UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended December 31, 2015

OR

For the transition period from _______ to _______

Commission File Number 001-36111

 

AMERICAN HONDA FINANCE CORPORATION

(Exact name of registrant as specified in its charter)

  

 

 

(310) 972-2555

(Registrant’s telephone number, including area code)

 

 

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.    x  Yes    ¨  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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    ¨  No

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.

 

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

As of January 29, 2016, the number of outstanding shares of common stock of the registrant was 13,660,000 all of which shares were held by American Honda Motor Co., Inc. None of the shares are publicly traded.

 

 

REDUCED DISCLOSURE FORMAT

American Honda Finance Corporation, a wholly owned subsidiary of American Honda Motor Co., Inc., which in turn is a wholly owned subsidiary of Honda Motor Co., Ltd., meets the requirements set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q with the reduced disclosure format.

 

 

 

 

 

 

 

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AMERICAN HONDA FINANCE CORPORATION

QUARTERLY REPORT ON FORM 10-Q

For the quarter ended December 31, 2015

Table of Contents

 

 

 

 

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Cautionary Statement Regarding Forward-Looking Statements

Certain statements included herein constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 that involve a number of risks and uncertainties. Certain such forward-looking statements can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “scheduled,” or “anticipates” or similar expressions or the negative thereof or other variations thereof or comparable terminology, or by discussions of strategy, plans, or intentions. In addition, all information included herein with respect to projected or future results of operations, cash flows, financial condition, financial performance, or other financial or statistical matters constitute forward-looking statements. Such forward-looking statements are necessarily dependent on assumptions, data, or methods that may be incorrect or imprecise and that may be incapable of being realized. The following factors, among others, could cause actual results and other matters to differ materially from those in such forward-looking statements:

Additional information regarding these and other risks and uncertainties to which our business is subject is contained in our Annual Report on Form 10-K for the year ended March 31, 2015, as updated by our Quarterly Report on Form 10-Q for the quarter ended June 30, 2015. Readers of this Quarterly Report should review the additional information contained in those reports, and in any subsequent Quarterly Report on Form 10-Q that we file with the Securities and Exchange Commission. We do not intend, and undertake no obligation to, update any forward-looking information to reflect actual results or future events or circumstances, except as required by applicable law.

 

 

 

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PART I – FINANCIAL INFORMATION

Item1. Financial Statements

AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(U.S. dollars in millions, except share amounts)

 

 

The following table presents the assets and liabilities of consolidated variable interest entities. These assets and liabilities are included in the consolidated balance sheets presented above. Refer to Note 9 for additional information.

 

 

See accompanying notes to consolidated financial statements.

 

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(U.S. dollars in millions)

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(U.S. dollars in millions)

 

  

See accompanying notes to consolidated financial statements.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (UNAUDITED)

(U.S. dollars in millions)

 

 

See accompanying notes to consolidated financial statements.

 

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(U.S. dollars in millions)

 

 

See accompanying notes to consolidated financial statements.

 

 

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

American Honda Finance Corporation (AHFC) is a wholly owned subsidiary of American Honda Motor Co., Inc. (AHM or the Parent). Honda Canada Finance Inc. (HCFI) is a majority-owned subsidiary of AHFC. Noncontrolling interest in HCFI is held by Honda Canada Inc. (HCI), an affiliate of AHFC. AHM is a wholly owned subsidiary and HCI is an indirect wholly owned subsidiary of Honda Motor Co., Ltd. (HMC). AHM and HCI are the sole authorized distributors of Honda and Acura products, including motor vehicles, parts, and accessories in the United States and Canada.

Unless otherwise indicated by the context, all references to the “Company”, “we”, “us”, and “our” in this report include AHFC and its consolidated subsidiaries, and references to “AHFC” refer solely to American Honda Finance Corporation (excluding AHFC’s subsidiaries).

The unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim information, and instructions to the Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X. In the opinion of management, these unaudited interim financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results of operations, cash flows, and financial condition for the interim periods presented. Results for interim periods should not be considered indicative of results for the full year or for any other interim period. These unaudited interim financial statements should be read in conjunction with the Company’s audited consolidated financial statements, significant accounting policies, and the other notes to the consolidated financial statements for the fiscal year ended March 31, 2015 included in the Company’s Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission (SEC) on June 26, 2015. All significant intercompany balances and transactions have been eliminated upon consolidation.

Effective April 1, 2015, the Company adopted Accounting Standards Update (ASU) 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The amendments require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. In August 2015, the Financial Accounting Standards Board (FASB) issued ASU 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements. This ASU states that the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are outstanding borrowings under the line-of-credit arrangement. The adoption of these ASU’s did not have material impact on the consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers and created the new Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers, and added ASC Subtopic 340-40, Other Assets and Deferred Costs—Contracts with Customers. The guidance in this update supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and most industry-specific guidance throughout the industry topics of the codification. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date for the Company from April 1, 2017 to April 1, 2018 while permitting early adoption as of April 1, 2017. The Company is currently assessing the impact the adoption of this guidance will have on the consolidated financial statements.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The amendments require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. The amendments are effective for the fiscal year ending March 31, 2017 and interim periods thereafter. The adoption of this new standard is not expected to have an impact on the consolidated financial statements.

In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. Under the amendments in this update, all reporting entities are within the scope of Subtopic 810-10, Consolidation—Overall, including limited partnerships and similar legal entities, unless a scope exception applies. The amendments are effective for the Company beginning on April 1, 2016. The Company is currently assessing the impact on the consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this Update address certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The amendments are effective for the Company beginning April 1, 2018, including interim periods within this fiscal year. The Company is currently assessing the impact on the consolidated financial statements.

Finance receivables consisted of the following:

 

 

 

Finance receivables include retail loans with a principal balance of $8.0 billion and $7.4 billion as of December 31, 2015 and March 31, 2015, respectively, which have been transferred to securitization trusts and considered to be legally isolated but do not qualify for sale accounting treatment. These finance receivables are restricted as collateral for the payment of the related secured debt obligations. Refer to Note 9 for additional information.

The uninsured portions of the lease residual values were $184 million and $298 million at December 31, 2015 and March 31, 2015, respectively. Included in the gain or loss on disposition of lease vehicles are end of term charges on both direct financing and operating leases of $7 million and $6 million for the three months ended December 31, 2015 and 2014, respectively, and $20 million and $16 million for the nine months ended December 31, 2015 and 2014, respectively.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Credit Quality of Financing Receivables

Credit losses are an expected cost of extending credit. The majority of the credit risk is with consumer financing and to a lesser extent with dealer financing. Credit risk can be affected by general economic conditions. Adverse changes such as a rise in unemployment rates can increase the likelihood of defaults. Declines in used vehicle prices can reduce the amount of recoveries on repossessed collateral. Credit risk on dealer loans is affected primarily by the financial strength of the dealers within the portfolio. Exposure to credit risk is managed through purchasing standards, pricing of contracts for expected losses, focusing collection efforts to minimize losses, and ongoing reviews of the financial condition of dealers.

Allowance for Credit Losses

The allowance for credit losses is management’s estimate of probable losses incurred on finance receivables, which requires significant judgment and assumptions that are inherently uncertain. The allowance is based on management’s evaluation of many factors, including the Company’s historical credit loss experience, the value of the underlying collateral, delinquency trends, and economic conditions.

Consumer finance receivables in the retail loan and direct financing lease portfolio segments are collectively evaluated for impairment. Delinquencies and losses are monitored on an ongoing basis and this historical experience provides the primary basis for estimating the allowance. Management utilizes various methodologies when estimating the allowance for credit losses including models which incorporate vintage loss and delinquency migration analysis. These models take into consideration attributes of the portfolio including loan-to-value ratios, internal and external credit scores, and collateral types. Market and economic factors such as used vehicle prices, unemployment rates, and consumer debt service burdens are also incorporated into these models.

Dealer loans are individually evaluated for impairment when specifically identified as impaired. Dealer loans are considered to be impaired when it is probable that the Company will be unable to collect all amounts due according to the terms of the contract. The Company’s determination of whether dealer loans are impaired is based on evaluations of dealership payment history, financial condition, and ability to perform under the terms of the loan agreements. Dealer loans that have not been specifically identified as impaired are collectively evaluated for impairment.

There were no modifications to dealer loans that constituted troubled debt restructurings during the three and nine months ended December 31, 2015 and 2014.

The Company generally does not grant concessions on consumer finance receivables that are considered to be troubled debt restructurings other than modifications of retail loans in reorganization proceedings pursuant to the U.S. Bankruptcy Code. Retail loans modified under bankruptcy protection were not material to the Company’s consolidated financial statements during the three and nine months ended December 31, 2015 and 2014. The Company does allow payment deferrals on consumer finance receivables. However, these payment deferrals are not considered to be troubled debt restructurings since the deferrals are deemed to be insignificant and interest continues to accrue during the deferral period.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

The following is a summary of the activity in the allowance for credit losses of finance receivables:

 

 

 

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Delinquencies

The following is an aging analysis of past due finance receivables:

 

 

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Credit Quality Indicators

Retail Loan and Direct Financing Lease Portfolio Segments

The Company utilizes proprietary credit scoring systems to evaluate the credit risk of applicants for retail loans and leases. The scoring systems assign internal credit scores based on various factors including the applicant’s credit bureau information and contract terms. The internal credit score provides the primary basis for credit decisions when acquiring retail loan and lease contracts. Internal credit scores are determined only at the time of origination and are not reassessed during the life of the contract.

Subsequent to origination, collection experience provides a current indication of the credit quality of consumer finance receivables. The likelihood of accounts charging off becomes significantly higher once an account becomes 60 days delinquent. Accounts that are current or less than 60 days past due are considered to be performing. Accounts that are 60 days or more past due are considered to be nonperforming. The table below presents the Company’s portfolio of retail loans and direct financing leases by this credit quality indicator:

 

 

Dealer Loan Portfolio Segment

The Company utilizes an internal risk rating system to evaluate dealer credit risk. Dealerships are assigned an internal risk rating based on an assessment of their financial condition. Factors including liquidity, financial strength, management effectiveness, and operating efficiency are evaluated when assessing their financial condition. Financing limits and interest rates are determined from these risk ratings. Monitoring activities including financial reviews and inventory inspections are performed more frequently for dealerships with weaker risk ratings. The financial conditions of dealerships are reviewed and their risk ratings are updated at least annually.

The Company’s outstanding portfolio of dealer loans has been divided into two groups in the tables below. Group A includes the loans of dealerships with the strongest internal risk rating. Group B includes the loans of all remaining dealers. Although the likelihood of losses can be higher for dealerships in Group B, the overall risk of losses is not considered to be significant.

 

 

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Investment in operating leases consisted of the following:

 

 

The Company recognized $1 million and $11 million of estimated early termination losses due to lessee defaults for the three months ended December 31, 2015 and 2014, respectively. Actual net losses realized for the three months ended December 31, 2015 and 2014 totaled $14 million and $10 million, respectively. The Company recognized $30 million and $29 million of estimated early termination losses due to lessee defaults for the nine months ended December 31, 2015 and 2014, respectively. Actual net losses realized for the nine months ended December 31, 2015 and 2014 totaled $32 million and $26 million, respectively.

Included in the provision for credit losses for both the three months ended December 31, 2015 and 2014 are provisions related to past due receivables on operating leases in the amount of $5 million. Included in the provision for credit losses for both the nine months ended December 31, 2015 and 2014 are provisions related to past due receivables on operating leases in the amount of $14 million.

The Company did not recognize impairment losses due to declines in estimated residual values during the three and nine months ended December 31, 2015 and 2014.

The Company issues debt in various currencies with both floating and fixed interest rates. Outstanding debt, weighted average contractual interest rates and range of contractual interest rates were as follows:

 

 

As of December 31, 2015, the outstanding principal balance of long-term debt with floating interest rates totaled $14.3 billion and long-term debt with fixed interest rates totaled $22.1 billion. As of March 31, 2015, the outstanding principal balance of long-term debt with floating interest rates totaled $12.6 billion and long-term debt with fixed interest rates totaled $21.0 billion.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Commercial Paper

As of December 31, 2015 and March 31, 2015, the Company had commercial paper programs that provide the Company with available funds of up to $8.4 billion and $8.6 billion, respectively, at prevailing market interest rates for periods up to one year. The commercial paper programs are supported by the Keep Well Agreements with HMC described in Note 6.

Outstanding commercial paper averaged $5.2 billion and $5.8 billion during the nine months ended December 31, 2015 and 2014, respectively. The maximum balance outstanding at any month-end during the nine months ended December 31, 2015 and 2014 was $5.9 billion and $6.7 billion, respectively.

Related Party Debt

AHFC routinely issues fixed rate short-term notes to AHM to help fund AHFC’s general corporate operations. The Company incurred interest expense on these notes totaling $0.5 million and $1 million for the three months ended December 31, 2015 and 2014, respectively, and $2 million and $3 million for the nine months ended December 31, 2015 and 2014, respectively.

HCFI routinely issues fixed rate short-term notes to HCI to help fund HCFI’s general corporate operations. The Company incurred interest expense on these notes totaling $3 million and $6 million for the three months ended December 31, 2015 and 2014, respectively, and $10 million and $17 million for the nine months ended December 31, 2015 and 2014, respectively.

Bank Loans

Outstanding bank loans as of December 31, 2015 had floating interest rates. Outstanding bank loans have prepayment options. No outstanding bank loans as of December 31, 2015 were supported by the Keep Well Agreements with HMC described in Note 6.

Medium Term Note (MTN) Programs

Private MTN Program

AHFC no longer issues MTNs under the Rule 144A Private MTN Program. Notes outstanding under the Private MTN Program as of December 31, 2015 were long-term, with either fixed or floating interest rates, and denominated in U.S. dollars.

Public MTN Program

In August 2015, AHFC increased the authorized maximum aggregate principal amount for issuance under the Public MTN Program from $16.0 billion to $30.0 billion. The aggregate principal amount of MTNs offered under this program may be increased from time to time. Notes outstanding under this program as of December 31, 2015 were both short-term and long-term, with either fixed or floating interest rates, and denominated in U.S. dollars, Euros and Sterling.

Euro MTN Programme

The Euro MTN Programme was retired in August 2014. Notes under this program that are currently listed on the Luxembourg Stock Exchange will remain listed through their maturities. Notes outstanding under this program as of December 31, 2015 were long-term, with either fixed or floating interest rates, and denominated in U.S. dollars, Japanese Yen, or Euros.

The MTN programs are supported by the Keep Well Agreement with HMC described in Note 6.

Other Debt

The outstanding balances as of December 31, 2015 consisted of private placement debt issued by HCFI, denominated in Canadian dollars, with either fixed or floating interest rates. Private placement debt is supported by the Keep Well Agreement with HMC described in Note 6.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Secured Debt

The Company issues notes through secured financing transactions that are secured by assets held by the issuing securitization trust. The notes generally have fixed interest rates (a limited number of notes had floating interest rates). Repayment on the notes is dependent on the performance of the underlying receivables. Refer to Note 9 for additional information on the Company’s secured financing transactions.

Credit Agreements

Syndicated Bank Credit Facilities

AHFC maintains a $3.5 billion 364 day credit agreement, as amended, which expires on March 4, 2016, and a $3.5 billion five year credit agreement, as amended, which expires on March 7, 2020. At December 31, 2015, no amounts were outstanding or repaid under the AHFC credit agreements. AHFC intends to renew or replace the credit agreements prior to or on their respective expiration dates.

HCFI maintains a $1.2 billion credit agreement, as amended, which provides that HCFI may borrow up to $578 million on a one year and a five-year revolving basis. The one year tranche of the credit agreement expires on March 24, 2016 and the five year tranche of the credit agreement expires on March 24, 2020. At December 31, 2015, no amounts were outstanding or repaid under the HCFI credit agreement. HCFI intends to renew or replace the credit agreement prior to or on the expiration date of each respective tranche.

The credit agreements contain customary conditions to borrowing and customary restrictive covenants, including limitations on liens and limitations on mergers, consolidations and asset sales. The credit agreements also require AHFC and HCFI, respectively, to maintain a positive consolidated tangible net worth as defined in their respective credit agreements. The credit agreements, in addition to other customary events of default, include cross-default provisions and provisions for default if HMC does not maintain ownership, whether directly or indirectly, of at least 80% of the outstanding capital stock of AHFC or HCFI, as applicable. In addition, the AHFC and HCFI credit agreements contain provisions for default if HMC’s obligations under the HMC-AHFC Keep Well Agreement or the HMC-HCFI Keep Well Agreement, as applicable, become invalid, voidable, or unenforceable. All of these conditions, covenants and events of default are subject to important limitations and exceptions under the agreements governing the credit agreements. As of December 31, 2015, management believes that AHFC and HCFI were in compliance with all covenants contained in the respective credit agreements.

Other Credit Agreements

In September 2015, AHFC entered into other committed lines of credit to allow the Company access to an additional $1.0 billion in unsecured funding with multiple banks. The credit agreements contain customary conditions to borrowing and customary restrictive covenants, including limitations on liens and limitations on mergers, consolidations and asset sales and a requirement for AHFC to maintain a positive consolidated tangible net worth. There were no amounts outstanding as of December 31, 2015. These agreements expire in September 2016.  

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

The notional balances and gross fair values of the Company’s derivatives are presented below. The derivative instruments are presented in the Company’s consolidated balance sheets on a gross basis by counterparty. Refer to Note 13 regarding the valuation of derivative instruments.

 

 

The income statement effect of derivative instruments is presented below. There were no derivative instruments designated as part of a hedge accounting relationship during the periods presented.

 

 

The fair value of derivative instruments is subject to the fluctuations in market interest rates and foreign currency exchange rates. Since the Company has elected not to apply hedge accounting, the volatility in the changes in fair value of these derivative instruments is recognized in earnings. All settlements of derivative instruments are recognized within cash flows from operating activities in the consolidated statements of cash flows.

These derivative instruments also contain an element of credit risk in the event the counterparties are unable to meet the terms of the agreements. However, the Company minimizes the risk exposure by limiting the counterparties to major financial institutions that meet established credit guidelines. In the event of default, all counterparties are subject to legally enforceable master netting agreements. The Company generally does not require or place collateral for these instruments under credit support agreements.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

The following tables summarize the income statement and balance sheet impact of transactions with the Parent and affiliated companies.

 

 

 

Support Agreements

HMC and AHFC are parties to a Keep Well Agreement, effective as of September 9, 2005. This Keep Well Agreement provides that HMC will (1) maintain (directly or indirectly) at least 80% ownership in AHFC’s voting stock and not pledge (directly or indirectly), or in any way encumber or otherwise dispose of, any such stock of AHFC that it is required to hold (or permit any of HMC’s subsidiaries to do so), (2) cause AHFC to have a positive consolidated tangible net worth with tangible net worth defined as (a) stockholder’s equity less (b) any intangible assets, determined on a consolidated basis in accordance with GAAP, and (3) ensure that AHFC has sufficient liquidity to meet its payment obligations for debt HMC has confirmed in writing is covered by this Keep Well Agreement, in accordance with its terms, or where necessary make available to AHFC, or HMC shall procure for AHFC, sufficient funds to enable AHFC to meet such obligations in accordance with such terms. This Keep Well Agreement is not a guarantee by HMC.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

HMC and HCFI are parties to a Keep Well Agreement effective as of September 26, 2005. This Keep Well Agreement provides that HMC will (1) maintain (directly or indirectly) at least 80% ownership in HCFI’s voting stock and not pledge (directly or indirectly), or in any way encumber or otherwise dispose of, any such stock of HCFI that it is required to hold (or permit any of HMC’s subsidiaries to do so), (2) cause HCFI to have a positive consolidated tangible net worth with tangible net worth defined as (a) stockholder’s equity less (b) any intangible assets, determined on a consolidated basis in accordance with generally accepted accounting principles in Canada, and (3) ensure that HCFI has sufficient liquidity to meet its payment obligations for debt HMC has confirmed in writing is covered by this Keep Well Agreement, in accordance with its terms, or where necessary make available to HCFI, or HMC shall procure for HCFI, sufficient funds to enable HCFI to meet such obligations in accordance with such terms. This Keep Well Agreement is not a guarantee by HMC.

Debt programs supported by the Keep Well Agreements consist of the Company’s commercial paper programs, Private MTN Program, Public MTN Program, Euro MTN Programme, and HCFI’s private placement debt. In connection with the above agreements, AHFC and HCFI have entered into separate Support Compensation Agreements, where each has agreed to pay HMC a quarterly fee based on the amount of outstanding debt that benefit from the Keep Well Agreements. Support Compensation Agreement fees are recognized in general and administrative expenses.

Incentive Programs

The Company receives subsidy payments from AHM and HCI, which supplement the revenues on financing products offered under incentive programs. Subsidy payments received on retail loans and leases are deferred and recognized as revenue over the term of the related contracts. The unearned balance is recognized as reductions to the carrying value of finance receivables and investment in operating leases. Subsidy payments on dealer loans are received as earned.

Related Party Debt

AHFC routinely issues short-term notes to AHM to fund AHFC’s general corporate operations. HCFI routinely issues short-term notes to HCI to fund HCFI’s general corporate operations. Interest rates are based on prevailing rates of debt with comparable terms. Refer to Note 4 for additional information.

Vehicle Service Contract (VSC) Administration

AHFC receives fees to perform administrative services for vehicle service contracts issued by AHM and its subsidiary. HCFI receives fees for marketing vehicle service contracts issued by HCI. Unearned VSC administration fees are included in other liabilities (Note 11). VSC administration income is recognized in other income (Note 12).

Shared Services

The Company shares certain common expenditures with AHM, HCI, and related parties including data processing services, software development, and facilities. The allocated costs for shared services are included in general and administrative expenses.

Benefit Plans

The Company participates in various employee benefit plans that are maintained by AHM and HCI. The allocated benefit plan expenses are included in general and administrative expenses.

Income taxes

The Company’s U.S. income taxes are recognized on a modified separate return basis pursuant to an intercompany income tax allocation agreement with AHM. Income tax related items are not included in the tables above. Refer to Note 7 for additional information.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Other

The majority of the amounts due from the Parent and affiliated companies at December 31, 2015 and March 31, 2015 related to subsidies. The majority of the amounts due to the Parent and affiliated companies at December 31, 2015 and March 31, 2015 related to wholesale flooring invoices payable to the Parent. These receivable and payable accounts are non-interest-bearing and short-term in nature and are expected to be settled in the normal course of business.

The Company’s effective tax rate was 38.7% and 45.3% for the three months ended December 31, 2015 and 2014, respectively, and 35.8% and 38.2% for the nine months ended December 31, 2015 and 2014, respectively. The decrease in the effective tax rate for the three and nine months ended December 31, 2015 is due to the relative effect of retroactive U.S. tax law changes, enacted in December 2014 and December 2015, on AHFC’s share of qualified domestic production deduction allocated between the Parent and affiliated companies. Also, there were changes in certain state apportionment methods and tax rates which lowered the effective tax rate.

To date, the Company has not provided for federal income taxes on its share of the undistributed earnings of its foreign subsidiary, HCFI, that are intended to be indefinitely reinvested outside the United States. At December 31, 2015, $685 million of accumulated undistributed earnings of HCFI were deemed to be so reinvested. If these undistributed earnings as of December 31, 2015 were to be distributed, the tax liability associated with these indefinitely reinvested earnings would be $159 million. The Company does not expect to repatriate any undistributed earnings in the foreseeable future.

The Protecting Americans from Tax Hikes Act of 2015, signed into law on December 18, 2015, enacted the tax law that defers the imposition of U.S. taxes on certain foreign active financing income until that income is repatriated to the U.S. as a dividend. AHFC will no longer recognize tax on its share of such income to the extent it is indefinitely reinvested.

The changes in the unrecognized tax benefits for the nine months ended December 31, 2015 were not significant. The Company does not expect any material changes in the amounts of unrecognized tax benefits during the remainder of the fiscal year ending March 31, 2016.

As of December 31, 2015, the Company is subject to examination by U.S. federal and state tax jurisdictions for returns filed for the taxable years ended March 31, 2008 to 2015, with the exception of one state which is subject to examination for returns filed for the taxable years ended March 31, 2001 to 2015. The Company’s Canadian subsidiary, HCFI, is subject to examination for returns filed for the taxable years ended March 31, 2009 to 2015 federally, and returns filed for the taxable years ended March 31, 2008 to 2015 provincially. The Company believes appropriate provision has been made for all outstanding issues for all open years.

The Company leases certain premises and equipment on a long-term basis under noncancelable leases. Some of these leases require the Company to pay property taxes, insurance, and other expenses. Lease expense was approximately $3 million for both the three months ended December 31, 2015 and 2014, and approximately $8 million for both the nine months ended December 31, 2015 and 2014.

The Company extends commercial revolving lines of credit to dealerships to support their business activities including facilities refurbishment and general working capital requirements. The amounts borrowed are generally secured by the assets of the borrowing entity. The majority of the lines have annual renewal periods. Maximum commercial revolving lines of credit were $468 million and $476 million as of December 31, 2015 and March 31, 2015, respectively, with $259 million and $261 million used, respectively, as of those dates. The Company also has a commitment to lend a total of $82 million to finance the construction of auto dealerships, of which $56 million has been funded as of December 31, 2015.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Legal Proceedings and Regulatory Matters

The Company establishes accruals for legal claims when payments associated with the claims become probable and the costs can be reasonably estimated. When able, the Company will determine estimates of reasonably possible loss or range of loss, whether in excess of any related accrued liability or where there is no accrued liability. Given the inherent uncertainty associated with legal matters, the actual costs of resolving legal claims and associated costs of defense may be substantially higher or lower than the amounts for which accruals have been established.

The Company is involved, in the ordinary course of business, in various legal proceedings including claims of individual customers and purported class action lawsuits. Certain of these actions are similar to suits filed against other financial institutions and captive finance companies. Most of these proceedings concern customer allegations of wrongful repossession or defamation of credit. The Company is also subject to governmental reviews from time to time. Based on available information and established accruals, management does not believe it is reasonably possible that the results of these proceedings, in the aggregate, will have a material adverse effect on the Company’s consolidated financial statements.

On July 14, 2015 (Effective Date), the Company reached a settlement with the Consumer Financial Protection Bureau (CFPB) and the U.S. Department of Justice (DOJ, together with the CFPB, the Agencies) related to the Agencies’ previously disclosed investigation of, and allegations regarding, pricing practices by dealers originating retail installment sale contracts for automobiles purchased by AHFC and entered into a consent order with each of the Agencies to reflect such settlement (collectively, the Consent Orders). Pursuant to the Consent Orders, the Company implemented a new dealer compensation policy on August 11, 2015. In connection with the implementation of such policy, the Company has agreed to maintain general compliance management systems reasonably designed to assure compliance with all relevant federal consumer financial laws. Additionally, the Company has agreed to pay $24 million in consumer remuneration and, pursuant to the Consent Order with the DOJ, the Company has submitted to the Agencies a proposal for the distribution of a $1 million donation by the Company for financial education programs for protected groups. These amounts were recognized in the consolidated financial statements in the fourth quarter of fiscal year 2015.

In addition, as previously disclosed, the Company also received a subpoena from the New York Department of Financial Services requesting information relating to its fair lending laws. The Company is cooperating with this request for information. Management cannot predict the outcome of this inquiry.

The trusts utilized for on-balance sheet securitizations are VIEs, which are required to be consolidated by their primary beneficiary. The Company is considered to be the primary beneficiary of these trusts due to (i) the power to direct the activities of the trusts that most significantly impact the trusts’ economic performance through its role as servicer, and (ii) the obligation to absorb losses or the right to receive residual returns that could potentially be significant to the trusts through the subordinated certificates and residual interest retained. The debt securities issued by the trusts to third-party investors along with the assets of the trusts are included in the Company’s consolidated financial statements.

During the nine months ended December 31, 2015 and 2014, the Company issued notes through asset backed securitizations, which were accounted for as secured financing transactions totaling $3.5 billion and $3.0 billion, respectively. The notes were secured by receivables with an initial principal balance of $4.6 billion and $3.1 billion, respectively.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

The table below presents the carrying amounts of assets and liabilities of consolidated securitization trusts as they are reported in the Company’s consolidated balance sheets. All amounts exclude intercompany balances, which have been eliminated upon consolidation. The assets of the trusts can only be used to settle the obligations of the trusts. The third-party investors in the obligations of the trusts do not have recourse to the general credit of the Company.

 

  

In their role as servicers, AHFC and HCFI collect principal and interest payments on the underlying receivables on behalf of the securitization trusts. Cash collected during a calendar month is required to be remitted to the trusts in the following month. AHFC and HCFI are not restricted from using the cash collected for their general purposes prior to the remittance to the trusts. As of December 31, 2015 and March 31, 2015, AHFC and HCFI had cash collections of $402 million and $420 million, respectively, which were required to be remitted to the trusts.

Other assets consisted of the following:

 

 

Depreciation and amortization are computed on a straight line basis over the estimated useful lives of the related assets, which range from three to five years. General and administrative expenses include depreciation and amortization expense of $1 million, for both the three months ended December 31, 2015 and 2014, and $3 million and $4 million for the nine months ended December 31, 2015 and 2014, respectively.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Other liabilities consisted of the following:

 

 

Other income consisted of the following:

 

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Level 1 inputs are quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are those other than quoted prices included within Level 1 that are observable for the asset or liability. Level 3 inputs are unobservable inputs for the asset or liability. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Nonperformance risk is also required to be reflected in the fair value measurement, including an entity’s own credit standing when measuring the fair value of a liability.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Recurring Fair Value Measurements

The following tables summarize the fair value hierarchy of assets and liabilities measured at fair value on a recurring basis:

 

 

 

The valuation techniques of assets and liabilities measured at fair value on a recurring basis are described below:

Derivative Instruments

The Company’s derivatives are transacted in over-the-counter markets and quoted market prices are not readily available. The Company uses third-party developed valuation models to value derivative instruments. These models estimate fair values using discounted cash flow modeling techniques, which utilize the contractual terms of the derivative instruments and market-based inputs, including interest rates and foreign exchange rates. Discount rates incorporate counterparty and HMC specific credit default spreads to reflect nonperformance risk.

The Company’s derivative instruments are classified as Level 2 since all significant inputs are observable and do not require management judgment. There were no transfers between fair value hierarchy levels during the nine months ended December 31, 2015 and 2014. Refer to Note 5 for additional information on derivative instruments.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Nonrecurring Fair Value Measurements

The following tables summarize nonrecurring fair value measurements recognized for assets still held at the end of the reporting periods presented:

 

 

The following describes the methodologies and assumptions used in nonrecurring fair value measurements, which relate to the application of lower of cost or fair value accounting on long-lived assets.

Vehicles Held for Disposition

Vehicles held for disposition consist of returned and repossessed vehicles. They are valued at the lower of their carrying value or estimated fair value, less estimated disposition costs. The fair value is based on current average selling prices of like vehicles at wholesale used vehicle auctions.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Fair Value of Financial Instruments

The following tables summarize the carrying values and fair values of the Company’s financial instruments except for those measured at fair value on a recurring basis. Certain financial instruments and all nonfinancial assets and liabilities are excluded from fair value disclosure requirements including the Company’s direct financing lease receivables and investment in operating leases.

 

 

 

The following describes the methodologies and assumptions used to estimate the fair value of the Company’s financial instruments not measured at fair value on a recurring basis:

Cash, Cash Equivalents, and Restricted Cash

The carrying values reported on the consolidated balance sheets approximate fair values due to the short-term nature of the assets and negligible credit risk. Restricted cash accounts held by securitization trusts are included in other assets.

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Finance Receivables

The fair values of the Company’s retail loans and dealer wholesale loans are based on estimated proceeds of hypothetical whole loan transactions. It is assumed that market participants in whole loan transactions would acquire the loans with the intent of securitizing the loans. Internally developed valuation models are used to estimate the pricing of securitization transactions, which is adjusted for the estimated costs of securitization transactions and required profit margins of market participants. The models incorporate projected cash flows of the underlying receivables, which include prepayment and credit loss assumptions. The models also incorporate current market interest rates and market spreads for the credit and liquidity risk of securities issued in the securitizations. The estimated fair values of the Company’s dealer commercial loans are based on a discounted cash flow model.

Debt

The fair value of the Company’s debt is estimated based on a discounted cash flow analysis. Projected cash flows are discounted using current market interest rates and credit spreads for debt with similar maturities. The Company’s specific nonperformance risk is reflected in the credit spreads on the Company’s unsecured debt.

The above fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no active market exists for a portion of the Company’s financial instruments, fair value estimates of such financial instruments are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value information presented in the tables above is based on information available at December 31, 2015 and March 31, 2015. Although the Company is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been updated since those dates, and therefore, the current estimates of fair value at dates subsequent to those dates may differ significantly from the amounts presented herein.

The Company’s reportable segments are based on the two geographic regions where operating results are measured and evaluated by management: the United States and Canada.

Segment performance is evaluated using an internal measurement basis, which differs from the Company’s consolidated results prepared in accordance with GAAP. Segment performance is evaluated on a pre-tax basis before the effect of valuation adjustments on derivative instruments and revaluations of foreign currency denominated debt. Since the Company does not elect to apply hedge accounting, the impact to earnings resulting from these valuation adjustments as reported under GAAP is not representative of segment performance as evaluated by management. Realized gains and losses on derivative instruments, net of realized gains and losses on foreign currency denominated debt, are included in the measure of net revenues when evaluating segment performance.

No adjustments are made to segment performance to allocate any revenues or expenses. Financing products offered throughout the United States and Canada are substantially similar. Segment revenues from the various financing products are reported on the same basis as GAAP consolidated results.

 

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

Financial information for the Company’s reportable segments for the three and nine months ended or at December 31, 2015 and 2014 is summarized in the following tables:

 

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AMERICAN HONDA FINANCE CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

 

 

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations  

Overview

Our primary focus, in collaboration with AHM and HCI, is to provide support for the sale of Honda and Acura products and maintain customer and dealer satisfaction and loyalty. To deliver this support effectively, we seek to maintain competitive cost of funds, efficient operations, and effective risk and compliance management. The primary factors influencing our results of operations, cash flows, and financial condition include the volume of Honda and Acura sales and the portion of those sales that we finance, our cost of funds, competition from other financial institutions, consumer credit defaults, and used motor vehicle prices.

A substantial portion of our consumer financing business is acquired through incentive financing programs sponsored by AHM and HCI. The volume of incentive financing programs and the allocation of those programs between retail loans and leases may vary from fiscal period to fiscal period depending upon the respective marketing strategies of AHM and HCI. AHM and HCI’s marketing strategies are based in part on their business planning, in which we do not participate. Therefore, we cannot predict the level of incentive financing programs AHM and HCI may sponsor in the future. Our consumer financing acquisition volumes are substantially dependent on the extent to which incentive financing programs are offered. Increases in incentive financing programs generally increase our financing penetration rates, which typically results in increased financing acquisition volumes for us. The amount of subsidy payments we receive from AHM and HCI is dependent on the terms of the incentive financing programs and the interest rate environment. Subsidy payments are received upon acquisition and recognized in revenue throughout the life of the loan or lease; therefore, a significant change in the level of incentive financing programs in a fiscal period often may not be reflected in our results of operations for that period. The amount of subsidy income we recognize in a fiscal period is dependent on the cumulative level of subsidized contracts outstanding that were acquired through incentive financing programs.

We seek to maintain high quality consumer and dealer account portfolios, which we support with strong underwriting standards, risk-based pricing, and effective collection capabilities. Our cost of funds is facilitated by the diversity of our funding sources, and effective interest rate and foreign currency exchange risk management. We manage expenses to increase our profitability, including adjusting staffing needs based upon our business volumes and centralizing support functions. Additionally, we use risk and compliance management practices to optimize credit and residual value risks and maintain compliance with our pricing, underwriting and servicing policies at the United States, Canadian, state and provincial levels.

In our business operations, we incur costs related to funding, credit loss, residual value loss, and general and administrative expenses, among other expenses.

We analyze our operations in two business segments defined by geography: the United States and Canada. We measure the performance of our United States and Canada segments on a pre-tax basis before the effect of valuation adjustments on derivative instruments and revaluations of foreign currency denominated debt. For additional information regarding our segments, see Note 14—Segment Information of Notes to Consolidated Financial Statements. The following tables and the related discussion are presented based on our geographically segmented consolidated financial statements.

References to “C$” are to the Canadian dollar. This report contains translations of certain Canadian dollar amounts into U.S. dollars at the rate specified below solely for your convenience. These translations should not be construed as representations that the Canadian dollar amounts actually represent such U.S. dollar amounts or that they could be converted into U.S. dollars at the rate indicated. U.S. dollar equivalents for “C$” amounts are calculated based on the exchange rate on December 31, 2015 of 1.3839 per U.S. dollar.

References in this report to our “fiscal year 2016” and “fiscal year 2015” refer to our fiscal year ending March 31, 2016 and our fiscal year ended March 31, 2015, respectively.

Results of Operations

The following table presents our income before income taxes:

  

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Comparison of the Three Months Ended December 31, 2015 and 2014

Our consolidated income before income taxes was $364 million during the third quarter of fiscal year 2016 compared to $380 million during the same period in fiscal year 2015. This decrease of $16 million, or 4%, was primarily due to a decline in revenue from retail loans of $25 million, a decline in revenue from direct financing leases of $18 million, an increase in provision for credit losses of $9 million, and an increase in interest expense of $6 million, partially offset by an increase in operating lease revenue, net of depreciation, of $32 million, and a decline in early termination loss on operating leases of $10 million.

Comparison of the Nine Months Ended December 31, 2015 and 2014

Our consolidated income before income taxes was $1,075 million during the first nine months of fiscal year 2016 compared to $1,240 million during the same period in fiscal year 2015. This decrease of $165 million, or 13%, was primarily due to a decline in gain on revaluation of foreign currency denominated debt of $214 million, a decline in revenue from retail loans of $86 million, a decline in revenue from direct financing leases of $50 million, an increase in provision for credit losses of $24 million, partially offset by a decline in loss on derivative instruments of $131 million, and an increase in operating lease revenue, net of depreciation, of $80 million.

Segment Results—Comparison of the Three Months Ended December 31, 2015 and 2014

Results of operations for the United States segment and the Canada segment are summarized below:

  

Revenues

Revenue from retail loans in the United States segment declined by $21 million, or 7%, during the third quarter of fiscal year 2016 compared to the same period in fiscal year 2015. The decline in revenue was primarily attributable to lower average outstanding retail loans. Revenue from retail loans in the Canada segment declined by $4 million, or 10%, primarily due to the effect of foreign currency translation adjustments.

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Operating lease revenue in the United States segment increased by $97 million, or 8%, during the third quarter of fiscal year 2016 compared to the same period in fiscal year 2015. The increase in revenue was due to higher average outstanding operating lease assets during the third quarter of fiscal year 2016 compared to the same period in fiscal year 2015. Operating lease revenue in the Canada segment increased by $68 million due to the increase in operating lease assets.

Direct financing lease revenue, which is generated only in Canada, declined by $18 million, or 53%, during the third quarter of fiscal year 2016 compared to the same period in fiscal year 2015. The decline in revenue was primarily attributable to the continued decline in outstanding direct financing lease assets.

Subsidy income from AHM and HCI sponsored incentive programs increased by $11 million, or 4%, to $277 million during the third quarter of fiscal year 2016 compared to the same period in fiscal year 2015.

Depreciation on operating leases

Depreciation on operating leases in the United States segment increased by $78 million, or 8%, during the third quarter of fiscal year 2016 compared to the same period in fiscal year 2015, primarily due to higher average outstanding operating lease assets. Depreciation on operating leases in the Canada segment increased by $55 million due to the increase in operating lease assets.

Operating lease revenue, net of depreciation, in the United States segment increased by $19 million, or 8%, during the third quarter of fiscal year 2016 compared to the same period in fiscal year 2015. This increase was attributable to the growth in our operating lease assets, which was partially offset by lower net revenue on more recently acquired operating leases. Operating lease revenue, net of depreciation, in the Canada segment increased by $13 million due to the increase in operating lease assets.

Interest expense

Interest expense in the United States segment increased by $14 million, or 12%, during the third quarter of fiscal year 2016 compared to the same period in fiscal year 2015. The increase was attributable to higher average cost of debt due to a change in the mix of short-term and long-term debt, which was partially offset by lower average outstanding debt. Interest expense in the Canada segment declined by $8 million, or 32%, due to the effect of foreign currency translation adjustments and lower average cost of debt. See “—Liquidity and Capital Resources” below for more information.

Gain/loss on disposition of lease vehicles

In the United States segment, we recognized a gain on disposition of lease vehicles of $3 million during the third quarter of fiscal year 2016 compared to a loss of $2 million during the same period in fiscal year 2015. The gain on disposition of lease vehicles in the Canada segment declined by $1 million during the third quarter of fiscal year 2016 compared to the same period in fiscal year 2015.

Provision for credit losses

The provision for credit losses in the United States segment increased by $9 million, or 30%, during the third quarter of fiscal year 2016 compared to the same period in fiscal year 2015. The increase was attributable to higher net charge-offs and adjustments to assumptions in our allowance for credit loss estimates. Certain assumptions were adjusted to reflect the higher loss rates experienced on recent vintages. The provision for credit losses in the Canada segment was consistent during the third quarter of fiscal year 2016 compared to the same period in fiscal year 2015. See “—Financial Condition—Credit Risk” below for more information.

Early termination losses on operating leases

Early termination losses on operating leases in the United States segment declined by $10 million during the third quarter of fiscal year 2016 compared to the same period in fiscal year 2015 as the result of adjusting the assumptions in our estimate of early termination losses. We reduced our loss assumptions as we experienced lower realized losses than was previously estimated. Early termination losses on operating leases in the Canada segment were consistent during the third quarter of fiscal year 2016 compared to the same period in fiscal year 2015. See “—Financial Condition—Credit Risk” below for more information.

Loss on lease residual values

Losses on lease residual values in the Canada segment increased by $2 million during the third quarter of fiscal year 2016 as compared to the same period in fiscal year 2015 due to an increase in loss severity.

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Gain/loss on derivative instruments

In the United States segment, we recognized a loss on derivative instruments of $65 million during the third quarter of fiscal year 2016 compared to a loss of $51 million during the same period in fiscal year 2015. The loss in the third quarter of fiscal year 2016 was comprised of losses on pay float interest rate swaps of $80 million and cross currency swaps of $72 million, which were partially offset by gains on pay fixed interest rate swaps of $87 million. The losses on pay float interest rate swaps and gains on pay fixed interest rate swaps were primarily due to a rise in interest rates during the third quarter of fiscal year 2016. The losses on cross currency swaps were primarily attributable to the U.S. dollar strengthening against the Euro and Sterling during the third quarter of fiscal year 2016. In the Canada segment, we recognized a gain on derivative instruments of less than $1 million during the third quarter of fiscal year 2016 compared to a loss of $10 million during the same period in fiscal year 2015. The gain during the third quarter of fiscal year 2016 was attributable to gains on interest rate swaps due to the rise in Canadian interest rates. See “—Derivatives” below for more information.

Gain/loss on foreign currency revaluation of debt

In the United States segment, we recognized a gain on the revaluation of foreign currency denominated debt of $71 million during the third quarter of fiscal year 2016 which was consistent with the same period in fiscal year 2015. The gain during the third quarter of fiscal year 2016 was primarily attributable to gains on Euro denominated debt as the U.S. dollar strengthened against the Euro during the quarter.

Income tax expense

Our consolidated effective tax rate was 38.7% for the third quarter of fiscal year 2016 and 45.3% for the same period in fiscal year 2015. The decrease in the effective tax rate for the three months ended December 31, 2015 is due to the relative effect of retroactive U.S. tax law changes, enacted in December 2014 and December 2015, on AHFC’s share of qualified domestic production deduction allocated between the Parent and affiliated companies. Also, there were changes in certain state apportionment methods and tax rates which lowered the effective tax rate.

Segment Results—Comparison of the Nine Months Ended December 31, 2015 and 2014

Results of operations for the United States segment and the Canada segment are summarized below:

 

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Revenues

Revenue from retail loans in the United States segment declined by $70 million, or 8%, during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015. The decline in revenue was primarily attributable to lower average outstanding retail loans. Revenue from retail loans in the Canada segment declined by $16 million, or 13%, primarily due to the effect of foreign currency translation adjustments.

Operating lease revenue in the United States segment increased by $296 million, or 9%, during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015. The increase in revenue was due to higher average outstanding operating lease assets during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015. Operating lease revenue in the Canada segment increased by $188 million due to the increase in operating lease assets.

Direct financing lease revenue, which is generated only in Canada, declined by $50 million, or 46%, during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015. The decline in revenue was primarily attributable to the continued decline in outstanding direct financing lease assets.

Subsidy income from AHM and HCI sponsored incentive programs increased by $20 million, or 2%, to $821 million during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015.

Depreciation on operating leases

Depreciation on operating leases in the United States segment increased by $251 million, or 9%, during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015, primarily due to higher average outstanding operating lease assets. Depreciation on operating leases in the Canada segment increased by $153 million due to the increase in operating lease assets.

Operating lease revenue, net of depreciation, in the United States segment increased by $45 million, or 6%, during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015. This increase was attributable to the growth in our operating lease assets, which was partially offset by lower net revenue on more recently acquired operating leases. Operating lease revenue, net of depreciation, in the Canada segment increased by $35 million due to the increase in operating lease assets.

Interest expense

Interest expense in the United States segment increased by $11 million, or 3%, during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015. The increase was attributable to higher average cost of debt due to a change in the mix of short-term and long-term debt, which was partially offset by lower average outstanding debt. Interest expense in the Canada segment declined by $18 million, or 25%, due to the effect of foreign currency translation adjustments and lower average cost of debt. See “—Liquidity and Capital Resources” below for more information.

Gain/loss on disposition of lease vehicles

The gain on disposition of lease vehicles in the United States segment declined by $1 million, or 3%, during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015. The gain on disposition of lease vehicles in the Canada segment declined by $3 million during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015.

Provision for credit losses

The provision for credit losses in the United States segment increased by $21 million, or 28%, during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015. The increase was attributable to higher net charge-offs and adjustments to assumptions in our allowance for credit loss estimates. Certain assumptions were adjusted to reflect the higher loss rates experienced on recent vintages. The provision for credit losses in the Canada segment increased by $3 million during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015 due to higher net charge-offs, adjustments to assumptions in our allowance for credit losses, and the increase in finance receivables. See “—Financial Condition—Credit Risk” below for more information.

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Early termination losses on operating leases

Early termination losses on operating leases in the United States segment was consistent during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015. The losses we recognized remained consistent despite the growth in operating lease assets during the first nine months of fiscal year 2016 as the result of adjusting the assumptions in our estimate of early termination losses. We reduced our loss assumptions as we experienced lower realized losses than was previously estimated. Early termination losses on operating leases in the Canada segment increased by $1 million during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015. See “—Financial Condition—Credit Risk” below for more information.

Loss on lease residual values

Losses on lease residual values in the Canada segment increased by $3 million during the first nine months of fiscal year 2016 as compared to the same period in fiscal year 2015 due to an increase in loss severity.

Gain/loss on derivative instruments

In the United States segment, we recognized a loss on derivative instruments of $53 million during the first nine months of fiscal year 2016 compared to a loss of $177 million during the same period in fiscal year 2015. The loss in the first nine months of fiscal year 2016 was comprised of losses on cross currency swaps of $41 million and pay fixed interest rate swaps of $47 million, which were partially offset by gains on pay float interest rate swaps of $35 million. The losses on pay fixed interest rate swaps and gains on pay float interest rate swaps were primarily due to the decline in duration of interest rate swaps. The losses on cross currency swaps were primarily attributable to losses on the swaps we entered into during the second and third quarters of fiscal year 2016 in conjunction with the issuance of Euro and Sterling denominated debt. The strength of the U.S. Dollar fluctuated during the first nine months of fiscal year 2016 but strengthened subsequent to entering into the Euro and Sterling currency swaps which resulted in the losses. In the Canada segment, the loss on derivative instruments declined by $7 million during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015. See “—Derivatives” below for more information.

Gain/loss on foreign currency revaluation of debt

In the United States segment, we recognized a gain on the revaluation of foreign currency denominated debt of $36 million during the first nine months of fiscal year 2016 compared to a gain of $250 million during the same period in fiscal year 2015. The gain during the first nine months of fiscal year 2016 was attributable to the gains on Euro and Sterling denominated debt that was issued during the second and third quarters of fiscal year 2016 as the U.S. Dollar strengthened since the issuance of this debt.

Income tax expense

Our consolidated effective tax rate was 35.8% for the first nine months of fiscal year 2016 and 38.2% for the same period in fiscal year 2015. The decrease in the effective tax rate for the nine months ended December 31, 2015 is due to the relative effect of retroactive U.S. tax law changes, enacted in December 2014 and December 2015, on AHFC’s share of qualified domestic production deduction allocated between the Parent and affiliated companies. Also, there were changes in certain state apportionment methods and tax rates which lowered the effective tax rate.

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Financial Condition

Consumer Financing

Consumer Financing Acquisition Volumes

The following table summarizes the number of retail loans and leases we acquired and the number of such loans and leases acquired through incentive financing programs sponsored by AHM and HCI:

 

  

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Consumer Financing Penetration Rates

The following table summarizes the percentage of AHM and/or HCI sales of new automobiles and motorcycles that were financed either with retail loans or leases that we acquired:

  

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Consumer Financing Asset Balances

The following table summarizes our outstanding retail loan and lease asset balances and units:

 

  

In the United States segment, total consumer financing acquisition volumes declined during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015 due to lower incentive financing volumes during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015, which also negatively affected our financing penetration rates. Throughout fiscal year 2015 and the first nine months of fiscal year 2016, for the incentive financing programs that AHM sponsored, AHM focused their support more toward lease incentive programs over retail loan incentive programs resulting in growth in our operating lease assets and a decline in retail loans during this period.

In the Canada segment, incentive financing volumes, total consumer financing acquisition volumes, and financing penetration rates increased during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015. HCI also continued to focus their support more toward lease incentive programs over retail loan incentive programs during the first nine months of fiscal year 2016. Outstanding direct financing lease assets continued to decline and operating lease assets continued to increase during the first nine months of fiscal year 2016 as the result of our remaining direct financing leases maturing and all newly acquired leases being classified as operating leases.

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Dealer Financing

Wholesale Flooring Financing Penetration Rates

The following table summarizes the number of dealerships with wholesale flooring financing agreements as a percentage of total authorized Honda and Acura dealerships in the United States and/or Canada, as applicable:

 

Wholesale Flooring Financing Percentage of Sales

The following table summarizes the percentage of AHM product sales in the United States and/or HCI product sales in Canada, as applicable, that we financed through wholesale flooring loans with dealerships:

 

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Dealer Financing Asset Balances

The following table summarizes our outstanding dealer financing asset balances and units:

 

  

Credit Risk

Credit losses are an expected cost of extending credit. The majority of our credit risk is in consumer financing and to a lesser extent in dealer financing. Credit risk of our portfolio of consumer finance receivables can be affected by general economic conditions. Adverse changes such as a rise in unemployment rates can increase the likelihood of defaults. Declines in used vehicle prices can reduce the amount of recoveries on repossessed collateral. We manage our exposure to credit risk in retail loans and direct financing leases by monitoring and adjusting our underwriting standards, which affect the level of credit risk that we assume, pricing contracts for expected losses, and focusing collection efforts to minimize losses.

We are also exposed to credit risk on our portfolio of operating lease assets. We expect a portion of our operating leases to terminate prior to their scheduled maturities when lessees default on their contractual obligations. Losses are generally realized upon the disposition of the repossessed operating lease vehicles. The factors affecting credit risk on our operating leases and our management of the risk are similar to that of our retail loans and direct financing leases.

Credit risk on dealer loans is affected primarily by the financial strength of the dealers within the portfolio, the value of collateral securing the financings, and economic and market factors that could affect the creditworthiness of dealers. We manage our exposure to credit risk in dealer financing by performing comprehensive reviews of dealers prior to establishing financing arrangements and monitoring the payment performance and creditworthiness of these dealers on an ongoing basis. In the event of default by a dealer, we seek all available legal remedies pursuant to related dealer agreements, guarantees, security interests on collateral, or liens on dealership assets. Additionally, we have entered into agreements with AHM and HCI that provide for the repurchase of any new, unused, undamaged and unregistered vehicle or equipment repossessed by us from a dealer in the United States and Canada, respectively, who defaulted under the terms of its wholesale flooring agreement with us at the net cost of the financing that we provided.

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An allowance for credit losses is maintained for management’s estimate of probable losses incurred on finance receivables. We also maintain an estimate for early termination losses on operating lease assets due to lessee defaults and an allowance for credit losses on past due operating lease rental payments.

Additional information regarding credit losses is provided in the discussion of “—Critical Accounting Policies—Credit Losses” below.

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The following table provides information with respect to our allowance for credit losses and credit loss experience of our finance receivables and losses related to lessee defaults on our operating leases:

 

  

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In the United States segment, the provision for credit losses on our finance receivables was $83 million during the first nine months of fiscal year 2016 compared to $62 million during the same period in fiscal year 2015. The increase was attributable to higher net charge-offs and adjustments to assumptions in our allowance for credit loss estimates. Certain assumptions were adjusted to reflect the higher loss rates experienced on recent vintages. We recognized early termination losses on operating lease assets of $27 million during the first nine months of fiscal year 2016 which was consistent with the same period in fiscal year 2015. The losses we recognized remained consistent despite the growth in operating lease assets as the result of adjusting the assumptions in our estimate of early termination losses. We reduced our loss assumptions as we experienced lower realized losses than was previously estimated.

In the Canada segment, the provision for credit losses on our finance receivables increased by $3 million during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015 due to higher net charge-offs, adjustments to assumptions in our allowance for credit losses, and the increase in finance receivables. Early termination losses on operating lease assets increased by $1 million during the first nine months of fiscal year 2016 compared to the same period in fiscal year 2015 due to the increase in outstanding operating lease assets.

Lease Residual Value Risk

Contractual residual values of lease vehicles are determined at lease inception based on expectations of future used vehicle values, taking into consideration external industry data and our own historical experience. Lease customers have the option at the end of the lease term to return the vehicle to the dealer or to buy the vehicle at the contractual residual value (or if purchased prior to lease maturity, for the outstanding contractual balance). Returned lease vehicles can be purchased by the grounding dealer at the contractual residual value (or if purchased prior to lease maturity, for the outstanding contractual balance) or for a market based price. Returned lease vehicles that are not purchased by the grounding dealers are sold through online and physical auctions. We are exposed to risk of loss on the disposition of returned lease vehicles when the proceeds from the sale of the vehicles are less than the contractual residual values at the end of the lease term.

We assess our estimates for end of lease term market values of leased vehicles, at minimum, on a quarterly basis. The primary factors affecting the estimates are the percentage of leased vehicles that we expect to be returned by the lessee at the end of lease term and the expected loss severity. Factors considered in this evaluation include, among other factors, economic conditions, historical trends, and market information on new and used vehicles. For operating leases, adjustments to estimated residual values are made on a straight line basis over the remaining term of the lease and are included as depreciation expense. For direct financing leases, downward adjustments for declines in estimated residual values deemed to be other-than-temporary are recognized as a loss on lease residual values in the period in which the estimate changed. Additional information regarding lease residual values is provided in the discussion of “—Critical Accounting Policies—Determination of Lease Residual Values” below.

We also review our investment in operating leases for impairment whenever events or changes in circumstances indicate that the carrying values may not be recoverable. If impairment conditions are met, impairment losses are measured by the amount carrying values exceed their fair values. There were no events or circumstances that indicated that the carrying values of our operating leases would not be recoverable during the first nine months of fiscal year 2016 and 2015.

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The following table summarizes our number of lease terminations and the method of disposition:

 

  

In February 2016, certain Honda and Acura vehicles were recalled based on a supplier’s determination of a safety related defect in driver’s airbag inflators. As a result, AHM and HCI have instructed their authorized dealers to cease the sale of affected new and used vehicles until the recall repairs are completed. We may experience delays in the disposition of returned lease vehicles and repossessed vehicles affected by this recall. We do not believe there will be a material impact to our financial results.

Liquidity and Capital Resources

Our liquidity strategy is to fund current and future obligations through our cash flows from operations and our diversified funding programs in a cost and risk effective manner. Our cash flows are generally impacted by cash requirements related to the volume of finance receivable and operating lease acquisitions and various operating and funding costs incurred, which are largely funded through payments received on our assets and our funding strategies outlined below. As noted, the levels of incentive financing sponsored by AHM and HCI can impact our financial results and liquidity from period to period. Increases or decreases in incentive financing programs typically increase or decrease our financing penetration rates, respectively, which result in increased or decreased acquisition volumes and increased or decreased liquidity needs, respectively. At acquisition, we receive the subsidy payments, which reduce the cost of consumer loan and lease contracts acquired, and we recognize such payments as revenue over the term of the loan or lease.

In an effort to minimize liquidity risk and interest rate risk and the resulting negative effects on our margins, results of operations and cash flows, our funding strategy incorporates investor diversification and the utilization of multiple funding sources including commercial paper, medium term notes, bank loans and asset-backed securities. During the nine months ended December 31, 2015, AHFC partially replaced related party debt issuances in the U.S. with issuances of Public MTN debt. We incorporate a funding strategy that takes into consideration factors such as the interest rate environment, domestic and foreign capital market conditions, maturity profiles, and economic conditions. We believe that our funding sources, combined with cash provided by operating and investing activities, will provide sufficient liquidity for us to meet our debt service and working capital requirements over the next twelve months.

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Summary of Outstanding Debt

The table below presents a summary of our outstanding debt by various funding sources:

 

Commercial Paper

As of December 31, 2015, we had commercial paper programs in the United States of $7.0 billion and in Canada of C$2.0 billion (U.S. $1.4 billion). Interest rates on the commercial paper are fixed at the time of issuance. During the nine months ended December 31, 2015, consolidated commercial paper month-end outstanding principal balances ranged from approximately $4.0 billion to $5.9 billion and the outstanding daily balance averaged $5.2 billion.

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Related Party Debt

AHFC routinely issues fixed rate notes to AHM to help fund AHFC’s general corporate operations. HCFI routinely issues fixed rate notes to HCI to help fund HCFI’s general corporate operations. Interest rates are based on prevailing rates of debt with comparable terms. Generally, the term of these notes is less than 120 days. During the nine months ended December 31, 2015, the consolidated related party debt month-end principal balances ranged from approximately $2.1 billion to $3.1 billion and the outstanding daily balance averaged $2.8 billion.

Bank Loans

During the nine months ended December 31, 2015, AHFC entered into a new bank loan agreement for $500 million and HCFI entered into three floating rate term loan agreements for C$100 million (U.S. $72 million), C$50 million (U.S. $36 million) and C$100 million (U.S. $72 million). As of December 31, 2015, we had bank loans denominated in U.S. dollars and Canadian dollars with floating interest rates, in principal amounts ranging from approximately $36 million to $600 million. As of December 31, 2015, the remaining maturities of all bank loans outstanding ranged from 74 days to approximately 5.7 years. The weighted average remaining maturities on all bank loans was 2.0 years as of December 31, 2015.

Our bank loans contain customary restrictive covenants, including limitations on liens, limitations on mergers and consolidations and asset sales, and a financial covenant that requires us to maintain positive consolidated tangible net worth. In addition to other customary events of default, the bank loans include cross-default provisions and provisions for default if HMC does not maintain ownership, whether directly or indirectly, of at least 80% of the outstanding capital stock of AHFC or HCFI, as applicable. All of these covenants and events of default are subject to important limitations and exceptions under the agreements governing the bank loans. As of December 31, 2015, management believes that AHFC and HCFI were in compliance with all covenants contained in our bank loans.

Medium Term Note (MTN) Programs

Private MTN Program

AHFC no longer issues MTNs under the Rule 144A Private MTN Program. As of December 31, 2015, the remaining maturities of Private MTNs outstanding ranged from 147 days to approximately 5.7 years. The weighted average remaining maturities of Private MTNs was 2.1 years as of December 31, 2015. Interest rates on the Private MTNs are fixed or floating. Private MTNs are issued pursuant to the terms of an issuing and paying agency agreement which requires AHFC to comply with certain covenants, including negative pledge provisions, and includes customary events of defaults. As of December 31, 2015, management believes that AHFC was in compliance with all covenants contained in the Private MTNs.

Public MTN Program

AHFC is a well-known seasoned issuer under SEC rules and issues Public MTNs pursuant to a registration statement on Form S-3 filed with the SEC. In August 2015, AHFC increased the authorized maximum aggregate principal amount for issuance under the Public MTN Program from $16.0 billion to $30.0 billion. In September 2015, AHFC began issuing foreign currency denominated notes into international markets under this program. The aggregate principal amount of MTNs offered under this program may be increased from time to time.

The Public MTNs may have original maturities of 9 months or more from the date of issue, may be interest bearing with either fixed or floating interest rates, or may be discounted notes. During the nine months ended December 31, 2015, AHFC issued $3.5 billion aggregate principal amount of U.S. dollar denominated MTNs, with an original maturity ranging from 2.0 years to 5.0 years, bearing interest at fixed and floating rates. During the nine months ended December 31, 2015, AHFC issued €1.2 billion (U.S. $1.3 billion) aggregate principal amount of MTNs with an original maturity ranging from 3.5 years to 7.2 years bearing interest at fixed and floating rates. During the nine months ended December 31, 2015, AHFC issued £250 million (U.S. $368 million) aggregate principal amount of MTNs with an original maturity of 6.8 years bearing interest at a fixed rate. The U.S. dollars were presented based on their respective exchange rates on December 31, 2015. As of December 31, 2015, the remaining maturities of all Public MTNs outstanding ranged from 11 days to approximately 6.9 years. The weighted average remaining maturities of all Public MTNs was 2.5 years as of December 31, 2015.

The Public MTNs are issued pursuant to an indenture, which requires AHFC to comply with certain covenants, including negative pledge provisions and restrictions on AHFC’s ability to merge, consolidate or transfer substantially all of its assets or the assets of its subsidiaries, and includes customary events of default. As of December 31, 2015, management believes that AHFC was in compliance with all covenants under the indenture.

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Euro MTN Programme

The Euro MTN Programme was retired in August 2014. Notes under this program that are currently listed on the Luxembourg Stock Exchange will remain listed through their maturity. As of December 31, 2015, the remaining maturities of Euro MTNs outstanding under this program ranged from 56 days to approximately 7.1 years. The weighted average remaining maturities of all Euro MTNs was 2.9 years as of December 31, 2015.

Other Debt

HCFI issues privately placed Canadian dollar denominated notes. During the nine months ended December 31, 2015, HCFI did not enter into any private placement trades. As of December 31, 2015, the remaining maturities of all of HCFI’s Canadian notes outstanding ranged from 1.3 years to approximately 3.6 years. The weighted average remaining maturities of these notes was 2.4 years as of December 31, 2015.

The notes are issued pursuant to the terms of an indenture, which requires HCFI to comply with certain covenants, including negative pledge provisions, and includes customary events of default. As of December 31, 2015, management believes that HCFI was in compliance with all covenants contained in the privately placed notes.

Secured Debt

Asset-Backed Securities

We enter into securitization transactions for funding purposes. Securitization transactions involve transferring pools of retail loans to trusts. The trusts are special-purpose entities that we establish to accommodate securitization structures. Securitization trusts have the limited purpose of acquiring assets, issuing asset-backed securities, and making payments on the securities. Assets transferred to securitization trusts are considered to be legally isolated from us and the claims of our creditors. We continue to service the retail loans transferred to the trusts. Investors in the notes issued by a trust only have recourse to the assets of such trust and do not have recourse to AHFC, HCFI, or our other subsidiaries or to other trusts.

Our securitizations are structured to provide credit enhancements to investors in the notes issued by the trusts. Credit enhancements can include the following:

We are required to consolidate the securitization trusts in our financial statements, which results in the securitizations being accounted for as on-balance sheet secured financings. The securitized receivables remain on our consolidated balance sheet along with the notes issued by the trusts. The notes are secured solely by the assets of the applicable trust and not by any of our other assets or those of other trusts. The assets of a trust are the only source of funds for repayment on the notes of such trust.

During the nine months ended December 31, 2015, we issued notes through asset-backed securitizations totaling $3.5 billion, which are secured by consumer finance receivables with an initial principal balance of $4.6 billion.

Asset-Backed Conduits

In September 2010, we entered into a receivables loan agreement with a bank-sponsored asset-backed commercial paper conduit to allow us access to additional secured funding. Under this agreement, we would transfer finance receivables to funding agents as collateral for debt issued by the funding agents who are contractually committed, at our option, to make advances to us of up to $500 million. This agreement was amended in September 2014 and terminated in September 2015.

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Credit Agreements

Syndicated Bank Credit Facilities

AHFC maintains a $3.5 billion 364 day credit agreement, as amended, which expires on March 4, 2016, and a $3.5 billion five year credit agreement, as amended, which expires on March 7, 2020. At December 31, 2015, no amounts were outstanding or repaid under the AHFC credit agreements. AHFC intends to renew or replace the credit agreements prior to or on their respective expiration dates.

HCFI maintains a C$1.6 billion (U.S. $1.2 billion) credit agreement, as amended, which provides that HCFI may borrow up to C$800 million (U.S. $578 million) on a one year and a five-year revolving basis. The one year tranche of the credit agreement expires on March 24, 2016 and the five year tranche of the credit agreement expires on March 24, 2020. At December 31, 2015, no amounts were outstanding or repaid under the HCFI credit agreement. HCFI intends to renew or replace the credit agreement prior to or on the expiration date of each respective tranche.

The credit agreements contain customary conditions to borrowing and customary restrictive covenants, including limitations on liens and limitations on mergers, consolidations and asset sales. The credit agreements also require AHFC and HCFI, respectively, to maintain a positive consolidated tangible net worth as defined in their respective credit agreements. The credit agreements, in addition to other customary events of default, include cross-default provisions and provisions for default if HMC does not maintain ownership, whether directly or indirectly, of at least 80% of the outstanding capital stock of AHFC or HCFI, as applicable. In addition, the AHFC and HCFI credit agreements contain provisions for default if HMC’s obligations under the HMC-AHFC Keep Well Agreement or the HMC-HCFI Keep Well Agreement, as applicable, become invalid, voidable, or unenforceable. All of these conditions, covenants and events of default are subject to important limitations and exceptions under the agreements governing the credit agreements. As of December 31, 2015, management believes that AHFC and HCFI were in compliance with all covenants contained in the respective credit agreements.

Other Credit Agreements

In September 2015, AHFC entered into other committed lines of credit to allow us access to additional $1.0 billion in unsecured funding with multiple banks. The credit agreements contain customary conditions to borrowing and customary restrictive covenants, including limitations on liens and limitations on mergers, consolidations and asset sales and a requirement for AHFC to maintain a positive consolidated tangible net worth. There were no amounts outstanding as of December 31, 2015. These agreements expire in September 2016.

Keep Well Agreements

HMC has entered into separate keep well agreements with AHFC and HCFI. Pursuant to the Keep Well Agreements, HMC has agreed to, among other things:

As consideration for HMC’s obligations under the Keep Well Agreements, we have agreed to pay HMC a quarterly fee based on the amount of outstanding Debt pursuant to support compensation agreements, dated October 1, 2005. We incurred expenses of $5 million and $4 million, during the three months ended December 31, 2015 and 2014, respectively, and $14 million and $13 million during the nine months ended December 31, 2015 and 2014, respectively, pursuant to these support compensation agreements.

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Indebtedness of Consolidated Subsidiaries

As of December 31, 2015, AHFC and its consolidated subsidiaries had approximately $53.7 billion of outstanding indebtedness and other liabilities, including current liabilities, of which approximately $13.2 billion consisted of indebtedness and liabilities of our consolidated subsidiaries. None of AHFC’s consolidated subsidiaries had any outstanding preferred equity.

Derivatives

We utilize derivative instruments to mitigate exposures to fluctuations in interest rates and foreign currency exchange rates. The types of derivative instruments include interest rate swaps, basis swaps, and cross currency swaps. Interest rate and basis swap agreements are used to mitigate the effects of interest rate fluctuations of our floating rate debt relative to our fixed rate finance receivables and operating lease assets. Cross currency swap agreements are used to manage currency and interest rate risk exposure on foreign currency denominated debt. The derivative instruments contain an element of credit risk in the event the counterparties are unable to meet the terms of the agreements.

All derivative financial instruments are recorded on our consolidated balance sheet as assets or liabilities, and carried at fair value. Changes in the fair value of derivatives are recognized in our consolidated statement of income in the period of the change. Since we do not elect to apply hedge accounting, the impact to earnings resulting from these valuation adjustments as reported under GAAP is not representative of our result of operations as evaluated by management. Realized gains and losses on derivative instruments, net of realized gains and losses on foreign currency denominated debt, are included in the measure of net revenues when we evaluate segment performance. Refer to Note 14—Segment Information of Notes to Consolidated Financial Statements (Unaudited) for additional information about segment information and Note 5—Derivative Instruments of Notes to Consolidated Financial Statements (Unaudited) for additional information on derivative instruments.

Off-Balance Sheet Arrangements

We are not a party to off-balance sheet arrangements.

Contractual Obligations

The following table summarizes our contractual obligations, excluding lending commitments to dealers and derivative obligations, for the periods indicated:

 

  

The obligations in the above table do not include certain lending commitments to dealers since the amount and timing of future payments is uncertain. Refer to Note 8—Commitments and Contingencies of Notes to Consolidated Financial Statements (Unaudited) for additional information on these commitments.

Our contractual obligations on derivative instruments are also excluded from the table above because our future cash obligations under these contracts are inherently uncertain. We recognize all derivative instruments on our consolidated balance sheet at fair value. The amounts recognized as fair value do not represent the amounts that will be ultimately paid or received upon settlement under these contracts. Refer to Note 5—Derivative Instruments of Notes to Consolidated Financial Statements (Unaudited) for additional information on derivative instruments.

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New Accounting Standards

Refer to Note 1(c)—Recently Adopted Accounting Standards and Note 1(d)—Recently Issued Accounting Standards of Notes to Consolidated Financial Statements (Unaudited).

Critical Accounting Policies

Critical accounting policies are those accounting policies that require the application of our most difficult, subjective, or complex judgments, often requiring us to make estimates about the effects of matters that are inherently uncertain and may change in subsequent periods, or for which the use of different estimates that could have reasonably been used in the current period would have had a material impact on the presentation of our financial condition, cash flows, and results of operations. The impact and any associated risks related to these estimates on our financial condition, cash flows, and results of operations are discussed throughout “Management’s Discussion and Analysis of Financial Condition and Results of Operation” where such estimates affect reported and expected financial results. Different assumptions or changes in economic circumstances could result in additional changes to the determination of the allowance for credit losses and the determination of residual values.

Credit Losses

We maintain an allowance for credit losses for management’s estimate of probable losses incurred on our finance receivables. We also maintain an estimate for early termination losses on operating lease assets due to lessee defaults and an allowance for credit losses on past due operating lease rental payments. These estimates are evaluated by management, at minimum, on a quarterly basis.

Consumer finance receivables are collectively evaluated for impairment. Delinquencies and losses are monitored on an ongoing basis and this historical experience provides the primary basis for estimating the allowance. Management utilizes various methodologies when estimating the allowance for credit losses including models which incorporate vintage loss and delinquency migration analysis. These models take into consideration attributes of the portfolio, including loan-to-value ratios, internal and external credit scores, and collateral types. Market and economic factors such as used vehicle prices, unemployment rates, and consumer debt service burdens are also incorporated into these models. Estimated losses on operating leases expected to terminate early due to lessee defaults are also determined collectively, consistent with the methodologies used for consumer finance receivables.

Dealer finance receivables are individually evaluated for impairment when specifically identified as impaired. Dealer finance receivables are considered to be impaired when it is probable that we will be unable to collect all amounts due according to the original terms of the loan. Our determination of whether dealer loans are impaired is based on evaluations of dealership payment history, financial condition, and cash flows, and their ability to perform under the terms of the loans. Dealer loans that have not been specifically identified as impaired are collectively evaluated for impairment.

Refer to Note 2—Finance Receivables of Notes to Consolidated Financial Statements (Unaudited) for additional information regarding charge-offs or write-downs of contractual balances of retail and dealer finance receivables.

Our allowance for credit losses and early termination losses on operating leases requires significant judgment about inherently uncertain factors. The estimates are based on management’s evaluation of many factors, including our historical credit loss experience, the value of the underlying collateral, delinquency trends, and economic conditions. The estimates are based on information available as of each reporting date. Actual losses may differ from the original estimates due to actual results varying from those assumed in our estimates. Refer to Note 3—Investment in Operating Leases of Notes to Consolidated Financial Statements (Unaudited) for additional information.

Sensitivity Analysis

If we had experienced a 10% increase in net charge-offs of finance receivables during the twelve month period ended December 31, 2015, our provision for credit losses would have increased by approximately $21 million during the period. Similarly, if we had experienced a 10% increase in realized losses on the disposition of repossessed operating lease vehicles during the twelve month period ended December 31, 2015, we would have recognized an additional $10 million in early termination losses in our consolidated statement of income during the period.

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Determination of Lease Residual Values

Contractual residual values of lease vehicles are determined at lease inception based on expectations of future used vehicle values, taking into consideration external industry data and our own historical experience. Lease customers have the option at the end of the lease term to return the vehicle to the dealer or to buy the vehicle at the contractual residual value (or if purchased prior to lease maturity, for the outstanding contractual balance). Returned lease vehicles can be purchased by the grounding dealer at the contractual residual value (or if purchased prior to lease maturity, for the outstanding contractual balance) or a market based price. Returned lease vehicles that are not purchased by the grounding dealer are sold through online and physical auctions. We are exposed to risk of loss on the disposition of returned lease vehicles when the proceeds from the sale of the vehicles are less than the contractual residual values at the end of lease term. We assess our estimates for end of term market values of the leased vehicles, at minimum, on a quarterly basis. The primary factors affecting the estimates are the percentage of leased vehicles that we expect to be returned by the lessee at the end of lease term and the expected loss severity. Factors considered in this evaluation include, among other factors, economic conditions, historical trends and market information on new and used vehicles.

For operating leases, adjustments to estimated residual values are made on a straight-line basis over the remaining term of each lease and are included as depreciation expense. For direct financing leases, downward adjustments for declines in estimated residual values deemed to be other-than-temporary are recognized as a loss on lease residual values in the period in which the estimate changed.

Sensitivity Analysis

If future estimated auction values for all outstanding operating leases as of December 31, 2015 were to decrease by $100 per unit from our current estimates, the total impact would be an increase of approximately $52 million in depreciation expense, which would be recognized over the remaining lease terms. If future return rates for all operating leases were to increase by one percentage point from our current estimates, the total impact would be an increase of approximately $8 million in depreciation expense, which would be recognized over the remaining lease terms. Similarly, if the future estimated auction values were to decrease by $100 per unit and future return rates were to increase by one percentage point from our current estimates for all direct financing leases as of December 31, 2015, we would have recognized an increase of approximately $1 million and less than $1 million in losses on lease residual values, respectively. This sensitivity analysis may be asymmetric and is specific to the conditions in effect as of December 31, 2015. Additionally, any declines in auction values are likely to have a negative effect on return rates which could affect the severity of the impact on our results of operations.  

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We have omitted this section pursuant to General Instruction H(2) of Form 10-Q.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our Principal Executive Officer and Principal Financial Officer have performed an evaluation of the Company's disclosure controls and procedures, as that term is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act), as of December 31, 2015, and each has concluded that such disclosure controls and procedures are effective, at the reasonable assurance level, to ensure that information required to be disclosed in our periodic reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms, and such information is accumulated and communicated to management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosures. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Changes in Internal Control over Financial Reporting

There were no changes in the internal control over financial reporting during the quarter ended December 31, 2015, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

 

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

For more information on our legal proceedings, see Note 8—Commitments and Contingencies—Legal Proceedings and Regulatory Matters of Notes to Consolidated Financial Statements (Unaudited), which is incorporated by reference herein.

Item 1A. Risk Factors

There are no material changes to the risk factors set forth under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended March 31, 2015, which was filed with the SEC on June 26, 2015, and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2015, which was filed with the SEC on August 10, 2015.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

We have omitted this section pursuant to General Instruction H(2) of Form 10-Q.

Item 3. Defaults Upon Senior Securities

We have omitted this section pursuant to General Instruction H(2) of Form 10-Q.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

Refer to the Exhibit Index immediately following the Signature page.

 

 

 

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Signature

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated: February 10, 2016

 

 

 

 

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