TOYOTA MOTOR CREDIT CORP – 10-K – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cautionary Statement Regarding Forward-Looking Information
Certain statements contained in this Form 10-K 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:
• Risks related to health epidemics and other outbreaks;
• Changes in general business, economic, and geopolitical conditions,
including trade policy, as well as in consumer demand and the competitive environment in the automotive markets inthe United States ; • A decline in TMNA or any private label sales volume and the level of
TMNA or any private label sponsored subvention, cash, and contractual
residual value support incentive programs; • Extreme weather conditions, natural disasters, changes in fuel prices, manufacturing disruptions and production suspensions ofToyota , Lexus, and private label vehicles and related parts supply; • Increased competition from other financial institutions seeking to increase their share of financingToyota , Lexus, and private label vehicles; • Changes in consumer behavior;
• Recalls announced by TMNA or private label companies and the perceived
quality ofToyota , Lexus, and any private label vehicles; • Availability and cost of financing;
• Failure or interruption in our operations, including our communications
and information systems, or as a result of our failure to retain existing or to attract new key personnel;
• Increased cost, credit and operating risk exposure, or our failure to
realize the anticipated benefits from our private label financial
services to third-party automotive and mobility companies, including
Mazda and
• Changes in our credit ratings and those of our ultimate parent, TMC and
changes in our credit support arrangements; • Changes in our financial position and liquidity, or changes or
disruptions in our funding sources or access to the global capital
markets;
• Revisions to the estimates and assumptions for our allowance for credit
losses;
• Flaws in the design, implementation and use of quantitative models and
revisions to the estimates and assumptions that are used to determine
the value of certain assets;
• Fluctuations in the value or market prices of our investment securities;
• Changes in prices of used vehicles and their effect on residual values of our off-lease vehicles and return rates; • Failure of our customers or dealers to meet the terms of any contract with us, or otherwise perform as agreed; • Fluctuations in interest rates and foreign currency exchange rates;
• Failure or changes in commercial soundness of our counterparties and
other financial institutions;
• Insufficient establishment of reserves, or the failure of a reinsurer to
meet its obligations, in our voluntary protection operations; 29
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• Changes to existing, or adoption of new, accounting standards; • A security breach or a cyber-attack;
• Failure to maintain compliant enterprise data practices, including the
collection, use, sharing, and security of personally identifiable and financial information of our customers and employees;
• Compliance with current laws and regulations or becoming subject to more
stringent laws, regulatory requirements and regulatory scrutiny;
• Changes in the economies and applicable laws in the states where we have
concentration risk; and
• 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. 30 --------------------------------------------------------------------------------
OVERVIEW
Key Performance Indicators and Factors Affecting Our Business
In our finance operations, we generate revenue, income, and cash flows by providing retail, lease, and dealer financing to dealers and their customers. We measure the performance of our finance operations using the following metrics: financing volume, market share, Net financing revenues, Operating and administrative expense, residual value and credit loss metrics. In our voluntary protection operations, we generate revenue primarily through marketing, underwriting, and providing claims administration for products that cover certain risks of customers. We measure the performance of our voluntary protection operations using the following metrics: issued contract volume, average number of contracts in force, loss metrics and investment income. Our financial results are affected by a variety of economic and industry factors including, but not limited to, new and used vehicle markets,Toyota , Lexus, and private label new vehicle production volume, vehicle inventory levels, vehicle sales and incentive programs, consumer behavior, employment levels, our ability to respond to changes in interest rates with respect to both contract pricing and funding, the actual or perceived quality, safety or reliability ofToyota , Lexus, and private label vehicles, the financial health of the dealers we finance, and competitive pressure. Our financial results may also be affected by the regulatory environment in which we operate, including as a result of new legislation or changes in regulation and any compliance costs or changes we may be required to make to our business practices. All of these factors can influence consumer contract and dealer financing volume, the number of consumer contracts and dealers that default and the loss per occurrence, our inability to realize originally estimated contractual residual values on leased vehicles, the volume and performance of our voluntary protection operations, and our Net financing revenues on consumer and dealer financing volume. Changes in the volume of vehicle sales, sales of our voluntary protection products, or the level of voluntary protection expenses and insurance losses could materially and adversely impact our voluntary protection operations. Additionally, our funding programs and related costs are influenced by changes in the global capital markets, prevailing interest rates, and our credit ratings and those of our parent companies, which may affect our ability to obtain cost effective funding to support earning asset growth. Our primary competitors are other financial institutions including national and regional commercial banks, credit unions, savings and loan associations, independent voluntary protection product contract providers, online banks, finance companies and, to a lesser extent, other automobile manufacturers' affiliated finance companies that actively seek to purchase consumer contracts throughToyota , Lexus, and private label dealers. We strive to achieve the following: Exceptional Customer Service: Our relationship withToyota , Lexus, and private label dealers and their customers offers us a competitive advantage. We seek to leverage this opportunity by providing exceptional service to the dealers and their customers. Through our DSCs and CSCs, we work closely with the dealers 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 dealers and theToyota , Lexus, and private label 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 TMNA, private label companies, and other third-party distributors to offer special retail, lease, dealer financing, and voluntary protection products. We also focus on providing a positive customer experience to existing retail, lease, and voluntary protection product 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 the dealers to assist them in benefiting from market opportunities. We continuously strive to refine our strategy and methodology for risk-based pricing. Liquidity: Our liquidity strategy is to maintain the capacity to fund assets and repay liabilities in a timely and cost-effective manner even in adverse market conditions. This capacity is primarily driven by our ability to raise funds in the global capital markets and through loans, credit facilities, and other transactions, as well as our ability to generate liquidity from our earnings assets. Our pursuit of this strategy has led us to develop a diversified borrowing base that is distributed across a variety of markets, geographies, investors, and financing structures, among other factors. 31 --------------------------------------------------------------------------------
Fiscal 2022 Operating Environment
During the fiscal year endingMarch 31, 2022 ("fiscal 2022"), theU.S. economy continued to be impacted by the global pandemic of COVID-19 and related variants and the extraordinary governmental measures intended to slow its spread. In conjunction with increases in vaccination rates and the easing of restrictive measures throughout fiscal 2022, there has been improvement in unemployment levels and consumer confidence from fiscal 2021 pandemic lows, but neither measure has returned to its pre-pandemic level. There remains uncertainty around the duration and the severity of the COVID-19 pandemic, the timing and strength of the economy's recovery, and the impacts of government support and lender relief programs ending. In addition, during fiscal 2022, inflation has increased significantly from pandemic lows in fiscal 2021 and has remained at elevated levels. The impact of the COVID-19 pandemic on our future operations is difficult to predict, but the curtailment of economic activities as a result of further outbreak of COVID-19, extended or additional government restrictions intended to slow the spread of the virus, ending of government support programs, delayed consumer response to the lifting of restrictive measures, or permanent behavior changes in consumer spending could have further negative impact on consumer economics, dealerships, and auction sites, which could have a material adverse impact on our business, financial condition, and future results of operations. In addition, changes in the economy that adversely impact the consumer, such as inflation, higher interest rates, elevated debt levels and an increase in unemployment from the current levels could adversely impact our results of operations. Economic conditions caused by the COVID-19 pandemic, including production halts and supply shortages affecting the automotive industry and additional delays affecting the supply chain and logistics networks, have resulted in a decrease in dealer new vehicle inventory levels. This includes the global shortage of semiconductor chips and other parts and raw materials the automotive industry continues to face. The duration and severity of the supply chain disruptions and shortages, including but not limited to the semiconductor chips, are difficult to predict, but should these persist or become more severe, the negative impact to the manufacturers' vehicle production and dealer new vehicle inventory levels could adversely impact our results of operations. Average used vehicle values further increased in fiscal 2022 compared to fiscal 2021 and remain elevated compared to historical levels, primarily due to the lack of availability of new vehicles. Future declines in used vehicle values resulting from increases in the supply of new and used vehicles and increases in new vehicle sales incentives could unfavorably impact return rates, residual values, depreciation expense and credit losses in the future. Conditions in the global capital markets were generally stable during the first nine months of fiscal 2022; however, during the fourth quarter of fiscal 2022, credit spreads widened and markets experienced periods of volatility in response to the conflict inUkraine , increases in the inflation rate, and uncertainty regarding the path ofU.S. monetary policy. While we continue to maintain broad global access to both domestic and international markets, these events could lead to cause further disruptions in the global capital markets and increases to our funding costs. Future changes in interest rates in theU.S. and foreign markets could result in volatility in our interest expense, which could affect our results of operations. 32
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RESULTS OF OPERATIONS Years ended March 31, (Dollars in millions) 2022 2021 2020 Net income: Finance operations 1$ 2,416 $ 1,606 $ 684
Voluntary protection operations 1 119 411 229
Total net income
$ 2,535 $ 2,017 $ 913
1 Refer to Note 14 - Segment Information of the Notes to Consolidated Financial
Statement for the total asset balances of our finance operations and voluntary
protection operations.
Fiscal 2022 Compared to Fiscal 2021
Our consolidated net income was$2,535 million in fiscal 2022, compared to$2,017 million in fiscal 2021. The increase in net income for fiscal 2022 compared to fiscal 2021 was primarily due to a$901 million decrease in interest expense, a$190 million decrease in provision for credit losses, a$121 million increase in total financing revenues, a$86 million decrease in depreciation on operating leases, partially offset by a$436 million decrease in investment and other income, net, a$210 million increase in operating and administrative expense, and a$157 million increase in provision for income taxes. Our overall capital position increased$2.5 billion , bringing total shareholder's equity to$18.1 billion atMarch 31, 2022 , as compared to$15.6 billion atMarch 31, 2021 . Our debt decreased to$109.2 billion atMarch 31, 2022 from$109.7 billion atMarch 31, 2021 . Our debt-to-equity ratio decreased to 6.0 atMarch 31, 2022 from 7.0 atMarch 31, 2021 .
Fiscal 2021 Compared to Fiscal 2020
Our consolidated net income was$2,017 million in fiscal 2021, compared to$913 million in fiscal 2020. The increase in net income for fiscal 2021 compared to fiscal 2020 was primarily due to an$888 million decrease in depreciation on operating leases, a$532 million decrease in interest expense, a$164 million decrease in provision for credit losses, an$88 million increase in investment and other income, net, an$86 million decrease in voluntary protection contract expenses and insurance losses, and a$74 million decrease in operating and administrative expense, partially offset by a$521 million increase in provision for income taxes, and a$230 million decrease in total financing revenues. Our overall capital position, taking into account the payment of a$700 million dividend inMarch 2021 to TFSIC, increased$1.1 billion , bringing total shareholder's equity to$15.6 billion atMarch 31, 2021 , as compared to$14.5 billion atMarch 31, 2020 . The adoption of ASU 2016-13 resulted in a cumulative-effect adjustment to decrease opening retained earnings by approximately$218 million , net of taxes, resulting from a pretax increase to our allowance for credit losses on finance receivables of approximately$292 million . Our debt increased to$109.7 billion atMarch 31, 2021 from$97.7 billion atMarch 31, 2020 . Our debt-to-equity ratio increased to 7.0 atMarch 31, 2021 from 6.7 atMarch 31, 2020 . 33 --------------------------------------------------------------------------------
Finance Operations
The following table summarizes key results of our Finance Operations:
Years ended March 31, Percentage change (Dollars in millions) 2022 2021 2020 2022 to 2021 2021 to 2020 Financing revenues: Operating lease$ 8,337 $ 8,481 $ 8,775 (2 )% (3 )% Retail 3,254 2,905 2,558 12 % 14 % Dealer 329 413 696 (20 )% (41 )% Total financing revenues 11,920 11,799 12,029 1 % (2 )% Depreciation on operating leases 1 5,846 5,932 6,820 (1 )% (13 )% Interest expense 1,401 2,302 2,854 (39 )% (19 )% Net financing revenues 4,673 3,565 2,355 31 % 51 % Investment and other income, net 45 93 155 (52 )% (40 )% Net financing and other revenues 4,718 3,658 2,510 29 % 46 % Expenses: Provision for credit losses 1 236 426 590 (45 )% (28 )% Operating and administrative 1,311 1,124 1,197 17 % (6 )% Total expenses 1,547 1,550 1,787 - % (13 )% Income before income taxes 3,171 2,108 723 50 % 192 % Provision for income taxes 755 502 39 50 % 1187 % Net income from finance operations$ 2,416 $ 1,606 $ 684 50 % 135 %
1 In conjunction with the adoption of ASU 2016-13 in fiscal 2021, we updated our
depreciation policy for operating leases and changed our presentation for
reporting early termination expenses related to our investments in operating
leases. We now present the effects of operating lease early terminations in
Depreciation on operating leases. The information for the comparative period
continues to be reported within the Provision for credit losses.
Our finance operations reported net income of$2,416 million and$1,606 million during fiscal 2022 and 2021, respectively. The increase in net income from finance operations for fiscal 2022 compared to fiscal 2021 was due to a$901 million decrease in interest expense, a$190 million decrease in provision for credit losses, a$121 million increase in total financing revenues, and an$86 million decrease in depreciation on operating leases, partially offset by a$253 million increase in provision for income taxes, a$187 million increase in operating and administrative expenses, and a$48 million decrease in investment and other income, net. Financing Revenues
Total financing revenues increased 1 percent during fiscal 2022 compared to
fiscal 2021 due to the following:
• Operating lease revenues decreased 2 percent in fiscal 2022 as compared to fiscal 2021, due to lower average outstanding earning asset balances partially offset by higher portfolio yields. • Retail financing revenues increased 12 percent in fiscal 2022 as
compared to fiscal 2021, due to higher average outstanding earning asset
balances partially offset by lower portfolio yields. • Dealer financing revenues decreased 20 percent in fiscal 2022 as compared to fiscal 2021, due to lower average outstanding earning asset balances from lower average inventory levels partially offset by higher portfolio yields. As a result of the above, our total portfolio yield, which includes operating lease, retail and dealer financing revenues, decreased to 5.0 percent for fiscal 2022, compared to 5.1 percent for fiscal 2021. 34 --------------------------------------------------------------------------------
Depreciation on Operating Leases
We recorded depreciation on operating leases of$5,846 million during fiscal 2022 compared to$5,932 million during fiscal 2021. The decrease is primarily due to lower average operating lease units outstanding, partially offset by residual value losses. The economic conditions caused by the COVID-19 pandemic and the current conflict inUkraine , including production halts and supply shortages affecting the automotive industry and additional delays affecting the supply chain and logistics networks, have resulted in a decrease in the availability of new vehicles. The lower levels of new vehicle inventory and higher off-lease vehicle purchases by dealers have led to historically high levels of average used vehicle values. Declines in used vehicle values resulting from increases in the supply of new vehicles and increases in new vehicle sales incentives could unfavorably impact return rates, residual values, and depreciation expense in the future.
Interest Expense
Our liabilities consist mainly of fixed and variable rate debt, denominated inU.S. dollars and various other currencies, which we issue in the global capital markets, while our assets consist primarily ofU.S. dollar denominated, fixed rate receivables. We enter into interest rate swaps and foreign currency swaps to economically hedge the interest rate and foreign currency risks that result from the different characteristics of our assets and liabilities. The following table summarizes the components of interest expense: Years ended March 31, (Dollars in millions) 2022 2021 2020 Interest expense on debt$ 1,498 $ 1,954 $ 2,488 Interest expense on derivatives 107 420
180
Interest expense on debt and derivatives 1,605 2,374
2,668
(Gains) losses on debt denominated in foreign currencies (438 ) 1,402 (703 ) Losses (gains) on foreign currency swaps 818 (1,351 ) 650 (Gains) losses onU.S. dollar interest rate swaps (584 ) (123 ) 219 Total interest expense$ 1,401 $ 2,302 $ 2,834 During fiscal 2022, total interest expense decreased to$1,401 million from$2,302 million in fiscal 2021. The decrease is attributable to a decrease in interest expense on debt and derivatives combined and higher gains onU.S. dollar interest rate swaps, partially offset by losses on foreign currency swaps net of gains from debt denominated in foreign currencies. Interest expense on debt and derivatives primarily represents contractual net interest settlements and changes in accruals on secured and unsecured notes and loans payable and derivatives, and includes amortization of discounts, premiums, and debt issuance costs. During fiscal 2022, interest expense on debt and derivatives decreased to$1,605 million from$2,374 million in fiscal 2021. The decrease in interest expense on debt is primarily due to decrease in weighted average interest rates. The decrease in interest expense on derivatives is primarily due to decrease in interest expense on pay fixed swaps. Gains or losses on debt denominated in foreign currencies represent the impact of translation adjustments. We use foreign currency swaps to economically hedge the debt denominated in foreign currencies. During fiscal 2022 and fiscal 2021, we recorded net losses of$380 million and$51 million , respectively, primarily due to increases in foreign currency swap rates across the various currencies in which our debt is denominated. Gains or losses onU.S. dollar interest rate swaps represent the change in the valuation of interest rate swaps. During fiscal 2022 and fiscal 2021, we recorded gains of$584 million and$123 million , respectively, primarily due to increases inU.S. dollar swap rates and net interest income on our pay-fixed swaps exceeding losses on our pay-float swaps. Future changes in interest and foreign currency exchange rates could continue to result in significant volatility in our interest expense, thereby affecting our results of operations. 35
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Investment and Other Income, Net
We recorded investment and other income, net of$45 million for fiscal 2022, compared to$93 million for fiscal 2021. The decrease in investment and other income, net for fiscal 2022 compared to fiscal 2021 was primarily due to lower average balances in our cash equivalents and investment in marketable securities portfolio. Provision for Credit Losses We recorded a provision for credit losses of$236 million for fiscal 2022, compared to$426 million for fiscal 2021. In fiscal 2022, in conjunction with continued improved dealer financial performance and lower charge-offs, the lower volatility in the macroeconomic conditions resulted in a lower provision for credit losses for our retail loan portfolio. In contrast, in fiscal 2021, we increased the expected credit losses for our retail loan portfolio due to a decline in economic conditions caused by the COVID-19 pandemic and the restrictions designed to slow the spread of COVID-19, which resulted in stay-at-home orders, increased unemployment, and decreased consumer spending.
Operating and Administrative Expenses
We recorded operating and administrative expenses of
fiscal 2022 compared to
operating and administrative expenses for fiscal 2022, compared to fiscal 2021,
was primarily due to increases in employee expenses and general operating
expenses.
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Voluntary Protection Operations
The following table summarizes key results of our Voluntary Protection Operations: Years ended March 31, Percentage change 2022 2021 2020 2022 to 2021 2021 to 2020 Contracts (units in thousands) Issued 3,020 2,604 2,593 16 % -% Average in force 9,989 9,525 9,301 5 % 2 % (Dollars in millions) Voluntary protection contract revenues and insurance earned premiums$ 1,015 $ 956 $ 933 6 % 2 % Investment and other (loss) income, net (71 ) 317 187 (122 )% 70 % Revenues from voluntary protection operations 944 1,273 1,120 (26 )% 14 % Expenses: Voluntary protection contract expenses and insurance losses 405 369 455 10 % (19 )% Operating and administrative 386 363 364 6 % -% Total expenses 791 732 819 8 % (11 )% Income before income taxes 153 541 301 (72 )% 80 % Provision for income taxes 34 130 72 (74 )% 81 % Net income from voluntary protection operations$ 119 $ 411 $ 229 (71 )% 79 % Our voluntary protection operations reported net income of$119 million for fiscal 2022 compared to$411 million for fiscal 2021. The decrease in net income from voluntary protection operations for fiscal 2022 compared to fiscal 2021 was primarily due to a$388 million decrease in investment and other (loss) income, net, and a$36 million increase in voluntary protection contract expenses and insurance losses, partially offset by a$96 million decrease in provision for income taxes and a$59 million increase in voluntary protection contract revenues and insurance earned premiums. Contracts issued increased 16 percent primarily due to prepaid maintenance, vehicle service, and tire and wheel protection contracts during fiscal 2022 compared to fiscal 2021. The higher contract issuances for fiscal 2022, compared to fiscal 2021, was mainly due to the continued growth of our private label services and our issuances were negatively impacted in fiscal year 2021 by the decline in economic conditions caused by the COVID-19 pandemic and the restrictions designed to slow the spread of COVID-19. The average number of contracts in force increased 5 percent during fiscal 2022 compared to fiscal 2021, due to net growth in the voluntary protection portfolio in recent years, most notably in prepaid maintenance, guaranteed auto protection and vehicle service contracts.
Revenue from Voluntary Protection Operations
Our voluntary protection operations reported voluntary protection contract revenues and insurance earned premiums of$1,015 million for fiscal 2022 compared to$956 million for fiscal 2021. Voluntary protection contract revenues and insurance earned premiums represent revenues from in force contracts and are affected by issuances as well as the level, age, and mix of in force contracts. Voluntary protection contract revenues and insurance earned premiums are recognized over the term of the contracts in relation to the timing and level of anticipated claims. The increase in voluntary protection contract revenues and insurance earned premiums in fiscal 2022 compared to fiscal 2021 was primarily due to an increase in our average in force contracts resulting from net growth in the voluntary protection portfolio in recent years. 37 --------------------------------------------------------------------------------
Investment and Other (Loss) Income, Net
Our voluntary protection operations reported investment and other loss, net of$71 million for fiscal 2022 compared to investment and other income, net of$317 million for fiscal 2021. Investment and other (loss) income, net, consists primarily of dividend and interest income, realized gains and losses on investments in marketable securities, changes in fair value from equity and available-for-sale debt securities for which the fair value option was elected, and credit loss expense on available-for-sale debt securities, if any. The decrease in investment and other income, net in fiscal 2022, compared to fiscal 2021, was primarily due to losses from the changes in fair value on our equity investments and available-for-sale debt securities for which the fair value option was elected as a result of market volatility, and a decrease in dividend income. Should market volatility persist or become more severe, it could continue to negatively impact our results of operations.
Voluntary Protection Contract Expenses and Insurance Losses
Our voluntary protection operations reported voluntary protection contract expenses and insurance losses of$405 million for fiscal 2022 compared to$369 million for fiscal 2021. Voluntary protection contract expenses and insurance losses incurred are a function of the amount of covered risks, the frequency and severity of claims associated with in force contracts and the level of risk retained by our voluntary protection operations. Voluntary protection contract expenses and insurance losses include amounts paid and accrued for reported losses, estimates of losses incurred but not reported, and any related claim adjustment expenses. The increase in voluntary protection contract expenses and insurance losses in fiscal 2022 compared to fiscal 2021 was primarily due to an increase in frequency of claims in our prepaid maintenance, tire and wheel protection and vehicle service contracts. These higher losses were partially offset by a decrease in losses on our guaranteed auto protection contracts in fiscal 2022, compared to fiscal 2021, which was driven by a decrease in frequency of claims. Our voluntary protection contract expenses and insurance losses in fiscal 2021 were impacted by lower claims as a result of changes in consumer driving patterns caused by the COVID-19 pandemic, including restrictions and other changes in behavior.
Operating and Administrative Expenses
Our voluntary protection operations reported operating and administrative expenses of$386 million for fiscal 2022 compared to$363 million for fiscal 2021. The increase in operating and administrative expenses in fiscal 2022 as compared to fiscal 2021 was attributable to higher product expenses driven by the continued growth of our voluntary protection product business as well as higher dealer back-end expenses. Dealer back-end program expenses are incentives or expense reduction programs we offer to dealers based on certain performance criteria. 38
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Provision for Income Taxes
We recorded a provision for income taxes of$789 million for fiscal 2022, compared to$632 million for fiscal 2021. Our effective tax rate for both fiscal 2022 and fiscal 2021 was 24 percent. The increase in the provision for income taxes for fiscal 2022, compared to fiscal 2021, was primarily due to an increase in income before income taxes. 39 --------------------------------------------------------------------------------
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 (units in thousands): 2022 2021 2020 2022 to 2021 2021 to 2020 Vehicle financing volume 1: New retail contracts 697 748 630 (7 )% 19 % Used retail contracts 466 482 337 (3 )% 43 % Lease contracts 423 498 470 (15 )% 6 % Total 1,586 1,728 1,437 (8 )% 20 % TMNA subvened vehicle financing volume 2: New retail contracts 253 300 201 (16 )% 49 % Used retail contracts 32 61 48 (48 )% 27 % Lease contracts 247 364 426 (32 )% (15 )% Total 532 725 675 (27 )% 7 % Market share of TMNA sales 3: 54.9 % 61.8 % 63.4 %
1 Total financing volume was comprised of approximately 65 percent
percent Lexus, 13 percent Mazda, and 7 percent non-
fiscal 2022. Total financing volume was comprised of approximately 66 percent
fiscal 2021. Total financing volume was comprised of approximately 79 percent
2 TMNA subvened volume units are included in the total vehicle financing. Units
exclude third-party subvened units.
3 Represents the percentage of total domestic TMNA sales of new
vehicles financed by us, excluding sales under dealer rental car and commercial
fleet programs, sales of a private
vehicles financed. Vehicle Financing Volume The volume of our retail and lease contracts, which are acquired primarily fromToyota , Lexus, and private label dealers, is substantially dependent upon TMNA and private label sales volume, the level of TMNA, private label, and third-party sponsored subvention and other incentive programs, as well as TMCC competitive rate and other incentive programs. Our financing volume decreased 8 percent in fiscal 2022, compared to fiscal 2021, primarily due to lower new vehicles inventory levels. The economic conditions caused by the COVID-19 pandemic and the current conflict inUkraine , including production halts and supply shortages affecting the automotive industry and additional delays affecting the supply chain and logistics networks, have resulted in a decrease in the availability of new vehicles. This has led to lower levels of incentives and subvention on new and used retail contracts and lease contracts, which has resulted in increased competition from other financial institutions. Our market share of TMNA sales decreased approximately 7 percentage points for fiscal 2022, compared to the same period in fiscal 2021, due to lower levels of incentives and subvention on new and used retail and lease contracts and increased competition from other financial institutions. 40 --------------------------------------------------------------------------------
The composition of our net earning assets is summarized below:
Years ended March 31, Percentage change (Dollars in millions) 2022 2021 2020 2022 to 2021 2021 to 2020 Net Earning Assets Finance receivables, net Retail finance receivables, net 2$ 72,185 $ 65,653 $ 56,364 10 % 16 % Dealer financing, net 1, 2 10,247 13,539 17,632 (24 )% (23 )%
Total finance receivables, net 2 82,432 79,192 73,996
4 % 7 % Investments in operating leases, net 35,455 37,091 36,387 (4 )% 2 % Net earning assets$ 117,887 $ 116,283 $ 110,383 1 % 5 % Average original contract term in months Lease contracts 3 37 37 36 Retail contracts 4 69 68 69 Dealer Financing (Number of dealers serviced)Toyota , Lexus, and private label dealers1 966 1,002 953 (4 )% 5 % Dealers outside of theToyota /Lexus/private label dealer network 399 395 371 1 % 6 % Total number of dealers receiving wholesale financing 1,365 1,397 1,324 (2 )% 6 % Dealer inventory outstanding (units in thousands) 64 185 294 (65 )% (37 )%
1 Includes wholesale and other credit arrangements in which we participate as
part of a syndicate of lenders.
2 In conjunction with the adoption of ASU 2016-13 in fiscal 2021, we changed the
presentation of accrued interest on the Consolidated Balance Sheets from
Finance receivables, net to Other assets. The information for the comparative
period continues to be reported within Finance receivables, net.
3 Lease contract terms range from 24 months to 60 months.
4 Retail contract terms range from 24 months to 85 months.
Retail Contract Volume and Earning Assets
Our new retail contract volume decreased 7 percent during fiscal 2022, compared to fiscal 2021, primarily due to a decrease in the availability of new vehicles and lower levels of incentives and subvention on new contracts. Economic conditions caused by the COVID-19 pandemic and the current conflict inUkraine , including production halts and supply shortages affecting the automotive industry and additional delays affecting the supply chain and logistics networks, have resulted in a decrease in the availability of new vehicles. Our used retail contracts decreased 3 percent during fiscal 2022, compared to the same period in fiscal 2021, primarily due to increased competition in the used vehicle marketplace caused by the reduction in new vehicle inventory levels. Our retail finance receivables, net increased 10 percent atMarch 31, 2022 as compared toMarch 31, 2021 due to higher retail contracts outstanding and higher average amount financed.
Lease Contract Volume and Earning Assets
Our lease contract volume decreased 15 percent during fiscal 2022, compared to fiscal 2021, primarily due to the decrease in the availability of new vehicles and lower levels of incentive and subvention programs. Our investments in operating leases, net, decreased 4 percent atMarch 31, 2022 as compared toMarch 31, 2021 , due to lower average operating lease units outstanding, partially offset by higher vehicle values.
Dealer Financing and Earning Assets
Dealer financing, net decreased 24 percent atMarch 31, 2022 , as compared toMarch 31, 2021 , primarily due to a decrease in dealer inventory and related financing. Economic conditions caused by the COVID-19 pandemic and the current conflict inUkraine , including production halts and supply shortages affecting the automotive industry and additional delays affecting the supply chain and logistics networks, have resulted in a decrease in dealer new vehicle inventory levels. 41
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Residual Value Risk
We are exposed to risk on the disposition of leased vehicles that are not purchased by lessees, dealers, or third parties at contractual residual value to the extent that sales proceeds realized upon the sale of returned lease vehicles are not sufficient to cover the contractual residual value that was estimated at lease inception.
Factors Affecting Exposure to Residual Value Risk
Residual value represents an estimate of the end-of-term market value of a leased vehicle. The primary factors affecting our exposure to residual value risk are the levels at which residual values are established at lease inception, current economic conditions and outlook, projected end-of-term market values, and the resulting impact on depreciation expense and lease return rates. Higher average operating lease units outstanding and the resulting increase in future maturities, a higher supply of used vehicles, as well as further deterioration in actual and expected used vehicle values forToyota , Lexus, and private label vehicles could unfavorably impact return rates, residual values, and depreciation expense. The evaluation of these factors involves significant assumptions, complex analyses, and management judgment. Refer to "Critical Accounting Estimates" for further discussion of the estimates involved in the determination of accumulated depreciation on investments in operating leases.
Residual Values at Lease Inception
Residual values of lease vehicles are estimated at lease inception by examining external industry data, the anticipatedToyota , Lexus, and private label product pipeline and our own experience. Factors considered in this evaluation include, macroeconomic forecasts, historical portfolio trends, new vehicle pricing, new vehicle incentive programs, new vehicle sales, product attributes of popular vehicles, the mix and level of used vehicle supply, current and projected used vehicle values, the actual or perceived quality, safety or reliability ofToyota , Lexus, and private label vehicles, and fuel prices. We use various channels to sell vehicles returned at lease-end. Refer to Part 1, 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 our carrying values. To the extent the estimated end-of-term market value of a leased vehicle is lower than the residual value established at lease inception, the residual value of the leased vehicle is adjusted downward so that the carrying value at lease end will approximate the estimated end-of-term market value. 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 these factors in the future. For investments in operating leases, adjustments are made on a straight-line basis over the remaining terms of the lease contracts and are included in Depreciation on operating leases in our Consolidated Statements of Income as a change in accounting estimate.
Lease Return Rate
The 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 or dealer 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 market value 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 residual value risk which impacts depreciation expense at lease termination.
Impairment of Operating Leases
We evaluate our investment in operating leases portfolio for potential impairment when we determine a triggering event has occurred. When a triggering event has occurred, 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 would be recorded in our Consolidated Statements of Income. As ofMarch 31, 2022 , 2021, and 2020 and during the years then ended, there was no impairment in our investment in operating leases portfolio. 42 --------------------------------------------------------------------------------
Disposition of Off-Lease Vehicles
The following table summarizes scheduled maturities on our operating lease
portfolio and off-lease vehicles sold at lease termination:
Years endedMarch 31 ,
Percentage Change
2022 to 2021 to (Units in thousands) 2022 2021 2020 2021 2020 Scheduled maturities 504 511 562 (1 )% (9 )% Vehicles sold through: Dealer Direct program Grounding dealer 34 110 119 (69 )% (8 )% Dealer Direct online program 3 31 60 (90 )% (48 )% Physical auction 7 74 137 (91 )% (46 )% Total vehicles sold at lease termination 1 44 215 316 (80 )% (32 )%
1 Excludes leased vehicles purchased by lessees or dealers at contractual
residual value prior to an authorized dealer securing the vehicle.
Scheduled maturities decreased 1 percent in fiscal 2022 compared to fiscal 2021, primarily due to lower operating lease units outstanding. Total vehicles sold at lease termination decreased 80 percent in fiscal 2022, compared to fiscal 2021, due to lower units being processed through the dealer direct program and physical auction. Higher average used vehicle values as well as lower new vehicle inventory during fiscal 2022 resulted in an increase of off-lease vehicles purchased by lessees and dealers at contractual residual value prior to an authorized dealer securing the vehicle. Refer to Part 1, Item 1. Business, "Finance Operations - Retail and Lease Financing - Remarketing" for additional information on disposal of lease vehicles.
Depreciation on 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 cost and its residual value established at lease inception. Changes to residual values 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 assumptions involved in the determination of residual values. In conjunction with the adoption of ASU 2016-13 in fiscal 2021, we updated our depreciation policy for operating leases and changed our presentation for reporting early termination expenses related to our investments in operating leases. We now present the effects of operating lease early terminations in Depreciation on operating leases. The information for the comparative period continues to be reported within the provision for credit losses. Depreciation on operating leases and average operating lease units outstanding are as follows: Years ended March 31, Percentage Change 2022 2021 2020 2022 to 2021 2021 to 2020 Depreciation on operating leases (dollars in millions)$ 5,846 $ 5,932 $ 6,820 (1 )% (13 )% Average operating lease units outstanding (in thousands) 1,314 1,336 1,400 (2 )% (5 )% We recorded depreciation expense on operating leases of$5,846 million for fiscal 2022, compared to$5,932 million for fiscal 2021. The decrease is primarily due to lower average operating lease units outstanding, partially offset by residual value losses. The economic conditions caused by the COVID-19 pandemic and the current conflict inUkraine , including production halts and supply shortages affecting the automotive industry and additional delays affecting the supply chain and logistics networks, have resulted in a decrease in the availability of new vehicles. The lower levels of new vehicle inventory and higher off-lease vehicle purchases by dealers have led to historically high levels of average used vehicle values. Declines in used vehicle values resulting from increases in the supply of new vehicles and increases in new vehicle sales incentives could unfavorably impact return rates, residual values, and depreciation expense in the future. 43 --------------------------------------------------------------------------------
Credit Risk
We are exposed to credit risk on our retail loans and dealer portfolios. Credit risk on our finance receivables is the risk of loss arising from the failure of consumers or dealers to make contractual payments. The level of credit risk on our retail loan 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 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 the financial condition of automotive manufacturers in general.
Factors Affecting Retail Loan 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,US Government stimulus and relief programs, and unforeseen events such as natural disasters, severe weather, health epidemics or geopolitical conflicts, among other factors, can influence both default frequency and loss severity.
Used Vehicle Market
Changes in used vehicle values 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, new vehicle inventory, the level of manufacturer incentive programs on new vehicles, the manufacturer's actual or perceived reputation for quality, safety, or 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 loan contracts influences credit losses. Longer term contracts generally experience a higher rate of default and thus affect 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 loan portfolio has 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 values of used vehicles and consequently, loss severity.
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 loan portfolio. 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. We are exposed to operational risk related to potential changes in the regulatory landscape which may limit our ability to conduct pre and post charge-off collections activity.
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 to focus on early and late stage delinquencies to increase the likelihood of resolution. We have also increased efficiency in our collections through the use of technology. 44 --------------------------------------------------------------------------------
Factors Affecting Dealer 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 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 dealers and 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 dealers and 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 periodic 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 in order 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 audits, and credit watch processes. Where appropriate, we increase the frequency of our audits and examine more closely the financial condition of the dealer or dealer group. We continue to be diligent in underwriting dealers and have conducted targeted personnel training to address dealer credit risk. Additionally, TMNA and other manufacturers may be obligated by applicable law, or under agreements with us, to repurchase or to reassign new vehicle inventory we financed that meets certain mileage and model year parameters, curtailing our risk. We also provide other types of financing to certainToyota and Lexus dealers and other third parties at the request of TMNA or privateToyota distributors, and the credit risk associated with such financing is mitigated by guarantees from TMNA or the applicable private distributors. We also provide financing for some dealerships which sell products not distributed by TMNA or any of its affiliates. A significant adverse change in a non-Toyota /Lexus manufacturer such as restructuring or bankruptcy may increase the risk associated with the dealers we have financed that sell these products. 45 --------------------------------------------------------------------------------
Origination, Credit Loss, and Delinquency Experience
Our credit loss experience may be affected by a number of factors including the economic environment, our purchasing, servicing, and collections practices, used vehicle market conditions and subvention. Changes in the economy that impact the consumer such as increasing interest rates, and a rise in the unemployment rate as well as higher debt balances, coupled with deterioration in actual and expected used vehicle values, could increase our credit losses. In addition, a decline in the effectiveness of our collection practices could also increase our credit losses. We continuously evaluate and refine our purchasing practices and collection efforts to minimize risk. In addition, subvention contributes to our overall portfolio quality, as subvened contracts typically have higher credit scores than non-subvened contracts. For 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 origination experience: Years Ended March 31, 2022 2021 2020
Average consumer portfolio origination FICO score 742 744
754
Average retail loan origination term (months) 1 69 68
69
1 Retail loan origination greater than or equal to 78 months was 10%, 8%, 7% as
of
While we have included the average origination FICO score to illustrate
origination trends, we also use a proprietary credit scoring system to evaluate
an applicant's risk profile. Refer to Part I. Item 1. Business "Finance
Operations" for further discussion of the proprietary manner in which we
evaluate risk.
The following table provides information related to our consumer finance
receivables and investment in operating leases:
Years endedMarch 31, 2022 2021
2020
Net charge-offs as a percentage of average finance receivables 4, 5 0.22 % 0.29 %
0.44 %
Default frequency as a percentage of outstanding finance receivables contracts 5 0.72 % 0.90 %
1.09 %
Average finance receivables loss severity per unit 1, 5$ 9,012 $ 10,035
Aggregate balances for accounts 60 or more days past due as a percentage of earning assets 2, 3, 4 Finance receivables 0.43 % 0.27 % 0.41 % Operating leases 0.26 % 0.20 % 0.34 %
1 Average loss per unit upon disposition of repossessed vehicles or charge-off
prior to repossession.
2 Substantially all retail 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.
4 In conjunction with the adoption of ASU 2016-13 in fiscal 2021, we changed the
presentation of accrued interest from Finance receivables, net to Other
assets. Accordingly, accrued interest is excluded from average finance
receivables with effect from
period continues to be reported for that period.
5 In conjunction with the adoption of ASU 2016-13 in fiscal 2021, we updated our
depreciation policy for operating leases and changed our presentation for
reporting early termination expenses related to operating leases. Accordingly,
with effect from
leases are excluded from the net charge-off ratio, default frequency ratio and
average loss per unit. 46
-------------------------------------------------------------------------------- Management considers historical credit loss information when assessing the allowance for credit losses. Historical credit losses are primarily driven by two factors: default frequency and loss severity. Net charge-offs as a percentage of average finance receivables decreased to 0.22 percent atMarch 31, 2022 from 0.29 percent atMarch 31, 2021 and default frequency as a percentage of outstanding finance receivables contracts decreased to 0.72 percent for fiscal 2022 compared to 0.90 percent for fiscal 2021. Our average finance receivables loss severity per unit for fiscal 2022 decreased to$9,012 from$10,035 in fiscal 2021. The changes in our net charge-offs, default frequency, and loss severity per unit were primarily due to historically high levels of average used vehicle values, which reduced net charge-offs, default frequency, and loss per unit. Our aggregate balances for accounts 60 or more days past due on finance receivables increased to 0.43 percent atMarch 31, 2022 , compared to 0.27 percent atMarch 31, 2021 . Our aggregate balances for accounts 60 or more days past due on operating leases increased to 0.26 percent atMarch 31, 2022 , compared to 0.20 percent atMarch 31, 2021 . The finance receivables delinquency rate in fiscal 2021 was positively impacted by the retail payment extension programs offered to our customers and dealers impacted by COVID-19, as well as influenced by government stimulus and other external programs in fiscal 2021, which are no longer available. In addition, for a portion of fiscal 2021, as a result of a decline in economic conditions caused by the COVID-19 pandemic, there were government restrictions on repossession activities in certain states for which we have a high percentage of lease contracts which had a negative impact on our operating lease payments delinquency. If the negative economic conditions caused by the COVID-19 pandemic and the conflict inUkraine continue, delinquencies and charge-offs could increase. 47
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Allowance for Credit Losses
We maintain an allowance for credit losses which is measured by an impairment
model that reflects lifetime expected losses.
The allowance for credit losses for our retail loan portfolio is measured on a collective basis when loans have similar risk characteristics such as loan-to-value ratio, book payment-to-income ratio, FICO score at origination, collateral type, contract term, and other relevant factors. We use statistical models to estimate lifetime expected credit losses of our retail loan portfolio segment by applying probability of default and loss given default to the exposure at default on a loan level basis. Probability of default models are developed from internal risk scoring models which consider variables such as delinquency status, historical default frequency, and other credit quality indicators. Other credit quality indicators include loan-to-value ratio, book payment-to-income ratio, FICO score at origination, collateral type (new or used, Lexus,Toyota , or private label), and contract term. Loss given default models forecast the extent of losses given that a default has occurred and consider variables such as collateral, trends in recoveries, historical loss severity, and other contract structure variables. Exposure at default represents the expected outstanding principal balance, including the effects of expected prepayment when applicable. The lifetime expected credit losses incorporate the probability-weighted forward-looking macroeconomic forecasts for baseline, favorable, and adverse scenarios. The loan lifetime is regarded by management as the reasonable and supportable period. We use macroeconomic forecasts from a third party and update such forecasts quarterly. On an ongoing basis, we review our models, including macroeconomic factors, the selection of macroeconomic scenarios and their weighting to ensure they reflect the risk of the portfolio. For the allowance for credit losses for our dealer portfolio, an allowance for credit losses is established for both outstanding dealer finance receivables and certain unfunded off-balance sheet lending commitments. The allowance for credit losses is measured on a collective basis when loans have similar risk characteristics such as dealer group internal risk rating and loan-to-value ratios. We measure lifetime expected credit losses of our dealer products portfolio segment by applying probability of default and loss given default to the exposure at default on a loan level basis. Probability of default is primarily established based on internal risk assessments. The probability of default model also considers qualitative factors related to macroeconomic outlooks. Loss given default is established based on the nature and market value of the collateral, loan-to-value ratios and other credit quality indicators. Exposure at default represents the expected outstanding principal balance. The lifetime of the loan or lending commitment is regarded by management as the reasonable and supportable period. On an ongoing basis, we review our models, including macroeconomic outlooks, to ensure they reflect the risk of the portfolio.
If management does not believe the models reflect lifetime expected credit
losses, a qualitative adjustment is made to reflect management judgment
regarding observable changes in recent or expected economic trends and
conditions, portfolio composition, and other relevant factors.
The following table provides information related to our allowance for credit losses for finance receivables and certain off-balance sheet lending commitments: Years ended March 31, (Dollars in millions) 2022 2021 2020
Allowance for credit losses at beginning of period
$ 499 Adoption of ASU 2016-13 1 - 292 - Charge-offs (237 ) (287 ) (370 ) Recoveries 58 57 50 Provision for credit losses 236 426 548
Allowance for credit losses at end of period 2
1 Cumulative pre-tax adjustments recorded to retained earnings as of
2020.
2 Ending balance as of
losses related to off-balance-sheet commitments of
respectively, which is included in Other liabilities on the Consolidated Balance Sheets. 48
--------------------------------------------------------------------------------
Years ended March 31, 2022 2021 2020
Allowance for credit losses as a percentage of
finance receivables 1, 2 1.49 % 1.47 %
0.97 %
1 Ending balance as of
losses related to off-balance-sheet commitments of
respectively, which is included in Other liabilities on the Consolidated
Balance Sheets.
2 In conjunction with the adoption of ASU 2016-13 in fiscal 2021, we changed the
presentation of accrued interest from Finance receivables, net to Other
assets. Accordingly, accrued interest is excluded from average finance
receivables with effect from
period continues to be reported for that period.
Our allowance for credit losses increased from$1,215 million atMarch 31, 2021 to$1,272 million atMarch 31, 2022 and the allowance for credit losses as a percentage of finance receivables increased to 1.49 percent in fiscal 2022 from 1.47 percent in fiscal 2021. The increase of$57 million in the allowance for credit losses was primarily due to the increase in size of our retail loan portfolio and an increase in delinquencies, as well as the economic conditions caused by the conflict inUkraine , partially offset by continued improved dealer financial performance in fiscal 2022. Future changes in the economy that impact the consumer and consumer confidence such as increasing interest rates and a rise in the unemployment rate as well as higher debt balances, coupled with deterioration in actual and expected used vehicle values, could result in further increases to our allowance for credit losses. In addition, a decline in the effectiveness of our collection practices could also increase our allowance for credit losses. 49 --------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
Cash Requirements, Obligations, and Arrangements
Our primary material cash requirements include the acquisition of finance receivables and investment in operating leases from dealers, providing various financing to dealers, payments related to debt, interest and interest rate swaps, operating expenses, voluntary protection contract expenses, income taxes, and dividend payments. In conjunction with our cash requirements, we have certain obligations to make future payments under contracts and commitments. Aggregate contractual obligations and commitments in existence atMarch 31, 2022 , are summarized as follows: (Dollars in millions) Payments due by
period
Contractual
obligations 2023 2024 2025 2026 2027 Thereafter Total Debt 1$ 51,171 $ 20,889 $ 13,466 $ 9,642 $ 7,279 $ 7,002 $ 109,449 Estimated interest payments for debt 2 1,175 777 532 365 258 452 3,559 Premises occupied under lease 19 16 14 13 12 45 119 Purchase obligations 3 27 16 - - - - 43 Total$ 52,392 $ 21,698 $ 14,012 $ 10,020 $ 7,549 $ 7,499 $ 113,170
1 Debt reflects the remaining principal obligation. Foreign currency denominated
debt principal is based on exchange rates as of
unamortized premium/discount and debt issuance costs of
2 Interest payments for debt payable in foreign currencies or based on variable
interest rates are estimated using the applicable current rates as of
2022.
3 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. The contracts noted herein contain
voluntary provisions under which the contract may be terminated for a specified
fee depending upon the contract.
The contractual obligations and commitments in the above table do not include our contractual obligations on derivative instruments because future cash obligations under these contracts are inherently uncertain. We recognize all derivative instruments on our consolidated balance sheet at fair value. The amounts recognized as fair value do not represent the amounts that will be ultimately paid or received upon settlement under these contracts. Refer to Note 6 - Derivatives, Hedging Activities and Interest Expense of the Notes to the Consolidated Financial Statements for additional discussion and disclosure. In addition, the contractual obligations and commitments in the above table do not include term loans and revolving lines of credit we extend to dealers and dealer groups and other off-balance sheet guarantees and commitments, as the amount, if any, and timing of future payments is uncertain. We provide fixed and variable rate credit facilities to dealers and various multi-franchise organizations referred to as dealer groups. These credit facilities are typically used for facilities construction and refurbishment, working capital requirements, real estate purchases, business acquisitions, and other general business purposes. These loans are typically secured with liens on real estate, vehicle inventory, and/or other dealership assets, as appropriate, and may be guaranteed by the individual or corporate guarantees of the affiliated dealers, dealer groups, or dealer principals. Refer to Note 9 - Commitments and Contingencies of the Notes to Consolidated Financial Statements for additional discussion and disclosure on credit facility commitments with dealers.
We have also extended credit facilities to affiliates as described in Note 12 -
Related Party Transactions of the Notes to Consolidated Financial Statements.
TMCC has guaranteed the payments of principal and interest with respect to the bond obligations that were issued byPutnam County, West Virginia andGibson County, Indiana to finance the construction of pollution control facilities at manufacturing plants of certain TMCC affiliates. 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 applicable affiliates for any amounts paid. TMCC receives a nominal annual fee 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 9 - Commitments and Contingencies of the Notes to Consolidated Financial Statements. 50 -------------------------------------------------------------------------------- In the ordinary course of business, we enter into agreements containing indemnification provisions standard in the industry related to several types of transactions. Refer to Note 9 - 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 ofMarch 31, 2022 , we determined that it is not probable that we will be required to make any material payments in the future. As ofMarch 31, 2022 and 2021, no amounts have been recorded under these indemnification provisions. Liquidity Liquidity risk is the risk relating to our ability to meet our financial obligations when they come due. Our liquidity strategy is to ensure that we maintain the ability to fund assets and repay liabilities in a timely and cost-effective manner, even in adverse market conditions. Our strategy includes raising funds via the global capital markets and through loans, credit facilities, and other transactions, as well as generating liquidity from our earning assets. This strategy has led us to develop a diversified borrowing base that is distributed across a variety of markets, geographies, investors, and financing structures. Liquidity management involves forecasting and maintaining sufficient capacity to meet our cash needs, including unanticipated events. To ensure adequate liquidity through a full range of potential operating environments and market conditions, we conduct our liquidity management and business activities in a manner that will preserve and enhance funding stability, flexibility and diversity. Key components of this operating strategy include a strong focus on developing and maintaining direct relationships with commercial paper investors and wholesale market funding providers and maintaining the ability to sell certain assets when and if conditions warrant. We develop and maintain contingency funding plans and regularly evaluate our liquidity position under various operating circumstances, allowing us to assess how we will be able to operate through a period of stress when access to normal sources of capital is constrained. The plans project funding requirements during a potential period of stress, specify and quantify sources of liquidity, and outline actions and procedures for effectively managing through the problem period. In addition, we monitor the ratings and credit exposure of the lenders that participate in our credit facilities to ascertain any issues that may arise with potential draws on these facilities if that contingency becomes warranted. We maintain broad access to a variety of domestic and global markets and may choose to realign our funding activities depending upon market conditions, relative costs, and other factors. We believe that our funding sources, combined with operating and investing activities, provide sufficient liquidity to meet future funding requirements and business growth. For liquidity purposes, we hold cash in excess of our immediate funding needs. These excess funds are invested in short-term, highly liquid and investment grade money market instruments as well as certain available-for-sale debt securities, which provide liquidity for our short-term funding needs and flexibility in the use of our other funding sources. We maintained excess funds ranging from$6.6 billion to$11.7 billion with an average balance of$9.1 billion during fiscal 2022. The amount of excess funds we hold may fluctuate, depending on market conditions and other factors. We also have access to liquidity under the$5.0 billion credit facility with TMS, which as ofMarch 31, 2022 had no outstanding amount and is further described in Note 7 - Debt and Credit Facilities of the Notes to the Consolidated Financial Statements. We believe we have sufficient capacity to meet our short-term funding requirements and manage our liquidity. Credit support is provided to us by our indirect parent TFSC, and, in turn, to TFSC by TMC. Taken together, these credit support agreements provide an additional source of liquidity to us, although we do not rely upon such credit support in our liquidity planning and capital and risk management. The credit support agreements are not a guarantee by TMC or TFSC of any securities or obligations of TFSC or TMCC, respectively. The fees paid pursuant to these agreements are disclosed in Note 12 - Related Party Transactions of the Notes to Consolidated Financial Statements. TMC's obligations under its credit support agreement with TFSC rank pari passu with TMC's senior unsecured debt obligations. Refer to Part 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, particularly in those countries experiencing significant economic, fiscal or political strain, and the corresponding likelihood of default. As ofMarch 31, 2022 , our exposure to foreign sovereign and non-sovereign counterparties was not significant. Refer to the "Liquidity and Capital Resources - Credit Facilities and Letters of Credit" section and Part I, Item 1A. Risk Factors - "The failure or commercial soundness of our counterparties and other financial institutions may have an effect on our liquidity, results of operations or financial condition" for further discussion. 51 --------------------------------------------------------------------------------
Funding
The following table summarizes the components of our outstanding debt which
includes unamortized premiums, discounts, debt issuance costs and the effects of
foreign currency translation adjustments:
March 31, 2022 March 31, 2021 Weighted average Weighted average Carrying contractual Carrying contractual
(Dollars in millions) Face value value interest rates
Face value value interest rates Unsecured notes and loans payable Commercial paper$ 16,896 $ 16,876 0.43 %$ 17,027 $ 17,021 0.20 %
("MTN") program 46,387 46,235 1.55 % 44,294 44,149 1.64 %
Euro medium term note
("EMTN") program 13,891 13,813 1.54 % 16,262 16,173 1.57 % Other debt 5,368 5,364 1.28 % 8,176 8,170 1.33 % Total Unsecured notes and loans payable 82,542 82,288 1.30 % 85,759 85,513 1.31 % Secured notes and loans payable 26,907 26,864 1.01 % 24,256 24,212 1.29 % Total debt$ 109,449 $ 109,152 1.23 %$ 110,015 $ 109,725 1.31 %
Unsecured notes and loans payable
The following table summarizes the significant activities by program of our
Unsecured notes and loans payable:
Total Unsecured notes and Commercial loans (Dollars in millions) paper 1 MTNs EMTNs Other payable Balance at March 31, 2021$ 17,027 $ 44,294 $ 16,262 $ 8,176 $ 85,759 Issuances - 17,205 2,141 2,006 21,352 Maturities and terminations (131 ) (15,112 ) (4,150 ) (4,810 ) (24,203 ) Non-cash changes in foreign currency rates - - (362 ) (4 ) (366 ) Balance at March 31, 2022$ 16,896 $ 46,387 $ 13,891 $ 5,368 $ 82,542 Issuances during the one month ended April 30, 2022$ 4,518 $ 250 $ -$ 124 $ 4,892
1 Changes in Commercial paper are shown net due to its short duration.
Commercial paper
Short-term funding needs are met through the issuance of commercial paper in theU.S. Commercial paper outstanding under our commercial paper programs ranged from approximately$16.7 billion to$18.5 billion during fiscal 2022, with an average outstanding balance of$17.2 billion . Our commercial paper programs are supported by the credit facilities discussed under the heading "Credit Facilities and Letters of Credit." We believe we have sufficient capacity to meet our short-term funding requirements and manage our liquidity.
MTN program
We maintain a shelf registration statement with theSEC to provide for the issuance of debt securities in theU.S. capital markets to retail and institutional investors. We currently qualify as a well-known seasoned issuer underSEC rules, which allows us to issue under our registration statement an unlimited amount of debt securities during the three-year period endingJanuary 2024 . Debt securities issued under theU.S. shelf registration statement are issued pursuant to the terms of an indenture which requires TMCC to comply with certain covenants, including negative pledge and cross-default provisions. We are currently in compliance with these covenants. 52 --------------------------------------------------------------------------------
EMTN program
Our EMTN program, shared with our affiliatesToyota Motor Finance (Netherlands) B.V .,Toyota Credit Canada Inc. andToyota Finance Australia Limited (TMCC and such affiliates, the "EMTN Issuers"), provides for the issuance of debt securities in the international capital markets. InSeptember 2021 , the EMTN Issuers renewed the EMTN program for a one-year period. The maximum aggregate principal amount authorized under the EMTN Program to be outstanding at any time is €60.0 billion or the equivalent in other currencies, of which €28.1 billion was available for issuance atApril 30, 2022 . The authorized amount is shared among all EMTN Issuers. The authorized aggregate principal amount under the EMTN program may be increased from time to time. Debt securities issued under the EMTN program are issued pursuant to the terms of an agency agreement. Certain debt securities issued under the EMTN program are subject to negative pledge provisions. We are currently in compliance with these covenants. We may issue other debt securities through the global capital markets or enter into other unsecured financing arrangements, including those in which we agree to use the proceeds solely to acquire retail or lease contracts financing newToyota and Lexus vehicles of specified "green" models. The terms of these "green" bond transactions have been consistent with the terms of other similar transactions except that the proceeds we receive are included in Restricted cash and cash equivalents on our Consolidated Balance Sheets, when applicable.
Other debt
TMCC has entered into term loan agreements with various banks. These term loan agreements contain covenants and conditions customary in transactions of this nature, including negative pledge provisions, cross-default provisions and limitations on certain consolidations, mergers and sales of assets. We are currently in compliance with these covenants and conditions. We may borrow from affiliates on terms based upon a number of business factors such as funds availability, cash flow timing, relative cost of funds, and market access capabilities. Amounts borrowed from affiliates are recorded in Other liabilities on our Consolidated Balance Sheets and are therefore excluded from Debt amounts.
Secured notes and loans payable
Asset-backed securitization of our earning asset portfolio provides us with an
alternative source of funding. We regularly execute public or private
securitization transactions.
The following table summarizes the significant activities of our Secured notes and loans payable: Secured notes and loans (Dollars in millions) payable Balance at March 31, 2021$ 24,256 Issuances 16,726 Maturities and terminations (14,075 ) Balance at March 31, 2022$ 26,907
Issuances during the one month ended
We securitize finance receivables and beneficial interests in investments in operating leases ("Securitized Assets") using a variety of structures. Our securitization transactions involve the transfer of Securitized Assets to bankruptcy-remote special purpose entities. These bankruptcy-remote entities are used to ensure that the Securitized Assets are isolated from the claims of creditors of TMCC and that the cash flows from these assets are available solely for the benefit of the investors in these asset-backed securities. Investors in asset-backed securities do not have recourse to our Other assets, and neither TMCC nor our affiliates guarantee these obligations. We are not required to repurchase or make reallocation payments with respect to the Securitized Assets that become delinquent or default after securitization. As seller and servicer of the Securitized Assets, we are required to repurchase or make a reallocation payment with respect to the underlying assets that are subsequently discovered not to have met specified eligibility requirements. This repurchase obligation is customary in securitization transactions. With the exception of our revolving asset-backed securitization program, funding obtained from our securitization transactions is repaid as the underlying Securitized Assets amortize. 53 -------------------------------------------------------------------------------- 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. Our securitizations are structured to provide credit enhancement to reduce the risk of loss to security holders and other interest holders in the asset-backed securities. Credit enhancement may include some or all of the following: • Overcollateralization: The principal of the Securitized Assets that exceeds the principal amount of the related secured debt.
• Excess spread: The expected interest collections on the Securitized
Assets that exceed the expected fees and expenses of the special purpose
entity, including the interest payable on the debt, net of swap settlements, if any.
• Cash reserve funds: A portion of the proceeds from the issuance of
asset-backed securities may be held by the securitization trust in a
segregated reserve fund and may be used to pay principal and interest to
security holders and other interest holders if collections on the underlying receivables are insufficient. • Yield supplement arrangements: Additional overcollateralization may be provided to supplement the future contractual interest payments from securitized receivables with relatively low contractual interest rates.
• Subordinated notes: The subordination of principal and interest payments
on subordinated notes may provide additional credit enhancement to holders of senior notes. In addition to the credit enhancement described above, we may enter into interest rate swaps with our special purpose entities that issue variable rate debt. Under the terms of these swaps, the special purpose entities are obligated to pay TMCC a fixed rate of interest on payment dates in exchange for receiving a floating rate of interest on notional amounts equal to the outstanding balance of the secured notes and loans payable. This arrangement enables the special purpose entities to mitigate the interest rate risk inherent in issuing variable rate debt that is secured by fixed rate Securitized Assets. Securitized Assets and the related debt remain on our Consolidated Balance Sheets. We recognize financing revenue on the Securitized Assets. We also recognize interest expense on the secured notes and loans payable issued by the special purpose entities and maintain an allowance for credit losses on the Securitized Assets to cover estimated lifetime expected credit losses using a methodology consistent with that used for our non-securitized asset portfolio. The interest rate swaps between TMCC and the special purpose entities are considered intercompany transactions and therefore are eliminated in our consolidated financial statements. We periodically enter into term securitization transactions whereby we agree to use the proceeds solely to acquire retail and lease contracts financing newToyota and Lexus vehicles of certain specified "green" models. The terms of these "green" securitization transactions have been consistent with the terms of our other similar transactions except that the proceeds we receive are included in Restricted cash and cash equivalents on our Consolidated Balance Sheets, when applicable. Our secured notes also include a revolving asset-backed securitization program, backed by a revolving pool of finance receivables and cash collateral. Cash flows from these receivables during the revolving period in excess of what is needed to pay certain expenses of the securitization trust and contractual interest payments on the related secured notes may be used to purchase additional receivables, provided that certain conditions are met following the purchase. The secured notes feature a scheduled revolving period, with the ability to repay the secured notes in full, after which an amortization period begins. The revolving period may also end with the amortization period beginning upon the occurrence of certain events that include certain segregated account balances falling below their required levels, credit losses or delinquencies on the pool of assets supporting the secured notes exceeding specified levels, the adjusted pool balance falling to less than 50% of the initial principal amount of the secured notes, or interest not being paid on the secured notes. 54 --------------------------------------------------------------------------------
Public Securitization
We maintain a shelf registration statement with theSEC to provide for the issuance of securities backed by Securitized Assets in theU.S. capital markets during the three-year period endingDecember 2024 . We regularly sponsor public securitization trusts that issue securities backed by retail finance receivables, including registered securities that we retain. None of these securities have defaulted, experienced any events of default or failed to pay principal in full at maturity. As ofMarch 31, 2022 and 2021, we did not have any outstanding lease securitization transactions registered with theSEC .
Credit Facilities and Letters of Credit
For additional liquidity purposes, we maintain credit facilities, which may be
used for general corporate purposes, as described below:
364-Day Credit Agreement, Three-Year Credit Agreement and Five-Year Credit
Agreement
TMCC,Toyota Credit de Puerto Rico Corp. ("TCPR"), a wholly-owned subsidiary, and otherToyota affiliates are party to a$5.0 billion 364-day syndicated bank credit facility, a$5.0 billion three-year syndicated bank credit facility, and a$5.0 billion five-year syndicated bank credit facility, expiring in fiscal 2023, 2025, and 2027, respectively. The ability to make draws is subject to covenants and conditions customary in transactions of this nature, including negative pledge provisions, cross-default provisions and limitations on certain consolidations, mergers and sales of assets. These agreements were not drawn upon and had no outstanding balances as ofMarch 31, 2022 and 2021. We are currently in compliance with the covenants and conditions of the credit agreements described above.
Committed Revolving Asset-backed Facility
We are party to a 364-day revolving securitization facility with certain bank-sponsored asset-backed conduits and other financial institutions expiring in fiscal 2023. Under the terms and subject to the conditions of this facility, the committed lenders under the facility have committed to make advances up to a facility limit of$7.0 billion backed by eligible retail finance receivables transferred by us to a special-purpose entity acting as borrower. We utilized$3.2 billion of this facility as ofMarch 31, 2022 and 2021, respectively.
Other Unsecured Credit Agreements
TMCC is party to additional unsecured credit facilities with various banks. As ofMarch 31, 2022 , TMCC had committed bank credit facilities totaling$4.6 billion of which$2.3 billion ,$300 million , and$2.0 billion mature in fiscal 2023, 2024, and 2025 respectively. These credit agreements contain covenants and conditions customary in transactions of this nature, including negative pledge provisions, cross-default provisions and limitations on certain consolidations, mergers and sales of assets. These credit facilities were not drawn upon and had no outstanding balances as ofMarch 31, 2022 and 2021. We are currently in compliance with the covenants and conditions of the credit agreements described above.
TMCC is party to a
expiring in fiscal 2025. This credit facility was not drawn upon and had no
outstanding balance as of
From time to time, we may borrow from affiliates based upon a number of business factors such as funds availability, cash flow timing, relative cost of funds, and market access capabilities. 55 --------------------------------------------------------------------------------
Credit Ratings
The cost and availability of unsecured financing is influenced by credit ratings, which are intended to be an indicator of the creditworthiness of a particular company, security, or obligation. Lower ratings generally result in higher borrowing costs as well as reduced access to capital markets. Credit ratings are not recommendations to buy, sell, or hold securities, and are subject to revision or withdrawal at any time by the assigning credit rating organization. Each credit rating organization may have different criteria for evaluating risk, and therefore ratings should be evaluated independently for each organization. Our credit ratings depend in part on the existence of the credit support agreements of TFSC and TMC. Refer to Part I, Item 1A. Risk Factors - "Our borrowing costs and access to the unsecured debt capital markets depend significantly on the credit ratings of TMCC and its parent companies and our credit support arrangements."
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 intangible assets) of at leastJPY 10 million , equivalent to$82 thousand atMarch 31, 2022 ; 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 unless and until (1) all Securities issued on or prior to the date of the termination notice have been repaid or (2) each rating agency that has issued a rating in respect of TFSC or any Securities upon the request of TMC or TFSC 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 ofJapan .
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 intangible 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,
"
The agreement is not a guarantee by TFSC of anyTMCC Securities . 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 ofJapan .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. Holders ofTMCC 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 receive such a claim from any holder ofTMCC 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 ofTMCC 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
56 -------------------------------------------------------------------------------- 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 ofTCPR 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 ofTCPR Securities entitled to credit support.
Derivative Instruments
Our liabilities consist mainly of fixed and variable rate debt, denominated inU.S dollars and various other currencies, which we issue in the global capital markets, while our assets consist primarily ofU.S. dollar denominated, fixed rate receivables. We enter into interest rate swaps and foreign currency swaps to economically hedge the interest rate and foreign currency risks that result from the different characteristics of our assets and liabilities. Our use of derivative transactions is intended to reduce long-term fluctuations in the fair value of assets and liabilities caused by market movements. All of our derivatives are categorized as not designated for hedge accounting, and all of our derivative activities are authorized and monitored by our management and our Asset-Liability Committee ("ALCO") which provides a framework for financial controls and governance to manage market risk. Refer to Note 6 - Derivatives, Hedging Activities and Interest Expense of the Notes to Consolidated Financial Statements for further discussion and disclosure on derivative instruments. 57
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LIBOR TRANSITION
The publication of non-U.S. dollar LIBOR rates on a representative basis, as well as the publication of the lesser used 1-week and 2-monthU.S. dollar LIBOR tenors, ceased as of the end ofDecember 2021 . While the most commonly usedU.S. dollar LIBOR tenors are expected to continue to be published untilJune 30, 2023 ,U.S. banking agencies issued guidance that financial institutions should cease usingU.S. dollar LIBOR as a reference rate in new contracts afterDecember 31, 2021 . We are exposed to LIBOR-based financial instruments, including through our dealer financing activities, derivative contracts, secured and unsecured debt, and investment securities. To facilitate an orderly transition from LIBOR to alternative reference rates ("ARRs"), we have established an initiative led by senior management, with Board and committee oversight, to assess, monitor and mitigate risks associated with the expected discontinuation of LIBOR, to achieve operational readiness and engage impacted borrowers and counterparties in connection with the transition to ARRs. Our efforts under this initiative include monitoring developments and the usage of ARRs, monitoring the regulatory and financial reporting guidance, as well as reviewing and updating current legal contracts, internal systems and processes to accommodate the use of ARRs. For example, we have committed to using Secured Overnight Financing Rate ("SOFR") linked rates in connection with various borrowing arrangements and Prime in connection with various lending arrangements, and we continue to evaluate other alternatives as potential ARRs to LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized byU.S. Treasury securities, and is based on directly observableU.S. Treasury -backed repurchase transactions. We are also continuously assessing how the expected discontinuation of LIBOR will impact accounting and financial reporting. For example, onApril 1, 2021 , we adopted ASU 2020-04, Reference Rate Reform: Facilitation of the Effects of Reference Rate Reform on Financial Reporting, as further discussed in Note 1 - Basis of Presentation and Significant Accounting Policies of the Notes to Consolidated Financial Statements. Refer to Part I, Item 1A. Risk Factors - "The transition away from theLondon Interbank Offered Rate ("LIBOR") and the adoption of alternative reference rates could adversely impact our business and results of operations" for further discussion. 58 --------------------------------------------------------------------------------
NEW ACCOUNTING GUIDANCE
Refer to Note 1 - Basis of Presentation and Significant Accounting Policies of
the Notes to Consolidated Financial Statements.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with accounting principles generally accepted inthe United States of America (U.S. GAAP) requires management to make certain estimates which affect reported financial results. The evaluation of the factors used in determining each of our critical accounting estimates involves significant assumptions, complex analyses, and management judgment. Changes in the evaluation of these factors may have a significant impact on the consolidated financial statements. Additionally, due to inherent uncertainties in making estimates, actual results could differ from those estimates, and those differences could be material. The accounting estimates we consider to be critical are the following: • Accumulated depreciation on investment in operating leases; and • Allowance for credit losses
Accumulated Depreciation on Investment in Operating Leases
Accumulated depreciation on investment in operating leases reduces the value of the leased vehicles from their original value at acquisition to their expected market value at the end of the lease term. Refer to Note 5 - Investments in Operating Leases, Net of the Notes to Consolidated Financial Statements for further discussion and disclosure of our investment in operating leases, including accumulated depreciation.
Nature of Estimates and Assumptions Required
The accumulated depreciation on investment in operating leases is based on assumptions of end-of-term market value of the leased vehicles and the number of vehicles that will be returned at maturity. At the inception of a lease, the residual values are estimated by examining external industry data, the anticipatedToyota and Lexus 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, competitor actions and behavior, product attributes of popular vehicles, the mix and level of used vehicle supply, current and projected used vehicle values, the actual or perceived quality, safety or reliability ofToyota and Lexus vehicles, buying and leasing behavior trends, and fuel prices. We review the estimated end-of-term market values of leased vehicles to assess the appropriateness of their carrying values on a quarterly basis. To the extent the estimated end-of-term market value of a leased vehicle is lower than the contractual 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 the contractual 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. 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 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. 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.
Sensitivity Analysis
AtMarch 31, 2022 , holding other estimates constant, if end-of-term market values for returned units were to decrease by one percent from our present estimates, the effect would be to increase depreciation expense by approximately$92 million . If the forecasted end-of-term market value of a leased vehicle is less than the contractual residual value, additional depreciation expense is recorded. AtMarch 31, 2022 , holding other estimates constant, if the return rate for our existing lease portfolio were to increase by one percentage point from our present estimates, the effect would be to increase depreciation expense by approximately$15 million . Adjustments are made on a straight-line basis over the remaining terms of the leases and are included in Investment in operating leases, net on our Consolidated Balance Sheets and in Depreciation on operating leases in our Consolidated Statements of Income. 59 --------------------------------------------------------------------------------
Allowance for Credit Losses
We maintain an allowance for credit losses to cover lifetime expected credit losses as of the balance sheet date on our earning assets resulting from the failure of customers or dealers to make required payments. For evaluation purposes, exposures to credit losses are segmented into the two primary categories of "retail loan" and "dealer". Our retail loan portfolio consists, for accounting purposes, of our retail loan portfolio segment which is characterized by smaller contract balances than our dealer portfolio. Our dealer portfolio consists, for accounting purposes, of our dealer products portfolio segment. The overall allowance is evaluated at least quarterly, considering a variety of assumptions and factors to determine whether allowances are considered adequate to cover lifetime expected credit losses as of the balance sheet date. Refer to Note 4 - Allowance for Credit Losses of the Notes to Consolidated Financial Statements for further discussion and disclosure of our allowance for credit losses. Retail Loan Portfolio The level of credit risk for the retail loan portfolio is influenced by various factors such as economic conditions, the used vehicle market, credit quality, contract structure, and collection strategies and practices. The allowance for credit losses is measured on a collective basis when loans have similar risk characteristics such as loan-to-value ratio, book payment-to-income ratio, FICO score at origination, collateral type, contract term, and other relevant factors. We use statistical models to estimate lifetime expected credit losses of our retail loan portfolio segment by applying probability of default and loss given default to the exposure at default on a loan level basis. Probability of default models are developed from internal risk scoring models which consider variables such as delinquency status, historical default frequency, and other credit quality indicators such as loan-to-value ratio, book payment to income ratio, FICO score at origination, collateral type (new or used, Lexus,Toyota , or private label), and contract term. Loss given default models forecast the extent of losses given that a default has occurred and considers variables such as collateral, trends in recoveries, historical loss severity, and other contract structure variables. Exposure at default represents the expected outstanding principal balance, including the effects of expected prepayment when applicable. The lifetime expected credit losses incorporate the probability-weighted forward-looking macroeconomic forecasts for baseline, favorable, and adverse scenarios. The loan lifetime is regarded by management as the reasonable and supportable period. We use macroeconomic forecasts from a third party and update such forecasts quarterly. On an ongoing basis, we review our models, including macroeconomic factors, the selection of macroeconomic scenarios and their weighting to ensure they reflect the risk of the portfolio.
If management does not believe the models reflect lifetime expected credit
losses, a qualitative adjustment is made to reflect management judgment
regarding observable changes in recent or expected economic trends and
conditions, portfolio composition, and other relevant factors.
Dealer Portfolio
The level of credit risk in the dealer portfolio is influenced primarily 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 the financial condition of automotive manufacturers. The allowance for credit losses is established for both outstanding dealer finance receivables and certain unfunded off-balance sheet lending commitments. The allowance for credit losses is measured on a collective basis when loans have similar risk characteristics such as dealer group internal risk rating and loan-to-value ratios. We measure lifetime expected credit losses of our dealer products portfolio segment by applying probability of default and loss given default to the exposure at default on a loan level basis. Probability of default is primarily established based on internal risk assessments. The probability of default model also considers qualitative factors related to macroeconomic outlooks. Loss given default is established based on the nature and market value of the collateral, loan-to-value ratios and other credit quality indicators. Exposure at default represents the expected outstanding principal balance. The lifetime of the loan or lending commitment is regarded by management as the reasonable and supportable period. On an ongoing basis, we review our models, including macroeconomic outlooks, to ensure they reflect the risk of the portfolio.
If management does not believe the models reflect lifetime expected credit
losses, a qualitative adjustment is made to reflect management judgment
regarding observable changes in recent or expected economic trends and
conditions, portfolio composition, and other relevant factors.
Sensitivity Analysis
The assumptions used in evaluating our exposure to credit losses involve estimates and significant judgment. The majority of our credit losses are related to our retail loan portfolio. Holding other estimates constant, a 10 percent increase or decrease in the assumptions used to derive probability of default and loss given default would have resulted in a change in the allowance for credit losses of$120 million as ofMarch 31, 2022 . 60
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