17).
Consolidated Statement of Cash Flows for the year ended December 31, 1997, 1996 and 1995 (pages 18 and 19).
Notes to Consolidated Financial Statements (pages 20 through 38).
2. Financial statement schedules required to be filed by Item 8 of this Form 10-K:
Schedules are omitted because of the absence of the conditions under which they are required or because the information is disclosed in the financial statements or in the notes thereto.
3. Exhibits required to be filed by Item 601 of Regulation S-K: Included in this Form 10-K:
Exhibit Number _______________
I. Agreement to furnish information defining the rights of debt holders
II. Statement re computation of ratios
III. Consent of experts and counsel
IV. Financial data schedule
Not included in this Form 10-K:
The Certificate of Incorporation of IBM Credit Corporation is filed pursuant to the quarterly report on Form 10-Q for the quarterly period ended June 30, 1993, on August 10, 1993, and is hereby incorporated by reference.
The By-Laws of IBM Credit Corporation are filed pursuant to the annual report of Form 10-K for the fiscal year ended December 31, 1996, on March 25, 1997, and are hereby incorporated by reference.
The Support Agreement dated as of April 15, 1981, between the Company and IBM is filed with Form SE dated March 26, 1987, and is hereby incorporated by reference.
Power of Attorney of Jeffrey D. Serkes
(b) Reports on Form 8-K: A Form 8-K dated October 21, 1997, was filed with respect to the Company's financial results for the period ended September 30, 1997.
[SIGNATURE] 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.
IBM CREDIT CORPORATION (Registrant)
By: /s/W. Wilson Lowery, Jr. ________________________ (W. Wilson Lowery, Jr.) Chairman Date: March 27, 1998
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 on March 27, 1998.
Signature Title _________ _____
_/s/W. Wilson Lowery, Jr.__ ___________________________ (W. Wilson Lowery, Jr.) Chairman and Director
_/s/Kimberly A. Kispert____ ___________________________ (Kimberly A. Kispert) Vice President, Finance, and Chief Financial Officer and Director _/s/Michael J. Twomey______ ___________________________ (Michael J. Twomey) Controller and Treasurer
| | | /s/Kimberly A. Kispert Jeffrey D. Serkes Director |By: ________________________ | (Kimberly A. Kispert) | Attorney-in-fact |
EXHIBIT INDEX _____________ Reference Number Exhibit Number per Item 601 of in This Regulation S-K Description of Exhibits Form 10-K ________________ _________________________________________ ______________
(2) Plan of acquisition, reorganization, Not liquidation or succession. applicable
(3) Certificate of Incorporation and By-Laws
The Certificate of Incorporation of IBM Credit Corporation is filed pursuant to Form 10Q for the quarterly period ended June 30, 1993, on August 10, 1993, and is hereby incorporated by reference.
The By-Laws of IBM Credit Corporation are filed pursuant to the annual report on Form 10-K for the fiscal year ended December 31, 1996, on March 25, 1997, and are hereby incorporated by reference.
(4)(a) Instruments defining the rights of security holders.
An agreement to furnish to the Securities I and Exchange Commission, on request, a copy of instruments defining the rights of debt holders.
(4)(b) Indenture dated as of January 15, 1989, filed electronically as Exhibit No. 4 to Amendment No. 1 to Form S-3 on April 3, 1989, is hereby incorporated by reference.
(9) Voting trust agreement. Not applicable (10) Material contracts.
The Support Agreement dated April 15, 1981, between the Company and IBM is filed with Form SE dated March 26, 1987, and is hereby incorporated by reference.
(11) Statement regarding computation of per Not share earnings. applicable
(12) Statement regarding computation of ratios. II
(16) Letter on change in certifying accountant. Not applicable
EXHIBIT INDEX _____________ (continued) Reference Number Exhibit Number per Item 601 of in This Regulation S-K Description of Exhibits Form 10-K ________________ _________________________________________ ______________
(18) Letter regarding change in accounting Not principles. Applicable
(21) Subsidiaries of the registrant. Omitted
(22) Published report regarding matters Not submitted to vote of security holders. Applicable
(23) Consent of experts and counsel. III
(24) Power of Attorney of Jeffrey D. Serkes (incorporated by reference to Exhibit IV(j) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995, electronically transmitted to the Securities and Exchange Commission on March 18, 1996).
(27) Financial data schedule. IV
(28) Information from reports furnished to Not state insurance regulatory authorities. applicable
(99) Additional exhibits. Not applicable
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:
OVERVIEW
Net earnings for 1997 were $283.9 million, yielding a return on average equity of 18.6 percent, as compared with 1996 net earnings of $271.1 million, yielding a return on average equity of 20.7 percent.
FINANCING ORIGINATED
For the year ended December 31, 1997, the Company originated capital equipment financing for end users of $6,950.1 million, a 21 percent increase from $5,750.4 million for 1996. For the year ended December 31, 1997, originations of working capital financing for dealers and remarketers of information industry products increased by 12 percent to $15,005.2 million, from $13,387.0 million for 1996.
The growth in capital equipment financing originated is related to IBM's increase in placements of its products and services in the United States and an increase in the propensity for customers to finance their acquisitions with the Company throughout 1997, compared with 1996.
Capital equipment financings for end users comprised purchases of $3,998.1 million of information handling systems from IBM, financing for IBM software and services of $1,182.9 million, installment and lease financing for state and local government customers of $411.0 million for the account of IBM, financing originated for installment receivables of $285.9 million and other financing of $1,072.2 million for IBM equipment, as well as related non-IBM equipment to meet IBM customers' total solution requirements. The purchases of $3,998.1 million from IBM consisted of $2,252.9 million for capital leases and $1,745.2 million for operating leases.
The Company's capital lease portfolio primarily includes direct financing leases. Direct financing leases consist principally of IBM information handling equipment with terms generally from three to five years. Operating leases consist principally of IBM information handling equipment with terms generally from two to four years.
The growth in working capital financing originations reflects volume increases in IBM's personal system client products for remarketers financed by the Company throughout 1997. Working capital financing receivables arise primarily from secured inventory and accounts receivable financing for dealers and remarketers of IBM and non-IBM products. Payment terms for inventory secured financing generally range from 30 days to 45 days. Payment terms for accounts receivable secured financing generally range from 30 days to 90 days.
REMARKETING ACTIVITIES
In addition to originating new financing, the Company remarkets used IBM equipment. This equipment is primarily sourced from the conclusion of lease transactions and is typically remarketed in cooperation with the IBM sales force. The equipment is generally leased or sold to end users. These transactions may be with existing lessees or, when equipment is returned, with new customers.
Remarketing activities are fully integrated in the Company's financial statements. Remarketing activities comprise income from follow-on capital and operating leases and gross profit on equipment sales, net of write-downs in residual values of certain leased equipment. For the year ended December 31, 1997, the remarketing activities contributed $211.4 million to pretax earnings, an increase of 42 percent compared with $149.2 million for 1996.
At December 31, 1997, the investment in remarketed equipment on capital and operating leases totaled $285.5 million, a decrease of 6 percent from the 1996 year-end investment of $305.3 million.
FINANCIAL CONDITION
ASSETS
Total assets increased to $16.6 billion at December 31, 1997, compared with $12.9 billion at December 31, 1996. This increase is primarily the result of growth in end user and working capital financings originated during 1997. Also contributing to the increase in total assets were factored receivables acquired from IBM, which totaled $824.0 million at December 31, 1997, and the lease portfolio purchased from General Electric Capital Technology Management Services Corporation (GECTMSC), a subsidiary of General Electric Capital Corporation (GECC).
Total financing assets serviced by the Company, at December 31, 1997, were $16.0 billion, compared with $12.7 billion at December 31, 1996. Total financing assets serviced include the remaining balance of financing receivables securitized and sold ($176.8 million in 1997, $324.2 million in 1996), capital and operating leases ($8,514.9 million in 1997, $6,766.2 million in 1996), loans receivable ($2,381.3 million in 1997, $1,846.9 million in 1996), working capital financing receivables ($3,249.3 million in 1997, $2,898.7 million in 1996), subordinated interests in trusts resulting from the securitization and sale of financing receivables ($11.4 million in 1997, $37.0 million in 1996) and other assets ($13.9 million in 1997, $44.6 million in 1996). Also included in total financing assets serviced are state and local government installment and lease financing receivables of IBM ($849.9 million in 1997, $805.9 million in 1996), which are not reflected on the Company's Statement of Financial Position and accounts receivable purchases from selected IBM subsidiaries during 1997 ($824.0 million).
The carrying amount of marketable securities, as reported in the Company's Consolidated Statement of Financial Position, approximates market value. At December 31, 1997, the
marketable securities consisted entirely of debt securities, and were available-for-sale.
FINANCIAL CONDITION (Continued)
LIABILITIES AND STOCKHOLDER'S EQUITY
The assets of the Company were financed with $11,068.3 million of debt at December 31, 1997. Total short-term and long-term debt increased by approximately $2,986.0 million, from $8,082.3 million at December 31, 1996. This increase was the result of increases in short-term notes of $1,826.8 million, short-term debt payable to IBM of $1,014.1 million, long-term debt of $371.3 million and long-term debt payable to IBM of $589.3 million, offset by a decrease in commercial paper outstanding of $815.5 million. Included in the increase in total debt are short-term borrowings associated with accounts receivable purchases from selected IBM subsidiaries during 1997. Included in short-term debt at December 31, 1997, was $539.0 million payable to IBM at market terms and conditions, maturing on January 5, 1998. Included in long-term debt at December 31, 1997, were $407.0 million and $182.3 million payable to IBM at market terms and conditions, maturing on August 21, 2000 and February 26, 2001, respectively. Included in short-term debt at December 31, 1996, was $125.0 million payable to IBM at market terms and conditions, which matured on November 1, 1997.
At December 31, 1997, the Company had available $878.2 million of a shelf registration with the Securities and Exchange Commission (SEC) for the issuance of debt securities. On January 12, 1998, the Company's registration of an additional $5.0 billion of debt securities was filed with the SEC. Currently, the Company has available a total of $4.6 billion on the shelf registration with the SEC for the issuance of debt securities. This allows the Company rapid access to domestic financial markets. The Company intends to continue to issue debt securities under this shelf registration. The Company has no firm commitments for the purchase of debt securities that it may issue from the unused portion of this shelf registration.
The Company has the option, as approved by the Board of Directors on November 1, 1997, to issue and sell up to $5.0 billion of debt securities in domestic and foreign financial markets through December 31, 1998. Included within this $5.0 billion authorization is the option, together with IBM and IBM International Finance, N.V., to issue and sell debt securities in an aggregate nominal amount of up to 3.0 billion in European Currency Units (ECU), or its equivalent in any other currency. At December 31, 1997, there was 1.4 billion in ECU available for the issuance of debt securities under this program. The Company may issue debt securities over the next twelve months under this program, dependent on prevailing market conditions and its need for such funding.
The Company has the option, as approved by the Board of Directors on November 1, 1996, to sell, assign, pledge or transfer up to $3.0 billion of assets to third parties through December 31, 1999. Included within this $3.0 billion authorization is $450.0 million of a separate shelf registration for issuance of asset-backed securities, which a subsidiary of the Company has available. The subsidiary's issuance of any asset-backed securities over the next twelve months under this shelf registration is dependent on prevailing market conditions and its need for such
FINANCIAL CONDITION (Continued)
funding. The Company is an authorized borrower of up to $3.0 billion under a $10.0 billion IBM committed global credit facility, and has a liquidity agreement with IBM for $500.0 million. The Company has no borrowings outstanding under the committed global credit facility or the liquidity agreement. The Company and IBM have also signed master loan agreements providing additional funding flexibility to each other. These agreements allow for short-term (up to 270-day) funding, made available at market terms and conditions, upon the request of either the Company or IBM. The Company had borrowings outstanding under this arrangement of $600.2 million at December 31, 1997. The Company had no borrowings outstanding under this agreement at December 31, 1996. These financing sources, along with the Company's internally generated cash and medium-term note and commercial paper programs, provide flexibility to the Company to grow its lease, working capital financings and loan portfolios, to fund working capital requirements and to service debt.
Amounts due to IBM and affiliates include trade payables arising from purchases of equipment for term leases and installment receivables, working capital financing receivables for dealers and remarketers, and software license fees. Also included in amounts due to IBM and affiliates are income taxes currently payable under the intercompany tax allocation agreement. Amounts due to IBM and affiliates increased by approximately $235.5 million to $2,524.5 million at December 31, 1997, from $2,289.0 million at December 31, 1996. The increase was primarily attributable to a $235.1 million increase in the amount payable for capital equipment purchases during 1997, compared with the same 1996 period.
Total stockholder's equity at December 31, 1997, was $1,668.9 million, up $233.9 million from year-end 1996. The increase in stockholder's equity reflects 1997 net earnings of $283.9 million, offset by the payment of $50.0 million in cash dividends to IBM during 1997.
At December 31, 1997, the Company's debt to equity ratio was 6.6:1, compared with 5.6:1 at December 31, 1996.
TOTAL CASH PROVIDED BEFORE DIVIDENDS
Total cash provided before dividends was $209.6 million in 1997, compared with total cash provided before dividends of $341.0 million in 1996. Total cash provided before dividends reflects $2,410.8 million of cash used in investing and financing activities before dividends, offset by $2,620.4 million of cash provided by operating activities in 1997. For 1996, total cash provided before dividends reflects $2,235.1 million of cash used in investing and financing activities before dividends, offset by $2,576.1 million of cash provided by operating activities. Cash and cash equivalents at December 31, 1997, totaled $792.4 million, an increase of $159.6 million, compared with the balance at December 31, 1996.
FINANCIAL CONDITION (Continued)
MARKET RISK
In the normal course of business, the financial position of the Company is routinely subjected to a variety of risks. In addition to the market risk associated with interest and currency rate movements on outstanding debt and non-U.S. dollar denominated assets and liabilities, other examples of risk include collectibility of accounts receivable and recoverability of residual values on leased assets.
The Company regularly assesses these risks and has established policies and business practices to protect against the adverse effects of these and other potential exposures. As a result, the Company does not anticipate any material losses in these areas. The Company manages this risk, in part, through the use of a variety of financial instruments including derivatives, as explained in Significant Accounting Policies in the Notes to Consolidated Financial Statements on page 21.
For purposes of specific risk analysis, the Company uses sensitivity analysis to determine the impacts that market risk exposures may have on the fair values of the Company's debt and financial instruments.
The financial instruments included in the sensitivity analysis consist of all of the Company's cash and cash equivalents, marketable securities, long-term non-lease receivables, investments, long-term and short-term debt and all derivative financial instruments. Interest rate swaps, interest rate options and foreign currency swaps constitute the Company's portfolio of derivative financial instruments.
To perform sensitivity analysis, the Company assesses the risk of loss in fair values from the impact of hypothetical changes in interest rates and foreign currency exchange rates on market sensitive instruments. The market values for interest and foreign currency exchange risk are computed based on the present value of future cash flows as impacted by the changes in the rates attributable to the market risk being measured. The discount rates used for the present value computations were selected based upon market interest and foreign currency exchange rates in effect at December 31, 1997.
The market values that result from these computations are compared with the market values of these financial instruments at December 31, 1997. The differences in this comparison are the hypothetical gains or losses associated with each type of risk.
The results of the sensitivity analysis at December 31, 1997, are as follows:
INTEREST RATE RISK:
A 10 percent decrease in the levels of interest rates with all other variables held constant would result in a decrease in the fair value of the Company's financial instruments by $34.2 million. A 10 percent increase in the levels of interest rates with all other variables held constant would
result in an increase in the fair value of the Company's financial instruments by $34.9 million.
FINANCIAL CONDITION (Continued)
FOREIGN CURRENCY EXCHANGE RATE RISK:
A 10 percent increase or decrease in the levels of foreign currency exchange rates against the U.S. dollar with all other variables held constant would result in a decrease in the fair value of the Company's financial instruments by $18.5 million or an increase in the fair value of the Company's financial instruments by $18.5 million, respectively.
RESULTS OF OPERATIONS
INCOME FROM LEASES
Income from leases increased 15 percent to $600.8 million for the year ended December 31, 1997, from $524.0 million in 1996. The growth in capital equipment financings for end users under capital and operating leases during 1997 contributed to the overall increase in income from leases. This increase in income from leases was partially offset by a more competitive environment for end user financing. Income from leases includes lease income resulting from remarketing transactions. Lease income from remarketing transactions was $185.5 million in 1997, an increase of 29 percent from 1996.
On a periodic basis, the Company reassesses the future residual values of its portfolio of leases. In accordance with generally accepted accounting principles, anticipated increases in specific future residual values may not be recognized before realization and are thus a source of potential future profits. Anticipated decreases in specific future residual values that are considered to be other than temporary must be recognized currently. A review of the Company's $1,105.6 million residual value portfolio at December 31, 1997, indicated that the overall estimated future value of the portfolio continues to be greater than the value currently recorded, which is the lower of the Company's cost or net realizable value. The Company however, did record a $34.7 million reduction to income from leases during 1997 to recognize decreases in the expected future residual value of specific leased equipment, compared with $36.4 million during 1996.
INCOME FROM WORKING CAPITAL FINANCING
Income from working capital financing decreased 3 percent to $257.6 million in 1997, compared with $265.3 million in 1996. This decrease was primarily due to declines in the average working capital receivables outstanding during 1997, compared with 1996. The year-to-year decline in average working capital financing receivables outstanding was due to an increase in cash collected prior to normal payment terms from the dealer.
INCOME FROM LOANS
Income from loans increased 13 percent to $168.0 million in 1997, compared with $148.8 million in 1996. This increase resulted from higher asset balances, which in turn were
primarily due to an increase in financing originated for software and services during 1996 and 1997.
RESULTS OF OPERATIONS (Continued)
EQUIPMENT SALES
Equipment sales amounted to $442.1 million in 1997, compared with $419.3 million in 1996. Contributing to this increase in equipment sales is the growth of equipment remarketed as sales, rather than as operating leases. The revenue associated with outright sales and sales-type leases is included in equipment sales. Company-owned equipment may be sold or released to existing lessees or, when equipment is returned, to new users of that equipment.
Gross profit on equipment sales in 1997 was $60.6 million, an increase of 19 percent, compared with $50.9 million in 1996. The gross profit margin in 1997 increased to 13.7 percent, compared with 12.1 percent in 1996. The mix of products available for sale and changing market conditions for certain used equipment during the applicable periods are factors contributing to the increase in gross profit margins.
INCOME FROM FACTORED IBM RECEIVABLES
Income from factored IBM receivables was $26.5 million for the 12 months ended December 31, 1997. Refer to Related Company Transactions in the Notes to Consolidated Financial Statements on page 32 for additional details.
OTHER INCOME
Other income decreased 3 percent to $135.9 million in 1997, compared with $140.4 million in 1996. The decrease in other income is primarily attributable to a decline in the fees for the servicing of IBM financing receivables sold, resulting from a decrease in the securitized asset portfolios during 1997, as compared with the same 1996 period. Partially offsetting the decrease in other income is an increase in the Company's interest income earned on cash and cash equivalents during 1997, compared with 1996.
The Company continues to service financing receivables securitized and sold in prior years, and earns a fee, which is included in other income. During 1997 and 1996, there were no securitizations or sales of financing receivables by the Company.
Also included in other income is interest income earned on notes, as well as fees for managing IBM's state and local government installment and lease financing receivables portfolio.
INTEREST EXPENSE
As a result of the growth in end user and working capital financings originated, the Company has experienced an increase in the average outstanding debt balance. This increase in the average outstanding debt balance resulted in a 24 percent growth in interest expense to $538.6 million in 1997, compared with $436.1 million in 1996. The Company's 1997 average cost of debt decreased to 5.7 percent, from 5.8 percent for 1996.
RESULTS OF OPERATIONS (Continued)
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES
Selling, general, and administrative expenses were $228.2 million in 1997, an increase of 13 percent compared with $201.2 million in 1996. This increase is primarily due to planned growth in the Company's resources during 1996 and 1997, resulting in an increase in compensation related expenses.
PROVISION FOR RECEIVABLE LOSSES
The Company's portfolio of capital equipment leases and loans is predominantly with investment grade customers. The Company generally retains ownership or takes a security interest in any underlying equipment financed. The Company provides for receivable losses at the time financings are originated and from time to time for capital equipment as conditions warrant. The portfolio is diversified by geography, industry and individual unaffiliated customer.
The Company provides for working capital financing receivable losses on the basis of actual collection experience and estimated collectibility of the related financing receivables. With the continued growth of the Company's working capital financing business in 1996 and 1997, and with the continuation of the trend toward consolidation in this industry segment, the concentration of such financings for certain large dealers and remarketers of information industry products is significant. At December 31, 1997, and December 31, 1996, approximately 62 percent of the working capital financing receivables outstanding were concentrated in ten working capital accounts. The Company's working capital financing business is predominantly with non-investment grade customers. Such financing receivables are typically collateralized by the inventory and accounts receivable of the dealers and remarketers. The Company did not experience material losses in 1997 or 1996. The Company does not believe that there is a risk of loss in this area that would have a material impact on its financial position or results of operations.
The overall provision for receivable losses decreased to $35.5 million in 1997, compared with $44.9 million in 1996. The decline in the provision for receivable losses was attributable to lower reserve requirements, based upon the Company's historical loss experience, assessment of collectibility of specific receivables and its ability to effectively manage credit risk and contain losses.
INCOME TAXES
Income taxes decreased 7 percent to $163.2 million for the year ended December 31, 1997, from $176.1 million for the same period in 1996. The decrease in the effective tax rate was primarily caused by reestimations made in the current period of tax liabilities established in prior periods.
The Company expects its effective tax rate to approximate the statutory federal (35%) and state (6.4%) income tax rates in future years.
RETURN ON AVERAGE EQUITY
The 1997 results yielded an annualized return on average equity of 18.6 percent, compared with 20.7 percent in 1996.
ACCOUNTING CHANGES
The Company implemented new accounting standards in 1997, and 1995. None of these standards had a material effect on the financial position or results of operations of the Company.
Effective January 1, 1997, the Company implemented SFAS 125, "Accounting for Transfer and Servicing of Financial Assets and Extinguishments of Liabilities." This standard provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. The Company was generally in compliance with this standard prior to adoption.
Effective January 1, 1995, the Company implemented SFAS 114, "Accounting by Creditors for Impairment of a Loan," and SFAS 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures." These standards prescribe impairment measurements and reporting related to certain loans.
In 1995, the Company implemented SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." This standard prescribes the method for asset impairment evaluation for long-lived assets and certain identifiable intangibles that are to be either held and used or intended for disposal. The Company was generally in compliance with this standard prior to adoption.
In 1998, the Company will implement two accounting standards issued by the Financial Accounting Standards Board (FASB) in June of 1997. SFAS 130, "Reporting Comprehensive Income," and SFAS 131, "Disclosures About Segments of an Enterprise and Related Information," will have no effect on the Company's financial position or results of operations as they require only changes to or additions to current disclosures.
CLOSING DISCUSSION
The Company's resources continue to be sufficient to enable it to carry out its mission of offering customers competitive leasing and financing and providing information technology remarketers with inventory and accounts receivable financing, which contributes to the growth and stability of IBM earnings.
FORWARD LOOKING STATEMENTS
Except for the historical information and discussions contained herein, statements contained in this Report on Form 10-K may constitute "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including, but not limited to, the Company's level of equipment financing originations; the propensity for customers to finance their acquisition of IBM products and services with the Company; the competitive environment in which the Company operates; the success of the Company in developing strategies to manage debt levels; non-performance by a customer of contractual requirements; the concentration of credit risk and creditworthiness of the customer; the Company's associated collection and asset management efforts; the Company's determination of residual values; currency fluctuations on the associated debt and liabilities; change in interest rates; non-performance by the counterparty in derivative transactions; the Company's ability to attract and retain key personnel; the Company's ability to manage acquisitions and alliances; legal, political and economic changes and other risks, uncertainties and factors inherent in the Company's business and otherwise discussed in this Form 10-K and in the Company's other filings with the Securities and Exchange Commission.
YEAR 2000
What is commonly known as the "Year 2000 issue" arises because many computer hardware and software systems use only two digits to represent the year. As a result, these systems and programs may not calculate dates beyond 1999, which may cause errors in information or systems failures.
With respect to its internal systems, the Company is taking appropriate steps to remediate the Year 2000 issues and does not expect the costs of these efforts to be material. However, the Year 2000 readiness of the Company's customers and the hardware and software offerings from the Company's suppliers, subcontractors and business partners may vary. The Company is also aware of the potential for claims against it and other companies for damages from products and services that were not Year 2000 ready. The Company believes that any such claims against it will be without merit. While the Company does not believe that the Year 2000 matters discussed above will have a material impact on its business, financial condition or results of operation, it is uncertain whether or to what extent the Company may be affected by such matters.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:
Report of Independent Accountants
To the Stockholder and Board of Directors of IBM Credit Corporation
In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a) 1. on page 40 present fairly, in all material respects, the financial position of IBM Credit Corporation and its subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
Price Waterhouse LLP Stamford, CT January 20, 1998, except as to the Subsequent Event note on page 38, which is as of February 26, 1998
IBM CREDIT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation: The consolidated financial statements include the accounts of the Company and those of its subsidiaries that are more than 50 percent owned. Investments in partnerships in which the Company has typically a 20 percent ownership are accounted for using the equity method.
Cash and Cash Equivalents: Time deposits with original maturities generally of three months or less are included in cash and cash equivalents. Cash paid for interest was $523.1 million, $443.2 million and $388.3 million in 1997, 1996 and 1995, respectively.
Marketable Securities: The Company's marketable securities, all of which are debt securities, are available-for-sale. The carrying amount of the debt securities approximates market value.
Finance Income Recognition: Income attributable to direct financing leases and loans receivable is initially recorded as unearned income and subsequently recognized as finance income at level rates of return over the term of the leases or receivables. Income recognized from leveraged leases includes the amortization of unearned finance income and deferred investment and other tax credits over the term of the leases, at level rates of return, during periods when the net investment balance is positive.
Equipment on Operating Leases: Equipment is depreciated on a straight-line basis to its estimated residual value over the lease term.
Equipment Sales Income Recognition: Revenue from equipment sales to existing lessees is recognized at the effective date a purchase provision is exercised. Revenue from sales to parties other than existing lessees is recognized when title transfers.
Allowance for Receivable Losses: The allowance for receivable losses is determined on the basis of actual collection experience and estimated collectibility of the related assets.
Income Taxes: Income tax expense is based on reported earnings before income taxes. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes on a separate company basis. In accordance with Statement of Financial Accounting Standards (SFAS) 109, "Accounting for Income Taxes," these deferred taxes are measured by applying currently enacted tax laws.
SIGNIFICANT ACCOUNTING POLICIES (Continued):
Financial Instruments: The Company uses agreements related to currencies and interest rates to lower costs of funding its business, to diversify sources of funding, or to manage interest rate and currency exposures arising from mismatches between assets and liabilities. The Company enters into such financial instruments solely for hedging purposes. The Company does not enter into such financial instrument transactions for trading or for other speculative purposes. Debt obligations denominated in foreign currencies and subject to foreign currency swap agreements are included in the Consolidated Statement of Financial Position at the contractual rate of exchange in the respective foreign currency swap agreement. Gains and losses on forward contracts and purchased options, designated as hedges, are deferred and included in the settlement of the related transaction. The Company routinely evaluates existing and potential counterparty credit exposures associated with such financial instrument transactions to ensure that these exposures remain within credit guidelines.
Under interest rate swaps, the Company agrees with other parties to exchange, at specified intervals, the difference between interest amounts calculated by reference to a floating index or a fixed rate on an agreed upon notional principal amount. Swap contracts are primarily between one and five years in duration. The Company enters into interest rate cap and floor agreements to reduce the potential impact of changes in interest rates on floating rate debt supporting fixed rate assets. Interest rate agreements generally involve the exchange of interest payments without the exchange of the underlying notional amount on which the interest payments are calculated. The Company enters into currency exchange agreements to hedge debt denominated in foreign currencies. The term of the currency derivatives is generally less than five years. The purpose of the Company's foreign currency hedging activities is to protect itself from the risk that the eventual dollar net cash outflows will be affected by changes in exchange rates. The Company does not anticipate any material adverse effect on its financial position or results of operations resulting from its use of these instruments, nor does it anticipate nonperformance by any of its counterparties.
Use of Estimates: Management uses estimates in preparing the consolidated financial statements, in conformity with generally accepted accounting principles. Significant estimates include collectibility of receivables, recoverability of residual values of equipment on capital and operating leases, and useful economic lives of long-term fixed assets. The Company regularly assesses these estimates, and while actual results may differ from these estimates, management believes that material changes will not occur in the near term.
RELATIONSHIP WITH IBM:
Pursuant to a Support Agreement between IBM and the Company, IBM has agreed to retain 100 percent of the voting capital stock of the Company, unless required to dispose of any or all such shares of stock pursuant to a court decree or order of any governmental authority that in the opinion of counsel to IBM may not be successfully challenged. IBM has also agreed to cause the Company to have a tangible net worth of at least $1.00 at all times. The Support Agreement provides that it shall not be deemed to constitute a guarantee by IBM to any party of the payment of any debt or other obligation, indebtedness or liability of the Company. The Support Agreement may not be modified, amended or terminated while there is outstanding any debt of the Company, unless all holders of such debt have consented in writing.
Pursuant to an operating agreement, IBM provides collection, administration and other services and products for the Company and is reimbursed for the cost of these services and products. The Company is compensated for services performed for IBM, primarily for management of IBM's state and local government installment receivables portfolio, the fees for which are reflected in other income.
The operating agreement with IBM also provides that installment receivables, which include finance charges, may be purchased by the Company at a mutually agreed-upon price. The Company is reimbursed by IBM for any price adjustments and concessions that reduce the amount of receivables previously purchased by the Company.
The operating agreement with IBM also provides that IBM will offer term leases of the Company to creditworthy potential lessees. IBM's sales price of the equipment to the Company will typically be at the purchase price payable by the lessee, unless the Company is participating in IBM product promotions.
The Company also has an indemnification agreement with IBM. IBM reimburses the Company for losses on working capital financing receivables with specific dealers and for specific transactions. Approximately $2.2 million, $10.5 million and $9.3 million of such losses have been reimbursed by IBM in 1997, 1996 and 1995, respectively.
The Company received compensation for services and benefits provided to IBM. Included in income from working capital financing is fee income earned from IBM Personal Systems Group of $73.1 million, $63.1 million and $51.1 million in 1997, 1996 and 1995, respectively. Also included in income from working capital financing is fee income from other IBM divisions of $27.3 million, $15.3 million and $7.1 million in 1997, 1996 and 1995, respectively. Included in other income are fees received for the management of IBM's portfolio of state and local government installment receivables of $51.8 million, $51.0 million and $46.8 million in 1997, 1996 and 1995, respectively.
The Company has a liquidity agreement with IBM International Finance, N.V. (IIF), whereby the Company has agreed to advance funds to IIF as an enhancement to IIF's ability to
carry out business. The amount of the advances is not to exceed the greater of $500.0 million or 5 percent of
RELATIONSHIP WITH IBM (Continued):
the Company's total assets. To support this agreement, the Company has entered into a backup agreement with IBM, whereby IBM has agreed to advance funds to the Company, in an amount not to exceed the greater of $500.0 million or 5 percent of the Company's total assets, if at any time the Company requires such funds to satisfy its agreement with IIF. The Company has neither received nor made any advances with respect to these agreements at December 31, 1997 and 1996.
The Company, together with IBM and IIF, has the option to issue and sell debt securities in an aggregate nominal amount of up to 3.0 billion in European Currency Units, or its equivalent in any other currency. This option is part of a $5.0 billion Board of Directors' authorization the Company has to issue and sell debt securities in domestic and foreign financial markets through December 31, 1998. As previously mentioned, at December 31, 1997, there was 1.4 billion in ECU available for the issuance of debt securities under this program. The Company's intention to issue any debt securities over the next twelve months under this program is dependent on prevailing market conditions and the Company's need for such funding.
From time to time, the Company will either borrow funds from or lend funds to IBM and its affiliates, at prevailing interest rates. During the fourth quarter of 1994, the Company and IBM signed master loan agreements providing additional funding flexibility to each other. These agreements allow for short-term (up to 270-day) funding, made available at market terms and conditions, upon the request of either the Company or IBM. The purpose of these agreements is to finance the borrower's assets, for working capital or for other general corporate purposes. At December 31, 1997, the Company had borrowings outstanding under these agreements of $600.2 million, payable to IBM. These borrowings were repaid on January 5, 1998. At December 31, 1996, the Company had no borrowings outstanding under these agreements.
The Company is an authorized borrower of up to $3.0 billion under a $10.0 billion IBM committed global credit facility and has a liquidity agreement with IBM for $500.0 million. The Company has no borrowings outstanding under the committed global credit facility or the liquidity agreement.
MARKETABLE SECURITIES:
The following is a summary of marketable securities at December 31, 1997 and December 31, 1996 which were available-for-sale. The marketable securities consisted entirely of debt securities. Contractual maturities of marketable debt securities at December 31, 1997 and December 31, 1996, are between one and five years. It is expected that actual maturities will differ from contractual maturities because some borrowers have the right to call or prepay certain obligations, sometimes without call or prepayment penalties.
(Dollars in thousands) 1997 1996
________ _________ Corporate . . . . . . . . . . . . . . . . $ 95,023 $125,138 U.S. federal agency . . . . . . . . . . . 32,824 34,210 _________ _________ Total, which approximates market value. . $127,847 $159,348 ========= =========
NET INVESTMENT IN CAPITAL LEASES:
The Company's capital lease portfolio includes direct financing and leveraged leases. The Company originates financing for customers in a variety of industries and throughout the United States. The Company has a diversified portfolio of capital equipment financings for end users.
Direct financing leases consist principally of IBM information handling equipment with terms generally from three to five years. The components of the net investment in direct financing leases at December 31, 1997 and 1996, are as follows:
(Dollars in thousands) 1997 1996 ___________ ___________ Gross lease payments receivable . . . . . $4,922,989 $4,299,250 Estimated unguaranteed residual values. . 327,239 260,004 Deferred initial direct costs . . . . . . 36,325 30,087 Unearned income . . . . . . . . . . . . . (502,564) (528,830) Allowance for receivable losses . . . . . (52,373) (44,131) ___________ ___________ $4,731,616 $4,016,380 =========== ===========
The scheduled maturities of minimum lease payments outstanding at December 31, 1997, expressed as a percentage of the total, are due approximately as follows:
Within 12 months. . . . . . . . . . . . . . . . . . . . 46% 13 to 24 months . . . . . . . . . . . . . . . . . . . . 34 25 to 36 months . . . . . . . . . . . . . . . . . . . . 15 37 to 48 months . . . . . . . . . . . . . . . . . . . . 4 After 48 months . . . . . . . . . . . . . . . . . . . . 1 ____ 100% ====
Included in the net investment in capital leases are $29.8 million and $55.6 million of seller interest at December 31, 1997 and 1996, respectively, relating to the securitization of such leases.
NET INVESTMENT IN CAPITAL LEASES (Continued):
Leveraged lease investments include coal-fired electric generating facilities, commercial aircraft and other non-IBM manufactured equipment. Leveraged leases have remaining terms ranging from five to twenty-one years. The components of the net investment in leveraged leases at December 31, 1997 and 1996, are as follows:
(Dollars in thousands) 1997 1996 __________ __________ Net rents receivable. . . . . . . . . . $ 254,059 $ 258,022 Estimated unguaranteed residual values. 39,752 39,752 Unearned and deferred income. . . . . . (90,773) (93,296) Allowance for receivable losses . . . . (3,362) (6,036) __________ __________ Investment in leveraged leases. . . . . 199,676 198,442 Less: Deferred income taxes. . . . . . (188,074) (196,460) __________ __________ Net investment in leveraged leases. . . $ 11,602 $ 1,982 ========== ==========
Refer to the note on page 28, Allowance for Receivable Losses, for a reconciliation of the direct financing leases and leveraged leases allowances for receivable losses.
EQUIPMENT ON OPERATING LEASES:
Operating leases consist principally of IBM information handling equipment with terms generally from two to four years. The components of equipment on operating lease at December 31, 1997 and 1996, are as follows:
(Dollars in thousands) 1997 1996 ____________ ____________ Cost. . . . . . . . . . . . . . . . . . . $ 6,640,874 $ 4,839,547 Accumulated depreciation. . . . . . . . . (3,057,233) (2,288,165) ____________ ____________ $ 3,583,641 $ 2,551,382 ============ ============
Minimum future rentals were approximately $3,201.1 million at December 31, 1997. The scheduled maturities of the minimum future rentals at December 31, 1997, expressed as a percentage of the total, are due approximately as follows:
Within 12 months. . . . . . . . . . . . . . . . . . . . 50% 13 to 24 months . . . . . . . . . . . . . . . . . . . . 34 25 to 36 months . . . . . . . . . . . . . . . . . . . . 13 37 to 48 months . . . . . . . . . . . . . . . . . . . . 2 After 48 months . . . . . . . . . . . . . . . . . . . . 1 ____ 100% ====
LOANS RECEIVABLE:
Loans receivable include installment receivables that are principally financings of customer purchases of IBM information handling products. Also included are other financings, comprising primarily IBM software and services. The components of loans receivable at December 31, 1997 and 1996, are as follows:
(Dollars in thousands) 1997 1996 ___________ ___________ Gross loans receivable . . . . . . . $2,736,356 $2,166,019 Deferred initial direct costs. . . . 17,890 13,168 Unearned income. . . . . . . . . . . (301,756) (268,876) Allowance for receivable losses. . . (71,229) (63,364) ___________ ___________ $2,381,261 $1,846,947 =========== ===========
The scheduled maturities of loans receivable outstanding at December 31, 1997, expressed as a percentage of the total, are due approximately as follows:
Within 12 months . . . . . . . . . . . . . . . . . . . 44% 13 to 24 months. . . . . . . . . . . . . . . . . . . . 31 25 to 36 months. . . . . . . . . . . . . . . . . . . . 15 37 to 48 months. . . . . . . . . . . . . . . . . . . . 8 After 48 months. . . . . . . . . . . . . . . . . . . . 2 ____ 100% ====
Included in loans receivable are $17.9 million and $40.0 million at December 31, 1997 and 1996, respectively, that are due from the Company's term lease partnerships. Such loans are secured by the general pool of leases in the partnerships. Also included in loans receivable are $6.2 million and $16.1 million of seller interest at December 31, 1997, and 1996, respectively, relating to the securitization of such loans.
Refer to the note on page 28, Allowance for Receivable Losses, for a reconciliation of the loans receivable allowance for receivable losses.
WORKING CAPITAL FINANCING RECEIVABLES:
Working capital financing receivables arise primarily from secured inventory and accounts receivable financing for dealers and remarketers of IBM and non-IBM products and services. Inventory financing includes the financing of the purchase by these dealers and remarketers of information handling products. As previously discussed in the note on pages 22 and 23, Relationship with IBM, the Company is reimbursed by IBM for certain losses on working capital financing receivables with specific dealers and for specific transactions. Approximately $2.2 million, $10.5 million and $9.3 million of such losses have been reimbursed by IBM in 1997, 1996 and 1995, respectively. With the growth of the Company's working capital financing business in 1997 and 1996, the concentration of such financings for certain large dealers and remarketers of information industry products is significant. However, the Company has a secured position on most of its inventory and accounts receivable financing, which mitigates the amount of potential loss. The Company does not believe that there is a risk of loss that would have a material impact on its financial position or results of operations, and it provides for unsecured exposures based upon historical experience.
Payment terms for inventory-secured financing generally range from 30 days to 45 days. Accounts receivable financing includes the financing of trade accounts receivable for these dealers and remarketers. Payment terms for accounts receivable secured financing typically range from 30 days to 90 days. The components of working capital financing receivables at December 31, 1997, and 1996, are as follows:
(Dollars in thousands) 1997 1996 ___________ ___________ Working capital financing receivables $3,289,860 $2,955,411 Allowance for receivable losses . . . (40,550) (56,723) ___________ ___________ $3,249,310 $2,898,688 =========== ===========
Included in working capital financing receivables are $742.9 million and $608.7 million of seller interest at December 31, 1997, and 1996, respectively, relating to the securitization of such receivables. Additionally, the Company has $2,069.1 million of approved but unused working capital financing credit lines available to customers at December 31, 1997.
Refer to the note on page 28, Allowance for Receivable Losses, for a reconciliation of the working capital financing receivables allowance for receivable losses.
ALLOWANCE FOR RECEIVABLE LOSSES:
The following is a reconciliation of the allowance for receivable losses, by portfolio, for the years ended December 31, 1997, 1996 and 1995:
(Dollars in thousands) Direct Working Financing Leveraged Loans Capital 1997 Total Leases Leases Receivable Fin. Rec. _____________________ _________ _________ __________ __________ _________ Beginning of year . . $170,254 $ 44,131 $ 6,036 $ 63,364 $ 56,723 Provision for receivable losses. . 35,541 22,271 (2,674) 11,800 4,144 Accounts written off (net of recoveries). (46,328) (15,321) - (5,453) (25,554) Transfers from allowance for losses on receivables sold and other, net . . . 8,047 1,292 - 1,518 5,237 _________ _________ __________ __________ _________ End of year . . . . . $167,514 $ 52,373 $ 3,362 $71,229 $40,550 ========= ========= ========== ========== =========
Direct Working Financing Leveraged Loans Capital 1996 Total Leases Leases Receivable Fin. Rec. _____________________ _________ _________ __________ __________ _________ Beginning of year . . $159,543 $ 46,266 $ 6,104 $ 59,369 $ 47,804 Provision for receivable losses. . 44,883 17,940 - 13,260 13,683 Accounts written off (net of recoveries). (40,849) (22,104) - (11,686) (7,059) Transfers (to) from allowance for losses on receivables sold and other, net . . . 6,677 2,029 (68) 2,421 2,295 _________ _________ __________ __________ _________ End of year . . . . . $170,254 $ 44,131 $ 6,036 $ 63,364 $ 56,723 ========= ========= ========== ========== =========
Direct Working Financing Leveraged Loans Capital 1995 Total Leases Leases Receivable Fin. Rec. _____________________ _________ _________ __________ __________ _________ Beginning of year . . $ 89,489 $ 24,389 $ 7,171 $ 41,665 $ 16,264 Provision for receivable losses. . 68,417 16,208 - 21,200 31,009 Accounts written off (net of recoveries). (5,680) 2,967 (1,067) (7,232) (348) Transfers from allowance for losses on receivables sold and other, net . . . 7,317 2,702 - 3,736 879 _________ _________ __________ __________ _________ End of year . . . . . $159,543 $ 46,266 $ 6,104 $ 59,369 $ 47,804 ========= ========= ========== ========== =========
ALLOWANCE FOR RECEIVABLE LOSSES (Continued):
The reconciliation of the allowance for receivable losses, by portfolio, presented on page 28, excludes the allowance for estimated credit losses on receivables sold, which was $1.7 million and $5.1 million at December 31, 1997 and 1996, respectively. Provisions for expected losses, as they relate to receivables sold, are provided during the periods in which the receivables were originated. No material provisions were made for the years ended December 31, 1997 and December 31, 1996.
Also excluded from the reconciliation of the allowance for receivable losses, by portfolio, presented on page 28, is the allowance for estimated credit losses on factored IBM receivables, which was $31.3 million at December 31, 1997. IBM factored receivables written off, net of recoveries, during 1997 were $2.8 million. There were no factored IBM receivables at December 31, 1996. Provisions for expected losses, as they relate to factored IBM receivables, are provide during the periods in which the receivables are purchased.
At December 31, 1997, 1996 and 1995, the allowance for receivable losses approximated 1.3 percent, 1.5 percent and 1.6 percent, respectively, of the Company's portfolio of leases, loans, factored IBM receivables and working capital financing receivables. The decline in this ratio from 1996 to 1997 was due to lower reserve requirements, based upon the Company's historical experience and its ability to effectively manage credit risk and contain losses.
INVESTMENTS AND OTHER ASSETS:
The components of investments and other assets at December 31, 1997, and 1996, are as follows:
(Dollars in thousands) 1997 1996 ________ ________ Receivables from customers . . . . . . . . . $303,077 $259,588 Investments in partnerships and other . . . . 170,994 142,742 Receivables from affiliates . . . . . . . . . 79,121 99,214 Due and deferred from receivable sales. . . . 35,928 63,046 Remarketing inventory . . . . . . . . . . . . 58,383 35,986 Other assets . . . . . . . . . . . . . . . . 34,760 41,542 ________ ________ $682,263 $642,118 ======== ========
Due and deferred from receivable sales are net of the allowance for estimated credit losses on receivables sold and include subordinated interests in trusts, cash deposits held by trustee, receivables from investors and interest in excess servicing cash flows. Due and deferred from receivable sales are restricted assets subject to limited recourse provisions. There were no sales in 1997 and 1996 of financing receivables to investors. The Company acts as servicer for receivables securitized and sold, and is contingently liable for up to $197.8 million in the event of nonperformance, default or other loss relating to the outstanding pool balance at December 31, 1997, of IBM state
and local government installment receivables securitized and sold. Adequate reserves exist to cover
INVESTMENTS AND OTHER ASSETS (Continued):
potential losses. Included in other assets at December 31, 1997, and 1996, are $14.4 million and $10.0 million, respectively, on deposit in restricted accounts, held as security deposits received from customers. Also included in other assets at December 31, 1997 and 1996, respectively, are $4.1 million on deposit in restricted accounts for purposes of credit enhancement. The Company, as servicer, deposited the cash in connection with certain tax-exempt grantor trusts comprised of pools of IBM state and local government installment receivables. The trustee of each grantor trust is entitled to draw upon the amounts in the restricted accounts, in the event of nonperformance, default or other loss relating to such installment receivables.
SHORT-TERM DEBT:
The components of short-term debt at December 31, 1997, and 1996, are as follows:
(Dollars in thousands) 1997 1996 __________ __________ Commercial paper, with rates averaging 5.8% in 1997 and 5.5% in 1996. . . . . . . . . $3,902,029 $4,717,531 Other short-term debt, with rates averaging 5.7% in 1997 and 5.5% in 1996. . . . . . . . . 2,134,245 1,509,994 Current maturities of long-term debt. . . . . . 1,416,394 213,875 __________ __________ 7,452,668 6,441,400 IBM short-term borrowings . . . . . . . . . . . 1,139,113 125,000 __________ __________ $8,591,781 $6,566,400 ========== ==========
The approximate weighted average effective interest rates above, are before the effects of interest rate swap agreements and have been calculated on the basis of rates in effect at December 31, 1997 and 1996. The approximate weighted average stated rates (after the effects of interest rate swap agreements) on commercial paper outstanding at December 31, 1997, and 1996, were 6.2% and 5.6%, respectively. The approximate weighted average stated rates (after the effects of interest rate swap agreements) on other short-term debt outstanding at December 31, 1997, and 1996, were 5.7% and 5.8%, respectively. Other short-term debt primarily includes notes having maturities between nine and twelve months offered through the Company's medium-term note program.
LONG-TERM DEBT:
The components of long-term debt at December 31, 1997, and 1996, are as follows:
(Dollars in thousands) 1997 1996 ___________ ___________ Medium-term notes with original maturities ranging from 1998 to 2008, with rates averaging 6.0% in 1997 and 5.9% in 1996. . . $3,302,600 $1,731,344 IBM loan payable, due 2001. . . . . . . . . . 589,253 - ___________ ___________ 3,891,853 1,731,344 Net unamortized premiums/(discounts). . . . . 1,029 (1,532) ___________ ___________ 3,892,882 1,729,812 Less: Current maturities . . . . . . . . . . 1,416,394 213,875 ___________ ___________ $2,476,488 $1,515,937 =========== ===========
The approximate weighted average effective interest rates above are before the effects of interest rate swap agreements and have been calculated on the basis of rates in effect at December 31, 1997, and 1996. The approximate weighted average stated rates (after the effects of interest rate swap agreements) on medium-term notes outstanding at December 31, 1997, and 1996, were 6.0% and 5.9%, respectively. Discounts and premiums have the effect of modifying the stated rate of interest on long-term debt offerings.
Annual maturity of long-term debt at December 31, 1997, is as follows:
(Dollars in thousands)
1998 . . . . . . . . . . . . . . . . . . . $1,416,394 1999 . . . . . . . . . . . . . . . . . . . 1,216,206 2000 . . . . . . . . . . . . . . . . . . . 191,000 2001 . . . . . . . . . . . . . . . . . . . 185,000 2002 . . . . . . . . . . . . . . . . . . . 50,000 2003 and thereafter . . . . . . . . . . . 244,000 __________ $3,302,600 ==========
RATIO OF EARNINGS TO FIXED CHARGES:
The ratio of earnings to fixed charges calculated in accordance with applicable Securities and Exchange Commission requirements was 1.83, 2.02 and 1.96 for the years ended December 31, 1997, 1996 and 1995, respectively.
RELATED COMPANY TRANSACTIONS:
IBM charged the Company $84.4 million, $64.8 million and $62.6 million in 1997, 1996 and 1995, respectively, representing costs for lease services, employee benefit plans, facilities rental and staff support.
Amounts due to IBM and affiliates include current income taxes payable, as well as amounts for software, services, purchases of receivables and purchases of equipment for term leases. At December 31, 1997, and 1996, amounts due to IBM and affiliates were $2,524.5 million and $2,289.0 million, respectively.
Interest and finance income of $6.7 million, $1.9 million and $6.9 million was earned from loans to IBM and affiliates in 1997, 1996 and 1995, respectively. Interest expense of $29.3 million, $10.6 million and $10.2 million was incurred on loans from IBM and affiliates during 1997, 1996 and 1995, respectively.
The Company also provides equipment financing at market rates to IBM and affiliated companies for both IBM and non-IBM products. The Company originated $1,054.4 million and $682.0 million of such financings during 1997 and 1996, respectively. At December 31, 1997, and 1996, approximately $1,255.0 million and $828.0 million, respectively, of such financings were included in the lease and loan portfolio. Of these amounts, $1,136.1 million and $723.4 million were included in the Company's operating lease portfolio at December 31, 1997, and 1996, respectively. The finance income earned from operating leases to IBM and affiliated companies, net of depreciation expense, was $151.3 million, $107.6 million and $91.9 million in 1997, 1996 and 1995, respectively.
In June 1997, IBM Credit International Factoring Corporation (ICIFC) and IBM Credit EMEA Factoring Co., Ltd (ICEFC), subsidiaries of the Company, entered into factoring agreements with selected IBM subsidiaries. Under these agreements, ICIFC and ICEFC will periodically purchase, without recourse, all the rights, title and interest to certain outstanding IBM customer receivables.
During 1997, ICIFC and ICEFC acquired IBM customer receivables having a nominal value of $4,222.2 million for approximately $4,159.2 million. The receivables acquired are short-term in nature and are denominated in non-U.S. currencies. The purchase was financed by the Company through the issuance of short-term debt. Transactions related to these receivables are fully integrated in the Company's consolidated financial statements.
RELATED COMPANY TRANSACTIONS (Continued):
An intercompany tax allocation agreement (the Agreement) exists between the Company and its parent company, IBM. The Agreement aligns the settlement of federal and state tax benefits and/or obligations with the Company's provision for income taxes determined on a separate company basis. The Company is part of the IBM consolidated federal tax return and files separate state tax returns in selected states. Included in amounts due to IBM and affiliates at December 31, 1997, and 1996, are $27.1 million and $5.5 million, respectively, of current income taxes payable determined in accordance with the Agreement. Cash paid for income taxes to IBM and to states that require separate tax returns in 1997, 1996 and 1995 was $18.4 million, $113.3 million and $339.2 million, respectively.
PROVISION FOR INCOME TAXES:
The components of the provision for income taxes are as follows:
(Dollars in thousands) 1997 1996 1995 _________ __________ __________ Federal: Current . . . . . . . . . . $ 32,401 $ 60,741 $ 114,262 Deferred. . . . . . . . . . 100,332 83,637 9,306 _________ __________ __________ 132,733 144,378 123,568 _________ __________ __________ State and local: Current . . . . . . . . . . 8,575 19,216 23,405 Deferred. . . . . . . . . . 21,907 12,528 2,482 _________ __________ __________ 30,482 31,744 25,887 _________ __________ __________ Total provision . . . . . . $ 163,215 $ 176,122 $ 149,455 ========== ========== ==========
Changes in the deferred tax assets and liabilities resulting from temporary differences between financial and tax reporting are as follows:
(Dollars in thousands) 1997 1996 __________ __________ Deferred tax assets (liabilities):
Provision for receivable losses. . . . . . $ 75,477 $ 90,909 Lease income and depreciation. . . . . . . (1,014,615) (901,514) Other, net . . . . . . . . . . . . . . . . 51,958 49,111 __________ __________ Deferred income taxes . . . . . . . . . . . . $ (887,180) $(761,494) ========== ==========
PROVISION FOR INCOME TAXES (Continued):
The provision for income taxes varied from the U.S. federal statutory income tax rate as follows:
1997 1996 1995 ______ ______ ______ Federal statutory rate. . . . . . . . 35.0% 35.0% 35.0% State and local taxes, net of federal tax benefit . . . . . . . . 4.4 4.4 4.4 Adjustments to prior years' tax liabilities . . . . . . . . . . . . (2.9) - - Other, net. . . . . . . . . . . . . . - - (0.1) ______ ______ ______ Effective income tax rate . . . . . . 36.5% 39.4% 39.3% ====== ====== ======
FINANCIAL INSTRUMENTS:
The Company has used derivative instruments as an element of its risk management strategy for many years. Although derivatives entail risk of non-performance by counterparties, the Company manages this risk by establishing explicit dollar and term limitations that correspond to the credit rating of each carefully selected counterparty. The Company has not sustained a material loss from these instruments nor does it anticipate any material adverse effect on its results of operations or financial position in the future.
The majority of the Company's derivative transactions relate to the matching of liabilities to assets. The Company issues debt, using the most efficient capital markets and products, which may result in a currency or interest rate mismatch with the underlying asset. Interest rate swaps or currency swaps are then used to match the interest rates and currencies of its debt to the related asset. Interest and currency rate differentials accruing under interest rate and currency swap contracts are recognized over the life of the contracts in interest expense. When the terms of the underlying instrument are modified, or if it ceases to exist, all changes to fair value of the swap contract are recognized in income each period until it matures.
The tables on page 35 summarize the notional value, maturity dates, weighted average receive and pay rates and net unrealized gain (loss) of derivative financial instruments by category at December 31, 1997, and 1996. The notional value at December 31 provides an indication of the extent of the Company's involvement in such instruments at that time, but does not represent exposure to market risk.
FINANCIAL INSTRUMENTS (Continued):
(Dollars in thousands)
At December 31, 1997:
Notional Weighted Average Rate Type Amount Maturities Receive Pay ____________________ __________ __________ _____________________ Swap to Fixed $2,675,750 1998-2002 5.68% 6.22% Swap to Floating 2,605,800 1999-2007 6.73% 5.70% Currency Related 435,297 1998-1999 n/a * n/a * Int. Rate Cap/Floor 615,000 1998-1999 n/a * n/a * __________ $6,331,847 ==========
At December 31, 1997 (Continued):
Notional Unrealized Unrealized Net Unrealized Type Amount Gross Gain Gross (Loss) Gain (Loss) ____________________ __________ __________ ____________ ______________ Swap to Fixed $2,675,750 $ 1,027 $(16,557) $(15,530) Swap to Floating 2,605,800 22,500 (483) 22,017 Currency Related 435,297 2,213 (39,024) (36,811) Int. Rate Cap/Floor 615,000 - - - __________ __________ ____________ ______________ $6,331,847 $25,740 $(56,064) $(30,324) ========== ========== ============ ==============
At December 31, 1996:
Notional Weighted Average Rate Type Amount Maturities Receive Pay ____________________ __________ __________ _____________________ Swap to Fixed $2,400,000 1997-2001 5.77% 6.27% Swap to Floating 1,670,800 1997-2001 5.86% 5.58% Currency Related 245,445 1998-1999 n/a * n/a * Int. Rate Cap 500,000 1997-1999 n/a * n/a * __________ $4,816,245 ==========
At December 31, 1996 (Continued):
Notional Unrealized Unrealized Net Unrealized Type Amount Gross Gain Gross (Loss) Gain (Loss) ____________________ __________ __________ ____________ ______________ Swap to Fixed $2,400,000 $ 1,848 $(17,876) $(16,028) Swap to Floating 1,670,800 4,838 (4,413) 425 Currency Related 245,445 961 (19,569) (18,608) Int. Rate Cap 500,000 675 - 675 __________ __________ ____________ ______________ $4,816,245 $ 8,322 $(41,858) $(33,536) ========== ========== ============ ==============
* n/a: not applicable
FINANCIAL INSTRUMENTS (Continued):
At December 31, 1997, approximately 57 percent of the Company's total debt was hedged through the use of currency and interest rate related agreements. Before the effects of such agreements, the Company's debt comprised approximately 27 percent fixed rate debt and 73 percent floating rate debt. After the effects of such agreements, the Company's debt consisted of approximately 41 percent fixed rate debt and 59 percent floating rate debt. At December 31, 1996, about 61 percent of the Company's total debt was hedged through the use of currency and interest rate related agreements. Before the effects of such agreements, the Company's debt comprised approximately 36 percent fixed rate debt and 64 percent floating rate debt. After the effects of such agreements, the Company's debt consisted of approximately 45 percent fixed rate debt and 55 percent floating rate debt.
The approximate weighted average effective interest rates for the commercial paper, other short-term debt, medium-term notes and other long-term debt, as disclosed in the notes on pages 30 and 31, Short-Term Debt and Long-Term Debt, include the effects of interest rate swap agreements.
Fair value is a very subjective and imprecise measurement that is based on numerous estimates and assumptions that require substantial judgment and may be valid only at a particular point in time. As such, fair value can represent only a very general approximation of possible value that may never actually be realized.
The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate.
Cash and cash equivalents: The carrying amount approximates fair value due to the short maturity of these instruments.
Marketable securities: The carrying amount approximates fair value, which is estimated using quoted market prices.
Loans receivable: The fair value is estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings with the same remaining maturities.
Working capital financing receivables: The carrying amount approximates fair value due to the short maturity of most of these instruments.
Due and deferred from receivable sales: The carrying amount approximates fair value.
Short and long-term debt and current maturities of long-term debt: The fair value of these instruments is estimated by discounting the future cash flows using the current rates offered to the Company for debt with the same maturities.
Interest rate related and currency related agreements: The fair value of these instruments has been estimated as the amount the Company would receive or pay to terminate the
agreements, taking into consideration current interest and currency exchange rates.
FINANCIAL INSTRUMENTS (Continued):
Commitments to extend credit: The fair value of commitments to extend credit is estimated as the amount of approved but unused working capital financing credit lines available to customers.
Financial guarantees: The fair value of financial guarantees is estimated as the amounts that would be paid if the Company had to settle the obligations.
The following table summarizes the carrying amount and the estimated fair value of all of the Company's financial instruments:
(Dollars in thousands) Carrying Estimated At December 31, 1997: Amount Fair Value __________ ___________
Cash and cash equivalents $ 792,471 $ 792,471 Marketable securities 127,847 127,847 Loans receivable 2,381,261 2,462,666 Working capital financing receivables 3,249,310 3,249,310 Short-term debt (excluding current maturities of long-term debt) 7,175,387 7,109,671 Long-term debt and current maturities of long-term debt 3,892,882 3,962,879 Off-balance-sheet derivatives: Currency related -- Assets - 2,370 Liabilities - 41,274 Interest rate related -- Assets - 14,385 Liabilities - 22,267 Commitments to extend credit - 2,069,076 Financial guarantees - 8,888
Carrying Estimated At December 31, 1996: Amount Fair Value __________ ___________
Cash and cash equivalents $ 632,834 $ 632,834 Marketable securities 159,348 159,348 Loans receivable 1,846,947 1,899,413 Working capital financing receivables 2,898,688 2,898,688 Short-term debt (excluding current maturities of long-term debt) 6,352,525 6,573,150 Long-term debt and current maturities of long-term debt 1,729,812 1,373,218 Off-balance-sheet derivatives: Currency related -- Assets - 961 Liabilities - 19,569 Interest rate related -- Assets - 7,361 Liabilities - 22,289 Commitments to extend credit - 2,051,496 Financial guarantees - 12,884
TRANSACTIONS WITH GENERAL ELECTRIC CAPITAL CORPORATION:
During the second and third quarters of 1997, the Company entered into agreements to purchase selected assets from the leasing portfolio of General Electric Capital Technology Management Services Corporation (GECTMSC), a subsidiary of General Electric Capital Corporation (GECC). The purchase price of approximately $353.3 million was primarily financed by the Company through short-term and long-term borrowings. The acquired capital and operating lease and loan portfolio consists of both IBM and non-IBM products.
Additionally, the Company entered into an alliance with General Electric Capital Information Technology Solutions Corporation (ITS), a GECC affiliate, wherein the Company will serve as the preferred financing provider for customers of ITS's products and services.
INDUSTRY SEGMENT REPORTING:
The Company operates principally in a single business segment offering customer financing of information industry products and services.
SUBSEQUENT EVENT:
On February 26, 1998, the Company's Board of Directors declared a $25.0 million dividend, payable to IBM on March 19, 1998.
SELECTED QUARTERLY FINANCIAL DATA: (Unaudited)
(Dollars in thousands)
Finance Gross Profit and Other Interest Equipment on Equipment Net Income Expense Sales Sales Earnings ___________ ________ _________ ____________ ________ ____
First Quarter . .$ 365,891* $112,966 $ 86,655 $11,305 $ 79,183 Second Quarter. . 363,110 126,824 85,459 12,566 68,583 Third Quarter . . 421,590 143,749 128,961 18,343 62,439 Fourth Quarter. . 480,304 155,021 141,030 18,360 73,688 ___________ ________ _________ _______ ________ $1,630,895 $538,560 $442,105 $60,574 $283,893 =========== ======== ========= ======= ======== ____
First Quarter . .$ 374,179* $106,280 $106,488 $18,689 $ 73,928 Second Quarter. . 368,114 106,931 101,432 17,626 74,075 Third Quarter . . 359,648 110,362 76,367 7,670 71,610 Fourth Quarter. . 395,859 112,536 135,005 6,951 51,469 ___________ ________ ________ _______ ________ $1,497,800 $436,109 $419,292 $50,936 $271,082 =========== ======== ======== ======= ========
* During the first quarter of 1997 and 1996, the Company recognized a pretax gain of $10.7 million and $9.3 million, respectively, upon the sale of certain restricted securities.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE:
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT: Omitted pursuant to General Instruction J.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION: Omitted pursuant to General Instruction J.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT: Omitted pursuant to General Instruction J.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS: Omitted pursuant to General Instruction J.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K:
(a) The following documents are filed as part of this report:
1. Consolidated Financial Statements included in Part II of this report:
Report of Independent Accountants (page 15).
Consolidated Statement of Financial Position at December 31, 1997 and 1996 (page 16).
Consolidated Statement of Earnings and Retained Earnings for the year ended December 31, 1997, 1996 and (page 17).
Consolidated Statement of Cash Flows for the year ended December 31, 1997, 1996 and 1995 (pages 18 and 19).
Notes to Consolidated Financial Statements (pages 20 through 38).
2. Financial statement schedules required to be filed by Item 8 of this Form 10-K:
Schedules are omitted because of the absence of the conditions under which they are required or because the information is disclosed in the financial statements or in the notes thereto.
3. Exhibits required to be filed by Item 601 of Regulation S-K: Included in this Form 10-K:
Exhibit Number _______________
I. Agreement to furnish information defining the rights of debt holders
II. Statement re computation of ratios
III. Consent of experts and counsel
IV. Financial data schedule
Not included in this Form 10-K:
The Certificate of Incorporation of IBM Credit Corporation is filed pursuant to the quarterly report on Form 10-Q for the quarterly period ended June 30, 1993, on August 10, 1993, and is hereby incorporated by reference.
The By-Laws of IBM Credit Corporation are filed pursuant to the annual report of Form 10-K for the fiscal year ended December 31, 1996, on March 25, 1997, and are hereby incorporated by reference.
The Support Agreement dated as of April 15, 1981, between the Company and IBM is filed with Form SE dated March 26, 1987, and is hereby incorporated by reference.
Power of Attorney of Jeffrey D. Serkes
(b) Reports on Form 8-K: A Form 8-K dated October 21, 1997, was filed with respect to the Company's financial results for the period ended September 30, 1997.
[SIGNATURE] 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.
IBM CREDIT CORPORATION (Registrant)
By: /s/W. Wilson Lowery, Jr. ________________________ (W. Wilson Lowery, Jr.) Chairman Date: March 27, 1998
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 on March 27, 1998.
Signature Title _________ _____
_/s/W. Wilson Lowery, Jr.__ ___________________________ (W. Wilson Lowery, Jr.) Chairman and Director
_/s/Kimberly A. Kispert____ ___________________________ (Kimberly A. Kispert) Vice President, Finance, and Chief Financial Officer and Director _/s/Michael J. Twomey______ ___________________________ (Michael J. Twomey) Controller and Treasurer
| | | /s/Kimberly A. Kispert Jeffrey D. Serkes Director |By: ________________________ | (Kimberly A. Kispert) | Attorney-in-fact |
EXHIBIT INDEX _____________ Reference Number Exhibit Number per Item 601 of in This Regulation S-K Description of Exhibits Form 10-K ________________ _________________________________________ ______________
(2) Plan of acquisition, reorganization, Not liquidation or succession. applicable
(3) Certificate of Incorporation and By-Laws
The Certificate of Incorporation of IBM Credit Corporation is filed pursuant to Form 10Q for the quarterly period ended June 30, 1993, on August 10, 1993, and is hereby incorporated by reference.
The By-Laws of IBM Credit Corporation are filed pursuant to the annual report on Form 10-K for the fiscal year ended December 31, 1996, on March 25, 1997, and are hereby incorporated by reference.
(4)(a) Instruments defining the rights of security holders.
An agreement to furnish to the Securities I and Exchange Commission, on request, a copy of instruments defining the rights of debt holders.
(4)(b) Indenture dated as of January 15, 1989, filed electronically as Exhibit No. 4 to Amendment No. 1 to Form S-3 on April 3, 1989, is hereby incorporated by reference.
(9) Voting trust agreement. Not applicable (10) Material contracts.
The Support Agreement dated April 15, 1981, between the Company and IBM is filed with Form SE dated March 26, 1987, and is hereby incorporated by reference.
(11) Statement regarding computation of per Not share earnings. applicable
(12) Statement regarding computation of ratios. II
(16) Letter on change in certifying accountant. Not applicable
EXHIBIT INDEX _____________ (continued) Reference Number Exhibit Number per Item 601 of in This Regulation S-K Description of Exhibits Form 10-K ________________ _________________________________________ ______________
(18) Letter regarding change in accounting Not principles. Applicable
(21) Subsidiaries of the registrant. Omitted
(22) Published report regarding matters Not submitted to vote of security holders. Applicable
(23) Consent of experts and counsel. III
(24) Power of Attorney of Jeffrey D. Serkes (incorporated by reference to Exhibit IV(j) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995, electronically transmitted to the Securities and Exchange Commission on March 18, 1996).
(27) Financial data schedule. IV
(28) Information from reports furnished to Not state insurance regulatory authorities. applicable
(99) Additional exhibits. Not applicable