TOYOTA MOTOR CREDIT CORP – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Edgar Online, Inc.

Cautionary Statement Regarding Forward-Looking Information

  Certain statements contained in this Form 10-K or incorporated by reference herein are "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and currently available information. However, since these statements are based on factors that involve risks and uncertainties, our performance and results may differ materially from those described or implied by such forward-looking statements. Words such as "believe," "anticipate," "expect," "estimate," "project," "should," "intend," "will," "may" or words or phrases of similar meaning are intended to identify forward-looking statements. We caution that the forward-looking statements involve known and unknown risks, uncertainties and other important factors such as the following that may cause actual results to differ materially from those stated:   

· Changes in general business and economic conditions, as well as in consumer

    demand and the competitive environment in the automotive markets in the     United States;   

· A decline in TMS sales volume and the level of TMS sponsored subvention

     programs;   

· Increased competition from other financial institutions seeking to increase

    their share of financing Toyota vehicles;    ·    Fluctuations in interest rates and currency exchange rates;   

· Changes or disruptions in our funding environment or access to the global

     capital markets;   

· Failure or changes in commercial soundness of our counterparties and other

     financial institutions;    ·   Changes in our credit ratings and those of TMC;   

· Changes in the laws and regulatory requirements, including as a result of

recent financial services legislation, and related costs;

· Natural disasters, changes in fuel prices, manufacturing disruptions and

production suspensions of Toyota, Lexus and Scion vehicles models and related

     parts supply;    

· Operational risks, including security breaches or cyber attacks;

· Changes in prices of used vehicles and their effect on residual values of our

off-lease vehicles and return rates;

· The failure of a customer or dealer to meet the terms of any contract with

us, or otherwise fail to perform as agreed;

· Recalls announced by TMS and the perceived quality of Toyota, Lexus and

      Scion vehicles; and    

· The other risks and uncertainties set forth in "Part I, Item 1A. Risk

Factors".

    Forward-looking statements speak only as of the date they are made. We will not update the forward-looking statements to reflect actual results or changes in the factors affecting the forward-looking statements.                                          26 --------------------------------------------------------------------------------

OVERVIEW

Key Performance Indicators and Factors Affecting Our Business

  In our finance operations, we generate revenue, income, and cash flows by providing retail financing, leasing, and dealer financing to vehicle and industrial equipment dealers and their customers. We measure the performance of our financing operations using the following metrics: financing volume, market share, financial leverage, financing margins, operating expense, residual value and credit loss metrics.  In our insurance operations, we generate revenue through marketing, underwriting, and claims administration related to covering certain risks of vehicle dealers and their customers. We measure the performance of our insurance operations using the following metrics: investment income, issued agreement volume, number of agreements in force, and loss metrics.  Our financial results are affected by a variety of economic and industry factors, including but not limited to, new and used vehicle markets, Toyota, Lexus and Scion sales volume, new vehicle incentives, consumer behavior, employment levels, our ability to respond to changes in interest rates with respect to both contract pricing and funding, the actual or perceived quality, safety or reliability of Toyota, Lexus and Scion vehicles, the financial health of the dealers we finance, and competitive pressure. Changes in these factors can influence financing and lease contract volume, the number of financing and lease contracts that default and the loss per occurrence, our inability to realize originally estimated contractual residual values on leased vehicles, the volume and performance of our insurance operations, and our gross margins on financing and leasing volume. Changes in the volume of vehicle sales, vehicle dealers' utilization of our insurance programs, or the level of coverage purchased by affiliates could materially impact our insurance operations. Additionally, our funding programs and related costs are influenced by changes in the global capital markets, prevailing interest rates, and our credit ratings and those of our parent companies, which may affect our ability to obtain cost effective funding to support earning asset growth.  Our primary competitors are other financial institutions including national and regional commercial banks, credit unions, savings and loan associations, independent insurance service contract providers, finance companies and, to a lesser extent, other automobile manufacturers' affiliated finance companies that actively seek to purchase retail consumer contracts through Toyota and Lexus independent dealerships ("dealerships"). We strive to achieve the following:  Exceptional Customer Service:  Our relationship with Toyota and Lexus vehicle dealers and industrial equipment dealers and their customers offer us a competitive advantage. We seek to leverage this opportunity by providing exceptional service to dealers and their customers. Through our DSSO network, we work closely with the dealerships to improve the quality of service we provide to them. We also focus on assisting the dealers with the quality of their customer service operations to enhance customer loyalty for the dealership and the Toyota, Lexus and Scion brands. By providing consistent and reliable support, training, and resources to our dealer network, we continue to develop and improve our dealer relationships. In addition to marketing programs targeted toward customer retention, we work closely with TMS, TMHU and HINO to offer special retail, lease, dealer financing, and insurance programs. We also focus on providing a positive customer experience to existing retail, lease, and insurance customers through our CSCs.  Risk-Based Origination and Pricing: We price and structure our retail and lease contracts to compensate us for the credit risk we assume. The objective of this strategy is to maximize operating results and better match contract rates across a broad range of risk levels. To achieve this objective, we evaluate our existing portfolio for key opportunities to expand volume in targeted markets. We deliver timely strategic information to dealerships to assist them in benefiting from market opportunities. We continuously strive to refine our strategy and methodology for risk-based pricing.                                            27 --------------------------------------------------------------------------------   Liquidity Strategy: Our liquidity strategy is to maintain the capacity to fund assets and repay liabilities in a timely and cost-effective manner even in the event of adverse market conditions. This capacity primarily arises from our credit ratings, our ability to raise funds in the global capital markets, and our ability to generate liquidity from our balance sheet. This strategy has led us to develop a borrowing base that is diversified by market and geographic distribution, investor type, and financing structure, among other factors.                                          28 --------------------------------------------------------------------------------

Fiscal 2013 Operating Environment

  During fiscal 2013, economic growth in the United States continued at a slow to moderate pace, as labor market conditions showed some signs of improvement. Consumer spending remained constrained, but sales of motor vehicles improved compared to fiscal 2012. The housing sector improved as housing starts continued to trend higher and home prices rose moderately in fiscal 2013.  Conditions in the global capital markets generally improved during fiscal 2013, yet remained challenging due to concerns over volatile European financial conditions.  Europe's ongoing debt and financial crisis continued to pose downside risks to the economic outlook. Economic activity in Europe continued to contract and the growth of emerging economies in the European and Asian regions slowed.  Fiscal concerns in the U.S. contributed to market volatility and are expected to continue to pose downside risks to the U.S. economic outlook. Despite the challenging fixed income market conditions, we continue to maintain broad global access to both domestic and international markets.  Industry-wide vehicle sales in the United States and sales incentives throughout the auto industry increased during fiscal 2013 as compared to fiscal 2012. Vehicle sales by TMS increased 24 percent in fiscal 2013 compared to fiscal 2012. The increase in TMS sales was primarily attributable to new product launches, return of consumer demand for new vehicles and the recovery in vehicle and related parts supply, which had been disrupted by the natural disasters that occurred in Japan and Thailand in 2011. Production of Toyota, Lexus and Scion vehicles returned to pre-disaster levels during the third quarter of fiscal 2012, and inventory generally recovered to pre-disaster levels in the latter part of fiscal 2013.  Prices of used vehicles remained near historically high levels during fiscal 2013 despite slight declines as compared to fiscal 2012. Natural disasters in Japan and Thailand in 2011 had the effect of reducing the availability of new Toyota, Lexus and Scion vehicles which in turn increased the demand for certain used Toyota, Lexus and Scion vehicles. The combination of lower new Toyota, Lexus and Scion vehicle inventory during most of the first nine months of fiscal 2013 and low used vehicle supply contributed to lower per unit loss severity, which favorably affected our credit losses and residual value risk.  In October 2012, Hurricane Sandy caused wide-spread flooding and power outages across large portions of the Northeastern United States.  As a result, we experienced an increase in insurance losses and loss adjustment expenses during the third quarter of fiscal 2013 and an increase in credit losses. However, these increases were not material to our operating results for fiscal 2013 due to the offset from insurance recoveries. In addition, we did not experience a significant impact on our financial condition or our finance and insurance volume. Refer to "Results of Operations" and "Financial Condition" within "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" for further discussion.                                          29 --------------------------------------------------------------------------------

  RESULTS OF OPERATIONS                             Years ended March 31, (Dollars in millions)     2013       2012       2011 Net income: Finance operations1   $  1,183$  1,350$  1,631 Insurance operations1      148        136        222 Total net income      $  1,331$  1,486$  1,853

1 Refer to Note 16 - Segment Information of the Notes to Consolidated Financial

Statement for the total asset balances of our finance and insurance operations.

Fiscal 2013 Compared to Fiscal 2012

Our consolidated net income was $1,331 million in fiscal 2013, compared to $1,486 million in fiscal 2012. Our consolidated net income for fiscal 2013 decreased as compared to fiscal 2012 primarily due to increases in our depreciation on operating leases and provision for credit losses. Total financing revenues also decreased, which was more than offset by a corresponding decline in interest expense.

  Our overall capital position, after taking into effect dividend payments to TFSA of $743 million and $744 million in March 2013 and September 2012, respectively, decreased by $0.1 billion, bringing total shareholder's equity to $7.6 billion at March 31, 2013, as compared to $7.7 billion at March 31, 2012. Our debt increased to $78.8 billion at March 31, 2013 from $73.2 billion at March 31, 2012. As a result, our debt-to-equity ratio increased to 10.4 at March 31, 2013 from 9.6 at March 31, 2012.  

Fiscal 2012 Compared to Fiscal 2011

  Our consolidated net income was $1,486 million in fiscal 2012, compared to $1,853 million in fiscal 2011. Our consolidated net income for fiscal 2012 decreased as compared to fiscal 2011 primarily due to decreases in total financing revenue and investment and other income, partially offset by decreases in interest expense and operating and administrative expenses. Our consolidated net income was also affected by a decrease in our benefit from credit losses for fiscal 2012 compared to fiscal 2011.  Our overall capital position, after taking into effect the payment of a $741 million dividend in September 2011 to TFSA, increased by $0.8 billion, bringing total shareholder's equity to $7.7 billion at March 31, 2012, as compared to $6.9 billion at March 31, 2011. Our debt decreased to $73.2 billion at March 31, 2012 from $77.3 billion at March 31, 2011. We experienced an improvement in our debt-to-equity ratio to 9.6 at March 31, 2012 from 11.3 at March 31, 2011.                                          30 --------------------------------------------------------------------------------

Finance Operations

The following table summarizes key results of our Finance Operations:

                                                 Years ended March 31,           Percentage change                                                                                2013 to      2012 to (Dollars in millions)                        2013           2012         2011    2012         2011 Financing revenues: Operating lease                       $     4,748$     4,693$  4,888       1 %        (4) % Retail1                                     2,062          2,371        2,791    (13) %       (15) % Dealer                                        409            349          363      17 %        (4) % Total financing revenues                    7,219          7,413        8,042     (3) %        (8) %  Investment and other income                    57             44           46      30 %        (4) % Gross revenues from finance operations                                  7,276          7,457        8,088     (2) %        (8) %  Less:

Depreciation on operating leases 3,568 3,339 3,353 7 % - %

      Interest expense                         940          1,303        

1,620 (28) % (20) %

      Provision for credit losses              121           (98)        

(433) 223 % 77 %

Operating and administrative

      expenses                                 734            703          

903 4 % (22) %

      Provision for income taxes               730            860        

1,014 (15) % (15) % Net income from finance operations $ 1,183$ 1,350$ 1,631 (12) % (17) %

            1 Includes direct finance lease revenues for all periods shown.    Our finance operations reported net income of $ 1,183 million and $ 1,350 million during fiscal 2013 and 2012, respectively. The decrease in net income was primarily due to increases in our depreciation on operating leases and provision for credit losses. Total financing revenues also decreased, which was more than offset by a corresponding decline in interest expense.  

Financing Revenues

Total financing revenues decreased 3 percent during fiscal 2013 compared to fiscal 2012 due to the following combination of factors:

· Operating lease revenues increased 1 percent in fiscal 2013 as compared to

     fiscal 2012, due to higher average outstanding earning asset balances      partially offset by lower portfolio yields.   

· Retail contract revenues decreased 13 percent in fiscal 2013 as compared to

fiscal 2012, primarily due to a decrease in our portfolio yields partially

     offset by higher average outstanding earning asset balances.   

· Dealer financing revenues increased 17 percent in fiscal 2013 as compared to

     fiscal 2012, due to higher average outstanding earning asset balances      partially offset by lower portfolio yields.    Our total portfolio, which includes operating lease, retail and dealer financing, had a yield of 4.5 percent during fiscal 2013 compared to 5.4 percent in fiscal 2012, due to decreases in our retail, operating lease and dealer portfolio yields. Lower yields were the result of the continued maturity of higher yielding earning assets being replaced by lower yielding earning assets during fiscal 2013.                                          31

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Interest Expense

  Our liabilities consist mainly of fixed and floating rate debt, denominated in various currencies, which we issue in the global capital markets, while our assets consist primarily of U.S. dollar denominated, fixed rate receivables. We enter into interest rate swaps and foreign currency swaps to hedge the interest rate and foreign currency risks that result from the different characteristics of our assets and liabilities. The following table summarizes the consolidated components of interest expense:                                               Years ended March 31, (Dollars in millions)                     2013         2012          2011 Interest expense on debt             $   1,330$   1,677$    1,943 Interest income on derivatives             (2)          (1)          (21) Interest expense on debt and derivatives                              1,328        1,676         1,922  Ineffectiveness related to hedge accounting derivatives                    (10)         (21)          (33) (Gain) loss on foreign currency transactions                             (430)        (182)         1,494 Loss (gain) on foreign currency swaps                                      431         (84)       (1,595) Gain on non-hedge accounting interest rate swaps                      (379)         (89)         (174) Total interest expense               $     940$   1,300$    1,614    During fiscal 2013, total interest expense decreased from $1,300 million during fiscal 2012 to $940 million. This decrease was primarily due to lower weighted average interest rates on debt and higher gains on interest rate swaps. Additionally, in fiscal 2013, gains on foreign currency transactions were completely offset by the associated foreign currency swaps, while during fiscal 2012 we recorded combined gains on foreign currency transactions and the associated foreign currency swaps.  

Interest expense on debt primarily represents net interest settlements and changes in accruals on secured and unsecured notes and loans payable and commercial paper, and includes amortization of discount and premium, debt issuance costs, and basis adjustments. Interest expense on debt decreased to $1,330 million during fiscal 2013 from $1,677 million during fiscal 2012 primarily as a result of lower weighted average interest rates on debt.

  Interest income on derivatives represents net interest settlements and changes in accruals on both hedge and non-hedge accounting interest rate and foreign currency derivatives. During fiscal 2013, we recorded net income on derivatives of $2 million compared to net income of $1 million during fiscal 2012.  

Ineffectiveness related to hedge accounting derivatives represents the net difference between the change in the fair value of the hedged debt due to the hedged risk and the change in the fair value of the associated derivative instrument.

  Gain or loss on foreign currency transactions represents the revaluation of foreign currency denominated debt transactions for which hedge accounting has not been elected. We use foreign currency swaps to economically hedge these foreign currency transactions. During fiscal 2013, we recorded combined losses of $1 million on foreign currency transactions net of the associated foreign currency swaps, as compared to gains of $266 million during fiscal 2012. During fiscal 2012, net gains resulted from declines in foreign currency swap rates.                                          32 --------------------------------------------------------------------------------   We recorded gains of $379 million on non-hedge accounting interest rate swaps during fiscal 2013 compared to gains of $89 million during fiscal 2012. The net gains on these swaps during both periods resulted from a decline in long-term swap rates.  

Future changes in interest and foreign exchange rates could continue to result in significant volatility in our interest expense.

Provision for Credit Losses

  We recorded a provision for credit losses of $121 million for fiscal 2013, compared to a benefit from credit losses of $98 million for fiscal 2012. The benefit from credit losses for fiscal 2012 was attributable to significant improvements in per unit loss severity, default frequency and net charge-offs in our consumer portfolio as compared to fiscal 2011. In fiscal 2013, net charge-offs increased primarily due to a decline in recoveries as compared to fiscal 2012. In addition, while default frequency improved in our consumer portfolio during fiscal 2013, this improvement was not significant enough to offset the increase in net charge-offs. Earning asset growth in our retail loan and investments in operating leases portfolios also contributed to an increased provision in fiscal 2013 as compared to fiscal 2012. As a result we recorded a provision for credit losses during fiscal 2013.  

Operating and Administrative Expenses

Operating expenses increased during fiscal 2013 compared to fiscal 2012 primarily due to increases in employee, general operating and insurance dealer back-end program expenses.

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Insurance Operations

The following table summarizes key results of our Insurance Operations:

                                           Years ended March 31,               Percentage change                                                                               2013 to    2012 to (Dollars in millions)                   2013            2012          2011      2012      2011 Agreements (units in thousands)      Issued                            1,557           1,357         2,200        15 %     (38) %      In force                          5,787           6,357         6,239       (9) %        2 %  Insurance earned premiums and      contract revenues            $      596$      620$    565       (4) %       10 % Investment and other income              116              72           196        61 %     (63) % Gross revenues from insurance      operations                          712             692           761         3 %      (9) %  Less: Insurance losses and loss adjustment      expenses                            293             325           247      (10) %       32 % Operating and administrative      expenses                            177             154           156        15 %      (1) % Provision for income taxes                94              77           136        22 %     (43) % Net income from insurance      operations                   $      148$      136$    222         9 %     (39) %    Our insurance operations reported net income of $ 148 million for fiscal 2013 compared to $136 million for fiscal 2012. The increase in net income for fiscal 2013 compared to fiscal 2012 was attributable to an increase in investment and other income and a decrease in insurance losses and loss adjustment expenses, partially offset by a decrease in insurance earned premiums and contract revenues, and an increase in operating and administrative expenses. While our insurance losses and loss adjustment expenses were negatively affected by the occurrence of Hurricane Sandy in October 2012, the effect was offset by a decrease in prepaid maintenance losses.  Agreements issued increased by 15 percent during fiscal 2013 compared to fiscal 2012. The increase was primarily due to the overall increase in TMS vehicle sales. Agreements in force, which represent active insurance policies written and contracts issued, decreased by 9 percent during fiscal 2013 compared to fiscal 2012. The decrease was attributable to the expiration during fiscal 2013 of affiliate agreements issued during fiscal 2011 in support of special TMS sales and customer loyalty programs.  Our insurance operations reported insurance earned premiums and contract revenues of $596 million for fiscal 2013 compared to $620 million for fiscal 2012. Insurance earned premiums and contract revenues represent revenues from agreements in force, and are affected by sales volume as well as the level, age, and mix of agreements in force. Our insurance earned premiums and contract revenues decreased for fiscal 2013 compared to fiscal 2012 primarily due to the decrease in our agreements in force for that period.                                           34 --------------------------------------------------------------------------------   Our insurance operations reported investment and other income of $116 million for fiscal 2013, compared to $72 million for fiscal 2012. Investment and other income for our insurance operations consists primarily of investment income on available-for-sale securities. The increase in investment and other income for fiscal 2013 compared to the prior year was primarily due to a decrease in realized losses from sales of securities and an increase in dividends.  Our insurance operations reported insurance losses and loss adjustment expenses of $293 million for fiscal 2013, compared to $325 million for fiscal 2012. Insurance losses and loss adjustment expenses incurred are a function of the amount of covered risks, the frequency and severity of claims associated with the agreements in force, and the level of risk retained by our insurance operations. Insurance losses and loss adjustment expenses include amounts paid and accrued for reported losses, estimates of losses incurred but not reported, and any related claim adjustment expenses. The decrease in insurance losses and loss adjustment expenses for fiscal 2013 compared to fiscal 2012 was primarily due to a decrease in prepaid maintenance losses of $50 million, partially offset by an increase in inventory insurance losses of $8 million. The decrease in prepaid maintenance losses was due to lower claim frequency, resulting from the expiration during fiscal 2013 of affiliate agreements issued in fiscal 2011 in support of special TMS sales and customer loyalty programs. The increase in inventory insurance losses was due to the occurrence of Hurricane Sandy in October 2012, which caused wide-spread flooding and power outages across large portions of the Northeastern United States.  Our insurance operations reported operating and administrative expenses of $177 million for fiscal 2013, compared to $154 million for fiscal 2012. The increase was attributable to an increase in insurance dealer back-end program expenses, various product expenses, and general operating expenses. Insurance dealer back-end program expenses are incentives or expense reduction programs we provide to dealers based on their sales volume or underwriting performance.  

Provision for Income Taxes

  Our overall provision for income taxes for fiscal 2013 was $824 million compared to $937 million for fiscal 2012. Our effective tax rate was 38.2 percent and 38.7 percent for fiscal 2013 and fiscal 2012, respectively. The decrease in our effective tax rate for fiscal 2013 is primarily attributable to the first time occurrence of the federal plug-in and electric vehicle credit in fiscal 2013 and a lower state effective tax rate, partially offset by an increase in the valuation allowance on deferred taxes. The change in our provision for income taxes, adjusted for these fiscal year differences, is consistent with the change in operating income for fiscal 2013 compared to fiscal 2012.                                          35 --------------------------------------------------------------------------------

FINANCIAL CONDITION

Vehicle Financing Volume and Net Earning Assets

  The composition of our vehicle contract volume and market share is summarized below:                                   Years ended March 31,             Percentage change                                                                    2013 to    2012 to (units in thousands):          2013         2012         2011        2012       2011 TMS new sales volume1         1,625        1,307        1,397            24 %    (6) %  Vehicle financing volume:2 New retail contracts            703          567          634            24 %   (11) % Used retail contracts           290          325          368          (11) %   (12) % Lease contracts                 333          242          351            38 %   (31) % Total                         1,326        1,134        1,353            17 %   (16) % 

TMS subvened vehicle financing volume (units included in the above table):

 New retail contracts            398          270          390            47 %   (31) % Used retail contracts            88           77           70            14 %     10 % Lease contracts                 272          206          321            32 %   (36) % Total                           758          553          781            37 %   (29) %  TMS subvened vehicle financing volume as a percent of vehicle financing volume:  New retail contracts           56.6 %       47.6 %       61.5 % Used retail contracts          30.3 %       23.7 %       19.0 % Lease contracts                81.7 %       85.1 %       91.5 % Overall subvened contracts                      57.2 %       48.8 %       57.7 %  Market share:3 Retail contracts               43.2 %       43.3 %       45.1 % Lease contracts                20.4 %       18.4 %       25.1 % Total                          63.6 %       61.7 %       70.2 %   

1 Represents total domestic TMS sales of new Toyota, Lexus and Scion vehicles

excluding sales under dealer rental car and commercial fleet programs and sales

of a private Toyota distributor. TMS new sales volume is comprised of

approximately 85 percent Toyota and Scion and 15 percent Lexus vehicles for

fiscal 2013, 84 percent Toyota and Scion and 16 percent Lexus vehicles for

fiscal 2012 and 85 percent Toyota and Scion and 15 percent Lexus vehicles for

fiscal 2011.

2 Total financing volume is comprised of approximately 82 percent Toyota and

Scion, 15 percent Lexus, and 3 percent non-Toyota/Lexus vehicles for fiscal

2013, 79 percent Toyota and Scion, 16 percent Lexus and 5 percent

non-Toyota/Lexus for fiscal 2012 and 80 percent Toyota and Scion, 15 percent

Lexus and 5 percent non-Toyota/Lexus for fiscal 2011.

3 Represents the percentage of total domestic TMS sales of new Toyota, Lexus and

Scion vehicles financed by us, excludes non-Toyota/Lexus sales, sales under

dealer rental car and commercial fleet programs and sales of a private Toyota

  distributor.                                             36

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Vehicle Financing Volume

  The volume of our retail and lease contracts, which are acquired primarily from Toyota and Lexus vehicle dealers, is dependent upon TMS sales volume and subvention. Natural disasters that occurred in Japan and Thailand in 2011 caused manufacturing disruptions and production suspensions of certain Toyota, Lexus and Scion vehicle models and parts during fiscal 2012. As a result of increased availability of vehicle and related parts supplies, vehicle sales by TMS increased 24 percent for fiscal 2013 compared to fiscal 2012. In addition, TMS sales were positively affected by new product and model launches and return of consumer demand for new vehicles.  Our financing volume and market share increased in fiscal 2013 compared to fiscal 2012. Higher volume and market share were driven primarily by an increase in new Toyota, Lexus and Scion vehicle sales and an increase in TMS subvention. Vehicle financing volume that was subvened by TMS increased by 37 percent in fiscal 2013 compared to fiscal 2012. TMS subvention volume increased as the supply of new vehicles grew during fiscal 2013 compared to fiscal 2012.  

The composition of our net earning assets is summarized below:

                                        As of March 31,              Percentage change                                                                     2013 to    2012 to (Dollars in millions)           2013         2012         2011       2012        2011 Net Earning Assets Finance receivables, net     Retail finance     receivables, net1         $  47,679$  45,296$  45,688       5 %       (1) %     Dealer financing, net        14,888       12,746       12,048      17 %         6 % Total finance receivables, net                              62,567       58,042       57,736       8 %         1 % Investments in operating leases, net                      20,384       18,743       19,041       9 %       (2) % Net earning assets            $  82,951$  76,785$  76,777       8 %         - % 

Retail Financing (average original contract term in months) Lease contracts2

                     38           38           39 Retail contracts3                    63           63           62  Dealer Financing (Number of dealers serviced) Toyota and Lexus dealers4           996          986          975       1 %         1 % Vehicle dealers outside of the     Toyota/Lexus dealer     network                         480          492          470     (2) %         5 % Industrial equipment dealers        140          142          139     (1) %         2 % Total number of dealers receiving     wholesale financing           1,616        1,620        1,584       - %         2 %  Dealer inventory financed (units in thousands)                300          245          253      22 %       (3) %                            1 Includes direct finance leases.               2 Lease contract terms range from 24 months to 60 months.              3 Retail contract terms range from 24 months to 85 months.   

4 Includes wholesale and other loan arrangements in which we participate as part of a syndicate of lenders.

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Retail Contract Volume and Earning Assets

  Our new retail contract volume increased 24 percent during fiscal 2013 as compared to fiscal 2012. The increase was mainly due to an increase in overall TMS vehicle sales and subvention. The natural disasters in Japan and Thailand in 2011 caused a shortage of new Toyota, Lexus and Scion vehicles in fiscal 2012 and a corresponding dealer focus on used vehicle sales. This resulted in lower used retail contract volume for fiscal 2013 compared to fiscal 2012. The increase in new vehicle financing volume during fiscal 2013 contributed to the increase in retail finance receivables, net at March 31, 2013.  

Lease Contract Volume and Earning Assets

  Our overall vehicle lease contract volume during fiscal 2013 increased 38 percent as compared to fiscal 2012. Much of the increase during fiscal 2013 was attributable to an increase in TMS vehicle sales and an increase in TMS subvention. The increase in vehicle lease volume during fiscal 2013 contributed to the increase in investments in operating leases, net at March 31, 2013.  

Dealer Financing and Earning Assets

  Net earning assets related to dealer financing increased 17 percent from March 31, 2012, primarily due to increases in dealer inventory financed. The higher level of dealer inventory was attributable to the return of vehicle production to pre-disaster levels during the third quarter of fiscal 2012. The total number of dealers receiving financing remained consistent at March 31, 2013 as compared to March 31, 2012.                                          38

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Residual Value Risk

  We are exposed to risk of loss on the disposition of leased vehicles and industrial equipment to the extent that sales proceeds realized upon the sale of returned lease assets are not sufficient to cover the residual value that was estimated at lease inception. Substantially all of our residual value risk relates to our vehicle lease portfolio. To date, we have not incurred material residual value losses related to our industrial equipment portfolios.  

Factors Affecting Exposure to Residual Value Risk

  Residual value represents an estimate of the end-of-term market value of a leased asset. The primary factors affecting our exposure to residual value risk are the levels at which residual values are established at lease inception, projected market values, and the resulting impact on vehicle lease return rates and loss severity. The evaluation of these factors involves significant assumptions, complex analysis, and management judgment. Refer to "Critical Accounting Estimates" for further discussion of the estimates involved in the determination of residual values.  

Residual Values at Lease Inception

  Residual values of lease earning assets are estimated at lease inception by examining external industry data, the anticipated Toyota, Lexus and Scion product pipeline and our own experience. Factors considered in this evaluation include, but are not limited to, local, regional and national economic forecasts, new vehicle pricing, new vehicle incentive programs, new vehicle sales, future plans for new Toyota, Lexus and Scion product introductions, competitor actions and behavior, product attributes of popular vehicles, the mix of used vehicle supply, the level of current used vehicle values, the actual or perceived quality, safety or reliability of Toyota, Lexus and Scion vehicles, buying and leasing behavior trends, and fuel prices. We use various channels to sell vehicles returned at lease end. Refer to Item 1. "Business - Finance Operations - Retail and Lease Financing - Remarketing" for additional information on remarketing.  

End-of-term Market Values

  On a quarterly basis, we review the estimated end-of-term market values of leased vehicles to assess the appropriateness of their carrying values. To the extent the estimated end-of-term market value of a leased vehicle is lower than the residual value established at lease inception, the residual value of the leased vehicle is adjusted downward so that the carrying value at lease end will approximate the estimated end-of-term market value. Factors affecting the estimated end-of-term market value are similar to those considered in the evaluation of residual values at lease inception discussed above. These factors are evaluated in the context of their historical trends to anticipate potential changes in the relationship among those factors in the future. For operating leases, adjustments are made on a straight-line basis over the remaining terms of the lease contracts and are included in depreciation on operating leases in the Consolidated Statement of Income as a change in accounting estimate. For direct finance leases, adjustments are made at the time of assessment and are recorded as a reduction of direct finance lease revenues which is included under our retail revenues in the Consolidated Statement of Income.                                          39 --------------------------------------------------------------------------------

Vehicle Lease Return Rate

  The vehicle lease return rate represents the number of leased vehicles returned to us for sale as a percentage of lease contracts that were originally scheduled to mature in the same period less certain qualified early terminations. When the market value of a leased vehicle at contract maturity is less than its contractual residual value (i.e., the price at which the lease customer may purchase the leased vehicle), there is a higher probability that the vehicle will be returned to us. In addition, a higher market supply of certain models of used vehicles generally results in a lower relative level of demand for those vehicles, resulting in a higher probability that the vehicle will be returned to us. A higher rate of vehicle returns exposes us to greater risk of loss at lease termination.  Loss Severity  Loss severity is the extent to which the end-of-term market value realized at sale/disposition of a leased vehicle is less than the estimated residual value established at lease inception. Overall loss severity is driven by used vehicle price levels as well as vehicle return rates.  

Impairment of Operating Leases

  We review operating leases for impairment whenever events or changes in circumstances indicate that the carrying value of the operating leases may not be recoverable. If such events or changes in circumstances are present, we perform a test of recoverability by comparing the expected undiscounted future cash flows (including expected residual values) over the remaining lease terms to the carrying value of the asset group. If the test of recoverability identifies a possible impairment, the asset group's fair value is measured in accordance with the fair value measurement framework. An impairment charge is recognized for the amount by which the carrying value of the asset group exceeds its estimated fair value and is recorded in the current period Consolidated Statement of Income. As of March 31, 2013, there was no indication of impairment in our operating lease portfolio.  

Disposition of Off-Lease Vehicles

The following table summarizes our vehicle sales at lease termination and our scheduled maturities related to our leased vehicle portfolio by period:

                                   Years ended March 31,     Percentage Change                                                             2013 to    2012 to (Units in thousands)             2013      2012     2011      2012      2011 Scheduled maturities              282       273      278         3  %     (2) %  Vehicles sold through:     Dealer Direct program        Grounding dealer            21        22       43       (5)  %    (49) %        Dealer Direct online        program                      5         2       11       150  %    (82) %     Physical auction               33        14       45       136  %    (69) % Total vehicles sold at lease termination                        59        38       99        55  %    (62) %                                            40

--------------------------------------------------------------------------------   Scheduled maturities increased 3 percent in fiscal 2013 as compared to fiscal 2012. Vehicles sold at lease termination relative to scheduled maturities in fiscal 2013 increased as compared to fiscal 2012. The higher rate of vehicles sold at lease termination during fiscal 2013, as compared to fiscal 2012 was the result of slight declines in used vehicle values resulting in higher lease return rates. Refer to Item 1. "Business - Finance Operations - Retail and Lease Financing - Remarketing" for additional information on lease disposition.  

Depreciation on Operating Leases

  The following table provides information related to our depreciation on operating leases:                                              Years ended March 31,               Percentage change                                                                                 2013 to    2012 to                                       2013           2012           2011          2012       2011 Depreciation on operating leases 

(dollars in millions) $ 3,568$ 3,339$ 3,353 7 % - %

  Average operating lease units outstanding     (in thousands)                          803            783            787       3 %       (1) %    We record depreciation expense on the portion of our lease portfolio classified as operating leases.  Depreciation expense is recorded on a straight-line basis over the lease term and is based upon the depreciable basis of the leased vehicle. The depreciable basis is originally established as the difference between a leased vehicle's original acquisition value and its residual value established at lease inception. Changes to residual values will have an effect on depreciation expense. To the extent the estimated end-of-term market value of a leased vehicle is lower than the residual value established at lease inception, the residual value of the leased vehicle is adjusted downward so that the carrying value at lease-end will approximate the estimated end-of-term market value. Refer to "Critical Accounting Estimates" for a further discussion of the estimates involved in the determination of residual values.  Depreciation expense on operating leases increased 7 percent during fiscal 2013 as compared to depreciation expense for fiscal 2012, due primarily to an increase in the average operating lease units outstanding and a slight decline in used vehicle values. Depreciation expense can be affected by changes in the used vehicle market because used vehicle market trends are a significant factor in estimating end-of-term market values. Despite this decline, used vehicle values remained near historically high levels during fiscal 2013. It remains uncertain whether the level of used vehicle values will remain high. The level of lease maturities during fiscal 2013 increased as compared to fiscal 2012 and is expected to continue to increase over the next few years. This increase could affect return rates, used vehicle values and depreciation expense.                                          41 --------------------------------------------------------------------------------

Credit Risk

  We are exposed to credit risk on our earning assets. Credit risk on our earning assets is the risk of loss arising from the failure of customers or dealers to make contractual payments. The level of credit risk on our retail installment sales and lease portfolio is influenced by two factors: default frequency and loss severity, which in turn are influenced by various factors such as economic conditions, the used vehicle market, purchase quality mix, and operational changes.  The level of credit risk on our dealer financing portfolio is influenced by the financial strength of dealers within our portfolio, dealer concentration, collateral quality, and other economic factors. The financial strength of dealers within our portfolio is influenced by, among other factors, general economic conditions, the overall demand for new and used vehicles and industrial equipment and the financial condition of automotive manufacturers in general.  

Factors Affecting Retail Contracts and Lease Portfolio Credit Risk

Economic Factors

General economic conditions such as changes in unemployment rates, housing values, bankruptcy rates, consumer debt levels, fuel prices, consumer credit performance, interest rates, inflation, household disposable income and unforeseen events such as natural disasters can influence both the default frequency and loss severity.

Used Vehicle Market

Changes in used vehicle prices directly affect the proceeds from sales of repossessed vehicles, and accordingly, the level of loss severity we experience. The supply of and demand for used vehicles, interest rates, inflation, the level of manufacturer incentives on new vehicles, the manufacturer's actual or perceived reputation for quality, safety, and reliability, and general economic outlook are some of the factors affecting the used vehicle market.

  Purchase Quality Mix  A change in the mix of contracts acquired at various risk levels may change the amount of credit risk we assume. An increase in the number of contracts acquired with lower credit quality (as measured by scores that establish a consumer's creditworthiness based on present financial condition, experience, and credit history) can increase the amount of credit risk. Conversely, an increase in the number of contracts with higher credit quality can lower credit risk. An increase in the mix of contracts with lower credit quality can also increase operational risk unless appropriate controls and procedures are established. We strive to price contracts to achieve an appropriate risk adjusted return on our investment.  The average original contract term of retail and lease contracts influences credit losses. Longer term contracts generally experience a higher rate of default and thus affect the default frequency. In addition, the carrying values of vehicles under longer term contracts decline at a slower rate, resulting in a longer period during which we may be subject to used vehicle market volatility, which may in turn lead to increased loss severity.  The types and models of the vehicles in our retail and lease portfolios have an effect on loss severity. Vehicle product mix can be influenced by factors such as customer preferences, fuel efficiency and fuel prices. These factors impact the demand for and prices of used vehicles and consequently, loss severity.                                          42 --------------------------------------------------------------------------------

Operational Changes

  Operational changes and ongoing implementation of new information and transaction systems and improved methods of consumer evaluation are designed to have a positive effect on the credit risk profile of our retail contract and lease portfolios. Customer service improvements in the management of delinquencies and credit losses increase operational efficiency and effectiveness. We remain focused on our service operations and credit loss mitigation methods.  In an effort to mitigate credit losses, we regularly evaluate our purchasing practices. We limit our risk exposure by limiting approvals of lower credit quality contracts and requiring certain loan-to-value ratios. We continue to refine our credit risk management and analysis to ensure that the appropriate level of collection resources are aligned with portfolio risk, and we adjust capacity accordingly. We continue our focus on early stage delinquencies to increase the likelihood of resolution. We have also increased efficiency in our collections through the use of technology.  

Factors Affecting Dealer Financing Portfolio Credit Risk

  The financial strength of dealers to which we extend credit directly affects our credit risk. Lending to dealers with lower credit quality, or a negative change in the credit quality of existing dealers, increases the risk of credit loss we assume. Extending a substantial amount of financing or commitments to a specific dealer or group of dealers creates a concentration of credit risk, particularly when the financing may not be secured by fully realizable collateral assets. Collateral quality influences credit risk in that lower quality collateral increases the risk that in the event of dealer default and subsequent liquidation of collateral, the value of the collateral may be less than the amount owed to us.  We assign risk classifications to each of our dealer groups based on their financial condition, the strength of the collateral, and other quantitative and qualitative factors including input from our field personnel. Our monitoring processes of the dealer groups are based on these risk classifications. We periodically update the risk classifications based on changes in financial condition. As part of our monitoring processes, we require dealers to submit monthly financial statements. We also perform periodic physical audits of vehicle inventory as well as monitor the timeliness of dealer inventory financing payoffs in accordance with the agreed upon terms to identify possible risks. We continue to enhance our risk management processes to mitigate dealer portfolio risk and to focus on higher risk dealers through enhanced risk governance, inventory audit, and credit watch processes. Where appropriate, we increase the frequency of our audits and examine more closely the financial condition of the dealer group. We continue to be diligent in underwriting dealers and have conducted targeted personnel training to address dealer credit risk.  

Dealer financing portfolio credit risk is mitigated by a repurchase agreement between TMCC and TMS. Pursuant to this agreement, TMS will arrange for the repurchase of new Toyota, Lexus and Scion vehicles at the aggregate cost financed by TMCC in the event of vehicle dealer default under floorplan financing.

  We also provide financing for some dealerships which sell products not distributed by TMS or one of its affiliates. A significant adverse change in a non-Toyota/Lexus manufacturer such as restructuring and bankruptcy may increase the risk associated with the dealers we have financed that sell these products.                                          43 --------------------------------------------------------------------------------

Credit Loss Experience

  The overall credit quality of our consumer portfolio in fiscal 2013 continued to benefit from our focus on purchasing practices and collection efforts. In addition, subvention contributes to our overall portfolio quality, as subvened contracts typically have higher credit scores than non-subvened contracts. These factors, combined with strong used vehicle prices, contributed to decreased levels of default frequency during fiscal 2013 as compared to fiscal 2012. For additional information regarding the potential impact of current market conditions, refer to "Part I. Item 1A. Risk Factors".  The following table provides information related to our credit loss experience:                                                     Years ended March 31,                                               2013          2012          2011 Net charge-offs as a percentage of average gross earning assets         Finance receivables                   0.29  %       0.24  %       0.61  %         Operating leases                      0.18  %       0.11  %       0.22  %         Total                                 0.27  %       0.21  %       0.52  %  Default frequency as a percentage of outstanding contracts                         1.23  %       1.43  %       2.11  % Average loss severity per unit1           $  5,737$  5,869      $  

7,110

  Aggregate balances for accounts 60 or more days past due as a 

percentage of gross earning assets2

        Finance receivables3                  0.19  %       0.19  %       0.27  %         Operating leases3                     0.18  %       0.16  %       0.23  %         Total                                 0.19  %       0.18  %       0.26  %   

1 Average loss per unit upon disposition of repossessed vehicles or charge-off

prior to repossession.

2 Substantially all retail, direct finance lease and operating lease receivables

do not involve recourse to the dealer in the event of customer default.

3 Includes accounts in bankruptcy and excludes accounts for which vehicles have

   been repossessed.    The level of credit losses primarily reflects two factors: default frequency and loss severity. Default frequency as a percentage of average outstanding contracts decreased to 1.23 percent during fiscal 2013 as compared to 1.43 percent during fiscal 2012. Our continued focus on purchasing practices and collection efforts have contributed to the improvement in default frequency. Strong used vehicle values have also had a positive impact on default frequency. Some customers, who otherwise might have defaulted, have been able to sell their vehicles to pay off their finance contracts.  These positive effects on default frequency were partially offset by the increase in the number of vehicles charged off in the latter part of fiscal 2013 due to damage from Hurricane Sandy.  Strong used vehicle values also positively impacted loss severity during fiscal 2013. Average loss severity per unit decreased to $5,737 at March 31, 2013 from $5,869 at March 31, 2012. In addition, loss severity was also positively impacted as losses incurred on vehicles damaged by Hurricane Sandy were mitigated to a large extent by the receipt of vehicle insurance proceeds. As a result, Hurricane Sandy's net impact to credit losses for fiscal 2013 was not material as its favorable impact on loss severity offset the unfavorable impact on default frequency.  Net charge-offs as a percentage of average gross earning assets increased from 0.21 percent at March 31, 2012 to 0.27 percent at March 31, 2013 due primarily to lower recoveries.                                           44

--------------------------------------------------------------------------------   The favorable levels in our per unit loss severity and default frequency reflect patterns of credit behavior different from our historical patterns and levels. An unusual combination of factors including the low supply of used vehicles and the impact of the natural disasters occurring in Japan and Thailand, and an extended period of economic uncertainty have contributed to these trends. We considered these factors as well as our historical seasonal patterns and the impact of the increased level of lease maturities, which increases supply of used vehicles at auction, in establishing our allowance for credit losses at March 31, 2013.  

Allowance for Credit Losses

  We maintain an allowance for credit losses to cover probable and estimable losses as of the balance sheet date resulting from the non-performance of our customers and dealers under their contractual obligations. The determination of the allowance involves significant assumptions, complex analysis, and management judgment. Refer to "Critical Accounting Estimates" for further discussion of the estimates involved in determining the allowance.  The allowance for credit losses for our consumer portfolio is established through a process that estimates probable losses incurred as of the balance sheet date based upon consistently applied statistical analyses of portfolio data. This process utilizes delinquency migration analysis, in which historical delinquency and credit loss experience is applied to the current aging of the portfolio, and incorporates current and expected trends and other relevant factors, including used vehicle market conditions, economic conditions, unemployment rates, purchase quality mix, and operational factors. This process, along with management judgment, is used to establish the allowance to cover probable and estimable losses incurred as of the balance sheet date. Movement in any of these factors would cause changes in estimated probable losses.  The allowance for credit losses for our dealer portfolio is established by first aggregating dealer financing receivables into loan-risk pools, which are determined based on the risk characteristics of the loan (e.g. secured by either vehicles and industrial equipment, real estate or dealership assets, or unsecured). We then analyze dealer pools using an internally developed risk rating. In addition, we have established procedures that focus on managing high risk loans in our dealer portfolio. Our field operations management and our special assets group are consulted each quarter to determine if any specific dealer loan is considered impaired. A receivables account balance is considered impaired when it is probable that we will be unable to collect all amounts due (including principal and interest) according to the terms of the contract. If impaired loans are identified, specific reserves are established, as appropriate, and the loan is removed from the loan-risk pool for separate monitoring.  

The following table provides information related to our allowance for credit losses on finance receivables and investments in operating leases:

                                                         Years ended March 

31,

 (Dollars in millions)                                  2013       2012      

2011

Allowance for credit losses at beginning of period $ 619$ 879$ 1,705 Provision for credit losses

                             121       (98)      

(433)

 Charge-offs, net of recoveries1                       (213)      (162)      

(393)

Allowance for credit losses at end of period $ 527$ 619 $

879

1 Charge-offs were net of recoveries of $87 million, $123 million, and $137

million in fiscal 2013, 2012, and 2011, respectively.

                                       45 --------------------------------------------------------------------------------

                                                         Years ended March 31, (Dollars in millions)                                2013      2012      2011

Allowance for credit losses as a percentage of

    gross earning assets         Finance receivables                          0.71 %    0.89 %    1.28 %         Operating leases                             0.40 %    0.51 %    0.65 %         Total                                        0.63 %    0.80 %    1.13 %    During fiscal 2013, our allowance for credit losses decreased $92 million from $619 million at March 31, 2012 to $527 million at March 31, 2013. The overall decline in our allowance for credit losses was primarily driven by an improvement in default frequency as described under "Credit Loss Experience".  We recorded a provision for credit losses for fiscal 2013, compared to a benefit from credit losses for fiscal 2012. The benefit from credit losses for fiscal 2012 was attributable to significant improvements in per unit loss severity, default frequency and net charge-offs in our consumer portfolio as compared to fiscal 2011. In fiscal 2013, while default frequency improved in our consumer portfolio during fiscal 2013, this improvement was not significant enough to offset the increase in net charge-offs. In addition, earning asset growth in our retail loan and investments in operating leases portfolios also contributed to an increased provision in fiscal 2013 as compared to fiscal 2012.                                          46 --------------------------------------------------------------------------------

LIQUIDITY AND CAPITAL RESOURCES

  Liquidity risk is the risk relating to our ability to meet our financial obligations when they become due. Our liquidity strategy is to ensure that we maintain the ability to fund assets and repay liabilities in a timely and cost-effective manner, even in adverse market conditions. Our strategy includes raising funds via the global capital markets, and through loans, credit facilities, and other transactions, as well as generating liquidity from our earning assets. This strategy has led us to develop a borrowing base that is diversified by market and geographic distribution, investor type, and financing structure, among other factors.  The following table summarizes the components of our outstanding funding sources at carrying value:                                              March 31, (Dollars in millions)                  2013          2012 Commercial paper1                    $  24,590$  21,247

Unsecured notes and loans payable2 46,707 41,415 Secured notes and loans payable 7,009 9,789 Carrying value adjustment3

                 526           783 Total Debt                           $  78,832$  73,234                        1 Includes unamortized premium/discount.  

2 Includes unamortized premium/discount and effects of foreign currency

transaction gains and losses on non-hedged or de-designated notes and loans

payable which are denominated in foreign currencies.

3 Represents the effects of fair value adjustments to debt in hedging

relationships, accrued redemption premiums, and the unamortized fair value

  adjustments on the hedged item for terminated fair value hedge accounting   relationships.    Liquidity management involves forecasting and maintaining sufficient capacity to meet our cash needs, including unanticipated events.  To ensure adequate liquidity through a full range of potential operating environments and market conditions, we conduct our liquidity management and business activities in a manner that will preserve and enhance funding stability, flexibility and diversity.  Key components of this operating strategy include a strong focus on developing and maintaining direct relationships with commercial paper investors and wholesale market funding providers, and maintaining the ability to sell certain assets when and if conditions warrant.  We develop and maintain contingency funding plans and regularly evaluate our liquidity position under various operating circumstances, allowing us to assess how we will be able to operate through a period of stress when access to normal sources of capital is constrained.  The plans project funding requirements during a potential period of stress, specify and quantify sources of liquidity, and outline actions and procedures for effectively managing through the problem period.  In addition, we monitor the ratings and credit exposure of the lenders that participate in our credit facilities to ascertain any issues that may arise with potential draws on these facilities if that contingency becomes warranted.  We maintain broad access to a variety of domestic and global markets and may choose to realign our funding activities depending upon market conditions, relative costs, and other factors.  We believe that our funding sources, combined with operating and investing activities, provide sufficient liquidity to meet future funding requirements and business growth.  Our funding volume is primarily based on expected net change in earning assets and debt maturities.                                           47

--------------------------------------------------------------------------------

For liquidity purposes, we hold cash in excess of our immediate funding needs. These excess funds are invested in short-term, highly liquid and investment grade money market instruments, which provide liquidity for our short-term funding needs and flexibility in the use of our other funding sources. We maintained excess funds ranging from $4.4 billion to $9.2 billion with an average balance of $6.5 billion for fiscal 2013.

We may lend to or borrow from affiliates on terms based upon a number of business factors such as funds availability, cash flow timing, relative cost of funds, and market access capabilities.

  Credit support is provided to us by our indirect parent Toyota Financial Services Corporation ("TFSC"), and, in turn to TFSC by Toyota Motor Corporation ("TMC"). Taken together, these credit support agreements provide an additional source of liquidity to us, although we do not rely upon such credit support in our liquidity planning and capital and risk management. The credit support agreements are not guarantees by TMC of any securities or obligations of TFSC or TMCC.  TMC's obligations under its credit support agreement with TFSC rank pari passu with TMC's senior unsecured debt obligations. Refer to Part I. Item 1A. Risk Factors "Our borrowing costs and access to the unsecured debt capital markets depend significantly on the credit ratings of TMCC and its parent companies and our credit support arrangements" for further discussion.  We routinely monitor global financial conditions and our financial exposure to our global counterparties. Specifically, we focus on those countries experiencing significant economic, fiscal or political strain and the corresponding likelihood of default. During the reporting period, we identified countries for which these conditions exist; Portugal, Ireland, Italy, Greece, Spain, Cyprus and certain other countries. We do not currently have exposure to these or other European sovereign counterparties. As of March 31, 2013, our gross non-sovereign exposures to investments in marketable securities and derivatives counterparty positions in the countries identified were not material, either individually or collectively. We also maintained a total of $17.4 billion in committed and uncommitted syndicated and bilateral credit facilities for our liquidity purposes as of March 31, 2013. As of March 31, 2013, less than 3 percent of such commitments were from counterparties in the countries identified. Refer to the "Liquidity and Capital Resources - Liquidity Facilities and Letters of Credit" section and "Item 1A. Risk Factors - The failure or commercial soundness of our counterparties and other financial institutions may have an effect on our liquidity, operating results or financial condition" for further discussion.  

Commercial Paper

  Short-term funding needs are met through the issuance of commercial paper in the United States. Commercial paper outstanding under our commercial paper programs ranged from approximately $20.5 billion to $27.4 billion during fiscal 2013, with an average outstanding balance of $23.7 billion. Our commercial paper programs are supported by the liquidity facilities discussed later in this section. We believe we have ample capacity to meet our short-term funding requirements and manage our liquidity.                                           48 --------------------------------------------------------------------------------

Unsecured Notes and Loans Payable

  The following table summarizes the components of our unsecured notes and loans payable:                                                                                                     Total                                    U.S. medium                                                  unsecured                                    term notes                                                   notes and                                   ("MTNs") and        Euro MTNs                                   loans (Dollars in millions)            domestic bonds       ("EMTNs")    Eurobonds       Other         payable5 Balance at March 31, 20121        $      18,461$   13,274$  1,180$    7,969$    40,884 Issuances during fiscal 2013             12,879  2        2,738  3          -        1,423  4         17,040 Maturities and terminations     during fiscal 2013                  (4,624)         (2,414)         

(377) (3,615) (11,030) Balance at March 31, 20131 $ 26,716$ 13,598$ 803$ 5,777$ 46,894

Issuance during the one

    month ended April 30, 2013    $         905  2   $        -  3   $      -   $      500  4    $     1,405

1 Amounts represent par values and as such exclude unamortized premium/discount,

foreign currency transaction gains and losses on debt denominated in foreign

currencies, fair value adjustments to debt in hedge accounting relationships,

accrued redemption premiums, and the unamortized fair value adjustments on the

hedged item for terminated hedge accounting relationships. Par values of

non-U.S. currency denominated notes are determined using foreign exchange rates

applicable as of the issuance dates.

2 MTNs and domestic bonds had terms to maturity ranging from approximately 1 year

to 25 years, and had interest rates at the time of issuance ranging from 0.3

percent to 3.3 percent.

3 EMTNs had terms to maturity ranging from approximately 3 years to 25 years, and

had interest rates at the time of issuance ranging from 1.3 percent to 4.6

percent.

4 Primarily consists of long-term borrowings, all with terms to maturity from

approximately ­­1 year to 6 years, and interest rates at the time of issuance

ranging from 0.1 percent to 1.0 percent.

5 Consists of fixed and floating rate debt and other obligations. Upon the

issuance of fixed rate debt and other obligations, we generally elect to enter

  into pay float interest rate swaps. Refer to "Derivative Instruments" for   further discussion.    We maintain a shelf registration statement with the SEC to provide for the issuance of debt securities in the U.S. capital markets to retail and institutional investors. We qualify as a well-known seasoned issuer under SEC rules, which allows us to issue under our registration statement an unlimited amount of debt securities during the three year period ending March 2015. Debt securities issued under the U.S. shelf registration statement are issued pursuant to the terms of an indenture which requires TMCC to comply with certain covenants, including negative pledge provisions. We are in compliance with these covenants.                                          49

--------------------------------------------------------------------------------   Our EMTN program, shared with our affiliates Toyota Motor Finance (Netherlands) B.V., Toyota Credit Canada Inc. and Toyota Finance Australia Limited (TMCC and such affiliates, the "EMTN Issuers"), provides for the issuance of debt securities in the international capital markets. In September 2012, the EMTN Issuers renewed the EMTN program for a one year period. The maximum aggregate principal amount authorized under the EMTN Program to be outstanding at any time is €50.0 billion, or the equivalent in other currencies, of which €34.4 billion was available for issuance at April 30, 2013. The authorized amount is shared among all EMTN Issuers. The authorized aggregate principal amount under the EMTN program may be increased from time to time. Debt securities issued under the EMTN program are issued pursuant to the terms of an agency agreement. Certain debt securities issued under the EMTN program are subject to negative pledge provisions. Debt securities issued under our EMTN program prior to October 2007 are also subject to cross-default provisions. We are in compliance with these covenants.  

In addition, we may issue other debt securities or enter into other unsecured financing arrangements through the global capital markets.

Secured Notes and Loans Payable

Overview

  Asset-backed securitization of our earning asset portfolio provides us with an alternative source of funding. We securitize finance receivables and beneficial interests in investments in operating leases ("Securitized Assets") using a variety of structures. Our securitization transactions involve the transfer of Securitized Assets to bankruptcy-remote special purpose entities. These bankruptcy-remote entities are used to ensure that the Securitized Assets are isolated from the claims of creditors of TMCC and that the cash flows from these assets are available solely for the benefit of the investors in these asset-backed securities. Investors in asset-backed securities do not have recourse to our other assets, and neither TMCC nor our affiliates guarantee these obligations. We are not required to repurchase or make reallocation payments with respect to the Securitized Assets that become delinquent or default after securitization. As seller and servicer of the Securitized Assets, we are required to repurchase or make a reallocation payment with respect to the underlying assets that are subsequently discovered not to have met specified eligibility requirements. This repurchase obligation is customary in securitization transactions.  We service the Securitized Assets in accordance with our customary servicing practices and procedures. Our servicing duties include collecting payments on Securitized Assets and submitting them to a trustee for distribution to security holders and other interest holders. We prepare monthly servicer certificates on the performance of the Securitized Assets, including collections, investor distributions, delinquencies, and credit losses. We also perform administrative services for the special purpose entities.  Our use of special purpose entities in securitizations is consistent with conventional practice in the securitization market. None of our officers, directors, or employees hold any equity interests or receive any direct or indirect compensation from our special purpose entities. These entities do not own our stock or the stock of any of our affiliates. Each special purpose entity has a limited purpose and generally is permitted only to purchase assets, issue asset-backed securities, and make payments to the security holders, other interest holders and certain service providers as required under the terms of the transactions.                                          50

--------------------------------------------------------------------------------   Our securitizations are structured to provide credit enhancement to reduce the risk of loss to security holders and other interest holders in the asset-backed securities. Credit enhancement may include some or all of the following:  

· Overcollateralization: The principal of the Securitized Assets that exceeds

the principal amount of the related secured debt.

· Excess spread: The expected interest collections on the Securitized Assets

that exceed the expected fees and expenses of the special purpose entity,

    including the interest payable on the debt and net of swap settlements, if     any.   ·   Cash reserve funds: A portion of the proceeds from the issuance of     asset-backed securities may be held by the securitization trust in a     segregated reserve fund and may be used to pay principal and interest to

security holders and other interest holders if collections on the underlying

    receivables are insufficient.   ·    Yield supplement arrangements: Additional overcollateralization may be

provided to supplement the future contractual interest payments from pledged

receivables with relatively low contractual interest rates.

· Subordinated notes: The subordination of principal and interest payments on

subordinated notes provides additional credit enhancement to holders of senior

<pre> notes. In addition to the credit enhancement described above, we may enter into interest rate swaps with special purpose entities that issue variable rate debt. Under the terms of these swaps, the special purpose entities are obligated to pay TMCC a fixed rate of interest on payment dates in exchange for receiving a floating rate of interest on notional amounts equal to the outstanding balance of the secured debt. This arrangement enables the special purpose entities to mitigate the interest rate risk inherent in issuing variable rate debt that is secured by fixed rate Securitized Assets. Securitized Assets and the related debt remain on our Consolidated Balance Sheet. We recognize financing revenue on the Securitized Assets. We also recognize interest expense on the secured debt issued by the special purpose entities and maintain an allowance for credit losses on the Securitized Assets to cover estimated probable credit losses using a methodology consistent with that used for our non-securitized asset portfolio. The interest rate swaps between TMCC and the special purpose entities are considered intercompany transactions and therefore are eliminated in our consolidated financial statements.

The following are asset-backed securitization transactions that we have executed.

Public Term Securitization

  We maintain shelf registration statements with the SEC to provide for the issuance of securities backed by Securitized Assets in the U.S. capital markets. We regularly sponsor public securitization trusts that issue securities backed by retail finance receivables, including registered securities that we retain. Funding obtained from our public term securitization transactions is repaid as the underlying Securitized Assets amortize. None of these securities have defaulted, experienced any events of default or failed to pay principal in full at maturity. As of March 31, 2013, we did not have any outstanding registered lease securitization transactions.  

Amortizing Asset-backed Commercial Paper Conduits

We have executed private securitization transactions of Securitized Assets with bank-sponsored multi-seller asset-backed conduits. The related debt will be repaid as the underlying Securitized Assets amortize.

                                       51 --------------------------------------------------------------------------------

Liquidity Facilities and Letters of Credit

For additional liquidity purposes, we maintain syndicated credit facilities with certain banks.

364 Day Credit Agreement, Three Year Credit Agreement and Five Year Credit Agreement

  In fiscal 2012, TMCC, its subsidiary Toyota Credit de Puerto Rico Corp. ("TCPR"), and other Toyota affiliates were parties to a $5.0 billion 364 day syndicated bank credit facility, a $5.0 billion three year syndicated bank credit facility, and a $3.0 billion five year syndicated bank credit facility expiring in fiscal 2013, 2014, and 2016, respectively. In February 2013, these agreements were terminated and TMCC, TCPR and other Toyota affiliates entered into a $3.8 billion 364 day syndicated bank credit facility, a $3.8 billion three year syndicated bank credit facility and a $3.8 billion five year syndicated bank credit facility, expiring in fiscal 2014, 2016, and 2018, respectively.  The ability to make draws is subject to covenants and conditions customary in transactions of this nature, including negative pledge provisions, cross-default provisions and limitations on consolidations, mergers and sales of assets. These agreements may be used for general corporate purposes and none were drawn upon as of March 31, 2013 and March 31, 2012.  

Other Unsecured Credit Agreements

TMCC has entered into additional unsecured credit facilities with various banks. As of March 31, 2013, TMCC had committed bank credit facilities totaling $5.5 billion of which $3.1 billion, $0.9 billion and $1.5 billion mature in fiscal 2014, 2015 and 2016, respectively.

TMCC also has an uncommitted bank credit facility in the amount of $0.5 billion which matures in fiscal 2014.

  These credit agreements contain covenants, and conditions customary in transactions of this nature, including negative pledge provisions, cross-default provisions and limitations on consolidations, mergers and sales of assets. These credit facilities were not drawn upon as of March 31, 2013 and March 31, 2012. 

We are in compliance with the covenants and conditions of the credit agreements described above.

Committed Revolving Asset-backed Commercial Paper Facility

  During fiscal 2013 we maintained a 364 day revolving securitization facility with certain bank-sponsored asset-backed commercial paper conduits and other financial institutions ("funding agents"). Under the terms of this facility, the funding agents were contractually committed, at our option, to purchase eligible retail finance receivables from us and make advances up to a facility limit of $3.0 billion. This facility expired in January 2013 and was not renewed. The remaining outstanding balance was fully repaid as of January 31, 2013.                                          52 --------------------------------------------------------------------------------

Credit Support Agreements

Under the terms of a credit support agreement between TMC and TFSC, TMC has agreed to:

 ·    maintain 100 percent ownership of TFSC;   

· cause TFSC and its subsidiaries to have a tangible net worth (the aggregate

amount of issued capital, capital surplus and retained earnings less any

tangible assets) of at least JPY 10 million, equivalent to $106,135 at March

     31, 2013; and    ·    make sufficient funds available to TFSC so that TFSC will be able to (i)

service the obligations arising out of its own bonds, debentures, notes and

other investment securities and commercial paper and (ii) honor its

obligations incurred as a result of guarantees or credit support agreements

that it has extended (collectively, "Securities").

    The agreement is not a guarantee by TMC of any securities or obligations of TFSC. TMC's obligations under the credit support agreement rank pari passu with TMC's senior unsecured debt obligations. Either party may terminate the agreement upon 30 days written notice to the other party. However, such termination cannot take effect until or unless (1) all Securities issued on or prior to the date of the termination notice have been repaid or (2) each rating agency that, upon the request of TMC or TFSC, has issued a rating in respect of TFSC or any Securities has confirmed to TFSC that the debt ratings of all such Securities will be unaffected by such termination. In addition, with certain exceptions, the agreement may be modified only by the written agreement of TMC and TFSC, and no modification or amendment can have any adverse effect upon any holder of any Securities outstanding at the time of such modification or amendment. The agreement is governed by, and construed in accordance with, the laws of Japan.  

Under the terms of a similar credit support agreement between TFSC and TMCC, TFSC has agreed to:

 ·    maintain 100 percent ownership of TMCC;   

· cause TMCC and its subsidiaries to have a tangible net worth (the aggregate

     amount of issued capital, capital surplus and retained earnings less any      tangible assets) of at least $100,000; and   

· make sufficient funds available to TMCC so that TMCC will be able to service

the obligations arising out of its own bonds, debentures, notes and other

     investment securities and commercial paper (collectively, "TMCC      Securities").    The agreement is not a guarantee by TFSC of any TMCC Securities or other obligations of TMCC. The agreement contains termination and modification provisions that are similar to those in the agreement between TMC and TFSC as described above. The agreement is governed by, and construed in accordance with, the laws of Japan. TMCC Securities do not include the securities issued by securitization trusts in connection with TMCC's securitization programs or any indebtedness under TMCC's credit facilities or term loan agreements.                                          53 --------------------------------------------------------------------------------   Holders of TMCC Securities have the right to claim directly against TFSC and TMC to perform their respective obligations under the credit support agreements by making a written claim together with a declaration to the effect that the holder will have recourse to the rights given under the credit support agreements. If TFSC and/or TMC receives such a claim from any holder of TMCC Securities, TFSC and/or TMC shall indemnify, without any further action or formality, the holder against any loss or damage resulting from the failure of TFSC and/or TMC to perform any of their respective obligations under the credit support agreements. The holder of TMCC Securities who made the claim may then enforce the indemnity directly against TFSC and/or TMC.  

In addition, TMCC and TFSC are parties to a credit support fee agreement which requires TMCC to pay to TFSC a fee which is based upon the weighted average outstanding amount of TMCC Securities entitled to credit support.

  TCPR is the beneficiary of a credit support agreement with TFSC containing the same provisions as the credit support agreement between TFSC and TMCC but pertaining to TCPR bonds, debentures, notes and other investment securities and commercial paper (collectively, "TCPR Securities").  Holders of TCPR Securities have the right to claim directly against TFSC and TMC to perform their respective obligations as described above. This agreement is not a guarantee by TFSC of any securities or other obligations of TCPR. TCPR has agreed to pay TFSC a fee which is based upon the weighted average outstanding amount of TCPR Securities entitled to credit support.                                          54 --------------------------------------------------------------------------------

  DERIVATIVE INSTRUMENTS  Risk Management Strategy  We use derivatives as part of our risk management strategy to hedge interest rate and foreign currency risks. We enter into derivative transactions with the intent to minimize fluctuations in earnings, cash flows and fair value adjustments of assets and liabilities caused by market movements. Our use of derivatives is limited to the management of interest rate and foreign currency risks.  Our derivative activities are authorized and monitored by our Asset-Liability Committee ("ALCO"), which provides a framework for financial controls and governance to manage market risks. We use internal models for analyzing and incorporating data from internal and external sources in developing various hedging strategies. We incorporate the resulting hedging strategies into our overall risk management strategies.  Our approach to asset-liability management involves hedging our risk exposures so that changes in interest rates have a limited effect on our net interest margin and cash flows. Our liabilities consist mainly of fixed and floating rate debt, denominated in various currencies, which we issue in the global capital markets, while our assets consist primarily of U.S. dollar denominated, fixed rate receivables. We enter into interest rate swaps and foreign currency swaps to hedge the interest rate and foreign currency risks that result from the different characteristics of our assets and liabilities. Our resulting asset liability profile is consistent with the overall risk management strategy directed by the ALCO. Gains and losses on these derivatives are recorded in interest expense.  

Accounting for Derivative Instruments

All derivative instruments are recorded on the balance sheet at fair value, taking into consideration the effects of legally enforceable master netting agreements that allow us to net settle positive and negative positions and offset cash collateral held with the same counterparty on a net basis. Changes in the fair value of derivatives are recorded in interest expense in the Consolidated Statement of Income.

  We categorize derivatives as those designated for hedge accounting ("hedge accounting derivatives") and those that are not designated for hedge accounting ("non-hedge accounting derivatives"). At the inception of a derivative contract, we may elect to designate a derivative as a hedge accounting derivative.  We may also, from time-to-time, issue debt which can be characterized as hybrid financial instruments. These obligations often contain an embedded derivative which may require bifurcation. Changes in the fair value of the bifurcated embedded derivative are reported in interest expense in the Consolidated Statement of Income. Refer to Note 1 - Summary of Significant Accounting Policies and Note 7 -Derivatives, Hedging Activities and Interest Expense of the Notes to the Consolidated Financial Statements for additional information.                                          55 --------------------------------------------------------------------------------

Derivative Assets and Liabilities

The following table summarizes our derivative assets and liabilities, which are included in other assets and other liabilities in the Consolidated Balance Sheet:

  (Dollars in millions)                            March 31, 2013        March 31, 2012 Gross derivative assets, net of credit valuation adjustment                            $         1,719       $     

2,660

 Less: Counterparty netting and collateral               (1,661)             

(2,590)

 Derivative assets, net                          $            58       $     

70

  Gross derivative liabilities, net of credit valuation adjustment                            $           897       $     

1,081

 Less: Counterparty netting and collateral                 (892)             

(1,038)

 Derivative liabilities, net                     $             5       $     

43

 Embedded derivative liabilities                 $            12       $     

24

    Collateral represents cash received or deposited under reciprocal arrangements that we have entered into with our derivative counterparties. As of March 31, 2013, we held collateral of $953 million which offset derivative assets and posted collateral of $184 million which offset derivative liabilities. We held collateral of $3 million which we did not use to offset derivative assets and we posted collateral of $6 million which we did not use to offset derivative liabilities. As of March 31, 2012, we held collateral of $1,748 million which offset derivative assets and posted collateral of $196 million which offset derivative liabilities. Refer to the "Interest Expense" section for discussion on changes in derivatives.                                          56

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OFF-BALANCE-SHEET ARRANGEMENTS

Guarantees

  TMCC has guaranteed the payments of principal and interest with respect to the bond obligations that were issued by Putnam County, West Virginia and Gibson County, Indiana to finance the construction of pollution control facilities at manufacturing plants of certain TMCC affiliates. TMCC would be required to perform under the guarantees in the event of non-payment on the bonds and other related obligations. TMCC is entitled to reimbursement by the affiliates for any amounts paid. TMCC receives an annual fee of $78 thousand for guaranteeing such payments. Other than this fee, there are no corresponding expenses or cash flows arising from our guarantees. The nature, business purpose, and amounts of these guarantees are described in Note 14 - Commitments and Contingencies of the Notes to Consolidated Financial Statements.  

Commitments

  We provide fixed and variable rate credit facilities to vehicle and industrial equipment dealers. These credit facilities are typically used for facilities refurbishment, real estate purchases, and working capital requirements. These loans are typically secured with liens on real estate, vehicle inventory, and/or other dealership assets, as appropriate. We obtain a personal guarantee from the vehicle or industrial equipment dealer or corporate guarantee from the dealership when deemed prudent. Although the loans are typically collateralized or guaranteed, the value of the underlying collateral or guarantees may not be sufficient to cover our exposure under such agreements. Our credit facility pricing reflects market conditions, the competitive environment, the level of dealer support required for the facility and the credit worthiness of each dealer. Amounts drawn under these facilities are reviewed for collectability on a quarterly basis, in conjunction with our evaluation of the allowance for credit losses.  We also provide financing to various multi-franchise dealer organizations, often as part of a lending consortium, for wholesale, working capital, real estate, and business acquisitions. Approximately two percent of these lending commitments at March 31, 2013 is unsecured. In addition, at March 31, 2013 and 2012, respectively, we had $11.5 billion and $10.3 billion of wholesale financing demand note facilities not considered to be commitments. We have also extended credit facilities to affiliates as described in Note 14 - Commitments and Contingencies of the Notes to Consolidated Financial Statements.  

Indemnification

  Refer to Note 14 - Commitments and Contingencies of the Notes to Consolidated Financial Statements for a description of agreements containing indemnification provisions. We have not made any material payments in the past as a result of these provisions, and as of March 31, 2013, we determined that it is not probable that we will be required to make any material payments in the future. As of March 31, 2013 and 2012, no amounts have been recorded under these indemnification provisions.                                          57

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CONTRACTUAL OBLIGATIONS AND CREDIT-RELATED COMMITMENTS

We have certain obligations to make future payments under contracts and credit-related financial instruments and commitments. Aggregate contractual obligations and credit-related commitments in existence at March 31, 2013 are summarized as follows (dollars in millions):

                                            Payments due by period                                          Less                              More                                         than 1                            than 5 Contractual obligations       Total      year     1-3 years   3-5 years   years Debt 1                     $   78,400$  40,473$    20,104$    11,576$  6,247 Estimated interest payments for debt 2             4,191       998       1,526         696      971 Estimated net receipts under    interest rate swap    agreements2                (1,386)      (78)       (367)       (295)    (646) Lending commitments 3           7,396     7,396           -           -        - Premises occupied under lease                              74        19          34          18        3 Purchase obligations 4             42        39           3           -        - Total                      $   88,717$  48,847$    21,300$    11,995$  6,575

1 Debt reflects the remaining principal obligation. Our foreign currency debt is

stated in USD at amounts representing our contractual obligations under the

foreign currency swaps that are used to hedge the corresponding debt. Excludes

unamortized premium/discount of $138 million as well as foreign currency and

fair value adjustments of $570 million.

2 Interest payments for debt and swap agreements payable in foreign currencies

or based on variable interest rates are estimated using the applicable current

rates as of March 31, 2013.

3 Lending commitments represent term loans and revolving lines of credit we

extended to vehicle and industrial equipment dealers and affiliates. Of the

amount shown above, $6.3 billion was outstanding as of March 31, 2013. The

amount shown above excludes $11.5 billion of wholesale financing lines not

considered to be contractual commitments at March 31, 2013, of which $8.3

billion was outstanding at March 31, 2013. The above lending commitments have

various expiration dates.

4 Purchase obligations represent fixed or minimum payment obligations under

supplier contracts. The amounts included herein represent the minimum

contractual obligations in certain situations; however, actual amounts

incurred may be substantially higher depending on the particular circumstance,

including in the case of information technology contracts, the amount of usage

once we have implemented it. Contracts that do not specify fixed payments or

provide for a minimum payment are not included. Certain contracts noted herein

contain voluntary provisions under which the contract may be terminated for a

specified fee, ranging up to $5.5 million, depending upon the contract.

NEW ACCOUNTING GUIDANCE

Refer to Note 1 - Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.

                                       58 --------------------------------------------------------------------------------

CRITICAL ACCOUNTING ESTIMATES

  We have identified the estimates below as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these estimates on business operations are discussed throughout this report where such estimates affect reported and expected financial results. The evaluation of the factors used in determining each of our critical accounting estimates involves significant assumptions, complex analysis, and management judgment. Changes in the evaluation of these factors may significantly impact the consolidated financial statements. Different assumptions or changes in economic circumstances could result in additional changes to the determination of the allowance for credit losses, the determination of residual values, the valuation of our derivative instruments, and our results of operations and financial condition. Our other significant accounting policies are discussed in Note 1 - Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.  

Determination of Residual Values

  The determination of residual values on our lease portfolio involves estimating end-of-term market values of leased vehicles and industrial equipment. Establishing these estimates involves various assumptions, complex analysis, and management judgment. Actual losses incurred at lease termination could be significantly different from expected losses. Substantially all of our residual value risk relates to our vehicle lease portfolio. For further discussion of the accounting treatment of residual values on our lease earning assets, refer to Note 1 - Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.  

Nature of Estimates and Assumptions Required

  Residual values are estimated at lease inception by examining external industry data, the anticipated Toyota, Lexus and Scion product pipeline and our own experience. Factors considered in this evaluation include, but are not limited to, local, regional and national economic forecasts, new vehicle pricing, new vehicle incentive programs, new vehicle sales, future plans for new Toyota, Lexus and Scion product introductions, competitor actions and behavior, product attributes of popular vehicles, the mix of used vehicle supply, the level of current used vehicle values, the actual or perceived quality, safety or reliability of Toyota, Lexus and Scion vehicles, buying and leasing behavior trends, and fuel prices. We periodically review the estimated end-of-term market values of leased vehicles to assess the appropriateness of their carrying values. To the extent the estimated end-of-term market value of a leased vehicle is lower than the residual value established at lease inception, the residual value of the leased vehicle is adjusted downward so that the carrying value at lease end will approximate the estimated end-of-term market value. Factors affecting the estimated end-of-term market value are similar to those considered in the evaluation of residual values at lease inception. These factors are evaluated in the context of their historical trends to anticipate potential changes in the relationship among those factors in the future. For operating leases, adjustments are made on a straight-line basis over the remaining terms of the leases and are included in depreciation on operating leases in the Consolidated Statement of Income. For direct finance leases, adjustments are made at the time of assessment and are recorded as a reduction of direct finance lease revenues which is included under our retail revenues in the Consolidated Statement of Income.  Sensitivity Analysis 

Estimated return rates and end-of-term market values represent two of the key assumptions involved in determining the amount and timing of depreciation expense to be recorded in the Consolidated Statement of Income.

<pre> 59 -------------------------------------------------------------------------------- The vehicle lease return rate represents the number of end-of-term leased vehicles returned to us for sale as a percentage of lease contracts that were originally scheduled to mature in the same period less certain qualified early terminations. When the market value of a leased vehicle at contract maturity is less than its contractual residual value (i.e., the price at which the lease customer may purchase the leased vehicle), there is a higher probability that the vehicle will be returned to us. In addition, a higher market supply of certain models of used vehicles generally results in a lower relative level of demand for those vehicles, resulting in a higher probability that the vehicle will be returned to us. A higher rate of vehicle returns exposes us to greater risk of loss at lease termination. At March 31, 2013, holding other estimates constant, if the return rate for our existing portfolio of leased vehicles were to increase by one percentage point from our present estimates, the effect would be to increase depreciation on these vehicles by approximately $11 million. This increase in depreciation would be charged to depreciation on operating leases in the Consolidated Statement of Income on a straight-line basis over the remaining terms of the operating leases. End-of-term market values determine the amount of loss severity at lease maturity. Loss severity is the extent to which the end-of-term market value of a leased vehicle is less than the estimated residual value. We may incur losses to the extent the end-of-term market value of a leased vehicle is less than the estimated residual value. At March 31, 2013, holding other estimates constant, if end-of-term market values for returned units of leased vehicles were to decrease by one percent from our present estimates, the effect would be to increase depreciation on these vehicles by approximately $56 million. This increase in depreciation would be charged to depreciation on operating leases in the Consolidated Statement of Income on a straight-line basis over the remaining terms of the operating leases.

Determination of the Allowance for Credit Losses

  We maintain an allowance for credit losses to cover probable and estimable losses as of the balance sheet date on our earning assets resulting from the failure of customers or dealers to make required payments. The level of credit losses is influenced by two factors: default frequency and loss severity. For evaluation purposes, exposures to credit losses are segmented into the two primary categories of "consumer" and "dealer". Our consumer portfolio is further segmented into retail finance receivables and investment in operating leases, both of which are characterized by smaller contract balances than our dealer portfolio. Our dealer portfolio consists of loans related to dealer financing. The overall allowance is evaluated at least quarterly, considering a variety of assumptions and factors to determine whether reserves are considered adequate to cover probable and estimable losses as of the balance sheet date. For further discussion of the accounting treatment of our allowance for credit losses, refer to Note 1 - Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.  

Nature of Estimates and Assumptions Required

The evaluation of the appropriateness of the allowance for credit losses and our exposure to credit losses involves estimates and requires significant judgment.

Consumer Portfolio

  The consumer portfolio is evaluated using methodologies such as roll rate, credit risk grade/tier, and vintage analysis. We review and analyze external factors, such as changes in economic conditions, actual or perceived quality, safety and reliability of Toyota, Lexus and Scion vehicles, unemployment levels, the used vehicle market, and consumer behavior. In addition, internal factors, such as purchase quality mix and operational changes are considered in the review. The majority of our credit losses are related to our consumer portfolio.                                          60 --------------------------------------------------------------------------------

Dealer Portfolio

  The dealer portfolio is evaluated by first aggregating dealer financing receivables into loan-risk pools, which are determined based on the risk characteristics of the loan (e.g. secured by either vehicles and industrial equipment, real estate or dealership assets, or unsecured). The dealer pools are then analyzed using an internally developed risk rating. In addition, field operations management and our special assets group are consulted each quarter to determine if any specific dealer loan is considered impaired. If impaired loans are identified, specific reserves are established as appropriate, and the loan is removed from the loan-risk pool for separate monitoring.  

Sensitivity Analysis

  The assumptions used in evaluating our exposure to credit losses involve estimates and significant judgment. The expected loss severity and default frequency on the vehicle retail and lease portfolios represent two of the key assumptions involved in determining the allowance for credit losses. Holding other estimates constant, a 10 percent increase or decrease in either the estimated loss severity or the estimated default frequency on the vehicle retail installment sales and lease portfolios would have resulted in a change in the allowance for credit losses of $42 million as of March 31, 2013.  

Derivative Instruments

  We manage our exposure to market risks such as interest rate and foreign currency risks with derivative instruments. These instruments include interest rate swaps, foreign currency swaps, and interest rate caps. Our use of derivatives is limited to the management of interest rate and foreign currency risks. For further discussion of the accounting treatment of our derivatives, refer to Note 1 - Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.  

Nature of Estimates and Assumptions Required

  We determine the application of derivatives accounting through the identification of hedging instruments, hedged items, and the nature of the risk being hedged, as well as the methodology used to assess the hedging instrument's effectiveness.  The fair values of our over-the-counter derivative assets and liabilities are determined using quantitative models that require the use of multiple market inputs including interest and foreign exchange rates, prices and indices to generate yield or pricing curves and volatility factors, which are used to value the position.  Market inputs are validated through external sources, including brokers, market transactions and third-party pricing services.  Estimation risk is greater for derivative asset and liability positions that are either option-based or have longer maturity dates where observable market inputs are less readily available or are unobservable, in which case quantitative based extrapolations of rate, price or index scenarios are used in determining fair values.  

Fair Value of Financial Instruments

A portion of our assets and liabilities is carried at fair value, including cash equivalents, available-for-sale securities and derivatives.

  Fair value is based upon quoted market prices, where available.  If listed prices or quotes are not available, fair value is based upon internally developed models that primarily use as inputs market-based or independently sourced market parameters.  We ensure that all applicable inputs are appropriately calibrated to market data, including but not limited to yield curves, interest rates, and foreign exchange rates.  In addition to market information, models also incorporate transaction details, such as maturity. Fair value adjustments, including credit (counterparties and TMCC), liquidity, and input parameter uncertainty are included, as appropriate, to the model value to arrive at a fair value measurement.                                          61

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   During fiscal 2013, no material changes were made to the valuation models. For a description of the assets and liabilities carried at fair value and the controls over valuation, refer to Note 2 - Fair Value Measurements of the Notes to the Consolidated Financial Statements. 

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