UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

Commission file number 001-15515

 

Textron Financial Corporation

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Registrant’s Telephone Number, Including Area Code: (401) 621-4200

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

 

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $100.00 par value

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act.  Yes X No   

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes    No X

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes X No   

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes    No   

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (Not applicable).

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes    No X

 

All of the shares of common stock of the registrant are owned by Textron Inc. and there was no voting or non-voting common equity held by non-affiliates as of the last business day of the registrant’s most recently completed fiscal quarter.

 

REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I (1) (a) AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT.

 

 

TABLE OF CONTENTS

 

 

 

General

 

Textron Financial Corporation (Textron Financial, TFC or the Company) is a diversified commercial finance company. In the fourth quarter of 2008, Textron Inc. (Textron) announced a plan to exit all of our commercial finance business, other than the portion supporting the financing of customer purchases of products which Textron manufactures. In the second quarter of 2009, we changed our management structure for the captive business to facilitate the management of its operations. Due to this change, we consolidated the portion of the former Golf Finance segment that finances customer purchases of Textron manufactured golf and turf-care equipment into the former Aviation Finance segment, forming the new Captive Finance segment. In the fourth quarter of 2009, due to further changes in how the performance of our business is measured and consolidation of our management and operational structure, we combined all remaining portions of our former operating segments into a new Non-captive Finance segment, which represents the business we are liquidating. All comparative segment information for prior periods has been recast to reflect this change.

 

We will continue to originate new customer relationships and finance receivables in the Captive Finance segment, which includes the Aviation and Golf Equipment product lines. The Aviation product line primarily provides loans, finance leases and operating leases to purchasers of new Cessna aircraft and Bell helicopters. Financing continues to be provided to purchasers of used Cessna aircraft and Bell helicopters on a limited basis. The Golf Equipment product line primarily provides finance and operating leases to purchasers of new E-Z-GO and Jacobsen golf and turf-care equipment. The Captive Finance segment also continues to manage our portfolio of loans and leases secured by non-Textron manufactured aircraft.

 

The Non-captive Finance segment now includes the Asset-Based Lending, Distribution Finance, Golf Mortgage, Hotel, Structured Capital, Timeshare and Other Liquidating product lines. Asset-Based Lending has historically provided revolving credit facilities secured by receivables and inventory and related equipment and real estate term loans, and factoring programs across a broad range of manufacturing and service industries; Distribution Finance has offered inventory finance programs for dealers of Textron manufactured products and for dealers of a variety of other household, housing, leisure, agricultural and technology products; Golf Mortgage has historically made mortgage loans for the acquisition and refinancing of golf courses; the Hotel product line was previously a component of our former Resort Finance segment and has historically provided mortgage loans for the construction and refinancing of hotels; the Timeshare product line has historically extended loans to developers of vacation interval resorts, secured principally by notes receivable and interval inventory; and Structured Capital has primarily engaged in long-term leases of large-ticket equipment and real estate, primarily with investment grade lessees.

 

Textron Financial’s financing activities are offered primarily in North America. However, we finance certain Textron products worldwide, principally Bell helicopters and Cessna aircraft. All of Textron Financial’s stock is owned by Textron, a global multi-industry company with operations in five business segments: Cessna, Bell, Textron Systems, Industrial and Finance. At January 2, 2010, 40% of Textron Financial’s total managed finance receivables represent finance receivables originated in support of Textron manufactured products. For further information on Textron Financial’s relationship with Textron, see “Relationship with Textron” below.

 

For additional financial information regarding Textron Financial’s business segments, refer to Note 18 to the Consolidated Financial Statements in Item 8 of this Form 10-K.

 

Competition

 

The commercial finance environment in which Textron Financial’s Captive Finance segment continues to operate has traditionally been extremely competitive. Textron Financial is subject to competition from various types of financing institutions, including banks, leasing companies, commercial finance companies and finance operations of equipment vendors. Competition within the commercial finance industry is primarily focused on price, term, structure and service. The Company may lose market share to the extent that it is unwilling to match competitors’ practices. To the extent that Textron Financial matches these practices, the Company may experience

decreased margins, increased risk of credit losses or both. Many of Textron Financial’s competitors are large companies that have substantial capital, technological and marketing resources. In some instances, Textron Financial’s competitors have access to capital at lower costs than Textron Financial.

 

Relationship with Textron

 

General

 

Textron Financial derives all of its continuing business from financing the sale and lease of products manufactured and sold by Textron. Textron Financial paid Textron $0.6 billion in 2009, $1.0 billion in 2008 and $1.2 billion in 2007 for the sale of manufactured products to third parties that were financed by the Company. In addition, the Company paid Textron $13 million in 2009, $18 million in 2008 and $27 million in 2007 for the purchase of equipment on operating leases. Textron Financial recognized finance charge revenues from Textron and affiliates (net of payments or reimbursements for interest charged at more or less than market rates on Textron manufactured products) of $3 million in 2009, $2 million in 2008 and $4 million in 2007, and operating lease revenues of $20 million in 2009, $29 million in 2008 and $27 million in 2007.

 

Textron Financial and Textron utilize an intercompany account for the allocation of Textron overhead charges and for the settlement of captive finance receivables. For additional information regarding the relationship between Textron Financial and Textron, see Notes 4, 5 and 10 to the Consolidated Financial Statements in Item 8 of this Form 10-K.

 

Agreements with Textron

 

Textron Financial and Textron are parties to several agreements, which govern many areas of the Textron Financial-Textron relationship. The material agreements are described below:

 

Receivables Purchase Agreement

 

Under a Receivables Purchase Agreement with Textron, Textron Financial has recourse to Textron with respect to certain finance receivables and operating leases relating to products manufactured and sold by Textron. Finance receivables of $76 million at January 2, 2010 and $54 million at January 3, 2009, and operating leases of $140 million at January 2, 2010 and $152 million at January 3, 2009, were subject to recourse to Textron or due from Textron.

 

Support Agreement with Textron

 

Under a Support Agreement with Textron dated as of May 25, 1994, Textron is required to pay to Textron Financial, quarterly, a cash payment sufficient to provide that Textron Financial maintains fixed charge coverage of no less than 125%. In 2009 and 2008, Textron Financial’s fixed charge coverage ratio dropped below the required 125%. As a result, Textron made cash payments of $270 million and $625 million to Textron Financial in 2009 and 2008, respectively, and an additional payment of $75 million on January 12, 2010, which were reflected as capital contributions to maintain compliance with the fixed charge coverage ratio required by the Support Agreement and certain of Textron Financial’s credit agreements. Textron also has agreed to maintain Textron Financial’s consolidated shareholder’s equity at an amount not less than $200 million. Pursuant to the terms of the Support Agreement, Textron is required to maintain a controlling interest in Textron Financial. The Support Agreement also contains a third-party beneficiary provision entitling Textron Financial’s lenders to enforce its provisions against Textron.

 

Intercompany Loan Agreement

 

In 2009 and 2008, pursuant to the terms of an Intercompany Loan Facility Agreement, Textron agreed to lend funds to Textron Financial, with interest. As of January 2, 2010 and January 3, 2009, we had an outstanding balance due to Textron of $447 million and $133 million, respectively, and had paid interest of $3 million in both 2009 and 2008. The interest rate on this borrowing at January 2, 2010 and January 3, 2009 was 7.00% and 4.03%,

respectively. These borrowings are reflected in Amounts due to Textron Inc. on Textron Financial’s Consolidated Balance Sheets.

 

Tax Sharing Agreement with Textron

 

Textron Financial’s revenues and expenses are included in the consolidated federal tax return of Textron. The Company files some of its state income tax returns on a separate basis. Under a Tax Sharing Agreement with Textron, Textron Financial is allocated federal tax benefits and charges on the basis of statutory U.S. tax rates applied to the Company’s taxable income or loss included in the consolidated returns. The benefits of general business credits, foreign tax credits and any other tax credits are utilized in computing current tax liability. Textron Financial is paid for tax benefits generated and utilized in Textron’s consolidated federal and unitary or combined state income tax returns, whether or not the Company would have been able to utilize those benefits on a separate tax return. Income tax assets or liabilities are settled on a quarterly basis. Textron has agreed to lend Textron Financial, on a junior subordinated interest-free basis, an amount equal to Textron’s deferred income tax liability attributable to the manufacturing profit not yet recognized for tax purposes on products manufactured by Textron and financed by Textron Financial. Borrowings under this arrangement are reflected in “Amounts due to Textron Inc.” on the Consolidated Balance Sheets in Item 8 of this Form 10-K.

 

Regulations

 

Textron Financial’s activities are subject, in certain instances, to supervision and regulation by state and federal governmental authorities. These activities also may be subject to various laws, including consumer finance laws in some instances, and judicial and administrative decisions imposing various requirements and restrictions, which, among other things:

 

 

Although most states do not intensively regulate commercial finance activity, many states impose limitations on interest rates and other charges, and prohibit certain collection and recovery practices. They also may require licensing of certain business activities and specific disclosure of certain contract terms. The Company also may be subject to regulation in those foreign countries in which it has operations.

 

Existing statutes and regulations have not had a material adverse effect on the Company’s business. However, it is not possible to forecast the nature of future legislation, regulations, judicial decisions, orders or interpretations or their impact upon Textron Financial’s future business, financial condition, results of operations or prospects.

 

Employees

 

As of January 2, 2010, Textron Financial had 467 employees. The Company is not subject to any collective bargaining agreements.

 

Risk Management

 

Textron Financial’s business activities involve various elements of risk. The Company considers the principal types of risk to be:

 

Proper management of these risks is essential. Accordingly, the Company has designed risk management systems and procedures to identify and quantify these risks. Textron Financial has established appropriate policies

and set prudent limits in these areas. The Company’s management of these risks, and levels of compliance with its policies and limits, is continuously monitored by means of administrative and information systems.

 

Credit Risk Management

 

Textron Financial manages credit risk through:

 

 

The Company has developed underwriting procedures for the Captive Finance segment which assess a prospective customer’s ability to perform in accordance with financing terms. We have also developed workout and restructuring procedures for both the Captive and Non-captive segments. These procedures include:

 

 

Textron Financial has developed a tiered credit approval system, which allows certain transaction types and sizes to be approved at the operating unit level. The delegation of credit authority is done under strict policy guidelines. Textron Financial’s operating units are also subject to annual internal audits by the Company and Textron.

 

Depending on transaction size and complexity, transactions outside of the segment’s authority require the approval of the Captive Finance segment President and Group Credit Officer. Transactions exceeding segment authority require one or more of the Executive Vice President and Chief Credit Officer, the President and Chief Executive Officer or Textron Financial’s Credit Committee depending on the size of the transaction, and in some cases approvals are required by Textron up to and including its Board of Directors. As of February 25, 2010, Textron Financial’s Credit Committee is comprised of its President and Chief Executive Officer, Executive Vice President and Chief Credit Officer, Executive Vice President and Chief Financial Officer, Executive Vice President, General Counsel and Secretary, Textron Assistant Treasurer, Executive Vice President Special Assets, the Distribution Finance product line President and the Timeshare product line President.

 

The Company controls the credit risk associated with its portfolio by limiting transaction sizes, as well as diversifying transactions by industry, geographic area, property type and borrower. Through these practices, Textron Financial identifies and limits exposure to unfavorable risks and seeks favorable financing opportunities. Management reviews receivable aging trends and watch list reports and conducts regular business reviews in order to monitor portfolio performance. Certain receivable transactions are originated with the intent of fully or partially selling them. This strategy provides an additional tool to manage credit risk.

 

Geographic Concentration

 

Textron Financial continuously monitors its portfolio to avoid any undue geographic concentration in any region of the U.S. or in any foreign country. At January 2, 2010, the largest concentration of domestic finance receivables was in the Southeastern U.S., representing 23% of Textron Financial’s managed finance receivable portfolio. At January 2, 2010, international finance receivables represented 30% of Textron Financial’s managed finance receivable portfolio. For additional information regarding Textron Financial’s concentrations, see Note 5 to the Consolidated Financial Statements in Item 8 of this Form 10-K.

 

Asset/Liability Risk Management

 

The Company continuously measures and quantifies interest rate risk and foreign exchange risk, in each case taking into account the effect of hedging activity. Textron Financial uses derivatives as an integral part of its asset/liability management program in order to reduce:

 

 

The Company does not use derivative financial instruments for the purpose of generating earnings from changes in market conditions. Before entering into a derivative transaction, the Company determines that there is a high correlation between the change in value of, or the cash flows associated with, the hedged asset or liability and the value of, or the cash flows associated with, the derivative instrument. When Textron Financial executes a transaction, it designates the derivative to a specific asset, liability, or set of cash flows and as either a fair value or cash flow hedge. Textron Financial monitors the effectiveness of derivatives through a review of the amounts and maturities of assets, liabilities and derivative positions. The Company’s Chief Financial Officer and Textron’s Vice President and Assistant Treasurer regularly review this information, so that appropriate remedial action can be taken, as necessary.

 

Textron Financial carefully manages exposure to counterparty risk in connection with its derivatives. In general, the Company engages in transactions with counterparties having ratings of at least A by Standard & Poor’s Rating Service or A2 by Moody’s Investors Service. Total credit exposure is monitored by counterparty, and managed within prudent limits. At January 2, 2010, the Company’s largest single counterparty credit exposure was $19 million.

 

Interest Rate Risk Management

 

Textron Financial manages interest rate risk by monitoring the duration and interest rate sensitivities of its assets, and by incurring liabilities (either directly or synthetically with derivatives) having a similar duration and interest sensitivity profile. The Company’s internal policies limit the aggregate mismatch of floating-rate assets and liabilities to 10% of total assets. For additional information regarding Textron Financial’s interest rate risk, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Interest Rate Sensitivity,” in Item 7 of this Form 10-K.

 

Foreign Exchange Risk Management

 

A portion of the finance assets owned by Textron Financial are located outside of North America. These finance receivables are generally in support of Textron’s overseas product sales and are predominantly denominated in U.S. Dollars. Textron Financial has foreign currency finance receivables primarily denominated in Canadian Dollars. In order to minimize the effect of fluctuations in foreign currency exchange rates on the Company’s financial results, Textron Financial borrows in these currencies and/or enters into forward exchange contracts and foreign currency interest rate exchange agreements in amounts sufficient to substantially hedge its foreign currency exposures.

 

Liquidity Risk Management

 

The Company requires cash to fund asset originations in support of the sales of Textron manufactured products and to meet debt obligations and other commitments. Textron Financial’s primary sources of funds are:

 

 

On February 3, 2009, we drew down on the available balance of the $1.75 billion committed bank credit line due to the economic environment and the risks associated with the capital markets in general, including the difficulty in accessing sufficient commercial paper on a daily basis. Textron also drew down on the available balance of its $1.25 billion committed bank credit line. These borrowings were utilized to repay all commercial paper outstanding. The remaining cash, combined with the proceeds from liquidation, have been used to repay our maturing debt and securitization obligations. For additional information regarding Textron Financial’s liquidity risk management, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources,” in Item 7 of this Form 10-K.

Available Information

 

The Company makes available free of charge on its Internet website (http://www.textronfinancial.com) its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission.

 

Forward-looking Information

 

Certain statements in this Annual Report on Form 10-K and other oral and written statements made by Textron Financial from time to time are forward-looking statements, including those that discuss strategies, goals, outlook or other non-historical matters; or project revenues, income, returns or other financial measures. These forward-looking statements speak only as of the date on which they are made, and we undertake no obligation to update or revise any forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those contained in the statements, including the Risk Factors contained herein and the following: (a) changes in worldwide economic, political or regulatory conditions that impact interest and foreign exchange rates; (b) the occurrence of slowdowns or downturns in customer markets in which Textron products are sold or supplied and financed or where we hold finance receivables; (c) the ability to realize full value of finance receivables and investments in securities; (d) the ability to control costs and successful implementation of various cost-reduction programs; (e) increases in pension expenses and other postretirement employee costs; (f) the impact of changes in tax legislation; (g) the ability to maintain portfolio credit quality and certain minimum levels of financial performance required under our committed bank line of credit and under our Support Agreement with Textron; (h) access to financing, including securitizations, at competitive rates; (i) access to equity in the form of retained earnings and capital contributions from Textron; (j) uncertainty in estimating contingent liabilities and establishing reserves to address such contingencies; (k) the launching of significant new products or programs which could result in unanticipated expenses; (l) risks and uncertainties related to acquisitions and dispositions, including difficulties or unanticipated expenses in connection with the consummation of acquisitions or dispositions, the disruption of current plans and operations, or the failure to achieve anticipated synergies and opportunities; (m) the ability to successfully exit from our commercial finance business, other than the captive finance business, including effecting an orderly liquidation or sale of certain portfolios and businesses; (n) uncertainty in estimating the market value of our Finance receivables held for sale and our Allowance for losses on finance receivables held for investment; (o) bankruptcy or other financial problems at major customers that could cause disruptions or difficulty in collecting amounts owed by such customers; (p) legislative or regulatory actions impacting our operations; (q) difficult conditions in the financial markets which may adversely impact our ability to obtain financing for our new finance receivable originations and, with respect to businesses which we are exiting, our customers’ ability to obtain alternative financing negatively impacting their ability to repay amounts owed to us; and (r) continued volatility in the economy resulting in a prolonged downturn in the markets in which we do business.

 

 

Our business, financial condition and results of operations are subject to various risks, including those discussed below, which may affect the value of our securities. The risks discussed below are those that we believe currently are the most significant, although additional risks not presently known to us or that we currently deem less significant also may impact our business, financial condition or results of operations, perhaps materially.

 

We may not be able to continue to execute the liquidation of our Non-captive Finance segment at a favorable pace and level of recovery.

 

In the fourth quarter of 2008, we announced a plan to exit all of the commercial finance business other than that portion of the business supporting customer purchases of products manufactured by Textron. The exit plan is being implemented through a combination of orderly liquidation and selected sales. We cannot be certain that we will be able to continue to accomplish the orderly liquidation of our portfolio on a timely or successful basis or in a manner that will generate cash sufficient to service our debt. We may encounter delays and difficulties in effecting

the continued orderly liquidation of our various receivable portfolios as a result of many factors, including the inability of our customers to find alternative financing, which could expose us to increased credit losses. We may have greater difficulty in selling the remaining receivables that have been designated for sale or transfer, assets that have been acquired upon foreclosure of receivables and/or other non-operating assets at the pricing that we anticipate or in the time frame that we anticipate. We may be required to make additional mark-to-market or other adjustments against the assets that we intend to sell or to take additional reserves against assets that we intend to retain. We may change our current strategy based on either our performance and liquidity position or changes in external factors affecting the value and/or marketability of our assets, which could result in changes in the classification of assets we intend to hold for investment and additional mark-to-market adjustments. We may incur higher costs than anticipated as a result of this exit plan or be subject to claims made by third parties, and the exit plan may result in increased credit losses. We expect that our portfolio quality will continue to deteriorate as we proceed through the liquidation and the mix of assets changes and that our cash conversion ratio on liquidation will decrease; this deterioration could be more severe and the cash conversion ratio lower than we anticipate, resulting in substantial credit losses. Significant delay or difficulty in executing the continued liquidation and/or substantial losses could result in the failure of our portfolio to generate the cash necessary to service our indebtedness, resulting in continuing or increased adverse effects on our financial condition and results of operations.

 

Difficult conditions in the financial markets have adversely affected our business and results of operations and we do not expect these conditions to improve in the near future.

 

Our financial performance depends on the quality of loans, leases and other finance assets in our portfolio. Portfolio quality may be adversely affected by several factors, including finance receivable underwriting procedures, collateral quality, or geographic or industry concentrations, the ability of our customers to obtain alternative financing as we exit certain lines of business, as well as the recent deterioration of the financial markets. Financial market conditions over the previous eighteen months have resulted in significant writedowns of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These writedowns, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions, and, in some cases, to fail. Many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers, including other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies and defaults, lack of consumer confidence, increased market volatility and widespread reduction of business activity. Valuations of the types of collateral securing our captive finance portfolio, particularly valuations of used aircraft, have decreased significantly and may continue to decrease if weak economic conditions continue. Declining collateral values could result in greater delinquencies and foreclosures as customers elect to discontinue payments on loan balances which exceed asset values. Our losses may increase if our collateral cannot be realized or is liquidated at prices not sufficient to recover the full amount of our finance receivable portfolio. In particular, declining collateral values in the portion of our captive finance portfolio secured by non-Textron manufactured aircraft may result in increased losses as we may have greater difficulty liquidating these assets. Further deterioration of our ability to successfully collect our finance receivable portfolio and to resolve problem accounts may adversely affect our cash flow, profitability and financial condition. If these negative market conditions persist or worsen, we could experience continuing or increased adverse effects on our financial condition and results of operations.

 

If our estimates or assumptions used in determining the fair value of certain of our assets and our allowance for losses on finance receivables prove to be incorrect, our cash flow, profitability, financial condition, and business prospects could be materially adversely affected.

 

We use estimates and various assumptions in determining the fair value of certain of our assets, including finance receivables held-for-sale which do not have active, quoted market prices. We also use estimates and assumptions in determining our allowance for losses on finance receivables held for investment and in determining the residual values of leased equipment and the value of repossessed assets and properties. It is difficult to determine the accuracy of these estimates and assumptions, and our actual experience may differ materially from these estimates and assumptions. A material difference between our estimates and assumptions and our actual experience may adversely affect our cash flow, profitability, and financial condition.

Failure to maintain investment grade credit ratings acceptable to investors may increase the cost of our funding and may adversely affect our access to the capital markets.

 

The major rating agencies regularly evaluate Textron and Textron Financial. Late in 2008 and during 2009 our long- and short-term credit ratings were subject to several downgrades resulting in the ratings disclosed on page 19 in the “Liquidity and Capital Resources” section. Failure to maintain investment grade credit ratings that are acceptable to investors may adversely affect the cost and other terms upon which we are able to obtain other financing, as well as our access to the capital markets.

 

Our ability to fund our Captive Finance segment activities at economically competitive levels depends on our ability to borrow and the cost of borrowing in the credit markets.

 

Our ability to continue to offer customer financing for the products which Textron manufactures, and the long-term viability and profitability of the Captive Finance segment, is largely dependent on our ability to obtain funding, whether directly from third-party funding sources or through Textron, at a reasonable cost. This ability and cost, in turn, are dependent on our credit ratings as well as the credit ratings of Textron and are subject to credit market volatility. In addition, because we, as a non-bank finance company, do not have access to any of the various assistance programs being provided by the federal government to banking institutions, we may not be able to continue to offer customer financing at rates and terms competitive with those offered by banking institutions. If we are unable to continue to offer competitive customer financing, it could adversely affect our results of operations, financial condition and our long-term viability.

 

If we fail to comply with the covenants contained in our various debt agreements, it may adversely affect our liquidity, results of operations and financial condition.

 

Our credit facility contains affirmative and negative covenants including (i) limitations on creation of liens on assets; (ii) prohibition of certain consolidations, mergers or sale or transfer of all or any substantial part of our assets; (iii) the requirement to continue in the finance business and maintain existence, rights and franchises, (iv) maintenance of maximum leverage (not to exceed nine times consolidated net worth and qualifying subordinated obligations, as defined), (v) maintenance of minimum consolidated net worth ($200 million), (vi) maintenance of a fixed charges coverage ratio (no less than 125%) and (vii) limitations on debt incurred by certain subsidiaries. The indentures governing our outstanding senior notes also contain covenants, including limitations on creation of liens on assets and maintenance of existence, rights and franchises; in addition, consolidations, mergers or sale of all or substantially all of our assets may only be effected if certain provisions are complied with. We also have issued various debt securities under other agreements which contain substantially similar covenants related to some or all of the items addressed in our credit facility and indentures.

 

Some of these covenants may limit our ability to engage in certain financing structures, create liens, sell assets or effect a consolidation or merger. In addition, our various agreements contain certain cross-default or cross-acceleration provisions which could result in a default under one agreement triggering rights or actions under another agreement. As a result, an event of default under our credit facility, for example, could result in all outstanding obligations under some or all of our other debt agreements to become immediately due and payable. If such acceleration were to occur, we may not have adequate funds to satisfy all of our outstanding obligations.

 

Under a Support Agreement between Textron Financial and Textron, Textron may be required to make additional cash payments in the future to ensure that Textron Financial maintains a fixed charge coverage ratio of no less than 125% and consolidated shareholder’s equity of no less than $200 million. In the event that Textron is unable or unwilling to make additional cash payments to Textron Financial, it could result in an event of default under the terms of our debt agreements. Failure to comply with material provisions of the covenants in the credit facility, the indentures or any of our other debt agreements could have a material adverse effect on our liquidity and financial condition.

The soundness of our customers and business partners could affect our business and results of operations.

 

We are exposed to risks associated with the creditworthiness of our key customers and business partners, including developers, manufacturers and syndication partners, many of whom may be adversely affected by general economic and financial market conditions. These conditions could result in financial instability or other adverse effects at any of our customers or business partners. The consequences of such adverse effects could include customer delinquencies or bankruptcies and deterioration of collateral values. Any of these events may adversely affect our cash flow, profitability and financial condition.

 

The soundness of financial institutions could adversely affect us.

 

We have relationships with many financial institutions and, from time to time, we execute transactions with counterparties in the financial services industry. As a result, defaults by, or even rumors or questions about, financial institutions or the financial services industry generally, could result in losses or defaults by these institutions. In the event that the volatility of the financial markets adversely affects these financial institutions or counterparties, we or other parties to the transactions with us may be unable to complete transactions as intended, which could adversely affect our business and results of operations.

 

Our international business is subject to the risks of doing business in foreign countries.

 

Our international business exposes us to certain unique and potentially greater risks than our domestic business, and our exposure to such risks may increase if our international business continues to grow. Our international business is subject to U.S. and local government regulations and procurement policies and practices, which may change from time to time, including regulations relating to import-export control, investments, exchange controls and repatriation of earnings or cash settlement challenges, as well as to varying currency, geopolitical and economic risks. These international risks may be especially significant with respect to sales of aerospace and defense products. We also are exposed to risks associated with using foreign representatives and consultants for international sales and operations and teaming with international suppliers in connection with international financial programs.

 

Currency and interest rate fluctuations, and our ability to hedge those transactions may adversely affect our results.

 

We are affected by changes in foreign exchange rates and interest rates. Changes in foreign exchange rates may adversely affect our income from international operations and the value realized on assets and liabilities denominated in non-functional currencies. Increases or decreases in interest rates may adversely affect interest margins due to variances between the interest rate profile of our receivable portfolio and our debt obligations. These variances can be attributed to a combination of interest rate and currency basis differences, asset/liability duration differences, and the portion of our receivable portfolio funded by equity. Changes in our credit ratings may also adversely affect interest rates on future borrowings, which would impact our profitability. In some instances, we enter into hedging instruments to mitigate fluctuations in foreign exchange rates and interest rates. If our hedging instruments are ineffective, these risks may not be adequately mitigated. Our hedging transactions rely on assumptions regarding portfolio mix, portfolio duration, and currency exposures. Changes in the assumptions supporting our hedging strategy may have a significant impact on our profitability, financial condition, or results of operations.

 

Changes in the regulatory environment in which we operate could have an adverse affect on our business and earnings.

 

We operate in the United States and certain other foreign markets, and we are subject to the supervision and regulation by governing bodies in those jurisdictions. Any noncompliance with the laws and regulations in those jurisdictions could result in the suspension or revocation of any licenses we hold or registrations at issue, as well as the imposition of civil or criminal penalties. Any inability to remain in compliance with applicable regulatory requirements could have a material adverse effect on our operations by limiting our access to capital, as well as

negatively impacting our public standing. Additionally, no assurance can be provided that laws and regulations that are applicable to our current operations will not be amended or interpreted differently, that new laws and regulations will not be passed which materially change our current business practices or operations, or that we will not be prohibited by state laws or certain other foreign laws from raising interest rates above certain desired levels, any of which could adversely impact our business, financial condition or results of operations.

 

We are subject to legal proceedings and other claims.

 

We are subject to legal proceedings and other claims arising out of the conduct of our business, including proceedings, claims and counter-claims relating to commercial and financial transactions (including claims which may be brought due to our decision to exit our Non-captive Finance segment); lack of compliance with applicable laws and regulations; disputes with syndication partners; loan servicing contracts; employment disputes; and environmental, safety and health matters. On the basis of information presently available, we do not believe that existing proceedings and claims will have a material effect on our financial position or results of operations. However, litigation is inherently unpredictable, and we could incur judgments or enter into settlements for current or future claims that could adversely affect our financial position or our results of operations in any particular period.

 

Unanticipated changes in our tax rates or exposure to additional income tax liabilities could affect our profitability.

 

We are subject to income taxes in both the U.S. and various non-U.S. jurisdictions, and our domestic and international tax liabilities are subject to the allocation of income among these different jurisdictions. Our effective tax rate could be adversely affected by changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax contingencies or changes in tax laws, which could affect our profitability. In particular, the carrying value of deferred tax assets is dependent on our ability to generate future taxable income. In addition, the amount of income taxes we pay is subject to audits in various jurisdictions, and a material assessment by a tax authority could affect our profitability.

 

 

None.

 

 

Textron Financial leases office space from a Textron affiliate for its corporate headquarters at 40 Westminster Street, Providence, Rhode Island 02903. The Company leases other offices throughout North America. For additional information regarding Textron Financial’s lease obligations, see Note 16 to the Consolidated Financial Statements in Item 8 of this Form 10-K.

 

 

On February 9, 2010 an amended complaint to a purported shareholder class action lawsuit by the City of Roseville Employees’ Retirement System was filed in the United States District Court in Rhode Island against TFC and three of its present and former officers. The original complaint, filed on August 13, 2009, contained claims only against Textron, its Chairman and former Chief Executive Officer and its former Chief Financial Officer. The suit alleges that the defendants violated the federal securities laws by making material misrepresentations or omissions related to Cessna and Textron Financial. The complaint seeks unspecified compensatory damages. Automotive Industries Pension Trust Fund has been appointed lead plaintiff in the case.

 

Textron Financial believes that this lawsuit is without merit and intends to defend it vigorously.

 

We are also subject to actual and threatened legal proceedings and other claims against Textron Financial and its subsidiaries arising out of the conduct of our business. These proceedings include claims and counterclaims relating to commercial and financial transactions; lack of compliance with applicable laws and regulations; disputes with syndication partners; loan servicing contracts; employment disputes; and environmental, safety and health

matters. Some of these suits and proceedings seek compensatory, treble or punitive damages, fines or penalties in substantial amounts or remediation of environmental contamination. These suits and proceedings are being defended by, or contested on behalf of, Textron Financial and its subsidiaries. On the basis of information presently available, we do not believe that existing proceedings and claims will have a material effect on our financial position or results of operations.

 

 

Omitted per Instruction I of Form 10-K.

 

 

 

The common stock of Textron Financial is owned entirely by Textron and, therefore, there is no trading of Textron Financial’s stock. Dividends of $358 million, $151 million and $144 million were declared and paid in 2009, 2008 and 2007, respectively. For additional information regarding restrictions as to dividend availability, see Note 10 to the Consolidated Financial Statements in Item 8 of this Form 10-K.

 

 

The following should be read in conjunction with Textron Financial’s Consolidated Financial Statements in Item 8 of this Form 10-K:

 

 

 

 

Overview

 

On December 22, 2008, due to weakness in the economy and in order to address Textron’s long-term liquidity position, Textron announced a plan to exit all of the commercial finance business of Textron Financial, other than that portion of the business supporting the financing of customer purchases of products which Textron manufactures. The exit plan currently applies to the managed finance receivables of our Non-captive Finance segment, which represent $4.1 billion of our $6.9 billion managed finance receivable portfolio and does not include finance receivables that are likely to be liquidated in our Captive Finance segment. The exit plan will be implemented utilizing a combination of orderly liquidation and selected sales and is expected, depending on market conditions, to be substantially complete over the next two to three years. The Captive Finance segment supports the financing of customer purchases of products manufactured by Textron by providing financing directly to Textron customers as well as arranging financing through third-party financial institutions and originating and servicing finance receivables on behalf of other Textron finance subsidiaries.

 

We are in the business of originating and servicing commercial finance receivables in the Captive Finance segment and servicing our existing portfolios in other commercial markets. The principal factors that influence our earnings are the credit quality, quantity and mix of finance assets across product lines and industries, fees earned related to these finance assets and services and the cost of borrowed funds utilized to invest in these assets. For finance receivables, net interest margin equals the difference between revenue earned on finance receivables, including fee income, gains and losses on disposal of finance receivables and impairment losses, and the cost of borrowed funds. For operating leases, net interest margin equals revenue earned on operating leases, less depreciation expense and the cost of borrowed funds. On certain types of finance receivables, interest rates earned are fixed at the time the contracts are originated, while other types are based on floating-rates that are generally tied to changes in the prime rate offered by major banks or the London Interbank Offered Rate (LIBOR). Rental charges on operating leases may be fixed at the time the contracts are originated or based on floating-rates that are generally tied to changes in LIBOR.

 

We have traditionally borrowed funds at various maturities at both fixed and floating interest rates, based primarily on LIBOR, to match the interest sensitivities and maturities of our finance receivables. During 2009, our borrowing has been substantially limited to amounts available under our $1.75 billion committed bank credit line, intercompany loans from Textron and the issuance of debt secured by specific finance receivables.

 

Our business performance is assessed on an owned, managed and a serviced basis. The owned basis includes only the finance receivables owned and reported on the Consolidated Balance Sheets. The managed basis includes owned finance receivables and finance receivables sold in securitizations where we have retained credit risk to the extent of our subordinated interest. The serviced basis includes managed finance receivables and serviced-only finance receivables, which generally consist of participation interests sold to third-party financial institutions without retained credit risk, finance receivables originated and serviced on behalf of other finance subsidiaries of Textron and receivables subject to servicing agreements with third-party financial institutions. We evaluate finance receivable credit risk and leverage on a managed, as well as an owned basis. We do not have a retained financial interest or credit risk in the performance of the serviced portfolio and, therefore, performance of these portfolios is limited to the difference between servicing fees received and the cost of servicing.

 

Key Business Initiatives and Trends

 

We achieved $3.9 billion of managed finance receivable reductions during 2009 as compared to the minimum liquidation target of $2.6 billion announced in December 2008. These managed finance receivable reductions occurred in both of our segments and all nine of our product lines, but were primarily driven by Non-captive reductions, including $2.3 billion (68%) in Distribution Finance, $479 million (74%) in Asset-Based Lending and $244 million (21%) in Golf Mortgage. These reductions resulted from the combination of scheduled finance receivable collections, sales, discounted payoffs, repossession of collateral, charge-offs and impairment charges recorded as Portfolio Losses in our Consolidated Statements of Operations. Finance receivable reductions in the Distribution Finance product line were aided by discount programs which encouraged borrowers to liquidate

inventory and resulted in $43 million of our Portfolio losses. Repossession, foreclosure or the maturity of leveraged leases with residual values represented $337 million of the managed finance receivable reduction. However, we also generated $236 million from the collection or sale of these assets and other investments during 2009. We expect to liquidate approximately $1.6 billion of additional managed finance receivables, net of originations, in 2010, a portion of which we expect will be liquidations in the Captive Finance segment.

 

Our $3.9 billion reduction in managed finance receivables also included $633 million of liquidations in the Captive portfolio primarily as a result of reduced loan and lease originations. The reduction in originations resulted from lower Cessna Aircraft Company sales, no longer originating non-captive aircraft loans and leases, the agreement signed by Textron in the second quarter of 2009 with a subsidiary of The PNC Financial Services Group to become a provider of financing for a portion of the sales of E-Z-GO golf cars and the impact of aircraft loans originated on behalf of a finance subsidiary of Textron. This subsidiary entered into a $500 million credit facility with the Export-Import Bank of the United States to provide funding for the financing of sales of Cessna Aircraft Company and Bell Helicopter products to non-U.S. buyers. We originated and service $182 million of finance receivables for this entity as of January 2, 2010. Continued use of this credit facility is expected to reduce our originations in future periods.

 

Managed finance receivable balances and percentages by product line are presented in the following table:

 

 

As of January 2, 2010, $819 million of owned finance receivables are designated for sale as compared to $1.7 billion as of January 3, 2009. Finance receivable sales accounted for $728 million of the reduction including $399 million in the Distribution Finance product line and $127 million in the Asset-Based Lending product line. We received proceeds approximating our carrying value for each of these transactions. The remaining $819 million finance receivables held for sale are primarily comprised of assets in the Distribution Finance, Golf Mortgage and Asset-Based Lending product lines, but also include $84 million of finance receivables in the Golf Equipment product line within the Captive Finance segment. In January 2010, we completed an additional sale of Distribution Finance receivables, which achieved a finance receivable reduction of approximately $200 million and generated proceeds in excess of our carrying value.

 

We continually assess the manner in which we will be able to maximize the economic value of our finance receivable portfolio, while still achieving our cash collection goals. This analysis can result in the reclassification of finance receivables previously classified as held for sale to held for investment. In addition, this analysis can result in the classification of additional assets as held for sale. Following efforts to market the portfolio and progress made through orderly liquidation in 2009, we reclassified certain portfolios from held for sale to held for investment. We also reclassified other portfolios from held for investment to held for sale as a result of unanticipated purchase inquiries. Due to the nature of these inquiries, we determined a sale of these portfolios would be consistent with our goal to maximize the economic value of our portfolio and accelerate cash collections. This activity resulted in net

reclassifications from finance receivables held for sale to finance receivables held for investment of $457 million in 2009.

 

 

We measure the progress of our exit plan related to the Non-captive Finance segment, in part, based on the percentage of managed finance receivable and other finance asset reductions converted to cash. During 2009, the Non-captive Finance segment achieved a 95% cash conversion ratio. This performance was primarily driven by the accelerated pace of liquidations in the Distribution Finance product line. Distribution Finance receivables typically have short durations associated with the sales pace of dealer inventory, and this natural liquidation pattern was accelerated by asset sales, discounted payoff programs and the transfer of borrowers with revolving credit lines to new lenders. We expect this ratio to decline over the duration of our exit plan due to the change in mix from shorter term assets in the Distribution Finance and Asset-Based Lending product lines to longer term assets in our Timeshare, Golf Mortgage and Structured Finance product lines and the existence of a higher concentration of nonaccrual finance receivables.

 

Portfolio quality statistics weakened significantly during 2009 as we executed our liquidation plan under difficult economic conditions. Nonaccrual finance receivables increased to $1,040 million as of January 2, 2010 from $277 million as of January 3, 2009 and 60+ day delinquent finance receivables increased to $569 million as of January 2, 2010 from $178 million as of January 3, 2009. This deterioration was most significant in the Timeshare and Aviation product lines. The notes receivable portfolios of our borrowers in the Timeshare product line were impacted by general economic conditions, including unemployment and the lack of liquidity available to finance operations, and borrowers in the Aviation product line were impacted by general economic conditions and a significant deterioration in used aircraft values. As a result of this continued trend, the Allowance for losses on finance receivables held for investment has increased $148 million or 77% as compared to January 3, 2009. We expect the rate of increase in nonaccrual finance receivables and delinquency to slow in future periods as general economic conditions begin to stabilize.

 

 

Financial Condition

 

Liquidity and Capital Resources

 

In light of our plan to exit the Non-captive Finance business, we expect to substantially rely on cash from finance receivable collections to fund maturing debt obligations. Under the exit plan, we originally expected to liquidate at least $2.6 billion of managed finance receivables, net of originations, in 2009, and expected to use approximately $2.0 billion of proceeds from liquidations to pay maturing securitized off-balance sheet debt. During 2009, we liquidated $3.9 billion of managed finance receivables, net of originations, and used $2.0 billion of liquidation proceeds to pay securitized debt, which was off-balance sheet at the beginning of the year. We expect to reduce managed finance receivables by approximately $1.6 billion, net of originations, in 2010.

 

In addition to cash from finance receivable collections, we also utilize our committed bank credit lines and borrow available cash from Textron when it is in the collective economic interest of Textron Financial and Textron. In the first quarter of 2009, we borrowed the $1.74 billion available balance of the $1.75 billion committed bank credit line. A portion of these borrowings were utilized to repay the $743 million of commercial paper outstanding as of January 3, 2009. The remaining cash was utilized to repay portions of our maturing term debt. Amounts borrowed under the credit facilities are due in April 2012.

 

In 2009 and 2008, Textron agreed to lend Textron Financial, with interest, amounts to pay down maturing debt. As of January 2, 2010 and January 3, 2009, the Company had an outstanding balance due to Textron of $447 million and $133 million, respectively.

 

Due to the progress made reducing our managed finance receivables and the availability of cash from the credit line, we extinguished, through open market repurchases, $655 million of our debt securities prior to maturity during 2009, resulting in gains of $47 million. During the fourth quarter, Textron Inc. and Textron Financial Corporation completed separate cash tender offers for up to a $650 million aggregate principal amount of five separate series of outstanding debt securities with maturity dates ranging from November 2009 to June 2012. As a result, we extinguished $319 million of our debt securities with maturity dates ranging from 2009 to 2011 and recognized a gain on these early extinguishments of $8 million.

The following table summarizes our contractual payments and receipts, including all managed finance receivables and both on- and off-balance sheet funding sources as of January 2, 2010, for the specified periods:

 

 

This liquidity profile is an indicator of our ability to repay outstanding funding obligations, assuming contractual collection of finance receivables and absent access to new sources of liquidity or origination of additional finance receivables. This profile excludes cash which may be generated by the disposal of Other assets and cash which may be used to pay future income taxes, Accrued interest and other liabilities or Amounts due to Textron Inc.

 

Finance receivable receipts are based on contractual cash flows. These amounts could differ due to sales, prepayments, charge-offs and other factors, including the inability of borrowers to repay the balance of the loan at the contractual maturity date. Finance receivable receipts on the held for sale portfolio represent the contractual balance of the finance receivables and therefore exclude the potential negative impact from selling the portfolio at the estimated fair value. Interest payments and receipts in the table above reflect the current contractual interest rate on the related debt and finance receivables. They do not include anticipated changes in market interest rates or the ability of the borrower to pay, which could have an impact on the interest rate according to the terms of the related debt or finance receivable contract.

 

At January 2, 2010, Textron Financial had unused commitments of $350 million to fund new and existing customers under committed revolving lines of credit, construction loans and equipment loans and leases. The revolving line of credit commitments generally have an original duration of less than three years and funding under these facilities is dependent on the availability of eligible collateral and compliance with customary financial covenants. Since many of the agreements will not be used to the extent committed or will expire unused, the total commitment amount does not represent future cash requirements. We also have ongoing customer relationships,

including manufacturers and dealers in the Distribution Finance product line, which do not contractually obligate us to provide funding, however, we may choose to fund under these relationships to facilitate an orderly liquidation and mitigate credit losses. Neither of these potential types of fundings is included as a contractual obligation in the table above.

 

In addition to the liquidity sources contained in the table above, management continues to pursue multiple avenues for improving our liquidity profile. These avenues include additional financing secured by finance receivables, sales of portfolios classified as held for sale, transfers of existing funding obligations to new financing providers and loans from government agencies specializing in assistance with the financing of the foreign sale of products. The successful execution of these liquidity solutions would mitigate the inherent risks associated with collecting our managed finance receivable portfolio in accordance with its contractual maturity in the current economic environment and aid in the financing of Textron manufactured products in the future. Depending on the success of these initiatives and changes in external factors affecting the marketability and value of our assets, we may also consider the sale of assets currently classified as held for investment.

 

During the third quarter of 2009, a subsidiary of Textron entered into a $500 million credit facility with the Export-Import Bank of the United States. The facility expires in December 2010. This facility provides funding for the financing of sales of Cessna Aircraft Company and Bell Helicopter products to non-U.S. buyers. Textron Financial originates and services loans and finance leases as servicer for this subsidiary, which is consolidated by Textron, and has provided a full guarantee of the debt obligations under this facility. Serviced finance receivables were $182 million and the outstanding balance of the guaranteed debt was $179 million at January 2, 2010.

 

In April 2009, Textron signed a 3-year agreement with a subsidiary of The PNC Financial Services Group to become a preferred provider of financing for a portion of the sales of E-Z-GO golf cars. We expect this agreement to reduce finance receivable originations in our Captive Finance segment.

 

The major rating agencies regularly evaluate us and our parent company. Both our long- and short-term credit ratings were downgraded during 2009. In connection with these rating actions, the rating agencies cited execution risks associated with our decision to exit portions of our commercial finance business, lower than expected business and financial outlook for 2009, the increase in outstanding debt resulting from the borrowing under our credit facilities, weak economic conditions and continued liquidity and funding constraints. In February 2010, Moody’s affirmed our rating and adjusted our outlook to stable. Moody’s cited better than expected progress to date in the liquidation of our non-captive assets. Our current credit ratings prevent us from efficiently accessing the commercial paper markets, and may adversely affect the cost and other terms upon which we are able to obtain other financing as well as our access to the capital markets. The credit ratings and outlooks of these three rating agencies are as follows:

 

 

The cash flows from operations are summarized below:

 

 

Cash provided by operating activities increased during 2009 as compared to 2008 primarily due to the timing of payments of income taxes and accrued interest and other liabilities, partially offset by a decrease in interest margin from lower average finance receivables. The decrease in cash provided by operating activities for 2008 was primarily due to the timing of payments of income taxes and accrued interest and other liabilities.

Cash flows provided by investing activities increased during 2009 by $2.4 billion as compared to 2008. This was primarily due to a decrease in finance receivable originations of $8.3 billion resulting from our decision to exit the Non-captive Finance segment, partially offset by a $6.4 billion decrease in finance receivable collections and an increase in proceeds from receivable sales and disposition of other assets of $293 million. Cash flows used in investing activities decreased during 2008 primarily due to a decrease in finance receivable originations, net of collections as a result of our exit plan.

 

Cash flows used by financing activities increased $2.3 billion during 2009 as a result of the decrease in managed finance receivables, which reduced the need to raise cash from financing activities. The decrease in cash flows provided by financing activities in 2008 is primarily due to the reduction in managed finance receivable growth as compared to 2007 and to a lesser extent the liquidation of certain portfolios.

 

Because the finance business involves the purchase and carrying of finance receivables, a relatively high ratio of borrowings to net worth is customary. Debt as a percentage of total capitalization was 81% at January 2, 2010 and 86% at January 3, 2009. Our ratio of earnings to fixed charges was (0.89)x in 2009, (0.74)x in 2008 and 1.56x in 2007.

 

In 2009, Textron Financial declared and paid $358 million of dividends to Textron, compared with $151 million of dividends declared and paid in 2008. The payment of these dividends represents a return of Textron’s investment consistent with maintaining our targeted leverage ratio. Textron contributed capital of $279 million to Textron Financial in 2009 compared with $634 million in 2008. Cash contributions of $625 million in 2008, $270 million in 2009 and an additional payment of $75 million on January 12, 2010, were made to maintain compliance with the fixed charge coverage and leverage ratios as more fully described in Note 4 to the Consolidated Financial Statements in Item 8 of this Form 10-K. Textron also contributed capital of $9 million to Textron Financial in 2009 and 2008 for Textron’s dividend on the preferred stock of Textron Funding Corporation.

 

Off-Balance Sheet Arrangements

 

During 2009, we had one significant off-balance sheet financing arrangement. The Distribution Finance revolving securitization trust was a master trust that purchased inventory finance receivables from the Company and issued asset-backed notes to investors. $1.4 billion of the outstanding notes issued by the Distribution Finance securitization trust were repaid through finance receivable collections. During the fourth quarter of 2009, a change in the pace of finance receivable collections triggered a corresponding change in required cash distributions, which provided us the ability to repurchase the finance receivables resulting in the consolidation of the securitization trust on our balance sheet. As a result, the finance receivables held by the securitization trust were recorded at their fair value of $720 million, $635 million of debt issued by the securitization trust was recorded on our balance sheet and $85 million of retained interests were removed from the balance sheets. Textron Financial then made a capital contribution to the trust sufficient to repay its $635 million of outstanding debt; following the repayment, the remaining receivables were legally conveyed to Textron Financial and the trust was dissolved.

 

Interest Rate Sensitivity

 

Textron Financial’s mix of fixed- and floating-rate debt is continuously monitored by management and is adjusted, as necessary, based on evaluations of internal and external factors. Management’s strategy of matching floating-rate assets with floating-rate liabilities limits Textron Financial’s risk to changes in interest rates. This strategy includes the use of interest rate exchange agreements. At January 2, 2010, floating-rate liabilities in excess of floating-rate assets were $0.6 billion after considering interest rate exchange agreements and the treatment of $1.4 billion of floating-rate loans with index rate floors as fixed-rate loans. These loans have index rates that are, on average, 219 basis points above the applicable index rate (predominately the Prime rate). The Company has benefited from these interest rate floor agreements in the recent low rate environment. However, in a rising rate environment, this benefit will dissipate until the Prime rate exceeds the floor rates embedded in these agreements.

 

We believe that our asset/liability management policy provides adequate protection against interest rate risks. Changes in interest rates, however, could have an adverse effect on our interest margin. Variable-rate finance receivables are tied to changes in the prime rate offered by major U.S. and Canadian banks and typically have index

resets on a monthly basis. Variable-rate debt is generally tied to changes in LIBOR and variable-rate term debt typically has index resets on a quarterly basis. As a consequence, changes in short-term borrowing costs do not always coincide with changes in variable-rate receivable yields. Historically, this basis difference has been stable, but was increasingly volatile during 2008, prompting the modification of the terms of many of our loan agreements to be based on LIBOR. We do not hedge this basis risk between different variable-rate indices and reset frequencies, as we believe the cost is disproportionately high in comparison to the magnitude of the risk over long periods of time. A 100 basis point increase in LIBOR with no corresponding change in the prime rate would result in a $14 million decrease in net income or cash flows for the following twelve-month period assuming no originations or maturities of LIBOR-based assets or liabilities.

 

We assess our exposure to interest rate changes using an analysis that measures the potential loss in net income, over a twelve-month period, resulting from a hypothetical change in all interest rates of 100 basis points across all maturities occurring at the outset of the measurement period (sometimes referred to as a “shock test”). The analysis also assumes that prospective receivable additions will be match-funded, existing portfolios will not prepay and contractual maturities of both debt and assets will result in increases or reductions in intercompany borrowing from Textron. This shock test model, when applied to our asset and liability position at January 2, 2010, indicates that an increase in interest rates of 100 basis points would have a negative $1 million impact on net income or cash flows for the following twelve-month period, respectively.

 

Financial Risk Management

 

Textron Financial’s results are affected by changes in U.S. and, to a lesser extent, foreign interest rates. As part of managing this risk, we enter into interest rate exchange agreements. The objective of entering into such agreements is not to speculate for profit, but generally to convert variable-rate debt into fixed-rate debt and vice versa. The overall objective of our interest rate risk management is to achieve match-funding objectives. These agreements do not involve a high degree of complexity or risk. The fair values of interest rate exchange agreements are recorded in either Other assets or Accrued interest and other liabilities on the Consolidated Balance Sheets. We do not trade in interest rate exchange agreements or enter into leveraged interest rate exchange agreements. The net effect of the interest rate exchange agreements designated as hedges of debt decreased interest expense by $56 million in 2009 and $25 million in 2008, and increased interest expense by $25 million in 2007.

 

We manage our foreign currency exposure by funding foreign currency denominated assets with liabilities in the same currency or by entering into foreign currency exchange agreements to convert foreign currency denominated assets, liabilities and cash flows into functional currency denominated assets, liabilities and cash flows. In addition, as part of managing our foreign currency exposure, we may enter into foreign currency forward exchange contracts. The objective of such agreements is to manage any remaining foreign currency exposures to changes in currency rates. The notional amounts outstanding for these agreements were $531 million and $536 million at January 2, 2010 and January 3, 2009, respectively. The fair values of these agreements are recorded in either Other assets or Accrued interest and other liabilities on the Company’s Consolidated Balance Sheets. As we hedge all substantial non-functional currency exposures within each of our subsidiaries, future changes in foreign currency rates would not have a significant impact on each subsidiary’s functional currency earnings.

 

As a result of our exit plan, we no longer view our investments in our Canadian and United Kingdom subsidiaries as permanent. Therefore, we began hedging our net investments in these subsidiaries during the fourth quarter of 2008 to prevent any reduction in the U.S. dollar equivalent cash flows we will receive upon liquidation of these subsidiaries. The notional amounts of these foreign currency forward exchange contracts were $71 million at January 2, 2010 and $139 million at January 3, 2009.

 

Critical Accounting Policies

 

Allowance for Losses on Finance Receivables Held for Investment

 

We evaluate our allowance for losses on finance receivables held for investment based on a combination of factors. For homogeneous loan pools, we examine current delinquencies, the characteristics of the existing

accounts, historical loss experience, the value of the underlying collateral and general economic conditions and trends and the potential impact of the lack of liquidity available to our borrowers and their customers as a result of our decision to exit portions of our commercial finance business. We estimate losses will range from 0.75% to 10.0% of finance receivables held for investment depending on the specific homogeneous loan pool. For larger balance commercial loans, we consider borrower specific information, industry trends and estimated discounted cash flows, as well as the factors described above for homogeneous loan pools.

 

Provision for losses on finance receivables held for investment are charged to income, in amounts sufficient to maintain the allowance for losses on finance receivables held for investment at a level considered adequate to cover losses inherent in the owned finance receivable held for investment portfolio, based on management’s evaluation and analysis of this portfolio. While management believes that its consideration of the factors and assumptions referred to above results in an accurate evaluation of existing losses in the portfolio based on prior trends and experience, changes in the assumptions or trends within reasonable historical volatility may have a material impact on our allowance for losses on finance receivables held for investment. The allowance for losses on finance receivables held for investment currently represents 5.63% of total finance receivables held for investment. During the last five years, net charge-offs as a percentage of finance receivables held for investment have ranged from 0.38% to 1.82%.

 

Income Taxes

 

Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities, applying tax rates expected to be in effect for the year in which we expect the differences will reverse or settle. Based on the evaluation of available evidence, we recognize future tax benefits, such as net operating loss carryforwards, to the extent that it is more likely than not that we will realize these benefits.

 

We periodically assess the likelihood that we will be able to recover our deferred tax assets and reflect any changes in our estimates in a valuation allowance, with a corresponding adjustment to earnings or other comprehensive income (loss), as appropriate. In assessing the need for a valuation allowance, we look to the future reversal of existing taxable temporary differences, taxable income in carryback years, the feasibility of tax planning strategies and estimated future taxable income. The valuation allowance can be affected by changes to tax laws, changes to statutory tax rates and changes to future taxable income estimates.

 

The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities. We assess our income tax positions and record tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances, and information available at the reporting date. For those tax positions for which it is more likely than not that a tax benefit will be sustained, we record an estimate of the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions for which it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements. Where applicable, associated interest has also been recognized. As future results may include favorable or unfavorable adjustments to our estimates due to closure of income tax examinations, new regulatory or judicial pronouncements, or other relevant events, our effective tax rate may fluctuate significantly on a quarterly and annual basis.

 

Fair Value of Financial Instruments

 

Fair values of financial instruments are based upon estimates at the balance sheet date of the price that would be received in an orderly transaction between market participants. We use quoted market prices and observable inputs when available. However, these inputs are often not available in the markets for many of our assets. In these cases management typically performs discounted cash flow analyses using our best estimates of key assumptions such as credit losses, prepayment speeds and discount rates based on both historical experience and our interpretation of how comparable market data in more active markets should be utilized. These estimates are subjective in nature and involve uncertainties and significant judgment in the interpretation of current market data. Therefore, the fair values presented may differ from amounts Textron Financial could realize or settle currently.

Finance Receivables Held for Sale

 

Finance receivables are classified as held for sale based on a determination that there is no longer the intent to hold the finance receivables for the foreseeable future, until maturity or payoff, or there is no longer the ability to hold the finance receivables until maturity. Our decision to classify certain finance receivables as held for sale is based on a number of factors, including, but not limited to contractual duration, type of collateral, credit strength of the borrowers, the existence of continued contractual commitments and the perceived marketability of the finance receivables. On an ongoing basis, these factors, combined with our overall liquidation strategy, determine which finance receivables we have the positive intent to hold for the foreseeable future and which finance receivables we will hold for sale. Our current strategy is based on an evaluation of both our performance and liquidity position and changes in external factors affecting the value and/or marketability of our finance receivables. A change in this strategy could result in a change in the classification of our finance receivables. As a result of the significant influence of economic and liquidity conditions on our business plans and strategies, and the rapid changes in these and other factors we utilize to determine which assets are classified as held for sale, we currently believe the term “foreseeable future” represents a time period of six to nine months. We also believe that unanticipated changes in both internal and external factors affecting our financial performance, liquidity position or the value and/or marketability of our finance receivables could result in a modification of this assessment.

 

Finance receivables held for sale are carried at the lower of cost or fair value. At the time of transfer to held for sale classification, a valuation allowance is created for any shortfall between the carrying value, net of all deferred fees and costs, and fair value. In addition, any allowance for loan losses previously allocated to these finance receivables is reclassified to the valuation allowance account, which is netted within Finance receivables held for sale on the Consolidated Balance Sheets. This valuation allowance is adjusted quarterly through earnings for any changes in the fair value of the finance receivables below the carrying value. Fair value changes can occur based on market interest rates, market liquidity and changes in the credit quality of the borrower and value of underlying loan collateral. If we determine that finance receivables classified as held for sale will not be sold and we have the intent and ability to hold the finance receivables for the foreseeable future, until maturity or payoff, they are reclassified as Finance receivables held for investment at the lower of cost or fair value at that time. Changes in the classification of which finance receivables are held for sale could result in the creation of additional valuation allowances based on the difference between the fair value of finance receivables and the current carrying value as reflected in Note 12 to the Consolidated Financial Statements in Item 8 of this Form 10-K.

 

Results of Operations

 

Revenues

 

Revenues decreased $363 million in 2009 as compared to 2008 and $152 million in 2008 as compared to 2007, primarily due to the following:

 

(Loss) Income before Income Taxes and Noncontrolling Interest

 

Loss before income taxes and noncontrolling interest decreased $234 million in 2009 as compared to 2008 and income before income taxes and noncontrolling interest decreased $761 million in 2008 as compared to 2007, primarily due to the following:

 

 

Portfolio losses recognized during 2009 include discounts taken on the sale or early termination of finance assets, including discounts associated with the liquidation of Distribution Finance and Golf Mortgage finance receivables of $60 million and $25 million in higher impairment charges associated with repossessed aircraft. In addition, we recognized impairment charges of $53 million during 2009 related to automobile manufacturing equipment and investments in real estate associated with matured leveraged leases. The increase in portfolio losses in 2008 as compared to 2007 was mostly the result of a gain on the sale of a leveraged lease investment in 2007.

 

The reduction in other income during 2009 includes increases to the held for sale valuation allowance of $14 million to reflect the estimated cost to exit certain portfolios.

 

Accretion of valuation allowance represents the recognition of interest earnings in excess of a loan’s contractual rate as a result of the discount rate utilized to record the loan at fair value in previous periods. These interest earnings are recognized over the remaining life of the portfolio to the extent the valuation allowance is not expected to be utilized to absorb losses associated with sales, discounted payoffs or credit losses.

 

The increase in provision for loan losses during 2009, as compared to 2008, was primarily the result of increases in the Captive Finance portfolio ($89 million), partially offset by a $58 million reduction in provision for loan losses in the Non-captive Finance portfolio. The increase related to the Captive Finance portfolio reflects an increase in both the rate and severity of defaults as a result of weaker general economic conditions and declining aircraft values. This increase was partially offset by lower provision for loan losses in the Non-captive Distribution Finance portfolio ($73 million) due to the liquidation of 68% of the Distribution Finance managed portfolio in 2009. Despite the reduction in provision for loan losses in the Non-captive Finance portfolio, the allowance for loan losses increased by $65 million. This increase reflects higher provision for loan losses resulting from a significant increase in nonaccrual finance receivables in the Timeshare portfolio. The increase in the Timeshare portfolio reflects increased defaults in our borrowers’ timeshare note portfolios and the lack of liquidity available to borrowers in this industry.

 

We strengthened the allowance for loan losses significantly during 2008 in response to weakening general market conditions, declining collateral values and the lack of liquidity available to our borrowers and their

customers. We also increased our estimate of credit losses as a result of our decision to exit portions of our commercial finance business in the fourth quarter. The increase in provision for loan losses during 2008 was primarily driven by an acute increase in defaults in the distribution finance marine and recreational vehicles portfolios ($81 million), an increase in the reserve rate for the Timeshare portfolio ($21 million), a $19 million reserve established for one account in the Golf Mortgage portfolio and a $16 million reserve established for one account in the Asset-Based Lending portfolio.

 

The decrease in borrowing costs relative to the target Federal Funds rate in 2009 is primarily attributable to the replacement of maturing and extinguished term debt and commercial paper with borrowing under our committed credit facility at favorable borrowing spreads to LIBOR. The decrease was also attributable to the return of the historical relationship between LIBOR and the target Federal Funds rate from the elevated spread that existed during 2008.

 

Borrowing costs increased in 2008 relative to the target Federal Funds rate as credit market volatility significantly impacted the historical relationships between market indices. The increase was primarily driven by an increase in the spread between LIBOR and the target Federal Funds rate and from increased borrowing spreads on issuances of commercial paper in comparison with 2007. These increases were partially offset by increased receivable pricing as a result of variable-rate receivables with interest rate floors.

 

As a result of the plan to exit certain portions of our commercial finance business in the fourth quarter of 2008, we designated approximately $1.7 billion of our owned finance receivables as held for sale. The balance of the available for sale finance receivables at the end of 2008 reflected a $293 million pre-tax mark-to-market adjustment, net of existing allowance for loan losses, required to adjust the previous carrying value of the finance receivables to fair value. In addition, we recorded a non-cash pre-tax impairment charge in the fourth quarter of 2008 of $169 million to eliminate the entire balance of goodwill.

 

Under the restructuring program established in the fourth quarter of 2008, we recorded a restructuring charge of $27 million which included $11 million of non-cash asset impairments, $1 million of contract termination costs and $15 million of estimated employee severance costs. During 2009, we incurred additional restructuring charges of $13 million, including $12 million of employee severance and pension curtailment costs and $1 million of contract termination costs. We expect restructuring charges over the remaining two to three years of our exit plan, which will primarily relate to employee severance, to be within a range from $10 million to $20 million.

 

Income Taxes

 

A reconciliation of the federal statutory income tax rate to the effective income tax rate is provided below:

 

 

For the year ended January 2, 2010, the difference between the statutory tax rate and the effective tax rate is primarily attributable to interest on tax contingencies, the majority of which is associated with leveraged leases, an increase in the estimate of the taxable amount of a distribution from the Company’s wholly-owned Canadian subsidiary and a change in management’s assessment of the amount of the state deferred tax asset that is realizable, partially offset by the benefit for state taxes.

For the year ended January 3, 2009, the difference between the statutory tax rate and the effective tax rate is primarily attributable to an impairment of goodwill that is not deductible for tax purposes, the provision of taxes on the earnings of a Canadian subsidiary in which we can no longer assert that we are permanently invested, interest on tax contingencies, the majority of which is associated with leveraged leases, and the effects of events related to cross border financing.

 

For the year ended December 29, 2007, the difference between the statutory tax rate and the effective tax rate is primarily attributable to interest on tax contingencies, the majority of which is associated with leveraged leases, and an increase in state taxes, partially offset by the effects of events related to cross border financing and tax credits.

 

Credit Quality

 

Nonaccrual Finance Receivables

 

We classify finance receivables as nonaccrual and suspend the recognition of earnings when accounts are contractually delinquent by more than three months, unless collection of principal and interest is not doubtful. In addition, earlier suspension may occur if we have significant doubt about the ability of the obligor to meet current contractual terms. Doubt may be created by payment delinquency, reduction in the obligor’s cash flows, deterioration in the loan to collateral value relationship or other relevant considerations.

 

Nonaccrual finance receivables, Repossessed assets and properties and Operating assets received in satisfaction of troubled finance receivables are presented separately as opposed to combining these as nonperforming assets due to their increasing significance and inherent differences. Nonaccrual finance receivables are carried at their amortized cost, net of the allowance for losses, while repossessed assets and properties and operating assets received in satisfaction of troubled finance receivables are both initially recorded at the lower of their previous carrying value or net realizable value. In addition, operating assets received in satisfaction of troubled finance receivables are assets we intend to operate for a substantial period of time and/or make substantial improvements to prior to sale.

 

Finance receivables classified as held for sale are reflected at fair value and are excluded from the portfolio statistics presented below. The following table summarizes nonaccrual finance receivables and the related percentage of finance receivables held for investment by product line:

 

 

The increase in nonaccrual finance receivables is primarily attributable to the lack of liquidity available to borrowers in the Timeshare product line, weaker general economic conditions and depressed aircraft values. The increase in Timeshare includes one $203 million account, of which $120 million is collateralized by notes receivable and $83 million is collateralized by several resort properties.We believe that the percentage of nonaccrual finance receivables generally will remain high as we execute our liquidation plan under current economic conditions. The liquidation plan is also likely to result in a slower pace of liquidations for nonaccrual finance receivables.

Allowance for Losses on Finance Receivables Held for Investment and Selected Portfolio Statistics

 

Allowance for losses on finance receivables held for investment is presented in the following table:

 

 

 

The ratio of allowance for losses to nonaccrual finance receivables held for investment decreased primarily as a result of nonaccrual Non-captive Timeshare and Captive Aviation accounts for which specific reserves were either not established due to sufficient collateral values and other considerations, or established at a percentage of the outstanding balance based on the expectation of partial recovery. This reflects our best estimate of loss based on a detailed review of our workout strategy and estimates of collateral value.

 

The increase in operating assets received in satisfaction of troubled finance receivables primarily reflects an increase in the number of golf courses whose ownership was transferred to us from the borrower during 2009. We intend to operate and improve the performance of these properties prior to their eventual disposition.

Portfolio (Losses) Gains

 

Portfolio (losses) gains include impairment charges related to repossessed assets and properties, operating assets received in satisfaction of troubled finance receivables, investments and (losses) gains incurred on the sale or early termination of finance assets. Portfolio (losses) gains of our business segments by product line are presented in the following table:

 

 

Operating Results by Segment

 

Segment (loss) income presented in the tables below reflects amounts before special charges, income taxes and noncontrolling interest.

 

Captive Finance

 

 

Captive finance revenues decreased $52 million during 2009 as compared to 2008 and $3 million during 2008 as compared to 2007, primarily due to the following:

 

Segment income decreased $123 million in 2009 as compared to 2008 and decreased $27 million in 2008 as compared to 2007, primarily due to the following:

 

 

Portfolio losses primarily include impairments recorded on repossessed assets as a result of weaker aircraft values.

 

Provision for losses increased in 2009 primarily as a result of an increase in the rate utilized to establish the provision for losses for the Captive Aviation portfolio ($44 million) and specific reserving actions ($45 million) reflecting an increase in both the rate and severity of defaults as a result of weaker general economic conditions and weaker aircraft values. Provision for losses increased in 2008 mostly as a result of an increase in the reserve rate utilized to establish the provision for losses as weakening general economic conditions and lower collateral values affected the Captive Aviation portfolio.

 

The decrease in finance receivable pricing in 2009 was primarily the result of a decrease in LIBOR relative to the target Federal Funds rate. A significant portion of the Captive Finance receivable portfolio has interest rates indexed to LIBOR.

 

Non-captive Finance

 

 

Non-captive finance revenues decreased $311 million in 2009 as compared to 2008 and $149 million in 2008 as compared to 2007, primarily due to the following:

 

Segment loss increased $119 million in 2009 as compared to 2008 and segment income decreased $245 million in 2008 as compared to 2007, primarily due to the following:

 

 

Portfolio losses recognized during 2009 include discounts taken on the sale or early termination of finance assets, including discounts associated with the liquidation of Distribution Finance and Golf Mortgage finance receivables of $60 million. In addition, we recognized impairment charges of $53 million during 2009 related to automobile manufacturing equipment and investments in real estate associated with matured leveraged leases. The increase in portfolio losses in 2008 as compared to 2007 was mostly the result of a gain on the sale of a leveraged lease investment in 2007.

 

The decrease in securitization gains, net of impairments, was primarily due to the decrease in origination and sales of Distribution Finance receivables to the Distribution Finance revolving securitization, which was ultimately terminated during the fourth quarter of 2009.

 

 

For information regarding Textron Financial’s Quantitative and Qualitative Disclosure about Market Risk, see “Risk Management” in Item 1 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Interest Rate Sensitivity,” in Item 7 of this Form 10-K.

 

 

REPORT OF MANAGEMENT

 

Management is responsible for the integrity and objectivity of the financial data presented in this Annual Report on Form 10-K. The Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States and include amounts based on management’s best estimates and judgments. Management is also responsible for establishing and maintaining adequate internal control over financial reporting for Textron Financial Corporation, as such term is defined in Exchange Act Rules 13a-15(f). With the participation of our management, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control-Integrated Framework, we have concluded that Textron Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of January 2, 2010.

 

The independent registered public accounting firm, Ernst & Young LLP, has audited the Consolidated Financial Statements of Textron Financial Corporation and has issued an attestation report on our internal control over financial reporting as of January 2, 2010, as stated in its reports, which are included herein.

 

We conduct our business in accordance with the standards outlined in the Textron Business Conduct Guidelines, which is communicated to all employees. Honesty, integrity and high ethical standards are the core values of how we conduct business. Textron Financial Corporation prepares and carries out an annual Compliance Plan to ensure these values and standards are maintained. Our internal control structure is designed to provide reasonable assurance, at appropriate cost, that assets are safeguarded and that transactions are properly executed and recorded. The internal control structure includes, among other things, established policies and procedures, an internal audit function, and the selection and training of qualified personnel. Textron Financial Corporation’s management is responsible for implementing effective internal control systems and monitoring their effectiveness, as well as developing and executing an annual internal control plan.

 

 

Warren R. Lyons

President and Chief Executive Officer

February 25, 2010

 

 

Thomas J. Cullen

Executive Vice President and

Chief Financial Officer

February 25, 2010

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors

Textron Financial Corporation

 

We have audited Textron Financial Corporation’s internal control over financial reporting as of January 2, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Textron Financial Corporation’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, Textron Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of January 2, 2010, based on the COSO criteria.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Consolidated Balance Sheets of Textron Financial Corporation as of January 2, 2010 and January 3, 2009, and the related Consolidated Statements of Operations, Cash Flows and Changes in Equity for each of the three years in the period ended January 2, 2010 of Textron Financial Corporation and our report dated February 25, 2010 expressed an unqualified opinion thereon.

 

Boston, Massachusetts

February 25, 2010

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors

Textron Financial Corporation

 

We have audited the accompanying Consolidated Balance Sheets of Textron Financial Corporation as of January 2, 2010 and January 3, 2009, and the related Consolidated Statements of Operations, Cash Flows and Changes in Equity for each of the three years in the period ended January 2, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Textron Financial Corporation at January 2, 2010 and January 3, 2009 and the consolidated results of its operations and its cash flows for each of the three years in the period ended January 2, 2010, in conformity with U.S. generally accepted accounting principles.

 

In 2007 the Company changed the manner in which it accounts for income tax uncertainties and changes (or projected changes) in the timing of cash flows relating to income taxes generated by leveraged lease transactions.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Textron Financial Corporation’s internal control over financial reporting as of January 2, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2010 expressed an unqualified opinion thereon.

 

Boston, Massachusetts

February 25, 2010

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

For each of the three years in the period ended January 2, 2010:

 

 

See Notes to the Consolidated Financial Statements.

 

CONSOLIDATED BALANCE SHEETS

 

 

See Notes to the Consolidated Financial Statements.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

For each of the three years in the period ended January 2, 2010: