Item 1. Business
The registrant, Navistar Financial Corporation ("NFC") was incorporated in Delaware in 1949 and is a wholly-owned subsidiary of Navistar International Transportation Corp. ("Transportation"), which is wholly-owned by Navistar International Corporation ("Navistar"). As used herein, the "Corporation" refers to Navistar Financial Corporation and its wholly-owned subsidiaries unless the context otherwise requires.
The Corporation provides wholesale, retail, and to a lesser extent, lease financing in the United States for sales of new and used trucks sold by Trans- portation and Transportation's dealers. The Corporation also finances wholesale accounts and selected retail accounts receivable of Transportation. To a minor extent, sales of new products (including trailers) of other manufacturers are also financed regardless of whether designed or customarily sold for use with Transportation truck products. Harco National Insurance Company, NFC's wholly-owned insurance subsidiary, provides commercial physical damage and liability insurance coverage to Transportation's dealers and retail customers, and to the general public through the independent insurance agency system.
Item 2.
Item 2. Properties
The Corporation uses leased facilities to carry out most of the administrative and finance sales activities.
Item 3.
Item 3. Legal Proceedings
During 1992, auditors of the Illinois Department of Revenue ("Department") began an income tax audit of NFC for the fiscal years ended October 31, 1989, 1990 and 1991. On February 1, 1994 the Department issued a Notice of Deficiency to NFC for approximately $11.9 million. The Department has taken the position that nearly 100% of NFC's income during these years should be attributed to and taxed by Illinois. NFC maintains that the Department's interpretation and application of the law is incorrect and improper, and that the Department's intended result is constitutionally prohibited. NFC's outside counsel is of the opinion that it is more likely than not that NFC's position will prevail such that the Department's action will not have a material impact on NFC's earnings and financial position.
In May 1993, a jury issued a verdict in favor of Vernon Klein Truck & Equipment, Inc. and against Transportation and the Corporation in the amount of $10.8 million in compensatory damages and $15 million in punitive damages. Transportation appealed the verdict and, in November 1994, the Court of Appeals of the State of Oklahoma reversed the verdict and entered judgment in favor of Transportation on virtually all aspects of the case.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Intentionally omitted. See the index page of this Report for explanation.
PART II
Item 6.
Item 6. Selected Financial Data
Intentionally omitted. See the index page to this Report for explanation.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
As a result of the continued improvement in the economy during fiscal 1994, industry retail sales of Class 5 through 8 trucks surpassed 1993 by 18%. The Corporation's financing of customers' purchases of new International trucks during fiscal 1994 increased 18% compared to the prior year. During 1994, rising interest rates resulted in increased costs to fund retail note acquisitions. Competition, coupled with liquidity in the commercial financing markets, limited the Corporation's ability to increase customer finance rates commensurate with the increase in funding costs, and as a result margins on retail financing were lower in fiscal 1994. The strong truck industry and economy continued to improve the financial strength of the International dealers and customers and NFC's portfolio quality remained high during 1994.
The components of net income for the three years ended October 31 are as follows:
Income before taxes in 1994 was $55 million, a 12% increase from $49 million in 1993, which included a $3.7 million pretax charge for the Corporation's portion of the Supplemental Trust contribution. Finance operations' income in 1994 was $1.7 million lower than 1993 as a result of lower margins on retail financing as rising interest costs could not be offset fully by increased retail note pricing. The decline in retail note income was offset in part by an increased volume of wholesale financing to support the increased demand for trucks. The Corporation's insurance subsidiary's income increased $4.2 million over 1993 as a result of improved underwriting results on truck liability insurance. The increase in income before income taxes between 1993 and 1992 was primarily the result of higher gains on sales of retail notes, partially offset by higher loss experience in the insurance subsidiary and the Supplemental Trust contribution. The more significant elements of revenue and expense impacting net income for these years are discussed in the following paragraphs.
Total revenue for 1994 was $210 million compared with $232 million and $228 million in 1993 and 1992, respectively. Retail note and lease financing revenue decreased to $69 million in 1994 from $102 million in 1993 as a higher proportion of retail notes were financed through the sale of the receivables. When receivables are sold only the net gains on the sales, rather than the individual components of revenue and expense, are reported in the Statement of Consolidated Income. During 1994, the Corporation gained access to the strong, reliable and economically attractive asset backed securitized market
Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
and significantly increased the sales of retail notes. Retail note and lease financing revenue was unchanged between 1993 and 1992.
Wholesale note revenue increased 22% in 1994 to $39 million and increased 13% in 1993 primarily as a result of higher average note balances in support of increased demand for Transportation truck products. In addition, revenue in 1994 increased from higher average yields relating to a higher prime interest rate. In December 1990, the Corporation sold $300 million of wholesale notes to a revolving sales trust. This revolving wholesale arrangement provides for the continuous sale of notes by the Corporation on a daily basis. Gains on wholesale notes sold to the trust are not material as a result of their short maturities.
Revenue from accounts increased in 1994 to $22 million from $18 million and $15 million in 1993 and 1992, respectively. The increase in 1994 and 1993 resulted from higher average balances in support of increased demand for Transportation truck products. In addition, revenue in 1994 increased from higher average yields relating to a higher prime interest rate.
Servicing fee income increased to $17 million in 1994 from $11 million in 1993 and $9 million in 1992 as a result of higher levels of sold note receivable balances.
Insurance premiums earned by Harco decreased 11% to $51 million in 1994 from $57 million in 1993 and 5% in 1993 from 1992. The decrease in 1994 and 1993 reflects a reduction in written premiums in response to adverse loss experience in 1993 and to increased competition. Harco's investment income decreased to $8 million in 1994 compared with $10 million in 1993 and $13 million in 1992. The decrease in 1994 resulted from lower yields on invested asset balances. The decrease in 1993 resulted from lower realized gains on sales of marketable securities caused by the stabilization of interest rates during 1993 and a decline in the yield on investments resulting from the lower market interest rates available on new investments.
Interest expense decreased 16% in 1994 to $63 million from $75 million and $82 million in 1993 and 1992, respectively. The decrease between 1994 and 1993 was the result of reduced debt required to finance the lower level of owned retail receivables, offset in part by higher interest rates. The decline in interest expense between 1993 and 1992 was primarily the result of lower interest rates. The ratio of debt to equity decreased to 4.8:1 at October 31, 1994 from 5.5:1 at October 31, 1993 and 1992.
On July 1, 1993, Navistar implemented a restructured retiree health care and life insurance plan ("the Plan"), as discussed in note 11 to the Consolidated Financial Statements. As part of the Plan, Navistar contributed $300 million to pre-fund Plan benefit liabilities and common stock valued at $513 million to a Supplemental Benefit Trust to help pay for Plan benefits in the future. The Corporation recognized $3.7 million of expense as its portion of the Supplemental Benefit Trust contribution.
The provision for losses on receivables totaled $2.3 million in 1994 compared with $1.5 million in 1993 and $3.6 million in 1992. The increase in the provision in 1994 reflects higher serviced portfolio balances and higher losses on retail notes and wholesale accounts. Finance receivables are written off against the allowance for losses as soon as they are determined to be uncollectible based on a review of each problem obligor. Truck note and account write-offs, including those on sold notes, totaled $.9 million in 1994, $.7 million in 1993, and $3.2 million in 1992. At October 31, 1994, the
Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Corporation's allowance for losses equaled .65% of net financing receivables, including sold receivables, compared with .69% and .77% as of October 31, 1993 and 1992, respectively. The allowance is maintained at a level which management considers appropriate in relation to the outstanding receivables balance, taking into consideration loss experience, current economic conditions and other factors.
Insurance claims and underwriting expense decreased to $54 million in 1994 from $65 million and $62 million in 1993 and 1992, respectively. The decline in expense in 1994 resulted from a $9 million decrease in losses incurred in Harco's truck physical damage and liability insurance lines. Additionally, insurance operating expenses decreased $3 million in 1994 over 1993, primarily as a result of decreased commission costs associated with lower volumes of premiums written through general agents in 1994. The increase in insurance claims and underwriting expense in 1993 resulted from increased losses sustained in Harco's truck physical damage and liability insurance lines.
Liquidity and Funds Management
The Corporation's operations are substantially dependent upon the production and sale of Transportation's truck products. Navistar Financial has traditionally obtained the funds to provide financing to Transportation's dealers and retail customers from commercial paper, short- and long-term bank borrowings, medium- and long-term debt issues, sales of receivables and equity capital. The current debt ratings of the Corporation, detailed below, have made bank borrowings and sales of finance receivables the most economical sources of cash. The Corporation's insurance operations generate their funds through internal operations and have no external borrowings.
The Corporation's serviced receivables portfolio, which includes sold receivables, totaled $2.5 billion at October 31, 1994 up from $2.2 billion and $1.8 billion at October 31, 1993 and 1992, respectively. During 1994, the Corporation supplied 93% of the wholesale financing of new trucks sold to Transportation's dealers, compared with 90% for 1993 and 89% for 1992. Acquisitions of retail notes and leases, net of unearned financed, increased 19% to $916 million in 1994 after a 17% increase to $770 million in 1993 from $659 million in 1992. The higher levels of acquisitions reflect increased sales by Transportation, especially of heavy trucks. The Corporation's share of the retail financing of new trucks manufactured by Transportation and sold in the United States was 15.3% in 1994 and 1993 up from 13.7% in 1992.
Receivable sales were a significant source of funding during 1994 as proceeds from sold retail notes were $995 million, an increase of $437 million over 1993. Outstanding sold receivable balances totaled $1,334 million at October 31, 1994 up from $839 million and $533 million at October 31, 1993 and 1992, respectively.
As a result of gaining access to the asset-backed public market in 1994, the Corporation was able to fund fixed rate retail note receivables at rates offered to companies with investment grade. In three separate receivable sales during fiscal 1994, the Corporation sold $830 million retail notes receivable, net of unearned finance, through its special purpose subsidiary, Navistar Financial Retail Receivables Corporation ("NFRRC"). NFRRC subsequently sold these notes to three individual owner trusts which, in turn, sold interests in the notes to investors in exchange for fixed rate notes and certificates. These three sales of retail notes, pursuant to a $1 billion registration filed with the Securities and Exchange Commission in September
Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
1993, resulted in proceeds of $771 million, net of $57 million in cash reserves with the trusts as credit enhancements, which reduced the Corporation's short-term debt and borrowings under the revolving bank credit facility. On October 7, 1994, NFRRC filed an additional registration with the Securities and Exchange Commission providing for the issuance from time to time of an additional $2 billion of asset-backed securities, bringing the total amount available for issuance by NFRRC to $2.17 billion at fiscal year- end.
Since December 1990, the Corporation has utilized a $300 million revolving wholesale note sales trust providing for the continuous sale of eligible wholesale notes on a daily basis. The sales trust sold three $100 million tranches of floating rate pass-through certificates, maturing serially from 1997 to 1999, to the public.
At October 31, 1994, the Corporation had a contractually committed bank revolving credit facility of $727 million and a contractually committed retail notes receivable purchase facility of $600 million. Unused commitments under the credit and purchase facilities were $595 million, of which $419 million provided funding backup for the outstanding short-term debt at October 31, 1994. The remaining $176 million when combined with unrestricted cash and cash equivalents made $204 million available to fund the general business purposes of the Corporation.
In November 1994, as discussed in note 16 to the Consolidated Financial Statements, the Corporation amended and restated its credit and purchase facility agreements. The revolving credit agreement commitment was expanded from $727 million to $900 million and the maturity date was extended to October 31, 1998. In addition, the purchasers' commitments under the $600 million retail notes purchase facility agreement were terminated and the Corporation established a $300 million asset-backed commercial paper program supported by a bank liquidity facility with a maturity date of October 31, 1998. As of October 31, 1994, $377 million of sold notes were outstanding under the retail notes purchase facility. Participants of the facility will continue to own the receivables during the normal run-off. While the amended revolving credit facility removes certain dividend restrictions, the Corporation is required to maintain tangible net worth at a minimum of $175 million and a debt to tangible net worth ratio of no greater than 7 to 1.
In October 1993, ratings on the Corporation's debt were reviewed by Standard and Poor's Corporation ("Standard and Poor's") and Moody's Investors Service, Inc. ("Moody's"). Standard and Poor's raised its ratings for the Corporation's debt from B- to BB for senior debt and from CCC to B+ for subordinated debt. Moody's confirmed their previous ratings of Ba3 for senior debt and B2 for subordinated debt. In November 1993, Duff & Phelps confirmed their debt ratings of BB+ for senior debt and BB for subordinated debt. The Corporation's commercial paper is rated "not prime" by Moody's.
On November 16, 1993, the Corporation sold $100 million of 8 7/8% Senior Subordinated Notes due 1998 to the public. On December 16, 1993, the net proceeds from the 8 7/8% subordinated issue were used to redeem the Corporation's 11.95% Subordinated Debentures due December 1995. The Corporation also redeemed its 7 1/2% Senior Debentures due January 1994 on December 15, 1993.
On December 15, 1994, the Corporation sold $315 of retail notes, net of unearned finance income, through NFRRC to an owner trust which, in turn, sold $304 of notes and $11 of certificates to investors. The proceeds of $314, net
Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
of $1 of underwriting fees, were used by the Corporation for general working capital purposes and to establish a $19 reserve account with the trust as credit enhancement for the public sale.
The Corporation manages sensitivity to interest rate changes by funding floating rate assets with floating rate debt, primarily borrowings under the bank revolving credit agreement, and fixed rate assets with fixed rate debt, equity and floating rate debt. Management has limited the amount of fixed rate assets funded with floating rate debt by selling retail receivables on a fixed rate basis. The Corporation will occasionally enter into a forward interest rate lock agreement prior to a retail note receivables sale to protect against rising interest rates.
Business Outlook
The truck industry is forecasted to continue to be strong in 1995. No significant change from the current level of financing support for Transportation truck product sales is anticipated by the Corporation. Competition coupled with potentially higher interest rates will put pressure on the Corporation's performance in 1995. Several financing institutions have entered the truck retail financing market, and this will put pressure on the Corporation's retail note acquisition activity. Higher funding costs will impact retail note margins and gains on sales of retail notes compared to 1994.
Management believes that collections on the outstanding receivables portfolio plus cash available from the Corporation's various funding sources will permit Navistar Financial to meet the financing requirements of Transportation's dealers and retail customers through 1995 and beyond.
NAVISTAR FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED OCTOBER 31, 1994
MILLIONS OF DOLLARS
1. SUMMARY OF ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Navistar Financial Corporation ("NFC") and its wholly-owned subsidiaries ("Corporation"). All significant intercompany accounts and transactions have been eliminated. All of the Corporation's capital stock is owned by Navistar International Transportation Corp. ("Transportation"), which is wholly-owned by Navistar International Corporation ("Navistar").
Revenue on Receivables
Finance charges on retail notes and finance leases are recognized as income over the term of the receivables on the accrual basis utilizing the actuarial method. Interest from interest-bearing notes and accounts is taken into income on the accrual basis.
Allowance for Losses on Receivables
The Corporation's allowance for losses on receivables is maintained at an amount management considers appropriate in relation to the outstanding receivables portfolio. Receivables are charged off to the allowance for losses as soon as they are determined to be uncollectible based on a note-by- note review, after all prelitigation collection efforts have been exhausted.
Repossessions are carried at the lower of the unpaid net receivable balance or estimated realizable value of the equipment.
Receivable Sales
The Corporation sells and securitizes receivables to public and private investors with limited recourse. The Corporation continues to service the receivables, for which a servicing fee is received. Servicing fees are earned on a level yield basis over the terms of the related sold receivables and are included in servicing fee income. In a subordinated capacity, the Corporation retains excess servicing cash flows, a limited interest in the principal balances of the sold receivables and certain cash deposits provided as credit enhancements for investors. Gains or losses on sales of receivables are credited or charged to financing revenue in the period in which the sales occur.
Insurance Operations
Insurance premiums are earned on a pro rata basis over the terms of the policies. Commission costs and premium taxes incurred in acquiring business are deferred and amortized on the same basis as such premiums are earned. The
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
1. SUMMARY OF ACCOUNTING POLICIES (Continued)
liability for unpaid insurance claims includes provisions for reported claims and an estimate of unreported claims based on past experience. Such provi- sions include an estimate of loss adjustment expense. The estimated liability for unpaid insurance claims is regularly reviewed and updated. Any change in such estimate is reflected in current operations.
Income Taxes
The tax effect of each item of revenue or expense reported in the Statement of Consolidated Income and Retained Earnings is recognized in the current period regardless of when the related tax is paid. Navistar and its subsidiaries file a consolidated Federal income tax return which includes Transportation and the Corporation. Federal income taxes for the Corporation are computed on a separate consolidated return basis and are payable to Transportation.
Cash and Cash Equivalents
Cash and cash equivalents include money market funds and marketable securities with original maturities of three months or less, except for such securities held by the insurance operations which are included in marketable securities.
Reclassification
Certain 1993 and 1992 amounts have been reclassified to conform with the presentation used in the 1994 financial statements.
Changes in Accounting Policy
In the first quarter of fiscal 1994, the Corporation adopted Statement of Financial Accounting Standards No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts" ("SFAS 113"), which is applicable to the Corporation's wholly-owned insurance subsidiary, Harco National Insurance Company ("Harco"). This statement eliminates the practice of reporting liabilities relating to reinsured contracts net of the effects of ceded reinsurance. Disclosures relating to SFAS 113 are provided in note 7. Effective October 31, 1994, the Corporation adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115") and Statement of Financial Accounting Standards No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments" ("SFAS 119"). SFAS 115 establishes financial accounting and reporting standards for investments in equity securities that have readily determinable fair values and for all investments in debt securities. SFAS 119 requires disclosures about the amounts, nature, and terms of derivative financial instruments. Disclosures relating to SFAS 115 and SFAS 119 are provided in notes 4 and 14, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
1. SUMMARY OF ACCOUNTING POLICIES (Continued)
In the third quarter of fiscal 1993, the Corporation adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109") and Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" ("SFAS 106") retroactive to November 1, 1992. The cumulative effect of adopting these changes in accounting policy resulted in an after tax charge to income of $8.8. Periods prior to November 1, 1992 were not required to be restated for the changes in accounting policy.
2. TRANSACTIONS WITH AFFILIATED COMPANIES
The Corporation's primary business is the retail, wholesale, and to a lesser extent, lease financing of products sold by Transportation and its dealers within the United States.
Wholesale Notes, Wholesale Accounts and Retail Accounts Revenue
In accordance with the agreements between the Corporation and Transportation relating to financing of wholesale notes, wholesale accounts and retail accounts, the Corporation receives interest income from Transportation at agreed upon interest rates applied to the average outstanding balances less interest amounts paid by dealers on wholesale notes and wholesale accounts.
The Corporation purchases wholesale notes and accounts of dealers from Transportation at the principal amount of the receivables. An acquisition fee applicable to purchases of wholesale notes secured by new equipment is charged to Transportation. The retail accounts are accounts of Transportation customers. Revenue collected from Transportation for wholesale notes, wholesale and retail accounts and leases was $50.7 in 1994, $41.2 in 1993 and $38.6 in 1992.
Support Agreements
Under provisions of certain public and private financing arrangements, agreements with Transportation and Navistar provide that the Corporation's consolidated income before interest expense and income taxes will be maintained at not less than 125% of its consolidated interest expense. Since 1984, no maintenance payments have been required under these agreements.
Administrative Expenses
The Corporation pays a fee to Transportation for data processing and other administrative services based on the actual cost of services performed. The amount of the fee was $2.5 in 1994, $2.3 in 1993 and $2.6 in 1992.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
2. TRANSACTIONS WITH AFFILIATED COMPANIES (Continued)
Short-Term Borrowings
During fiscal 1994, the Corporation had daily average short-term borrowings from Transportation of $83 on which interest accrued at the Corporation's incremental short-term borrowing rate. These borrowings, including $4 of interest expense, were repaid during the year.
Accounts Payable
Accounts payable include $16.3 and $19.5 payable to Transportation at October 31, 1994 and 1993, respectively.
3. INDUSTRY SEGMENTS
The Corporation is engaged in two industry segments in the United States: finance and insurance. The Corporation provides wholesale, retail and lease financing for the sales of new and used trucks and related equipment by Transportation and its dealers. To a lesser extent, the Corporation also finances other commercial vehicles, primarily trailers, sold by independent dealers. Harco National Insurance Company, NFC's wholly-owned insurance subsidiary, provides commercial physical damage and liability insurance coverage to Transportation's dealers and retail customers, and to the general public through the independent insurance agency system.
Information by industry segment is summarized as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
4. MARKETABLE SECURITIES
Effective October 31, 1994, the Corporation applied SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities." Marketable securities at October 31, 1994 are classified as securities available-for-sale and are stated at fair value. The fair value of marketable securities is estimated based on quoted market prices, when available. If a quoted price is not available, fair value is estimated using quoted market prices for similar financial instruments. The Corporation's retained earnings as of October 31, 1994 were decreased by $2.2 for unrealized holding losses, net of income taxes, and are included as a separate component of shareowner's equity in the Statement of Consolidated Financial Condition. As the restatement of prior years' financial statements is not permitted, marketable securities at October 31, 1993, consisting of investments in debt securities, were carried at amortized cost. The following table sets forth, by type of security issuer, the amortized cost and estimated market values at October 31, 1994 and 1993:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
4. MARKETABLE SECURITIES (Continued)
The amortized cost and estimated market values for investments in debt securities at October 31, 1994 by contractual maturity, are shown below:
Proceeds from sales or maturities of marketable securities available-for- sale were $45.1 during 1994 and $64.8 during 1993. Gross gains of $.9 and $1.3 were realized on those sales or maturities in 1994 and 1993, respectively. There were gross losses of $.2 in 1994 and 1993.
All marketable securities at October 31, 1994 and 1993 were held by Harco National Insurance Company, of which $29.5 and $26.5, respectively, were on deposit with various state departments of insurance or otherwise restricted as to use.
5. FINANCE RECEIVABLES
Finance receivable balances, net of unearned finance income, at October 31 are summarized as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
5. FINANCE RECEIVABLES (Continued)
Contractual maturities of finance receivables including unearned finance income at October 31, 1994 are summarized as follows:
The actual cash collections from finance receivables will vary from the contractual cash flows because of sales, prepayments, extensions and renewals. The contractual maturities, therefore, should not be regarded as a forecast of future collections.
The Corporation sells finance receivables to public and private investors with limited recourse provisions. Uncollected sold receivable net balances at October 31 are as follows:
Gains or losses from the sales of receivables are recognized in the period in which such sales occur. As the allowance for credit losses is adequately provided prior to the receivable sales, gains from receivable sales are not reduced for expected credit losses. Included in "Retail notes and lease financing" revenue are gains totaling $11.8, $14.2 and $5.5 for the fiscal years ended October 31, 1994, 1993 and 1992, respectively. Gains on sales of wholesale receivables are not material as a result of their short maturities.
The Corporation has two wholly-owned subsidiaries, Navistar Financial Retail Receivables Corporation ("NFRRC") and Navistar Financial Securities Corporation ("NFSC"), which have a limited purpose of purchasing retail and wholesale receivables, respectively, and transferring an undivided ownership interest in such notes to investors in exchange for pass-through notes and certificates. These subsidiaries have limited recourse on the sold receivables and their assets are available to satisfy the claims of their creditors prior to such assets becoming available to the Corporation or affiliated companies. At October 31, 1994, NFSC had in place a $300 revolving
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
5. FINANCE RECEIVABLES (Continued)
wholesale note sales trust providing for the continuous sale of eligible wholesale notes on a daily basis. The sales trust is comprised of three $100 pools of notes maturing serially from 1997 to 1999. On September 16, 1993, NFRRC filed a registration with the Securities and Exchange Commission providing for the issuance from time to time of $1,000 of asset-backed securities. During fiscal 1994, in three separate sales, the Corporation sold $830 of retail notes, net of unearned finance income, through NFRRC to three individual owner trusts. The owner trusts, in turn, sold $801 of notes and $29 of certificates to investors. The proceeds of $828, net of $2 of underwriting fees, were used by the Corporation for general working capital purposes and to establish $57 in cash reserves with the trusts as credit enhancement for the public sales. On October 7, 1994, NFRRC filed an additional registration with the Securities and Exchange Commission providing for the issuance from time to time of an additional $2,000 of asset-backed securities, bringing the total amount available for issuance by NFRRC to $2,170 at fiscal year-end.
The Corporation's retained interest in sold receivables and other related amounts are generally restricted and subject to limited recourse provisions. Holdback reserves were established pursuant to the limited recourse provisions of the retail note sales to private investors. The securitized sales structure requires the Corporation to maintain cash reserves with the trusts as credit enhancement for public sales. The cash reserves are held by the trusts and restricted for use by the securitized sales agreements. The following is a summary of amounts included in "Amounts Due from Sales of Receivables":
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
6. ALLOWANCE FOR LOSSES
The allowance for losses on receivables is summarized as follows:
7. REINSURANCE RECEIVABLES
In the normal course of business, the Corporation's wholly-owned insurance subsidiary, Harco National Insurance Company, limits its exposure on any single loss occurrence by ceding reinsurance to other insurance enterprises. SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts", prescribes the accounting standards for such reinsurance arrangements and was adopted by the Corporation in the first quarter of fiscal 1994. This statement eliminates the practice of reporting liabilities relating to reinsured contracts net of the effects of reinsurance. It requires reinsurance receivables including amounts related to unpaid insurance claims and prepaid reinsurance premiums to be reported as assets. In accordance with SFAS 113, the Corporation's assets include $33.7 of reinsurance receivables at October 31, 1994. The adoption of SFAS 113 did not have a material effect on the Corporation's financial results. Restatement of prior years' financial statements is not required.
8. TAXES ON INCOME
During fiscal 1993, the Corporation adopted SFAS 109 "Accounting for Income Taxes." Under SFAS 109, deferred tax assets and liabilities are generally determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. SFAS 109 generally allows recognition of deferred tax assets if future realization is more likely than not.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
8. TAXES ON INCOME (Continued)
Taxes on income are summarized as follows:
The effective tax rate of 38% in 1994 and 36% in 1993 and 1992 differs from the statutory United States Federal tax rate of 35% in 1994 and 1993 and 34% in 1992 primarily because of state and local income taxes. Deferred tax assets and liabilities at October 31, 1994 and 1993 are comprised of the following:
During 1992, auditors of the Illinois Department of Revenue ("Department") began an income tax audit of NFC for the fiscal years ended October 31, 1989, 1990 and 1991. On February 1, 1994 the Department issued a Notice of Deficiency to NFC for approximately $11.9 million. The Department has taken the position that nearly 100% of NFC's income during these years should be attributed to and taxed by Illinois. NFC maintains that the Department's interpretation and application of the law is incorrect and improper, and that the Department's intended result is constitutionally prohibited. NFC's outside counsel is of the opinion that it is more likely than not that NFC's position will prevail such that the Department's action will not have a material impact on NFC's earnings and financial position.
9. SHORT-TERM DEBT
Commercial paper is issued by the Corporation with varying terms. The Corporation also has short-term borrowings with various banks on a non- committed basis. Compensating cash balances and commitment fees are not required under these agreements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
9. SHORT-TERM DEBT (Continued)
Short-Term Debt at October 31 is summarized as follows:
Information regarding short-term borrowings is as follows:
Unused commitments under the Corporation's bank revolving credit facility and retail notes receivable purchase facility are used as backup for outstanding short-term borrowings.
10. SENIOR AND SUBORDINATED DEBT
Senior and Subordinated Debt outstanding at October 31 is summarized as follows:
The unrecognized net obligation as of the transition date is being amortized on a straight-line basis over 15 years. The effect of plan amendments is amortized over the remaining average service life of active employees.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
11. RETIREMENT BENEFITS (Continued)
Pension Assets and Liabilities
The plans' funded status and reconciliation to the Statement of Consolidated Financial Condition as of October 31 were as follows:
The weighted average rate assumptions used in determining the projected benefit obligation and pension expense were:
Postretirement Benefits Other Than Pensions
During 1993, the Corporation adopted SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" retroactive to November 1, 1992. SFAS 106 requires the accrual of the expected cost of providing postretirement benefits during employees' active service periods. The Corporation's previous practice was to charge the cost of these benefits against operations on a pay- as-you-go basis. The adoption of SFAS 106 did not affect cash flow, but it did change the timing of the recognition of costs.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
11. RETIREMENT BENEFITS (Continued)
The Corporation elected to recognize the SFAS 106 transition obligation as a one-time non-cash charge to earnings. The cumulative effect of this change in accounting policy, as of November 1, 1992, was $8.8, net of income taxes of $5.4.
The components of expense under SFAS 106 for postretirement benefits other than pensions that are included in the Statement of Consolidated Income and Retained Earnings for 1994 and 1993 include the following:
The components of the liability for postretirement benefits other than pensions as of October 31, 1994 were as follows:
The discount rate used to determine the accumulated postretirement benefit obligation at October 31, 1994, was 8.9%, based on the estimated income of high-quality fixed income securities which could be purchased to effectively settle the obligation. For 1995, the weighted average rate of increase in the per capita cost of covered health care benefits is projected to be 10.0%. The rate is projected to decrease to 5.0% in the year 2003 and remain at that level each year thereafter. If the cost trend rate assumptions were increased by one percentage point for each year, the accumulated postretirement benefit obligation would increase by approximately $1.0 and the associated expense recognized for the year ended October 31, 1994 would increase by an estimated $.2. Conversely, a decrease in the cost trend rate would lower the accumulated postretirement benefit obligation and the associated expense.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
12. LEASES
The Corporation is obligated under noncancelable operating leases for the majority of its office facilities and equipment. These leases are generally renewable and provide that property taxes and maintenance costs are to be paid by the lessee. At October 31, 1994, future minimum lease commitments under noncancelable operating leases with remaining terms in excess of one year are as follows:
13. SHAREOWNER'S EQUITY
The number of authorized shares of capital stock as of October 31, 1994 and 1993 was 2,000,000 of which 1,600,000 shares were issued and outstanding. All of the issued and outstanding capital stock is owned by Transportation and no shares are reserved for officers and employees, or for options, warrants, conversions and other rights. As discussed in note 16, the Corporation amended and restated its bank credit facility in November 1994 which among other things changed previous limitations on the Corporation's authority to pay dividends to Transportation.
14. FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Corporation, using available market information and valuation methodologies as described below. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Corporation could realize in a current market exchange. The use of different market assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.
The methods and assumptions used to estimate the fair value of each class of financial instruments are summarized as follows:
Cash and Cash Equivalents
The carrying amount approximates fair value.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
14. FINANCIAL INSTRUMENTS (Continued)
Marketable Securities
Fair value is estimated based on quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar financial instruments. The fair value of marketable securities held by insurance affiliates at October 31, 1994 is disclosed, as required, in note 4 and included below.
Finance Receivables
The fair value of truck retail notes is estimated by discounting the future cash flows using an estimated discount rate reflecting current rates paid to purchasers of similar types of receivables with similar credit, interest rate and prepayment risks. For other retail notes, primarily variable-rate notes that reprice frequently, and for wholesale notes and retail and wholesale accounts, the carrying amounts approximate fair value.
Amounts Due from Sales of Receivables
The fair values of excess servicing cash flows and other subordinated amounts due the Corporation arising from receivable sale transactions were derived by discounting expected cash flows at estimated current market rates. The fair value of cash deposits approximates their carrying value.
Senior and Subordinated Debt
For variable-rate borrowings under the bank revolving credit agreement that reprice frequently, the carrying amount approximates fair value. The fair values of notes and debentures are estimated based on quoted market prices where available and, where not available, on quoted market prices of debt with similar characteristics.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
14. FINANCIAL INSTRUMENTS (Continued)
The carrying amounts of financial instruments as reported in the Statement of Financial Condition and described in the various notes to the financial statements and their fair values at October 31 are as follows:
Derivative Financial Instruments
The Corporation acquires floating rate wholesale receivables and fixed rate retail receivables and generally funds floating rate receivables with floating rate funding and fixed rate receivables with fixed rate funding and equity. Interest rate caps and swaps are used when needed to convert floating rate funds to fixed and vice versa to match the asset portfolio. In addition, the Corporation will use a variety of contracts to lock in interest rates during the period in which retail receivables are being sold. During fiscal 1994, the Corporation entered into two short-term forward interest rate lock agreements related to two sales of receivables. At October 31, 1994, there were no swap agreements outstanding and only one interest rate cap purchased in 1985 for a notional amount of $50 million which serves to partially hedge the interest cost of variable rate debt. The Corporation's wholly-owned insurance subsidiary has investments in Collateralized Mortgage Obligations of $18.2 and are included in the Corporation's marketable securities at October 31, 1994.
15. LEGAL PROCEEDINGS
In May 1993, a jury issued a verdict in favor of Vernon Klein & Equipment, Inc. and against Transportation and the Corporation in the amount of $10.8 in compensatory damages and $15 in punitive damages. Transportation appealed the verdict and, in November 1994, the Court of Appeals of the State
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
15. LEGAL PROCEEDINGS (Continued)
of Oklahoma reversed the verdict and entered judgment in favor of Transportation on virtually all aspects of the case.
The Corporation and its subsidiaries are subject to various other claims arising in the ordinary course of business, and are parties to various legal proceedings which constitute ordinary routine litigation incidental to the business of the Corporation and its subsidiaries. In the opinion of the Corporation's management, none of these proceedings or claims are material to the business or the financial condition of the Corporation.
16. SUBSEQUENT EVENTS
In November 1994, the Corporation amended and restated its $727 million bank revolving credit agreement, extending the maturity date to October 31, 1998 and expanding the commitment to $900 million. In addition, the purchasers' commitments under the $600 million retail notes purchase facility agreement were terminated and the Corporation established a $300 million asset backed commercial paper ("ABCP") program supported by a bank liquidity facility with a maturity date of October 31, 1998. While the amended revolving credit facility removes certain dividend restrictions, the Corporation is required to maintain tangible net worth at a minimum of $175 million and a debt to tangible net worth ratio of no greater than 7 to 1. Consistent with the previous revolving credit agreement, the restated agreement grants security interests in substantially all of the Corporation's assets to the Corporation's debtholders.
As of October 31, 1994, approximately $377 million of sold notes were outstanding under the $600 million retail notes purchase facility. Participants of the facility will continue to own the receivables during the run off.
Under the terms of the ABCP program, a special purpose wholly-owned subsidiary of NFC will purchase retail and lease receivables. All assets of the subsidiary will be pledged to a Trust that will fund the receivables with A1/P1 rated commercial paper. In addition, the assets may be sold to the Trust.
Compensating cash balances are not required under the restated revolving credit facility. Facility fees are paid quarterly regardless of usage. The Corporation also pays a commitment fee on the unused portion of the $300 million ABCP liquidity facility.
On December 15, 1994, the Corporation sold $315 of retail notes, net of unearned finance income, through NFRRC to an owner trust which, in turn, sold $304 of notes and $11 of certificates to investors. The proceeds of $314, net of $1 of underwriting fees, were used by the Corporation for general working capital purposes and to establish a $19 reserve account with the trust as credit enhancement for the public sale.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MILLIONS OF DOLLARS
17. QUARTERLY FINANCIAL INFORMATION (unaudited)
SUPPLEMENTARY FINANCIAL DATA (Continued)
Gross Finance Receivables and Leases Acquired
Analysis of Finance Retail Notes Acquired
SUPPLEMENTARY FINANCIAL DATA (Continued)
Analysis of Gross Retail Notes and Lease Financing With Installments Past Due Over 60 Days
Analysis of Repossessions
SUPPLEMENTARY FINANCIAL DATA (Continued)
Analysis of Loss Experience
Includes loss experience on sold notes.
Navistar Financial Corporation and Subsidiaries
Statement of Financial Reporting Responsibility
Management of Navistar Financial Corporation and its subsidiaries is responsible for the preparation and for the integrity and objectivity of the accompanying financial statements and other financial information in this report. The financial statements have been prepared in accordance with generally accepted accounting principles and include amounts that are based on management's estimates and judgments.
The accompanying financial statements have been audited by Deloitte & Touche LLP, independent auditors. Management has made available to Deloitte & Touche LLP all the Corporation's financial records and related data, as well as the minutes of Directors' meetings. Management believes that all representations made to Deloitte & Touche LLP during its audit were valid and appropriate.
Management is responsible for establishing and maintaining a system of internal controls throughout its operations that provides reasonable assurance as to the integrity and reliability of the financial statements, the protec- tion of assets from unauthorized use and the execution and recording of transactions in accordance with management's authorization. The system of internal controls which provides for appropriate division of responsibility is supported by written policies and procedures that are updated by management as necessary. The system is tested and evaluated regularly by the parent Company's internal auditors as well as by the independent auditors in connec- tion with their annual audit of the financial statements. The independent auditors conduct their audit in accordance with generally accepted auditing standards and perform such tests of transactions and balances as they deem necessary. Management considers the recommendations of its internal auditors and independent auditors concerning the Corporation's system of internal controls and takes the necessary actions that are cost-effective in the cir- cumstances to respond appropriately to the recommendations presented. Manage- ment believes that the Corporation's system of internal controls accomplishes the objectives set forth in the first sentence of this paragraph.
John J. Bongiorno President and Chief Executive Officer
Phyllis E. Cochran Vice President and Controller
Navistar Financial Corporation and Subsidiaries
Independent Auditors' Report
Navistar Financial Corporation:
We have audited the financial statements of Navistar Financial Corporation and its subsidiaries listed in Item 8.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None
PART III
Items 10, 11, 12 and 13
Intentionally omitted. See the index page of this Report for explanation.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
Financial Statements
See Index to Financial Statements in Item 8.
Financial Statement Schedules
All schedules are omitted because of the absence of the conditions under which they are required or because information called for is shown in the financial statements and notes thereto.
Exhibits, Including Those Incorporated By Reference
Reports on Form 8-K
No reports on Form 8-K were filed for the three months ended October 31, 1994.
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NAVISTAR FINANCIAL CORPORATION (Registrant)
By: /s/PHYLLIS E. COCHRAN January 27,1995 Phyllis E. Cochran Vice President and Controller (Principal Accounting Officer)