TEXTRON FINANCIAL CORP - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 3, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-27559

TEXTRON FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

DELAWARE 05-6008768
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

40 WESTMINSTER STREET, P.O. BOX 6687, PROVIDENCE, R.I. 02940-6687
(401) 621-4200
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

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

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

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2.) Yes [ ] No [X]

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

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

PART I.
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 9
Item 3. Legal Proceedings........................................... 9
Item 4. Submission of Matters to a Vote of Security Holders......... 9
PART II.
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 9
Item 6. Selected Financial Data..................................... 10
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 11
Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 26
Item 8. Financial Statements and Supplementary Data................. 27
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 55
Item 9A. Controls and Procedures..................................... 55
PART III.
Item 10. Directors and Executive Officers of the Registrant.......... 55
Item 11. Executive Compensation...................................... 55
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 55
Item 13. Certain Relationships and Related Transactions.............. 56
Item 14. Principal Accountant Fees and Services...................... 56
PART IV.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form
8-K....................................................... 56

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PART I.

ITEM 1. BUSINESS

GENERAL

Textron Financial Corporation (Textron Financial or the Company) is a
diversified commercial finance company with core operations in six segments.
Aircraft Finance provides financing for new and used Cessna business jets and
piston-engine airplanes, Bell helicopters, and other general aviation aircraft;
Asset-Based Lending provides asset-based loans to smaller middle-market
companies that manufacture or distribute finished goods, and provides factoring
arrangements for freight companies and utility service providers; Distribution
Finance offers inventory finance programs for dealers of Textron manufactured
products and for dealers of a variety of other household, housing, leisure,
agricultural and technology products; Golf Finance makes mortgage loans for the
acquisition and refinancing of golf courses and provides term financing for
E-Z-GO golf cars and Jacobsen turf-care equipment; Resort Finance extends loans
to developers of vacation interval resorts, secured primarily by notes
receivable and interval inventory; and Structured Capital engages in
tax-oriented, long-term leases of large-ticket equipment and real estate,
primarily with investment grade lessees. Textron Financial Corporation's other
financial services and products include transaction syndication, equipment
appraisal and disposition, and portfolio servicing. Some of these ancillary
services are offered through Asset Control LLC and TBS Business Services, Inc.

All of Textron Financial's stock is owned by Textron Inc. (Textron), a $10
billion global multi-industry company with operations in five business segments:
Bell, Cessna, Fastening Systems, Industrial and Finance. At January 3, 2004, 24%
of Textron Financial's total managed finance receivables were related to the
financing of Textron's products (captive receivables). For further information
on Textron Financial's relationship with Textron, see "Relationship with
Textron" below.

Textron Financial's financing activities are confined almost exclusively to
secured lending and leasing to commercial markets. Textron Financial
Corporation's services are offered primarily in North America. However, Textron
Financial Corporation finances Textron products worldwide, principally Bell
helicopters and Cessna aircraft.

Textron Financial also maintains an Other segment that includes non-core
assets related to franchise finance and media finance, and other liquidating
portfolios from product lines that were discontinued in 2001. The Company ceased
new finance receivable originations in these business markets, and continues to
actively manage the accounts to maximize value as the accounts run-off or are
sold.

Consistent with the Company's strategy to exit these non-core businesses,
Textron Financial sold its small business direct portfolio (small business
finance) in December 2003. The following discussion of portfolio quality in Item
1, the selected financial data in Item 6 and the discussion of the Company's
results in Item 7 exclude the results of this discontinued operation, as defined
by SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets,
which is described in Note 4 to the consolidated financial statements in Item 8
of this Form 10-K.

For additional information regarding Textron Financial's business segments,
refer to Note 21 to the consolidated financial statements in Item 8 of this Form
10-K.

COMPETITION

The commercial finance environment in which Textron Financial operates is
highly fragmented and extremely competitive. Textron Financial Corporation is
subject to competition from various types of financing institutions, including
banks, leasing companies, insurance companies, commercial finance companies and
finance operations of equipment vendors. Competition within the commercial
finance industry is primarily focused on price, terms, structure and service.
The Company may lose market share to the extent that it is unwilling to match
competitors' practices. To the extent that Textron Financial matches these
practices, the Company may experience decreased margins, increased risk of
credit losses or both. Many of Textron Financial's competitors are large
companies that have substantial capital, technological and marketing

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resources. This has become increasingly the case given the consolidation
activity in the commercial finance industry. In some instances, Textron
Financial's competitors have access to capital at a lower cost than Textron
Financial.

RELATIONSHIP WITH TEXTRON

General

Textron Financial derives a portion of its business from financing the sale
and lease of products manufactured and sold by Textron. In 2003, 2002 and 2001,
Textron Financial paid Textron $0.8 billion, $1.1 billion and $1.3 billion,
respectively, for the sale of manufactured products to third parties that were
financed by the Company. In addition, the Company paid Textron $56.3 million in
2003, $104.3 million in 2002 and $62.1 million in 2001 for the purchase of
operating lease equipment. Textron Financial recognized finance charge revenues
from Textron and affiliates (net of payments or reimbursements for interest
charged at more or less than market rates on Textron manufactured products) of
$6.3 million in 2003, $9.4 million in 2002, and $4.0 million in 2001, and
operating lease revenues of $22.4 million in 2003, $21.0 million in 2002, and
$10.9 million in 2001.

Textron Financial and Textron utilize an intercompany account for the
allocation of Textron overhead charges and for the settlement of captive
receivables. For additional information regarding the relationship between
Textron Financial and Textron, see Notes 5, 6, and 11 to the consolidated
financial statements in Item 8 of this Form 10-K.

Agreements with Textron

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

Receivables Purchase Agreement

Under a Receivables Purchase Agreement with Textron, Textron Financial has
recourse to Textron with respect to certain finance receivables and operating
leases relating to products manufactured and sold by Textron. Finance
receivables of $427.5 million at January 3, 2004 and $526.7 million at December
28, 2002, and operating leases of $126.3 million at January 3, 2004, and $122.3
million at December 28, 2002, were subject to recourse to Textron or due from
Textron. In addition, Textron Financial had recourse to Textron on seller
certificates of $26.2 million and $59.2 million at year-end 2003 and 2002,
respectively, and on cash reserve accounts of $4.0 million and $10.4 million at
year-end 2003 and 2002, respectively. Both the seller certificates and the cash
reserve accounts are retained interests related to finance receivable
securitizations.

Support Agreement with Textron

Under a Support Agreement with Textron dated as of May 25, 1994, Textron is
required to pay to Textron Financial, quarterly, an amount sufficient to provide
that Textron Financial's pre-tax earnings, before extraordinary items and fixed
charges (including interest on indebtedness and amortization of debt discount
"fixed charges"), will not be less than 125% of the Company's fixed charges. No
such payments under the Support Agreement were required for the years ended
2003, 2002 or 2001, when Textron Financial's fixed-charge coverage ratios (as
defined) were 167%, 164%, and 173%, respectively. Textron also has agreed to
maintain Textron Financial's consolidated shareholder's equity at an amount no
less than $200 million. Pursuant to the terms of the Support Agreement, Textron
is required to directly or indirectly own 100% of Textron Financial's common
stock. The Support Agreement also contains a third-party beneficiary provision
entitling Textron Financial's lenders to enforce its provisions against Textron.

Tax Sharing Agreement with Textron

Textron Financial's revenues and expenses are included in the consolidated
federal tax return of Textron. The Company files some of its state income tax
returns on a separate basis. Under a Tax Sharing Agreement

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

REGULATIONS

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

- Regulate credit-granting activities;

- Establish maximum interest rates, finance charges and other charges;

- Require disclosures to customers;

- Govern secured transactions;

- Affect insurance brokerage activities; and

- Set collection, foreclosure, repossession and claims handling procedures
and other trade practices.

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

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

EMPLOYEES

As of January 3, 2004, Textron Financial had 1,287 employees. The Company
is not subject to any collective bargaining agreements.

RISK MANAGEMENT

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

- Credit risk;

- Asset/liability risk (including interest rate and foreign exchange risk);
and

- Liquidity risk.

Proper management of these risks is essential to maintaining profitability.
Accordingly, the Company has designed risk management systems and procedures to
identify and quantify these risks. Textron Financial has established appropriate
policies and set prudent limits in these areas. The Company's management of
these

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risks, and levels of compliance with its policies and limits, is continuously
monitored by means of administrative and information systems.

Credit Risk Management

Textron Financial manages credit risk through:

- Underwriting procedures;

- Centralized approval of individual transactions exceeding certain size
limits; and

- Active portfolio and account management.

The Company has developed underwriting procedures for each operating unit
that assess a prospective customer's ability to perform in accordance with
financing terms. These procedures include:

- Analyzing business or property cash flows and collateral values;

- Performing financial sensitivity analyses; and

- Assessing potential exit strategies.

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

Depending on transaction size and complexity, transactions outside of
operating unit authority require the approval of a Group President and Group
Credit Officer or Corporate Risk Management Officer. Transactions exceeding
group authority require one or more of the Executive Vice President and Chief
Credit Officer, the President and Chief Operating Officer, Textron Financial's
Credit Committee, or the Chairman and Chief Executive Officer depending on the
size of the transaction, and in some cases approvals are required by Textron up
to and including its Board of Directors. Textron Financial's Credit Committee is
comprised of its President and Chief Operating Officer, Executive Vice President
and Chief Credit Officer, Executive Vice President and Chief Financial Officer,
Executive Vice President, General Counsel and Secretary, President of the
Capital Markets Group, and President of Distribution Finance.

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

Geographic Concentration

Textron Financial continuously monitors its portfolio to avoid any undue
geographic concentration in any region of the U.S. or in any foreign country.
The largest concentration of domestic receivables was in the Southeastern U.S.,
representing 26% of Textron Financial's total managed finance receivable
portfolio at January 3, 2004. International receivables are generated mostly in
support of Textron product sales. At January 3, 2004, international receivables
represented 13% of Textron Financial's managed finance receivable portfolio,
with the largest country, Brazil, representing 3%.

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Asset/Liability Risk Management

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

- Interest rate exposure arising from changes in interest rates; and

- Foreign currency exposure arising from changes in exchange rates.

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

Textron Financial carefully manages exposure to counterparty risk in
connection with its derivatives. In general, the Company engages in transactions
with counterparties having ratings of at least A by Standard & Poor's Rating
Service or A2 by Moody's Investors Service. Total notional exposure is monitored
by counterparty, and managed within prudent limits. At January 3, 2004, the
Company's largest single counterparty credit exposure was $15 million.

Interest Rate Risk Management

Textron Financial manages interest rate risk by monitoring the duration and
interest rate sensitivities of its assets, and by incurring liabilities (either
directly or synthetically with derivatives) having a similar duration and
interest sensitivity profile. The Company's internal policies limit the
aggregate mismatch of floating rate assets and liabilities to 10% of total
assets.

Foreign Exchange Risk Management

A small portion of finance assets owned by Textron Financial are located
outside of the United States. These receivables are generally in support of
Textron's overseas product sales and are predominantly denominated in U.S.
Dollars. Textron Financial presently has foreign currency receivables
principally denominated in Canadian Dollars and Australian Dollars. In order to
minimize the effect of fluctuations in foreign currency exchange rates on the
Company's financial results, Textron Financial borrows in these currencies
and/or enters into forward exchange contracts, on a monthly basis, in amounts
sufficient to hedge its non-functional currency exposures.

Liquidity Risk Management

The Company uses cash to fund asset growth and to meet debt obligations and
other commitments. Textron Financial's primary sources of funds are:

- Cash from operations;

- Commercial paper borrowings;

- Issuances of medium-term notes and other term debt securities; and

- Syndication and securitization of receivables.

All commercial paper borrowings are fully backed by committed bank lines of
credit, providing liquidity in the event of capital market dislocation. If
Textron Financial is unable to access these markets on acceptable terms, the
Company can draw on its bank line of credit facilities and use cash flows from
operations and

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portfolio liquidations to satisfy its liquidity needs. For additional
information regarding Textron Financial's liquidity risk management, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources," in Item 7 of this Form 10-K.

PORTFOLIO QUALITY

The following table presents information about the credit quality of the
Company's portfolio:

Nonperforming Assets

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

Delinquent Earning Accounts and Loan Modifications

Textron Financial does not have any earning accounts that are contractually
delinquent by more than three months with the exception of the captive
receivables described above. Loans that are modified are not returned to
accruing status until six months of timely payments have been received or
Textron Financial otherwise deems that full collection of principal and interest
is not doubtful.

Allowance for Losses on Receivables

Management evaluates its allowance for losses on receivables based on a
combination of factors. For its homogeneous loan pools, Textron Financial
examines current delinquencies, the characteristics of the existing accounts,
historical loss experience, the value of the underlying collateral and general
economic conditions and trends. Textron Financial estimates losses will range
from 0.5% to 4.0% of finance receivables depending on the specific homogeneous
loan pool. For larger balance commercial loans, Textron Financial considers
borrower specific information, industry trends and estimated discounted cash
flows, as well as the factors described above for homogeneous loan pools.

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Provisions for losses on finance receivables are charged to income, in
amounts sufficient to maintain the allowance for losses on receivables at a
level considered adequate to cover losses in the existing finance receivable
portfolio, based on management's evaluation and analysis of this portfolio.

Finance receivables are charged off when they are deemed uncollectible.
Finance receivables are written down to the fair value (less estimated costs to
sell) of the related collateral at the earlier of the date the collateral is
repossessed or when no payment has been received for six months, unless
management deems the receivable collectible.

Loan Impairment

Textron Financial periodically evaluates finance receivables, excluding
homogeneous loan portfolios and finance leases, for impairment. A loan is
considered impaired when it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. Impairment is measured by comparing the fair value of a loan to its
carrying amount. Fair value is based on the present value of expected future
cash flows discounted at the loan's effective interest rate, the loan's
observable market price or, if the loan is collateral dependent, at the fair
value of the collateral. If the fair value of the loan is less than its carrying
amount, the Company establishes a reserve based on this difference. This
evaluation is inherently subjective, as it requires estimates, including the
amount and timing of future cash flows expected to be received on impaired
loans, that may differ from actual results.

ITEM 2. PROPERTIES

Textron Financial leases office space from a Textron affiliate for its
corporate headquarters at 40 Westminster Street, Providence, Rhode Island 02903.
The Company leases other offices throughout North America. For additional
information regarding Textron Financial's lease obligations, see Note 18 to the
consolidated financial statements in Item 8 of this Form 10-K.

ITEM 3. LEGAL PROCEEDINGS

There are pending or threatened lawsuits and other proceedings against
Textron Financial and its subsidiaries. Some of these suits and proceedings seek
compensatory, treble or punitive damages in substantial amounts. These suits and
proceedings are being defended by, or contested on behalf of, Textron Financial
and its subsidiaries. On the basis of information presently available, Textron
Financial believes any such liability would not have a material effect on
Textron Financial's financial position or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Omitted per Instruction I of Form 10-K.

PART II.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The common stock of Textron Financial is owned entirely by Textron and,
therefore, there is no trading of Textron Financial's stock. Dividends of $114.0
million, $62.0 million and $51.1 million were declared and paid in 2003, 2002,
and 2001, respectively. For additional information regarding restrictions as to
dividend availability, see Note 11 to the consolidated financial statements in
Item 8 of this Form 10-K.

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ITEM 6. SELECTED FINANCIAL DATA

The following data has been recast to reflect discontinued operations and
should be read in conjunction with Textron Financial's consolidated financial
statements in Item 8 of this Form 10-K.

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(1) Textron Financial's year-end dates conform with Textron's year-end, which
falls on the nearest Saturday to December 31.

(2) Tangible shareholder's equity equals Shareholder's equity, excluding
Accumulated other comprehensive income or loss, less Goodwill.

(3) Represents revenues earned less interest expense on borrowings and
operating lease depreciation as a percentage of average net investment.
Average net investment includes finance receivables plus operating leases,
less deferred taxes on leveraged leases.

(4) Return on average equity excludes the cumulative effect of change in
accounting principle.

(5) Return on average assets excludes the cumulative effect of change in
accounting principle.

(6) Average managed and serviced finance receivables include owned receivables,
receivables serviced under securitizations, participations and third-party
portfolio servicing agreements.

(7) Operating efficiency ratio is selling and administrative expenses divided
by net interest margin.

(8) Delinquency excludes captive receivables with recourse to Textron. Captive
receivables represent third-party finance receivables originated in
connection with the sale or lease of Textron manufactured products.
Percentages are expressed as a function of total Textron Financial
independent and nonrecourse captive receivables.

(9) Finance assets include: finance receivables; equipment on operating leases,
net of accumulated depreciation; repossessed assets and properties;
retained interests in securitizations; interest-only securities; investment
in equipment residuals; ADC arrangements; and short and long-term
investments (some of which are classified in Other assets on Textron
Financial's Consolidated Balance Sheets). Nonperforming assets include
independent and nonrecourse captive finance assets.

(10) Excludes net charge-offs recorded against the real estate owned valuation
allowance of $8.0 million in 2000.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

Information regarding general information and characteristics of Textron
Financial is included in Item 1, Business, of this Form 10-K.

Textron Financial is in the business of originating and servicing
commercial finance receivables for Textron-related products and other commercial
markets. The principal factors that influence our earnings are the amount and
mix of different types of finance receivables, fees earned related to these
finance receivables and services, and the credit quality of these finance
receivables over time. For finance receivables, net interest margin equals the
difference between revenue earned on finance receivables, including fee income,
and the cost of borrowed funds. For operating leases, net interest margin equals
revenue earned on operating leases, less depreciation expense and the cost of
borrowed funds. On certain types of finance receivables, interest rates earned
are fixed at the time the contracts are originated, while other types are based
on floating rates that are generally tied to changes in the prime rate offered
by major U.S. banks or the London Interbank Offered Rate (LIBOR). Rental charges
on operating leases may be fixed at the time the contracts are originated or
based on floating rates that are generally tied to changes in LIBOR.

Textron Financial borrows funds at various maturities at both fixed and
floating interest rates to match the interest sensitivities and maturities of
its finance receivables. External market conditions and our debt ratings affect
these interest rates. The Company also may, from time to time, enter into
interest rate exchange agreements related to new debt issuances in an effort to
access the debt markets in the most efficient manner available at the time of
issuance. As an alternative source of funding, Textron Financial sells finance
receivables in securitizations, retaining an interest in the sold receivables
and continuing to service such receivables for a fee.

11

The Company assesses business performance on an owned basis, managed basis
and a serviced basis. The owned basis includes only the finance receivables
owned and reported on the consolidated balance sheet. The managed basis includes
owned finance receivables and finance receivables sold in securitizations and
private transactions, where the Company has retained some element of credit
risk, and continues to service the accounts. The serviced basis includes managed
receivables and serviced-only receivables, which generally consist of finance
receivables of resort developers and other third-party financial institutions
without retained credit risk.

Textron Financial retains subordinated interests in finance receivables
sold in securitizations and recourse obligations on certain private portfolio
sales resulting in credit risk. As a result, the Company evaluates finance
receivables and leverage on a managed as well as owned basis. In contrast, the
Company does not have a retained financial interest or credit risk in the
performance of the serviced portfolio and, therefore, performance of these
portfolios is limited to billing and collection activities.

KEY BUSINESS INITIATIVES AND TRENDS

During 2003, Textron Financial experienced improvements in portfolio
quality and renewed its focus on growing core businesses. While the
collectibility of the Company's finance receivable portfolio remains one of the
Company's most significant business risks, the improved portfolio quality
measures in 2003 demonstrate the Company's successful efforts to resolve problem
accounts. The provision for losses declined 27% in 2003 as compared to 2002 due
to improving portfolio quality and, to a lesser extent, declining portfolio
growth. The Company continued to make steady progress liquidating non-core
assets. The Company also implemented steps to streamline the organization
through the consolidation of operations in each of two core segments.

During the third quarter of 2002, Textron Financial made a strategic
decision to exit franchise finance, media finance, small business finance and
other discontinued product lines, and initiated a plan to sell or liquidate
approximately $1.7 billion of non-core assets related to these businesses. The
Company also realigned the remaining business units into six operating segments
based on the markets served and the products offered: Aircraft Finance,
Asset-Based Lending, Distribution Finance, Golf Finance, Resort Finance and
Structured Capital. The Company has ceased originating new business in the
non-core areas and continues to actively manage the non-core accounts to
maximize value. At January 3, 2004, non-core managed finance assets were $748
million.

Operating efficiency (the ratio of Selling and administrative expenses
divided by Net interest margin) has deteriorated over the past two years, as a
consequence of higher legal and collection expenses related to nonperforming
accounts and the inability to rapidly reduce infrastructure costs in response to
slower growth. The Company has taken certain actions to reverse this trend,
including restructuring operations and initiatives related to the improvement of
information systems and processes. In the fourth quarter of 2003, the Company
initiated a restructuring plan to consolidate operations within its corporate
headquarters and within each of two core segments: Asset-Based Lending and
Resort Finance. As part of the restructuring plan, two facilities were closed
and 85 employees terminated. Severance and other costs of $6.3 million related
to the restructuring plan were identified in plans approved by senior management
and were recorded at year-end. The Company expects to see modest improvement in
the near term, with a targeted operating efficiency ratio of less than 40%.

FINANCIAL CONDITION

Liquidity and Capital Resources

Textron Financial mitigates liquidity risk (i.e., the risk that the Company
will be unable to fund maturing liabilities or the origination of new finance
receivables) by developing and preserving reliable sources of capital. The
Company uses a variety of financial resources to meet these capital needs. Cash
is provided from finance receivable sales and collections, and from many types
of borrowings, including the issuance of commercial paper and term debt in the
public and private markets, as well as finance receivable securitizations. This
diversity of capital resources enhances the Company's funding flexibility,
limits dependence on any one source of funds, and results in cost-effective
funding. In making particular funding decisions, management
12

considers market conditions, prevailing interest rates and credit spreads, and
the maturity profile of its assets and liabilities.

In general, the funding environment for commercial finance companies was
difficult in 2002. A weak corporate bond market, combined with a downgrade of
the Company's debt credit ratings, increased the Company's unsecured borrowing
spreads substantially. Despite these adverse conditions, the Company issued $2.0
billion of term debt. The Company also utilized a revolving securitization
conduit for its Distribution Finance business to expand its short-term funding
alternatives.

During 2003, the Company's credit spreads recovered substantially in light
of a much stronger corporate bond market and Textron Financial's improving
credit profile. Term debt of approximately $1.2 billion was issued throughout
the year at increasingly narrower credit spreads. By year-end, credit spreads
had recovered to historically low levels not experienced since 2001.

As part of its commercial paper program, the Company has a policy of
maintaining unused committed bank lines of credit in an amount not less than
outstanding commercial paper balances. These lines of credit have recently been
well in excess of outstanding commercial paper levels, with coverage of 302% and
183% at year-end 2003 and 2002, respectively. These lines of credit currently
total $1.5 billion, of which $500 million expires in 2004 and $1.0 billion
expires in 2008. The $500 million facility includes a one-year term out option,
effectively extending its expiration into 2005. In addition, during the third
quarter of 2003, Textron amended its credit facilities to permit Textron
Financial to borrow under those facilities. None of these lines of credit were
used at January 3, 2004, or December 28, 2002. Textron Financial also maintains
a CAD 50 million committed facility, under which it can borrow an additional CAD
50 million on an uncommitted basis. At January 3, 2004, Textron Financial had
used CAD 20 million of the committed portion of the facility. Textron Financial
also has a $25 million multi-currency facility, of which $17 million remained
unused at January 3, 2004. Both the Canadian and multi-currency facilities
expire in 2004. Lines of credit not reserved as support for outstanding
commercial paper or letters of credit were $966 million at January 3, 2004,
compared to $716 million at December 28, 2002.

During the third quarter of 2003, Textron Financial filed a shelf
registration statement with the Securities and Exchange Commission enabling the
Company to issue public debt securities in one or more offerings up to a total
maximum offering of $4 billion. Under this facility, Textron Financial issued
$372 million of term notes during 2003, primarily in U.S. and Canadian markets.
The proceeds from these issuances were used to refinance maturing commercial
paper and long-term debt. Under a shelf registration statement previously filed
with the Securities and Exchange Commission, Textron Financial issued $816
million of term notes during the first half of 2003.

13

The following table contains projected primary cash outflows and inflows
for the specified periods:

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

(1) Based on contractual cash flows; amount could differ due to prepayments,
chargeoffs and other factors.

(2) Excludes finance charges and discounts from receivables, debt interest
payments, proceeds from sale of operating lease equipment and other items.

As shown in the preceding table, cash collections from finance assets are
expected to be sufficient to cover maturing debt and other contractual
liabilities throughout the next five years and thereafter.

At January 3, 2004, Textron Financial had unused commitments to fund new
and existing customers under $1.1 billion of committed revolving lines of credit
as compared to $1.5 billion of committed revolving lines of credit at December
28, 2002. The decrease was largely related to the continued liquidation of the
non-core syndicated bank loan portfolio in 2003. Additionally, since many of the
agreements will not be used to the extent committed or will expire unused, the
total commitment amount does not necessarily represent future cash requirements.

At January 3, 2004, Textron Financial's credit ratings were as follows:
Standard & Poor's (A- long-term, A2 short-term, outlook stable), Moody's
Investors Service (A3 long-term, P2 short-term, outlook negative) and Fitch (A-
long-term, F2 short-term, outlook negative).

During the first quarter of 2003, Textron Financial's commercial paper and
long-term debt credit ratings were downgraded from F1 to F2 and from A to A-,
respectively, by Fitch. In the second quarter of 2003, Standard & Poor's
affirmed the Company's long-term debt rating at A- and upgraded the outlook from
negative to stable. Further downgrades in Textron Financial's ratings could
increase borrowing spreads or limit its access to the commercial paper,
securitization and term debt markets.

Cash provided by operating activities of continuing operations totaled $242
million in 2003, $206 million in 2002 and $266 million in 2001. The increase in
the cash provided in 2003 and the decrease in 2002 were primarily due to the
timing of payments of accrued interest and other liabilities, principally income
taxes payable of $82 million and the remittance cash received on serviced
receivables of $25 million for 2003.

Cash provided (used) by investing activities of continuing operations
totaled $273 million in 2003, $(499) million in 2002 and $(390) million in 2001.
These cash flows largely resulted from the origination, purchase, repayment and
sales, including securitizations, of finance receivables. The 2003 increase was
primarily the result of a $389 million increase in finance receivable repayments
relative to new finance
14

receivable originations and $196 million of higher proceeds from receivable
sales. The decrease in 2002 was the result of a higher level of new finance
receivable originations relative to finance receivable repayments and sales of
$(455) million, mostly offset by a $(388) million business acquisition in 2001.

Cash provided (used) by financing activities of continuing operations
totaled $(355) million in 2003, $270 million in 2002 and $115 million in 2001.
The cash used in 2003 mostly relates to the pay down of commercial paper and
other short-term debt at year-end from the proceeds received from receivable
sales in the fourth quarter. The $270 million of cash provided in 2002 was
mostly used to fund finance asset growth. In addition, the Company issued $2.0
billion of term debt in 2002 to refinance maturing term debt and repay a 2001
advance of $510 million from Textron. In 2001, the Company's term debt issuances
of $0.9 billion were used to refinance maturing commercial paper and term debt.

Net cash provided (used) by discontinued operations represents the small
business finance operation and totaled $175 million in 2003, $27 million in 2002
and $21 million in 2001.

Because the finance business involves the purchase and carrying of
receivables, a relatively high ratio of borrowings to net worth is customary.
Debt as a percentage of total capitalization was 81% at January 3, 2004,
compared to 83% at December 28, 2002. Textron Financial's ratio of earnings to
fixed charges was 1.67x in 2003 (1.64x in 2002 and 1.73x in 2001). Commercial
paper and Other short-term debt as a percentage of total debt was 12% at January
3, 2004, compared to 19% at the end of 2002.

In 2003, Textron Financial declared and paid dividends to Textron of $114.0
million, compared to dividends declared and paid of $62.0 million in 2002. The
increase in 2003 was due to excess capital that resulted from slower than
anticipated receivable growth and the return of capital to Textron associated
with the sale of small business finance. Textron contributed capital of $9.0
million to Textron Financial in both 2003 and 2002, which consisted of Textron's
dividend on the preferred stock of Textron Funding Corporation.

Off-Balance Sheet Arrangements

Textron Financial sells finance receivables utilizing both securitizations
and whole-loan sales. As a result of these transactions, finance receivables are
removed from the Company's balance sheet and the proceeds received are used to
reduce the Company's recorded debt levels. Despite the reduction in the recorded
balance sheet position, the Company generally retains a subordinated interest in
the finance receivables sold through securitizations, which may affect operating
results through periodic fair value adjustments. The Company also sells
receivables in whole-loan sales in which it retains a continuing interest,
through limited credit enhancement, in the form of a contingent liability
related to finance receivable credit losses and, to a lesser extent, prepayment
risk.

The Company utilizes off-balance sheet financing arrangements (primarily
asset-backed securitizations) to further diversify the Company's funding
alternatives. These arrangements are an important source of funding that
provided net proceeds from continuing operations of $765 million and $707
million in 2003 and 2002, respectively. Textron Financial has used the proceeds
from these arrangements to fund the origination of new finance receivables in
the Distribution Finance, Aircraft Finance, Resort Finance and golf equipment
businesses, and to retire commercial paper. Gains related to these transactions
amounted to $47 million and $45 million in 2003 and 2002, respectively. Cash
collections on current and prior period securitization gains were $46 million
and $36 million for 2003 and 2002, respectively.

Termination of the Company's off-balance sheet financing arrangements would
significantly reduce the Company's short-term funding alternatives. While these
arrangements do not contain provisions that require Textron Financial to
repurchase significant balances of receivables previously sold, there are risks
that could reduce the availability of these funding alternatives in the future.
Potential barriers to the continued use of these arrangements include
deterioration in finance receivable portfolio quality, downgrades in the
Company's debt credit ratings and a reduction of new finance receivable
originations in the businesses that utilize these funding arrangements. Textron
Financial does not expect any of these factors to have a material impact on the
Company's liquidity or income from continuing operations.

15

The retained subordinate interests related to the Company's off-balance
sheet financing arrangements are typically in the form of interest-only
securities, seller certificates, cash reserve accounts and servicing rights and
obligations. These interests are typically subordinate to other investors'
interests in the off-balance sheet structure and therefore, realization of these
interests by the Company is dependent on repayment of other investors' interests
and ultimately, the performance of the finance receivables sold. The retained
subordinate interests act as credit enhancement to the other investors and
represent a deferral of proceeds received from the sale of finance receivables.
As a result, the retention of these subordinate interests expose the Company to
a level of risk substantially consistent with that of ownership of these finance
receivables. Textron Financial does not provide legal recourse to investors that
purchase interests in Textron Financial's securitizations beyond the credit
enhancement inherent in the retained subordinate interests.

Following the initial sale, and on an ongoing basis, the retained
subordinate interests are maintained at fair value in Other assets on the
Company's consolidated balance sheets. The Company estimates fair values based
on the present value of future cash flows expected under management's best
estimates of key assumptions - credit losses, prepayment speeds, forward
interest rate yield curves and discount rates commensurate with the risks
involved. Management's best assumptions used to record the initial gain on sale
and measure the continuing fair value of the retained interests, along with the
impact of changes in these assumptions are described in Note 7 to the
consolidated financial statements in Item 8 of this Form 10-K.

Whole-loan finance receivable sales, in which the Company maintains a
continuing interest, differ from securitizations as loans are sold directly to
investors and no portion of the sale proceeds is deferred. Limited credit
enhancement is typically provided for these transactions in the form of a
contingent liability related to finance receivable credit losses and, to a
lesser extent, prepayment risk. Textron Financial has a contingent liability
related to the sale of equipment lease rents in 2003 and 2001. The maximum
liability at January 3, 2004, was $45 million, and in the event Textron
Financial's credit rating falls below BBB, the Company is required to pledge a
related pool of equipment residuals that amount to $103 million. The Company has
valued this contingent liability based on assumptions for annual credit losses
and prepayment rates of 0.25% and 7.5%, respectively. An instantaneous 20%
adverse change in these rates would have a $0.3 million impact on the valuation
of this recourse liability.

Managed Finance Assets

Managed finance assets consist of owned finance assets, and finance
receivables that Textron Financial has sold in securitizations or similar
structures and continues to service. Finance assets include finance receivables,
equipment on operating leases -- net of accumulated depreciation, repossessed
assets and properties, retained interests in securitizations, interest-only
securities, investment on equipment residuals, ADC arrangements, and other
long-term investments (some of which are classified in Other assets in Textron
Financial's Consolidated Balance Sheets). The managed finance assets of our
business segments are presented in the following table.

The decrease in finance assets within the Other segment reflects the sales
of franchise finance receivables of $168 million, prepayments within the
syndicated bank loan portfolio of $42 million and the continued runoff

16

of the liquidating portfolios. Overall, managed finance assets within the core
business decreased $173 million. The decrease was the result of lower growth and
continued portfolio run-off related to the land finance portfolio within Resort
Finance, lower operating lease assets and lower volume in Aircraft Finance, and
lower volume and higher portfolio run-off in the golf equipment portfolio. These
decreases were partially offset by growth in the private brands portfolio within
Distribution Finance.

Nonperforming Assets

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

The following table sets forth certain information about nonperforming
assets and the related percentages of owned finance assets at 2003, 2002 and
2001 by business segment.

In general, the Company believes that nonperforming assets will generally
be in the range of 2% to 4% of finance assets depending on economic conditions.
After peaking in March 2003, the Company has experienced steady improvement in
total nonperforming assets with a $51.5 million decrease year over year at
January 3, 2004. The decrease in 2003 was largely attributable to the Other
segment with reductions in liquidating equipment portfolios ($22.7 million),
franchise finance ($8.3 million), media finance ($6.5 million) and
telecommunications ($4.6 million). In the core businesses, Distribution Finance
declined ($9.4 million) mostly due to the liquidation of portfolios purchased at
a discount. The Company also experienced improvements in Asset-Based Lending
($7.1 million) and Aircraft Finance ($8.8 million). Aircraft values have
historically tracked well with the business cycles of the U.S. economy, although
the effects typically lag changes in the business cycles by about six months.
The Company believes that 2002 was the low point of the current cycle and
witnessed improvements in 2003. Textron Financial expects that as the economy
continues to improve, aircraft values will follow the trend.

The increase in Resort Finance ($10.2 million) was largely the result of
increases in the land finance portfolio ($7.4 million). Nonperforming assets of
Resort Finance related to its portfolio of loans to developers of vacation
interval resorts were $39.6 million (4.7%) at year-end 2003 as compared to $36.7
million (4.3%) at year-end 2002. While the level of nonperforming assets for the
portfolio of loans to developers of vacation interval resorts is relatively
unchanged, there has been a shift in nonperforming assets to high-end,
fractional shares from the more common weekly vacation ownership interval
product. The Golf Finance segment also experienced an increase in nonperforming
assets for both the golf course and golf equipment finance portfolios in 2003.
The increases were partially attributable to the weaker general economic
conditions that resulted in fewer golf rounds played in both 2003 and 2002, a
decline in corporate sponsored events in the golf industry and increased
competition among golf properties. The Other segment continues to comprise a
disproportionate amount of the Company's nonperforming assets accounting for 26%
of total nonperforming assets, yet comprising only 13% of the total finance
assets at January 3, 2004. Overall, the Company expects continued

17

modest improvement as these portfolios runoff. However, the Company could
realize a temporary, out-of-trend result in any one quarter.

The preceding nonperforming assets table does not include captive
receivables with recourse to Textron. Captive receivables with recourse that
were 90 days or more delinquent amounted to $69 million, $85 million and $90
million at the years ended 2003, 2002 and 2001, respectively. Revenues
recognized on these delinquent accounts were $5.6 million, $7.4 million and $9.5
million for the years ended 2003, 2002 and 2001, respectively.

Interest Rate Sensitivity

Textron Financial's mix of fixed and floating rate debt is continuously
monitored by management and is adjusted, as necessary, based on evaluations of
internal and external factors.

Management's strategy of matching floating rate assets with floating rate
liabilities limits Textron Financial's risk to changes in interest rates. This
strategy includes the use of interest rate exchange agreements. At January 3,
2004, floating rate assets were equal to floating rate liabilities, after
including the impact of $1.9 billion of interest rate exchange agreements on
long-term debt and $238 million of interest rate exchange agreements on finance
receivables. Classified within fixed rate assets are approximately $1.0 billion
of floating rate loans with index rate floors that are on average 163 basis
points above the applicable index rate (predominately the prime rate). As a
consequence, these assets are classified as fixed rate, and will remain so until
the prime rate increases above the floor rates. Generally, in periods of a low
interest rate environment, the Company has benefited from these interest rate
floor agreements. However, during periods of rising interest rates, this benefit
will dissipate until such time as the prime rate exceeds the floor rates
embedded in these agreements.

Management believes that its asset/liability management policy provides
adequate protection against interest rate risks. Increases in interest rates,
however, could have an adverse effect on interest margin. Variable rate
receivables are generally tied to changes in the prime rate offered by major
U.S. banks. Changes in short-term borrowing costs generally precede changes in
variable rate receivable yields. Textron Financial assesses its exposure to
interest rate changes using an analysis that measures the potential loss in net
income, over a twelve-month period, resulting from a hypothetical change in
interest rates of 100 basis points across all maturities occurring at the outset
of the measurement period (sometimes referred to as a "shock test"). Textron
Financial also assumes in its analysis that prospective receivable additions
will be match funded, existing portfolios will not prepay and all other relevant
factors will remain constant. This shock test model, when applied to Textron
Financial's asset and liability position at January 3, 2004, indicates that an
increase in interest rates of 100 basis points would have a negative impact on
Textron Financial's net income and cash flows of $2.7 million for the following
twelve-month period.

Financial Risk Management

Textron Financial's results are affected by changes in U.S. and, to a
lesser extent, foreign interest rates. As part of managing this risk, Textron
Financial enters into interest rate exchange agreements. Textron Financial's
objective of entering into such agreements is not to speculate for profit, but
generally to convert variable rate debt into fixed rate debt and vice versa. The
overall objective of Textron Financial's interest rate risk management is to
achieve match funding objectives. These agreements do not involve a high degree
of complexity or risk. Textron Financial does not trade in interest rate
exchange agreements or enter into leveraged interest rate exchange agreements.
The net effect of these interest rate exchange agreements decreased interest
expense by $43.0 million, $19.6 million, and $1.2 million in 2003, 2002, and
2001, respectively.

Textron Financial manages its foreign currency exposure by funding most
foreign currency denominated assets with liabilities in the same currency. The
Company may enter into foreign currency exchange agreements to convert foreign
currency denominated assets and liabilities into functional currency denominated
assets and liabilities. In addition, as part of managing its foreign currency
exposure, Textron Financial may enter into foreign currency forward exchange
contracts. The objective of such agreements is to manage
18

any remaining non-functional currency exposures to changes in currency rates.
The notional amounts of outstanding foreign currency forward exchange contracts
in 2003 and 2002 were nominal.

CRITICAL ACCOUNTING POLICIES

Allowance for Losses on Receivables

Management evaluates its allowance for losses on receivables based on a
combination of factors. For its homogeneous loan pools, Textron Financial
examines current delinquencies, the characteristics of the existing accounts,
historical loss experience, the value of the underlying collateral and general
economic conditions and trends. Textron Financial estimates losses will range
from 0.5% to 4.0% of finance receivables depending on the specific homogeneous
loan pool. The range of estimated losses is consistent with prior periods. For
larger balance commercial loans, Textron Financial considers borrower specific
information, industry trends and estimated discounted cash flows, as well as the
factors described above for homogeneous loan pools.

Provisions for losses on finance receivables are charged to income, in
amounts sufficient to maintain the allowance for losses on receivables at a
level considered adequate to cover existing losses in the existing finance
receivable portfolio, based on management's evaluation and analysis of this
portfolio.

Finance receivables are charged off when they are deemed uncollectible.
Finance receivables are written down to the fair value (less estimated costs to
sell) of the related collateral at the earlier of the date the collateral is
repossessed or when no payment has been received for six months, unless
management deems the receivable collectible.

Goodwill and Other Intangible Assets

Textron Financial evaluates the recoverability of goodwill and other
intangible assets annually in the fourth quarter, or more frequently if events
or changes in circumstances, such as declines in interest margin or cash flows
or material adverse changes in the business climate, indicate that the carrying
value of an asset might be impaired. Textron Financial completed its annual
impairment test in the fourth quarter of 2003 using the estimates from its
long-term strategic plan. No adjustment was required to the carrying value of
goodwill or other intangible assets based on the analysis performed.

Goodwill is considered to be impaired when the net book value of a
reporting unit exceeds its estimated fair value. Fair values are primarily
established using a discounted cash flow methodology. The determination of
discounted cash flows is based on the businesses' strategic plans and long-range
planning forecasts. The assumptions relative to interest margin, operating
expenses and provision for losses included in the plans are management's best
estimates based on current and forecasted market conditions. If different
assumptions were used in these plans, the related undiscounted cash flows used
in measuring impairment could be different potentially resulting in an
impairment charge.

Securitized Transactions

Securitized transactions involve the sale of finance receivables to
qualified special purpose trusts. Textron Financial may retain an interest in
the assets sold in the form of interest-only securities, seller certificates,
cash reserve accounts and servicing rights and obligations. At the time of sale,
a gain or loss is recorded based on the difference between the proceeds received
and the allocated carrying value of the finance receivables sold. The allocated
carrying value is determined based on the relative fair values of the finance
receivables sold and the interests retained. As such, the fair value estimate of
the retained interests has a direct impact on the gain or loss recorded by the
Company. Textron Financial estimates fair value based on the present value of
future cash flows expected under management's best estimates of key
assumptions -- credit losses, prepayment speeds, forward interest rate yield
curves and discount rates commensurate with the risks involved. Retained
interests are recorded at fair value as a component of Other assets on Textron
Financial's Consolidated Balance Sheets.

Textron Financial reviews the fair values of the retained interests
quarterly using updated assumptions and compares such amounts with the carrying
value of the retained interests. When the carrying value exceeds
19

the fair value of the retained interests, the Company determines whether the
decline in fair value is other than temporary. When the Company determines the
value of the decline is other than temporary, it writes down the retained
interests to fair value with a corresponding charge to income. When a change in
fair value of the Company's retained interests is deemed temporary, the Company
records a corresponding credit or charge to Other comprehensive income for any
unrealized gains or losses. Refer to Note 7 to the consolidated financial
statements in Item 8 of this Form 10-K for a summary of key assumptions used to
record initial gains related to the sale of finance receivables through
securitizations and to measure the current fair value of the retained interests,
along with the sensitivity of the fair values to adverse changes in these
assumptions.

RESULTS OF OPERATIONS

REVENUES AND NET INTEREST MARGIN

A comparison of revenues and net interest margin is set forth in the
following table.

2003 vs. 2002

The decrease in finance charges principally reflects lower average finance
receivables, a change in mix between fixed rate and floating rate finance
receivables, and, to a lesser extent, a lower interest rate environment. The
decrease in other income was mostly due to lower syndication income ($7.6
million), primarily resulting from a $9.3 million nonrecurring gain on the sale
of a franchise finance portfolio in 2002 and lower investment income ($5.4
million) from a decrease in earnings on retained securitization assets,
partially offset by higher servicing income ($9.3 million) from the revolving
securitization conduit for Distribution Finance receivables. The decrease in
interest expense was attributable to a lower interest rate environment and the
maturity of higher cost debt. The increase in depreciation of equipment on
operating leases reflects higher average operating leases in 2003.

2002 vs. 2001

Finance charges and discounts for 2002 declined 17.4% reflecting lower
yields on finance receivables, primarily due to a lower interest rate
environment largely reflecting a reduction in the prime rate. Rental revenues on
operating leases increased reflecting higher average operating lease assets
primarily related to Aircraft Finance. The decrease in other income was
primarily due to lower prepayment gains ($15.0 million), mostly due to a $14.3
million nonrecurring prepayment gain in 2001, and lower syndication income ($7.8
million), partially offset by higher servicing income ($5.9 million), mostly
related to a revolving securitization conduit. The decrease in interest expense
was mostly due to a lower interest rate environment. The decrease in net
interest margin as a percentage of average net investment primarily reflects
higher relative borrowing costs and lower other income, partially offset by
receivable pricing increases. The Company's relative borrowing costs increased
despite a lower interest rate environment, due to an increase in corporate
borrowing rates as compared to major borrowing indices, such as three-month
LIBOR and U.S. Treasury rates.

20

SELLING AND ADMINISTRATIVE EXPENSES

2003 vs. 2002

The increase in 2003 selling and administrative expenses largely resulted
from higher legal and collection costs ($12.2 million), primarily related to the
continued resolution of nonperforming accounts and the accrual of settlement
costs associated with litigation during the year, refer to Notes 19 and 20 to
the consolidated financial statements in Item 8 of this Form 10-K, and higher
data processing costs ($3.6 million) and healthcare ($3.2 million), and to a
lesser extent, growth in average managed and serviced finance receivables ($2.2
million).

2002 vs. 2001

The increase in selling and administrative expenses for 2002 was mostly due
to an increase in legal and collections costs ($15.4 million) related to the
continued resolution of nonperforming accounts, partially offset by a reduction
in goodwill amortization of $12.1 million (reflecting the change in accounting).

PROVISION FOR LOSSES

Allowance for losses on receivables is presented in the following table.

21

2003 vs. 2002

The decrease in the 2003 provision for losses primarily reflected a
declining rate of portfolio growth and an improvement in portfolio quality as
measured by improvements in nonperforming assets and 60+ delinquency. The
increase in net charge-offs was primarily attributable to Distribution Finance,
reflecting increased portfolio growth and net charge-offs related to portfolios
purchased at a discount. The Other segment continued to represent a
disproportionate share of the Company's total net charge-offs accounting for 58%
of the 2003 net charge-off amount, while comprising only 14% of the owned
finance receivables at year-end 2003.

The decrease in the allowance for losses on receivables as a percentage of
nonaccrual loans reflects a $62.5 million decrease in under-collateralized
nonaccrual loans with identified reserve requirements of $47.4 million at
January 3, 2004 as compared to $109.9 million at December 28, 2002.

2002 vs. 2001

The increase in the provision for losses in 2002 reflected declining
portfolio quality and the strengthening of the allowance for losses on
receivables. The increase in net charge-offs reflected increases primarily in
the Other segment, including syndicated bank loans ($23.1 million), principally
related to the telecommunications industry. The Other segment represented a
disproportionate share of the Company's total net charge-offs accounting for 68%
of the 2002 net charge-off amount, while comprising only 19% of the owned
finance receivables at year-end 2002. The increase in Aircraft Finance reflected
the down business cycle in the aircraft industry, while the increase in
Distribution Finance was largely the result of portfolio growth.

The decrease in the allowance for losses as a percentage of nonaccrual
loans was related to an increase in nonaccrual accounts in 2002, supported by
strong collateral values.

Although management believes it has made adequate provision for anticipated
losses, realization of these assets remains subject to uncertainties. Subsequent
evaluations of nonperforming assets, in light of factors then prevailing,
including economic conditions, may require additional increases in the allowance
for losses for such assets.

OPERATING RESULTS BY SEGMENT

Segment income presented in the tables below represents income from
continuing operations before special charges, income taxes, distributions on
preferred securities and cumulative effect of change in accounting principle.

Distribution Finance

The improvement in Distribution Finance segment income in 2003 was driven
by a stronger net interest margin, partially offset by higher selling and
administrative expenses and higher provision for losses. The higher net interest
margin was principally due to higher average finance receivables ($219 million),
the effect of prime rate floors on floating rate receivables and an increase in
other income ($16.2 million) mostly due to increased securitization activity.
Segment income in 2002 increased due to higher net interest margin, offset by
higher selling and administrative expenses and higher provision for losses
related to increased growth. The

22

higher net interest margin was principally due to higher fee income ($14.2
million, principally revolving securitization income), higher pricing and higher
average finance receivables ($40 million).

Resort Finance

Resort Finance segment income declined in 2003 reflecting lower net
interest margin and higher selling and administrative expenses, primarily legal
and collections expense, partially offset by lower provision for losses. The
decrease in net interest margin reflected lower receivable pricing and lower
other income ($4.5 million), partially offset by higher average finance
receivables ($85 million). The increase in segment income for 2002 reflected
higher net interest margin and lower selling and administrative expenses,
partially offset by higher provision for losses. The increase in net interest
margin was mostly due to increased pricing and higher average finance assets
($55 million), while selling and administrative expenses decreased due to a
reduction in goodwill amortization (reflecting the change in accounting).

Golf Finance

Golf Finance segment income improved in 2003 principally reflecting an
increase in net interest margin from higher other income ($6.6 million), mostly
related to a $4.1 million gain on the sale of rents related to a golf equipment
portfolio. The increase in net interest margin was partially offset by higher
selling and administrative expenses related to an expansion of servicing
responsibilities related to the captive golf equipment portfolio. Average
finance receivables were relatively unchanged. Segment income in 2002 increased
reflecting higher interest net margin principally due to higher average finance
assets ($155 million), which was partially offset by higher selling and
administrative expenses and higher provision for losses.

Aircraft Finance

23

Aircraft Finance segment income rose modestly in 2003, largely reflecting a
lower provision for losses and lower selling and administrative expenses,
partially offset by a lower interest margin. The reduction in net interest
margin primarily reflected a decrease in other income ($4.7 million), mostly
securitization gains and investment income, and a decrease in average finance
receivables ($87 million). The decrease in segment income for 2002 largely
reflected lower interest margin, despite $168 million of higher average finance
receivables, in addition to a write-down of retained interests in securitized
assets ($11.0 million) reflecting lower expected realization on defaulted
assets. Also contributing to lower income was higher provision for losses,
partially offset by lower selling and administrative expenses. The lower
interest margin in 2002 was due to competitive pressures inhibiting the ability
to pass on higher borrowing costs related to an increase in interest rate
spreads to benchmark borrowing rates (such as U.S. Treasury rates and LIBOR).

Asset-Based Lending

Asset-Based Lending segment income increased during 2003 due to a lower
provision for losses, reflecting an improvement in portfolio quality, partially
offset by higher selling and administrative expenses and a lower interest
margin. Lower interest margin was primarily the result of lower average finance
receivables ($33 million). Segment income decreased in 2002 reflecting a higher
provision for losses and lower net interest margin due to lower finance
receivable pricing on lower average finance assets ($18 million), partially
offset by a decrease in selling and administrative expenses.

Structured Capital

Structured Capital segment income decreased in 2003 mostly due to lower net
interest margin. The decrease in net interest margin was largely the result of
lower portfolio yields from new originations and higher allocated money cost.
Average finance receivables are relatively unchanged. Income decreased in 2002
by $9.2 million reflecting lower interest margin, largely due to a nonrecurring
prepayment gain of $14.3 million in 2001.

24

Other Segment

Other segment loss increased in 2003 reflecting lower net interest margin,
partially offset by a lower provision for losses and lower selling and
administrative expenses. The decrease in net interest margin was partly due to
lower other income ($18.2 million), principally syndication gains from the sale
of a franchise finance receivable portfolio in 2002, and the run-off of
liquidating portfolios. The decrease in 2002 segment income reflected lower net
interest margin and higher provision for losses, primarily due to higher net
charge-offs from nonperforming assets in syndicated bank loans ($23.1 million),
principally related to the telecommunication industry, and other liquidating
portfolios ($11.1 million), primarily small-ticket equipment finance.

Income from Continuing Operations

Income from continuing operations of $78.8 million for 2003 was $2.4
million or 3.1% higher than 2002. The increase was due to a lower loss provision
($30.3 million) and a lower effective tax rate ($4.2 million), partially offset
by higher operating expenses ($26.2 million), an increase in special charges
($6.3 million) due to the restructuring of operations, and lower interest margin
($1.7 million).

Income from continuing operations for 2002 was $43.1 million or 36.1% lower
than 2001. The decrease was the result of a higher provision for losses ($42.4
million), lower interest margin ($28.2 million) and higher operating expenses
($2.6 million), partially offset by a decrease in special charges ($2.6 million)
and a lower effective tax rate.

NEW ACCOUNTING PRONOUNCEMENTS

FASB Interpretation No. 46

In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46 ("FIN 46" or the "Interpretation", "Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51"). The
Interpretation requires the consolidation of variable interest entities in which
an enterprise absorbs a majority of the entity's expected losses, receives a
majority of the entity's expected residual returns, or both, as a result of
ownership, contractual or other financial interests in the entity. Currently,
entities are generally consolidated by an enterprise that has a controlling
financial interest through ownership of a majority voting interest in the
entity. FIN 46 originally was effective immediately for variable interest
entities created after January 31, 2003, and effective in the third quarter of
Textron Financial's fiscal 2003 for those created prior to February 1, 2003.
Textron Financial has adopted FIN 46 for an agreement that was entered into in
June 2003 and determined that the entity was not a variable interest entity.

Subsequent to the original issuance of the Interpretation, the effective
date for entities created or interests obtained prior to February 1, 2003 was
deferred, and in December 2003, the FASB issued a revised version of FIN 46 that
provided clarification of the original Interpretation and excluded certain
operating entities from its scope. Public companies are required to apply the
provisions of this Interpretation specifically to entities commonly referred to
as special-purpose entities (SPE) in financial statements for periods ending
after December 15, 2003. The effective date for all other types of entities
within the scope of the Interpretation is for financial statements periods
ending after March 15, 2004.

25

Textron Financial will adopt FIN 46 in the first quarter of 2004 for
entities created or interests obtained prior to February 2003. The Company has
substantially completed the process of evaluating the Interpretation and
believes its adoption will not have a material impact on its results of
operations or financial position.

FASB Staff Position 150-3

In May 2003, the FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity". SFAS No. 150
requires that an issuer classify certain financial instruments as liabilities.
Many of the instruments included within the Statement's scope, such as
mandatorily redeemable shares, were previously classified as equity. SFAS No.
150 was effective for financial instruments entered into or modified after May
31, 2003, and was effective at the beginning of the first interim period
beginning after June 15, 2003 for all other instruments. As required, Textron
Financial adopted this Statement when it became effective in July 2003 and
reported its obligated mandatorily redeemable preferred securities as a
liability and all related expenses prospectively as components of income from
continuing operations.

Subsequent to adoption, on November 7, 2003, the FASB issued FASB Staff
Position (FSP) 150-3 "Effective Date, Disclosures, and Transition for
Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and
Certain Mandatorily Redeemable Noncontrolling Interests under FASB Statement No.
150, Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity". FSP 150-3 deferred the effective date of SFAS No. 150
for certain mandatorily redeemable non-controlling interests. Textron
Financial's obligated mandatorily redeemable preferred securities were included
in this deferral. FSP 150-3 states that entities that have already adopted SFAS
No. 150 for instruments within the scope of its indefinite deferral shall
reverse the effects of that adoption in the first fiscal period beginning after
the date the FSP was issued. Textron Financial will adopt FSP 150-3 in the first
quarter of 2004. Since Textron Financial's mandatorily redeemable preferred
securities will be included in the adoption of FIN 46 in the first quarter of
2004, the adoption of FSP 150-3 will have no impact on Textron Financial's
results of operations or financial position.

FORWARD-LOOKING INFORMATION

Certain statements in this Annual Report and other oral and written
statements made by Textron Financial from time to time are forward-looking
statements, including those that discuss strategies, goals, outlook or other
nonhistorical matters; or project revenues, income, returns or other financial
measures. These forward-looking statements are subject to risks and
uncertainties that may cause actual results to differ materially from those
contained in the statements, including the following: (a) the extent to which
Textron Financial is able to achieve savings from its restructuring plans; (b)
uncertainty in estimating the amount and timing of restructuring charges and
related costs; (c) changes in worldwide economic and political conditions that
impact interest and foreign exchange rates; (d) the occurrence of further
downturns in customer markets to which Textron products are sold or supplied and
financed or where Textron Financial offers financing; (e) the ability to control
costs and successful implementation of various cost reduction programs; (f) the
impact of changes in tax legislation; (g) the ability to maintain portfolio
credit quality; (h) Textron Financial's access to debt financing at competitive
rates; (i) access to equity in the form of retained earnings and capital
contributions from Textron; and (j) uncertainty in estimating contingent
liabilities and establishing reserves tailored to address such contingencies.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

For information regarding Textron Financial's Quantitative and Qualitative
Disclosure about Market Risk, see "Risk Management" in Item 1 of this Form 10-K.

26

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT AUDITORS

The Board of Directors
Textron Financial Corporation

We have audited the accompanying consolidated balance sheets of Textron
Financial Corporation as of January 3, 2004 and December 28, 2002, and the
related consolidated statements of income, cash flows, and changes in
shareholder's equity for each of the three years in the period ended January 3,
2004. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Textron
Financial Corporation at January 3, 2004 and December 28, 2002, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended January 3, 2004, in conformity with accounting
principles generally accepted in the United States.

Boston, Massachusetts
January 29, 2004

27

CONSOLIDATED STATEMENTS OF INCOME

For each of the three years in the period ended January 3, 2004

See notes to consolidated financial statements.
28

CONSOLIDATED BALANCE SHEETS

See notes to consolidated financial statements.
29

CONSOLIDATED STATEMENTS OF CASH FLOWS

For each of the three years in the period ended January 3, 2004

See notes to consolidated financial statements.
30

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY

For each of the three years in the period ended January 3, 2004

See notes to consolidated financial statements.
31

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Textron Financial Corporation (Textron Financial or the Company) is a
diversified commercial finance company with operations in six segments: Aircraft
Finance, Asset-Based Lending, Distribution Finance, Golf Finance, Resort Finance
and Structured Capital. Aircraft Finance provides financing for new and used
Cessna business jets and piston-engine airplanes, Bell helicopters and other
general aviation aircraft. Asset-Based Lending provides asset-based loans to
smaller middle-market companies that manufacture or distribute finished goods,
and factoring arrangements for freight companies and utility service providers.
Distribution Finance offers inventory finance programs for dealers of Textron
manufactured products and for dealers of a variety of other household, housing,
leisure, agricultural and technology products. Golf Finance makes mortgage loans
for the acquisition and refinancing of golf courses, and provides term financing
for E-Z-GO golf cars and Jacobsen turf-care equipment. Resort Finance extends
loans to developers of vacation interval resorts, secured primarily by notes
receivable and interval inventory. Structured Capital engages in tax-oriented,
long-term leases of large-ticket equipment and real estate, primarily with
investment grade lessees. Textron Financial's other financial services and
products include transaction syndication, equipment appraisal and disposition,
and portfolio servicing.

Textron Financial's financing activities are confined almost exclusively to
secured lending and leasing to commercial markets. Textron Financial's services
are offered primarily in North America. However, Textron Financial does finance
Textron products worldwide, principally Bell helicopters and Cessna aircraft.

Textron Financial is a subsidiary of Textron Inc. (Textron), a $10 billion
multi-industry company with operations in five business segments: Bell, Cessna,
Fastening Systems, Industrial and Finance. At January 3, 2004, 24% of Textron
Financial's total managed finance receivables involved the financing of
Textron's products, compared to 23% at December 28, 2002. Textron Financial's
year-end dates conform with Textron's year-end, which falls on the nearest
Saturday to December 31.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of
Textron Financial and its subsidiaries, all of which are wholly-owned. All
significant intercompany transactions have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in those statements and
accompanying notes. Actual results may differ from such estimates.

Finance Charges and Discounts

Finance charges and discounts include interest on loans, capital lease
earnings, leveraged lease earnings and discounts on certain revolving credit and
factoring arrangements. Finance charges are recognized in finance charge
revenues using the interest method to produce a constant rate of return over the
terms of the finance assets. Accrual of interest income is suspended for
accounts that are contractually delinquent by more than three months, unless
collection is not doubtful. In addition, detailed reviews of loans may result in
earlier suspension if collection is doubtful. Cash payments on nonaccrual
accounts, including finance charges, generally are applied to reduce loan
principal. Accrual of interest is resumed when the loan becomes contractually
current, and suspended interest income is recognized at that time.

32

Finance Receivable Origination Fees and Costs

Fees received and direct loan origination costs are deferred and amortized
to finance charge revenues over the contractual lives of the respective
receivables using the interest method. Unamortized amounts are recognized in
revenues when receivables are sold or paid in full.

Other Income

Other income includes securitization and syndication gains on the sale of
loans and leases, late charges, prepayment gains, residual gains, servicing fees
and other miscellaneous fees, which are primarily recognized as income when
received. It also includes earnings on retained interests in securitizations
including interest on seller certificates and cash reserve accounts as well as
the accretable yield on interest-only securities.

Allowance for Losses on Receivables

Management evaluates its allowance for losses on receivables based on a
combination of factors. For its homogeneous loan pools, Textron Financial
examines current delinquencies, the characteristics of the existing accounts,
historical loss experience, the value of the underlying collateral and general
economic conditions and trends. For larger balance commercial loans, Textron
Financial considers borrower specific information, industry trends and estimated
discounted cash flows, as well as the factors described above for homogeneous
loan pools.

Provisions for losses on finance receivables are charged to income, in
amounts sufficient to maintain the allowance for losses on receivables at a
level considered adequate to cover losses in the existing finance receivable
portfolio, based on management's evaluation and analysis of this portfolio.

Finance receivables are charged off when they are deemed uncollectible.
Finance receivables are written down to the fair value (less estimated costs to
sell) of the related collateral at the earlier of the date the collateral is
repossessed or when no payment has been received for six months, unless
management deems the receivable collectible.

Loan Impairment

Textron Financial periodically evaluates finance receivables, excluding
homogeneous loan portfolios and finance leases, for impairment. A loan is
considered impaired when it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. Impairment is measured by comparing the fair value of a loan to its
carrying amount. Fair value is based on the present value of expected future
cash flows discounted at the loan's effective interest rate, the loan's
observable market price or, if the loan is collateral dependent, at the fair
value of the collateral. If the fair value of the loan is less than its carrying
amount, the Company establishes a reserve based on this difference. This
evaluation is inherently subjective, as it requires estimates, including the
amount and timing of future cash flows expected to be received on impaired
loans, that may differ from actual results.

Equipment on Operating Leases

Income from operating leases is recognized in equal amounts over the lease
terms. The costs of such assets are capitalized and depreciated to estimated
residual values using the straight-line method over the estimated useful life of
the asset or the lease term.

Goodwill and Other Intangible Assets

Management evaluates the recoverability of goodwill and other intangibles
annually, or more frequently if events or changes in circumstances, such as
declines in interest margin, earnings or cash flows or material adverse changes
in the business climate, indicate that the carrying value of an asset might be
impaired. Goodwill is considered to be impaired when the net book value of a
reporting unit exceeds its estimated fair value. Fair values are primarily
established using a discounted cash flow methodology. The determination of
discounted cash flow is based on the businesses' strategic plans and long-range
planning forecasts.
33

Pension Benefits and Postretirement Benefits Other than Pensions

Textron Financial participates in Textron's defined contribution and
defined benefit pension plans. The cost of the defined contribution plan
amounted to approximately $0.6 million, $2.1 million and $1.9 million in 2003,
2002 and 2001, respectively. The cost of the defined benefit pension plan
amounted to approximately $6.6 million, $4.7 million and $3.4 million in 2003,
2002 and 2001, respectively. Defined benefits under salaried plans are based on
salary and years of service. Textron's funding policy is consistent with federal
law and regulations. Pension plan assets consist principally of corporate and
government bonds and common stocks. Accrued pension expense is included in
Accrued interest and other liabilities on Textron Financial's Consolidated
Balance Sheets.

Income Taxes

Textron Financial's revenues and expenses are included in Textron's
consolidated tax return. Current tax expense is based on allocated federal tax
charges and benefits on the basis of statutory U.S. tax rates applied to the
Company's taxable income or loss included in Textron's consolidated returns.

Deferred income taxes are recognized for temporary differences between the
financial reporting basis and income tax basis of assets and liabilities, based
on enacted tax rates expected to be in effect when such amounts are expected to
be realized or settled.

Securitized Transactions

Securitized transactions involve the sale of finance receivables to
qualified special purpose trusts. Textron Financial may retain an interest in
the assets sold in the form of interest-only securities, seller certificates,
cash reserve accounts and servicing rights and obligations. The Company's
retained interests are subordinate to other investors' interests in the
securitizations. Gain or loss on the sale of the loans or leases depends in part
on the previous carrying amount of the financial assets involved in the
transfer, allocated between the assets sold and the retained interests based on
their relative fair values at the date of transfer. Retained interests are
recorded at fair value as a component of Other assets on Textron Financial's
Consolidated Balance Sheets. The Company estimates fair values based on the
present value of future cash flows expected under management's best estimates of
key assumptions -- credit losses, prepayment speeds and discount rates
commensurate with the risks involved.

Textron Financial reviews the fair values of the retained interests
quarterly using updated assumptions and compares such amounts with the carrying
value of the retained interests. When the carrying value exceeds the fair value
of the retained interests, the Company determines whether the decline in fair
value is other than temporary. When the Company determines the value of the
decline is other than temporary, it writes down the retained interests to fair
value with a corresponding charge to income. When a change in fair value of the
Company's retained interests is deemed temporary, the Company records a
corresponding credit or charge to Other comprehensive income for any unrealized
gains or losses.

Textron Financial does not provide legal recourse to third-party investors
that purchase interests in Textron Financial's securitizations beyond the credit
enhancement inherent in the retained interest-only securities, seller
certificates and cash reserve accounts.

Derivative Financial Instruments

Textron Financial has entered into various interest rate and foreign
exchange agreements to mitigate its exposure to changes in interest and foreign
exchange rates. The Company records all derivative financial instruments on its
balance sheet at fair value and recognizes changes in fair values in current
earnings unless the derivatives qualify as hedges of future cash flows. For
derivatives qualifying as hedges of future cash flows, the Company records the
effective portion of the change in fair value as a component of Other
comprehensive income in the periods the hedged transaction affects earnings.

Textron Financial recognizes the net interest differential on interest rate
exchange agreements, including premiums paid or received, as adjustments to
finance income or interest expense to correspond with the
34

hedged positions. In the event of an early termination of a derivative financial
instrument, the Company defers the gain or loss in Other comprehensive income
until it recognizes the hedged transaction in earnings.

While these exchange agreements expose Textron Financial to credit losses
in the event of nonperformance by the counterparties to the agreements, the
Company does not expect any such nonperformance. The Company minimizes the risk
of nonperformance by entering into contracts with financially sound
counterparties having long-term bond ratings of generally no less than single A,
by continuously monitoring such credit ratings and by limiting its exposure with
any one financial institution. Textron Financial had minimal exposure to loss
from nonperformance by the counterparties to these agreements at the end of
2003.

Fair Value of Financial Instruments

Fair values of financial instruments are based upon estimates at a specific
point in time using available market information and appropriate valuation
methodologies. These estimates are subjective in nature and involve
uncertainties and significant judgment in the interpretation of current market
data. Therefore, the fair values presented are not necessarily indicative of
amounts Textron Financial could realize or settle currently.

Cash and Equivalents

Cash and equivalents consist of cash in banks and overnight
interest-bearing deposits in banks.

Reclassifications

Certain prior year amounts have been reclassified to conform with the
current year presentation.

New Accounting Pronouncements

FASB Interpretation No. 46

In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46 ("FIN 46" or the "Interpretation", "Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51"). The
Interpretation requires the consolidation of variable interest entities in which
an enterprise absorbs a majority of the entity's expected losses, receives a
majority of the entity's expected residual returns, or both, as a result of
ownership, contractual or other financial interests in the entity. Currently,
entities are generally consolidated by an enterprise that has a controlling
financial interest through ownership of a majority voting interest in the
entity. FIN 46 originally was effective immediately for variable interest
entities created after January 31, 2003, and effective in the third quarter of
Textron Financial's fiscal 2003 for those created prior to February 1, 2003.
Textron Financial has adopted FIN 46 for an agreement that was entered into in
June 2003 and determined that the entity was not a variable interest entity.

Subsequent to the original issuance of the Interpretation, the effective
date for entities created or interests obtained prior to February 1, 2003 was
deferred, and in December 2003, the FASB issued a revised version of FIN 46 that
provided clarification of the original Interpretation and excluded certain
operating entities from its scope. Public companies are required to apply the
provisions of this Interpretation specifically to entities commonly referred to
as special-purpose entities (SPE) in financial statements for periods ending
after December 15, 2003. The effective date for all other types of entities
within the scope of the Interpretation is for financial statements periods
ending after March 15, 2004.

Textron Financial will adopt FIN 46 in the first quarter of 2004 for
entities created or interests obtained prior to February 2003. The Company has
substantially completed the process of evaluating the Interpretation and
believes its adoption will not have a material impact on its results of
operations or financial position.

FASB Staff Position 150-3

In May 2003, the FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity". SFAS No. 150
requires that an issuer classify certain financial instruments as liabilities.
Many of the instruments included within the Statement's scope, such as
mandatorily

35

redeemable shares, were previously classified as equity. SFAS No. 150 was
effective for financial instruments entered into or modified after May 31, 2003,
and was effective at the beginning of the first interim period beginning after
June 15, 2003 for all other instruments. As required, Textron Financial adopted
this Statement when it became effective in July 2003 and reported its obligated
mandatorily redeemable preferred securities as a liability and all related
expenses prospectively as components of income from continuing operations.

Subsequent to adoption, on November 7, 2003, the FASB issued FASB Staff
Position (FSP) 150-3 "Effective Date, Disclosures, and Transition for
Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and
Certain Mandatorily Redeemable Noncontrolling Interests under FASB Statement No.
150, Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity". FSP 150-3 deferred the effective date of SFAS No. 150
for certain mandatorily redeemable non-controlling interests. Textron
Financial's obligated mandatorily redeemable preferred securities were included
in this deferral. FSP 150-3 states that entities that have already adopted SFAS
No. 150 for instruments within the scope of its indefinite deferral shall
reverse the effects of that adoption in the first fiscal period beginning after
the date the FSP was issued. Textron Financial will adopt FSP 150-3 in the first
quarter of 2004. Since Textron Financial's mandatorily redeemable preferred
securities will be included in the adoption of FIN 46 in the first quarter of
2004, the adoption of FSP 150-3 will have no impact on Textron Financial's
results of operations or financial position.

NOTE 2 OTHER INCOME

The Other component of Other income includes custodial fees, commitment
fees, residual gains, insurance fees and other miscellaneous fees, which are
primarily recognized as income when received.

NOTE 3 SPECIAL CHARGES

During the fourth quarter of 2003, the Company's management performed a
strategic review of its operations and committed to a plan to restructure the
operations within its corporate headquarters and within each of two core
segments -- Asset Based Lending and Resort Finance. As a result of the
restructuring program, two facilities were closed, 85 employees were terminated
and the Company recorded a restructuring charge of $6.3 million. This charge is
summarized below for the applicable segments:

As of January 3, 2004, the Company had paid severance related benefits and
other expenses of $3.7 million, which were charged against the restructuring
reserve, leaving a balance in the reserve of

36

$2.6 million. The Company will pay the remaining restructuring costs in 2004.
The detail of the reserve account is presented below:

In 2001, the Company recorded a restructuring charge of $2.7 million
related to severance costs and contract terminations, which was fully paid out
during 2001 and 2002.

NOTE 4 DISCONTINUED OPERATIONS

On December 19, 2003, the Company sold its small business direct portfolio
(small business finance) for $421 million in cash and based upon the terms of
the transaction no gain or loss was recorded. Textron Financial's Consolidated
Financial Statements and related footnotes have been recast to reflect small
business finance as a discontinued operation for the periods presented.

The major classes of assets for discontinued operations at December 28,
2002 are presented below.

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

(1) Finance receivables are net of a revolving securitization conduit of $204
million.

Operating results for discontinued operations are as follows:

NOTE 5 RELATIONSHIP WITH TEXTRON INC.

Textron Financial is a wholly-owned subsidiary of Textron and derives a
portion of its business from financing the sale and lease of products
manufactured and sold by Textron. Textron Financial recognized finance charge
revenues from Textron and affiliates (net of payments or reimbursements for
interest charged at more or less than market rates on Textron manufactured
products) of $6.3 million in 2003, $9.4 million in 2002, and $4.0 million in
2001, and operating lease revenues of $22.4 million in 2003, $21.0 million in
2002, and $10.9 million in 2001. In 2003, 2002, and 2001, Textron Financial paid
Textron $0.8 billion, $1.1 billion and $1.3 billion, respectively, relating to
the sale of manufactured products to third parties that were financed

37

by the Company. In addition, the Company paid Textron $56.3 million, $104.3
million and $62.1 million, respectively, for the purchase of operating lease
equipment.

Textron Financial and Textron are parties to several agreements,
collectively referred to as operating agreements, which govern many areas of the
Textron Financial-Textron relationship. It is the intention of these parties to
execute transactions at market terms. Under operating agreements with Textron,
Textron Financial has recourse to Textron with respect to certain finance
receivables and operating leases. Finance receivables of $427.5 million at
January 3, 2004 and $526.7 million at December 28, 2002, and operating leases of
$126.3 million at January 3, 2004, and $122.3 million at December 28, 2002, were
subject to recourse to Textron or due from Textron. In addition, Textron
Financial had recourse to Textron on seller certificates of $26.2 million and
$59.2 million at year-end 2003 and 2002, respectively, and on cash reserve
accounts of $4.0 million and $10.4 million at year-end 2003 and 2002,
respectively. Both the seller certificates and the cash reserve accounts are
retained interests related to receivable securitizations.

Under the operating agreements between Textron and Textron Financial,
Textron has agreed to lend Textron Financial, interest-free, an amount not to
exceed the deferred income tax liability of Textron attributable to the
manufacturing profit deferred for tax purposes on products manufactured by
Textron and financed by Textron Financial. The Company had borrowings from
Textron of $21.4 million at January 3, 2004 ($23.7 million at December 28, 2002)
under this arrangement. These borrowings are reflected in Amounts due to Textron
Inc. on Textron Financial's Consolidated Balance Sheets. In addition, Textron
has amended its credit agreements to permit Textron Financial to borrow under
these facilities. Textron Financial had not utilized those facilities at January
3, 2004.

Textron has also agreed to cause Textron Financial's pretax income
available for fixed charges to be no less than 125% of its fixed charges and its
consolidated Shareholder's equity to be no less than $200 million. No related
payments were required for 2003, 2002 or 2001.

The Company had income taxes payable of $79.2 million and $9.1 million at
January 3, 2004 and December 28, 2002, respectively. These accounts are settled
with Textron as Textron manages its consolidated federal tax position.

NOTE 6 FINANCE RECEIVABLES

Contractual Maturities

The contractual maturities of finance receivables outstanding at January 3,
2004, were as follows:

Finance receivables often are repaid or refinanced prior to contractual
maturity. Accordingly, the above tabulation should not be regarded as a forecast
of future cash collections. The ratio of cash collections (net of finance
charges) to average net receivables, excluding distribution finance receivables
and revolving loans, was approximately 57% in 2003 and 54% in 2002. During 2003
and 2002, cash collections of finance receivables (excluding proceeds from
receivable sales or securitizations) were $8.8 billion and $7.5 billion,
respectively.

38

Installment contracts and finance leases have initial terms generally
ranging from two to twenty years. Installment contracts and finance leases are
secured by the financed equipment and, in some instances, by the personal
guarantee of the principals or recourse arrangements with the originating
vendor. Finance leases include residual values expected to be realized at
contractual maturity.

Revolving loans generally have terms of one to five years, and at times
convert to term loans that contractually amortize over an average term of four
years. Revolving loans consist of loans secured by trade receivables, inventory,
plant and equipment, pools of vacation interval resort notes receivable, pools
of residential and recreational land loans and the underlying real property.

Golf course mortgages have initial terms generally ranging from five to
seven years with amortization periods from 15 to 25 years. Resort mortgages
generally represent construction and inventory loans with terms up to two years.
Golf course and resort mortgages are secured by real property and are generally
limited to 75% or less of the property's appraised market value at loan
origination. Golf course mortgages, totaling $643.4 million, consist of loans
with an average balance of $4.2 million and an average remaining contractual
maturity of four years. Resort mortgages, totaling $301.1 million, consist of
loans with an average balance of $4.1 million and an average remaining
contractual maturity of two years.

Distribution finance receivables generally mature within one year.
Distribution finance receivables are secured by the inventory of the financed
distributor or dealer and, in some programs, by recourse arrangements with the
originating manufacturer. Revolving loans and Distribution finance receivables
are cyclical and result in cash turnover that is several times larger than
contractual maturities. In 2003, such cash turnover was 9.3 times contractual
maturities.

Leveraged leases are secured by the ownership of the leased equipment and
real property. Leveraged leases reflect contractual maturities net of
contractual nonrecourse debt payments and include residual values expected to be
realized at contractual maturity. Leveraged leases have initial terms up to
approximately 30 years.

Textron Financial's finance receivables are diversified across geographic
region, borrower industry and type of collateral. Textron Financial's geographic
concentrations (as measured by managed finance receivables) at January 3, 2004,
were as follows: Southeast 26%; Far West 19%; Midwest 15%; Southwest 12%;
Mideast 10%; New England 4%; other domestic 1%; South America 4%; and other
international 9%. Textron Financial's most significant collateral concentration
was general aviation aircraft, which accounted for 22% of managed finance
receivables at January 3, 2004. The Company has industry concentrations in the
golf and vacation interval industries, which accounted for 15% and 14%,
respectively, of managed finance receivables at January 3, 2004. The Company has
one account with a balance in excess of one percent of managed finance
receivables totaling $85 million. The Company has full recourse to Textron with
respect to this account.

Leveraged Leases

Estimated residual values of leased assets include guaranteed residuals of
$21.8 million and $2.6 million for 2003 and 2002, respectively. Approximately
39% of Textron Financial's investment in leveraged leases is collateralized by
real estate.

39

The components of income from leveraged leases were as follows:

Finance Leases

Minimum lease payments due under finance leases for each of the next five
years and the aggregate amounts due thereafter are as follows: $51.5 million in
2004, $29.1 million in 2005, $20.3 million in 2006, $15.0 million in 2007, $9.8
million in 2008 and $161.4 million thereafter.

Loan Impairment

The Company had $152.0 million of nonaccrual finance receivables at January
3, 2004, compared to $177.3 million at December 28, 2002. Nonaccrual finance
receivables resulted in Textron Financial's revenues being reduced by
approximately $16.2 million, $15.9 million and $10.4 million for 2003, 2002 and
2001, respectively. No interest income was recognized using the cash basis
method. Excluding homogeneous loan portfolios and finance leases, the Company
had impaired loans of $98.8 million and $122.1 million at January 3, 2004 and
December 28, 2002, respectively. Impaired loans with identified reserve
requirements were $47.4 million at January 3, 2004, compared to $109.9 million
at December 28, 2002. The allowance for losses on receivables related to
impaired loans with identified reserve requirements was $17.8 million and $32.7
million at January 3, 2004 and December 28, 2002, respectively. The average
recorded investment in impaired loans during 2003 was $123.1 million, compared
to $96.7 million in 2002.

Captive finance receivables with recourse that were 90 days or more
delinquent amounted to $69 million, $85 million and $90 million at the years
ended 2003, 2002 and 2001, respectively, and were 16.1%, 16.1% and 13.9% of
captive finance receivables with recourse, respectively. Revenues recognized on
these delinquent accounts were approximately $5.6 million, $7.4 million and $9.5
million for the years ended 2003, 2002 and 2001, respectively.

Allowance for Losses on Receivables

40

Managed and Serviced Finance Receivables

Textron Financial manages and services finance receivables for a variety of
investors, participants and third-party portfolio owners.

Nonrecourse participations consist of undivided interests in loans
originated by Textron Financial, primarily in vacation interval resorts and golf
finance, which are sold to independent investors.

Third-party portfolio servicing largely relates to finance receivable
portfolios of resort developers and loan portfolio servicing for third-party
financial institutions.

Other managed finance receivables represent the rental streams related to
equipment lease portfolios sold to a third-party financial institution, which
continue to be serviced and managed by Textron Financial. The Company has a
contingent recourse liability related to these portfolios, which minimizes the
purchaser's exposure to credit loss and prepayment risk. The maximum liability
at January 3, 2004 was $45 million, and in the event Textron Financial's credit
rating falls below BBB, the Company is required to pledge related equipment
residuals of $103 million. The Company recorded a gain upon the sale of the
portfolios net of the valuation of the recourse liability based on annual credit
loss and prepayment rates of 0.25% and 7.5%, respectively. An instantaneous 20%
adverse change in these rates would have a $0.3 million impact on the valuation
of this recourse liability.

Owned receivables include approximately $37 million of finance receivables
that were unfunded at January 3, 2004, primarily as a result of holdback
arrangements. The corresponding liability is included in Accrued interest and
other liabilities on Textron Financial's Consolidated Balance Sheets.

NOTE 7 RECEIVABLE SECURITIZATIONS

During 2003, the Company securitized general aviation loans, finance
receivables for the lease or purchase of E-Z-GO golf cars and Jacobsen turf-care
equipment (equipment loans and leases), distribution finance receivables (dealer
financing arrangements), and vacation interval loans (timeshare notes
receivable). The Company recognized pretax gains as follows:

41

These gains represent estimates of the cash flows to be received from the
Company's retained interests in the loans sold. The retained interests are
recorded in Other assets and are in the form of interest-only strips,
subordinate seller certificates, cash reserve accounts and rights to receive
servicing fees, which range from 50 to 150 basis points. These interests are
typically subordinate to the interests of third-party investors and therefore
realization of the Company's cash flows is subject to the performance of the
receivables sold as compared with the estimates utilized to measure the initial
gain. The investors and the securitization trusts have no recourse to the
Company's other assets and liabilities for failure of debtors to pay when due.
Key economic assumptions used in measuring the retained interests at the date of
securitization resulting from securitizations completed during 2003 were as
follows:

At January 3, 2004, key economic assumptions and the sensitivity of the
current fair value of residual cash flows to immediate 10% and 20% adverse
changes in these assumptions are as follows:

A securitization conduit of equipment loans and leases was voluntarily
terminated and liquidated in December 2003.

These sensitivities are hypothetical and should be used with caution. As
the figures indicate, changes in fair value based on a 10% variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption, when in reality, changes in one factor may result in another that
may magnify or counteract the analysis' losses, such as increases in market
interest rates may result in lower prepayments and increased credit losses.
Adverse changes in credit loss rates in the vacation interval securitized
portfolio typically do not significantly impact the value of Textron Financial's
retained interests as the Company does not hold the most subordinate interests
in the loans sold. Resort developers, who originate the loan portfolio sold,
typically hold both an interest-only strip and a seller certificate, which are
subordinate to the interests of Textron Financial and absorb all but severe
changes in these credit loss rates.

42

Static pool losses are calculated by summing the actual and projected
future credit losses and dividing them by the original balance of each pool of
assets. At January 3, 2004, static pool losses related to term securitizations
in the general aviation aircraft loan portfolio are as follows:

These loss rates relate to 51% of the total securitized general aviation
aircraft loans. Static pool losses are not calculated by the Company for
revolving period securitizations, which encompass the majority of the
securitized portfolio outstanding, as receivables are added to the portfolio on
a continual basis and are not tracked as discrete pools. Therefore, loss rates
for the entire portfolio are more relevant as a measure of the performance of
retained interests related to revolving period securitizations.

Historical loss and delinquency amounts for Textron Financial's securitized
portfolio and all similarly managed owned receivables for the year ended January
3, 2004, were as follows:

The table below summarizes certain cash flows received from and paid to
securitization trusts during the years ended January 3, 2004 and December 28,
2002, respectively.

NOTE 8 EQUIPMENT ON OPERATING LEASES

43

Initial lease terms of equipment on operating leases range from one year to
ten years. Future minimum rentals at January 3, 2004, are $25.3 million in 2004,
$20.0 million in 2005, $13.7 million in 2006, $10.7 million in 2007, $7.0
million in 2008 and $15.3 million thereafter.

NOTE 9 GOODWILL

On December 30, 2001, Textron Financial adopted SFAS No. 142, "Goodwill and
Other Intangible Assets," which requires companies to stop amortizing goodwill
and certain intangible assets with indefinite useful lives and requires an
annual review for impairment. All existing goodwill as of December 30, 2001 was
required to be tested for impairment on a reporting unit basis with the adoption
of this standard. Goodwill is considered to be impaired when the net book value
of a reporting unit exceeds its estimated fair value. Fair values were
established using a discounted cash flow methodology.

Upon adoption, Textron Financial recorded an after-tax transitional
impairment charge of $15.4 million ($23.7 million, pre-tax) in the second
quarter of 2002, which was retroactively recorded in the first quarter of 2002.
This charge is included in the caption "Cumulative effect of change in
accounting principle, net of income taxes" in Textron Financial's Consolidated
Statements of Income. This after-tax charge related to the Franchise Finance
division within the Other segment and was primarily the result of decreasing
loan volumes and an unfavorable securitization market.

Textron Financial also adopted the remaining provisions of SFAS No. 141,
"Business Combinations," on December 30, 2001. For goodwill and intangible
assets reported in connection with acquisitions made prior to July 1, 2001,
these provisions broaden the criteria for recording intangible assets separate
from goodwill and require that certain intangible assets that do not meet the
new criteria, such as workforce, be reclassified into goodwill. Upon adoption of
these provisions, intangible assets totaling $0.9 million were reclassified into
goodwill within the Resort Finance segment, for 2002.

Textron Financial sold the portfolio of its small business finance
operation on December 19, 2003. The sale resulted in a reduction of goodwill
amounting to $11.6 million. See Note 4 for further details.

Goodwill totaled $110.0 million in the Resort Finance segment, $40.6
million in the Asset-Based Lending segment, $16.6 million in the Aircraft
Finance segment and $2.1 million in the Other segment at January 3, 2004.

The impact on net income of discontinuing the amortization of goodwill is
presented below:

44

NOTE 10 OTHER ASSETS

The Investment in equipment residuals represents the remaining equipment
residual values associated principally with Textron golf and turf equipment
lease payments that were securitized in years 2000 through 2003.

The cost of fixed assets is being depreciated using the straight-line
method based on the estimated useful lives of the assets.

NOTE 11 DEBT AND CREDIT FACILITIES

During the third quarter, Textron Financial renewed and extended its bank
lines of credit. In addition, Textron amended its credit facilities to permit
Textron Financial to borrow under those facilities. The Company has committed
bank lines of credit of $1.5 billion, of which $500 million expires in 2004 and
$1.0 billion expires in 2008. Textron Financial's lines of credit, not reserved
as support for commercial paper or utilized for letters of credit at January 3,
2004, were $966 million. The Company also maintains a CAD 50 million committed
facility under which it can borrow an additional CAD 50 million on an
uncommitted basis. At January 3, 2004, the Company had used CAD 20 million of
the committed portion of the facility. Textron Financial also has a $25 million
multi-currency facility, of which $17 million remains unused at year-end 2003.
Both the Canadian and multi-currency facilities expire in 2004. Textron
Financial generally pays fees in support of these lines.

Textron Financial had interest rate exchange agreements related to the
conversion of fixed rate debt to variable rate debt at the time of issuance, of
$1.9 billion and $1.4 billion at January 3, 2004, and December 28,

45

2002, respectively, whereby the Company makes periodic floating rate payments in
exchange for periodic fixed rate receipts.

Through its subsidiary, Textron Financial Canada Funding Corp. (Textron
Canada Funding), the Company periodically issues debt securities. Textron
Financial owns 100% of the common stock of Textron Canada Funding. Textron
Canada Funding is a financing subsidiary of Textron Financial with no
operations, revenues or cash flows other than those related to the issuance,
administration and repayment of debt securities that are fully and
unconditionally guaranteed by Textron Financial.

The weighted average interest rates on short-term borrowings at year-end
were as follows:

The corresponding weighted average interest rates on these borrowings
during the last three years were 1.47% in 2003, 2.07% in 2002 and 4.12% in 2001.
Weighted average interest rates have been determined by relating interest costs
for each year to the daily average dollar amounts outstanding.

Interest on Textron Financial's variable rate notes is predominately tied
to the three-month LIBOR for U.S. Dollar deposits. The weighted average interest
rate on these notes before consideration of the effect of interest rate exchange
agreements, was 2.29% at January 3, 2004, 2.16% at December 28, 2002, and 2.41%
at December 29, 2001. The corresponding weighted average interest rates on these
notes during the last three years were 2.47% in 2003, 2.58% in 2002 and 4.89% in
2001.

Securitizations are an important source of liquidity for Textron Financial
and involve the periodic transfer of finance receivables to qualified special
purpose trusts. At January 3, 2004, and December 28, 2002, the amount of debt
related to these securitization trusts was $1.9 billion and $2.3 billion,
respectively.

The amount of net assets available for dividends and other payments to
Textron is restricted by the terms of the Company's lending agreements. At
January 3, 2004, $480 million of net assets were available to be transferred to
Textron under the most restrictive covenant. The lending agreements contain
various restrictive provisions regarding additional debt (not to exceed 800% of
consolidated net worth and qualifying subordinated obligations), minimum net
worth ($200 million), the creation of liens and the maintenance of a fixed
charges coverage ratio (no less than 125%).

Required principal payments on long-term debt outstanding at January 3,
2004, are $1,181 million in 2004, $581 million in 2005, $809 million in 2006,
$819 million in 2007 and $497 million in 2009.

Cash payments made by Textron Financial for interest were $182 million in
2003, $196 million in 2002 and $282 million in 2001.

NOTE 12 DERIVATIVE FINANCIAL INSTRUMENTS

Textron Financial utilizes derivative instruments to mitigate its exposure
to fluctuations in interest rates and foreign currencies. These instruments
include interest rate exchange agreements, foreign currency exchange agreements
and interest rate cap and floor agreements. The Company does not hold or issue
derivative financial instruments for trading or speculative purposes and did not
experience a significant net gain or loss in earnings as a result of the
ineffectiveness, or the exclusion of any component from its assessment of hedge
effectiveness, of its derivative financial instruments in 2003, 2002 and 2001.

In order to mitigate exposure to changes in the fair value of its fixed
rate portfolios of receivables and debt due to changes in interest rates, the
Company enters into interest rate exchange agreements, which convert its fixed
rate cash flows to floating rates. The Company has designated these instruments
as fair value hedges. Changes in the fair value of these instruments are
recorded in Finance charges and discounts and Interest expense related to hedges
of receivables and debt, respectively, and the corresponding offsetting changes
in value in the hedged receivables and debt are also recorded in Finance charges
and discounts and Interest

46

expense. At January 3, 2004, the Company had interest rate exchange agreements
with a fair value of $8.1 million designated as fair value hedges, compared to a
fair value of $42.2 million at December 28, 2002.

Textron Financial has also entered into interest rate exchange, cap and
floor agreements to mitigate its exposure to variability in the cash flows
received from its investments in interest-only securities resulting from
securitizations, which are caused by fluctuations in interest rates. The
combination of these instruments convert net residual floating rate cash flows
expected to be received by the Company as a result of the securitization trust's
assets, liabilities and derivative instruments to fixed rate cash flows and are
designated as cash flow hedges. Changes in the fair value of these instruments
are recorded net of the tax effect in Other comprehensive income. At January 3,
2004, these instruments had a fair value liability of $13.7 million, compared to
a fair value liability of $37.4 million at December 28, 2002. The Company
expects approximately $2.0 million of net of tax deferred losses to be
reclassified to earnings related to these hedge relationships in 2004.

At January 3, 2004, the Company had $8.2 million of net of tax deferred
losses recorded in Other comprehensive income related to terminated forward
starting interest rate exchange agreements. These agreements were executed to
hedge the exposure to the variability in cash flows from anticipated future
issuances of fixed rate debt and were terminated upon issuance of the debt. The
Company is amortizing the deferred losses into Interest expense over the
remaining life of the hedged debt of 50 months and expects approximately $1.9
million, net of income taxes, deferred losses to be reclassified to earnings in
2004.

Textron Financial utilizes foreign currency interest rate exchange
agreements to hedge the exposure through March 2005, in a Canadian dollar
functional currency subsidiary, to fluctuations in the cash flows to be received
on $107.0 million of LIBOR based variable rate notes receivable as a result of
changes in both foreign currency exchange rates and LIBOR. The Company has
designated these agreements cash flow hedges and records changes in the fair
value of these instruments net of tax in Other comprehensive income. At January
3, 2004, these instruments had a fair value of $26.0 million, compared to a fair
value of $3.4 million at December 28, 2002. The Company expects approximately
$3.0 million of net of tax deferred gains to be reclassified to earnings related
to these hedge relationships in 2004.

The Company also utilizes foreign currency interest rate exchange
agreements to hedge its exposure, in a Canadian dollar functional currency
subsidiary, to changes in the fair value of $60.0 million U.S. dollar
denominated fixed rate debt as a result of changes in both foreign currency
exchange rates and Canadian Banker's Acceptance rates. The Company has
designated these agreements as fair value hedges and records changes in the fair
value of these instruments, as well as the corresponding changes in the fair
value of the debt being hedged in Interest expense. At January 3, 2004, these
instruments had a fair value liability of $1.1 million. At December 28, 2002,
the Company had similar instruments hedging $32.5 million U.S. dollar
denominated fixed rate debt, which had a fair value asset of $0.8 million.

In relation to one of the Company's asset-backed securitizations, Textron
Financial enters into back-to-back interest rate exchange agreements with both
third-party financial institutions and commercial customers of the Resort
Finance Segment. These instruments are designed to have an equal and offsetting
impact to the Company and transfer the risk of differences between actual and
scheduled cash flows related to the receivables sold from the financial
institution to the commercial customers who originated the loan contracts sold.
Since these instruments are utilized by Textron Financial to facilitate the
securitization transaction rather than mitigate interest rate risk to the
Company, they are not designated in hedging relationships. There were no gains
and losses related to these instruments in the Company's earnings in 2003.

NOTE 13 TEXTRON FINANCIAL AND LITCHFIELD OBLIGATED MANDATORY REDEEMABLE
PREFERRED SECURITIES OF TRUST SUBSIDIARY HOLDING SOLELY LITCHFIELD JUNIOR
SUBORDINATED DEBENTURES

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity," that
became effective at the beginning of the third quarter of 2003. SFAS No. 150
established standards for how an issuer classifies and measures certain
financial instruments with characteristics of liabilities and equity. Financial
instruments within its scope that were previously classified as equity, such as
mandatorily redeemable shares, must be classified as a liability. Upon
47

adoption, Textron Financial classified its obligated mandatory redeemable
preferred securities as a liability and related distributions on preferred
securities as interest expense. Subsequent to this adoption, in November 2003,
the FASB issued staff position (FSP) 150-3 which indefinitely deferred SFAS No.
150 for these obligated mandatorily redeemable preferred securities. Refer to
Note 1 to the consolidated financial statements for additional information.

Prior to Textron Financial's acquisition of Litchfield on November 3, 1999,
a trust, sponsored and wholly-owned by Litchfield, issued to the public $26.2
million of mandatory redeemable preferred securities (Preferred Securities). The
trust subsequently invested the proceeds in $26.2 million aggregate principal
amount of Litchfield 10% Series A Junior Subordinated Debentures (Series A
Debentures), due 2029. The Series A Debentures are the sole asset of the trust.
The amounts due to the trust under the Series A Debentures and the related
income statement amounts have been eliminated in Textron Financial's
consolidated financial statements.

The Preferred Securities were recorded by Textron Financial at the fair
value of $28.6 million as of the acquisition date and the fair value adjustment
is being amortized through June 2004.

The Preferred Securities accrue and pay cash distributions quarterly at a
rate of 10% per annum. The trust's obligations under the Preferred Securities
are fully and unconditionally guaranteed by Litchfield, including, without
limitation, all obligations arising under the Declaration Trust, the Trust
Preferred Securities, the Indenture, the Debentures and the ancillary agreements
entered into in connection with the foregoing. The trust will redeem all of the
outstanding Preferred Securities when the Series A Debentures are paid at
maturity on June 30, 2029, or otherwise become due. Litchfield will have the
right to redeem 100% of the principal plus accrued and unpaid interest on or
after June 30, 2004.

As a result of the acquisition, Textron Financial has agreed to make
payments to the holders of the Preferred Securities, when due, to the extent not
paid by or on behalf of the trust or the subsidiary.

NOTE 14 INVESTMENT IN PARENT COMPANY PREFERRED STOCK

On April 12, 2000, Textron made a $25 million noncash capital contribution
to Textron Financial consisting of all of the outstanding shares of Textron
Funding Corporation (Textron Funding), a related corporate holding company.
Textron Funding's only asset is 1,522 shares of Textron Inc. Series D cumulative
preferred stock, bearing an annual dividend yield of 5.92%. The preferred stock,
which has a face value of $152.2 million, is carried at its original cost of $25
million and is presented in a manner similar to treasury stock for financial
reporting purposes. Dividends on the preferred stock are treated as additional
capital contributions from Textron.

NOTE 15 ACCUMULATED OTHER COMPREHENSIVE LOSS

48

NOTE 16 INCOME TAXES

Income from continuing operations before income taxes and distributions on
preferred securities:

The components of income taxes were as follows:

Cash (received) paid for income taxes was ($5.5) million in 2003, ($30.8)
million in 2002 and $15.8 million in 2001.

The federal statutory income tax rate was reconciled to the effective
income tax rate as follows:

49

The components of Textron Financial's deferred tax assets and liabilities
were as follows:

At January 3, 2004, Textron Financial had state net operating loss
carryforwards of approximately $379 million available to offset future state
taxable income. The state net operating loss carryforwards will expire in years
2004 through 2022. The valuation allowance reported above represents the tax
effect of certain state net operating loss carryforwards. Textron Financial is
unable to conclude that "more likely than not" it will realize the benefit from
such carryforwards.

NOTE 17 FAIR VALUE OF FINANCIAL INSTRUMENTS

The following methods and assumptions were used in estimating the fair
value of Textron Financial's financial instruments:

Finance Receivables

The estimated fair values of fixed rate installment contracts, revolving
loans, golf course and resort mortgages and distribution finance receivables
were estimated based on discounted cash flow analyses using interest rates
currently being offered for similar loans to borrowers of similar credit
quality. The estimated fair values of all variable rate receivables approximated
the net carrying value of such receivables. The estimated fair values of
nonperforming loans were based on independent appraisals, discounted cash flow
analyses using risk adjusted interest rates or Textron Financial valuations
based on the fair value of the related collateral. The fair values, net of
carrying amounts of Textron Financial's leveraged leases, finance leases and
operating leases ($513.2 million, $308.9 million and $210.2 million,
respectively, at January 3, 2004, and $460.2 million, $345.0 million and $255.1
million, respectively, at December 28, 2002), are specifically excluded from
this disclosure under generally accepted accounting principles. As a result, a
significant portion of the assets which are included in the Company's asset and
liability management strategy are excluded from this fair value disclosure.

Debt, Interest Rate Exchange Agreements, Foreign Currency Forward Exchange
Contracts and Foreign Currency Exchange Agreements

The estimated fair value of fixed rate debt and variable rate long-term
notes was determined by either independent investment bankers or discounted cash
flow analyses using interest rates for similar debt with

50

maturities similar to the remaining terms of the existing debt. The fair values
of short-term borrowing supported by credit facilities approximated their
carrying values. The estimated fair values of interest rate exchange agreements,
foreign currency forward exchange contracts and foreign currency exchange
agreements, were determined by independent investment bankers and represent the
estimated amounts that Textron Financial would be required to pay to (or collect
from) a third party to assume Textron Financial's obligations under the
agreements.

The carrying values and estimated fair values of Textron Financial's
financial instruments for which it is practicable to calculate a fair value are
as follows:

NOTE 18 COMMITMENTS

Textron Financial generally enters into various revolving lines of credit,
letters of credit and loan commitments in response to the financing needs of its
customers. The revolving lines of credit include both committed and uncommitted
facilities. Included in the committed facilities are $283 million of commitments
where funding is dependent on compliance with customary financial covenants.
Advances under the remaining $840 million of committed facilities are dependent
on both compliance with customary financial covenants and the availability of
eligible collateral. Advances under the uncommitted facilities of $243 million
are generally at Textron Financial's discretion and the Company has the right to
reduce or cancel these lines at any time. Letters of credit are conditional
commitments issued by the Company to guarantee the performance of a borrower or
an affiliate to a third party. Loan commitments represent agreements to fund
eligible costs of assets generally within one year. Generally, interest rates on
all of these commitments are not set until amounts are funded. Therefore,
Textron Financial is not exposed to interest rate changes.

These financial instruments generate fees and involve, to varying degrees,
elements of credit risk in excess of amounts recognized in the Company's
consolidated balance sheets. Since many of the agreements are expected to expire
unused, the total commitment amount does not necessarily represent future cash
requirements. The credit risk involved in issuing these instruments is
essentially the same as that involved in

51

extending loans to borrowers and the credit quality and collateral policies for
controlling this risk are similar to those involved in the Company's normal
lending transactions.

The contractual amounts of the Company's outstanding commitments to extend
credit at January 3, 2004, are shown below:

Textron Financial's offices are occupied under noncancelable operating
leases expiring on various dates through 2009. Rental expense was $7.4 million
in 2003 ($7.6 million in 2002 and $6.4 million in 2001). Future minimum rental
commitments for all noncancelable operating leases in effect at January 3, 2004,
approximated $4.8 million for 2004, $3.3 million for 2005, $2.5 million for
2006, $2.3 million for 2007 and $2.3 million for 2008. Of these amounts, $0.7
million in 2004 and $0.1 million in 2005 are payable to Textron and its
subsidiaries.

NOTE 19 CONTINGENCIES

In March 2003, the United States Department of Justice (DOJ) authorized the
filing of a civil action against Textron Financial and its Litchfield Financial
Corporation (Litchfield), and other third parties, arising from the financing of
certain land purchases by consumers through a third-party land developer
commonly known as "Buyer's Source." During the third quarter, the Company
entered into a settlement agreement with DOJ, which required the Company to
offer affected consumers various options, ranging from cash payments to
forgiveness of debt in exchange for return of the property. The Florida Attorney
General's office also opened a preliminary investigation into Litchfield's
activities relative to Buyer's Source and, while the Company believes it has
good defenses to any potential claims by the State of Florida, it is engaged in
settlement discussions with Florida. On February 3, 2004, in the Court of Common
Pleas for Knox County, Ohio, a purported class action lawsuit was commenced
against the Company and Litchfield, certain of their current and former
officers, and other third-parties, related to the Buyer's Source matter. Among
other claims, the purported class action alleges fraud in the financing of the
third-party land developers described above and seeks compensatory damages and
punitive damages in excess of $10 million. The Company intends to aggressively
defend this litigation. The Company believes that the purported class action
will not have a material effect on the Company's financial position and results
of operations.

There are other pending or threatened lawsuits and other proceedings
against Textron Financial and its subsidiaries. Some of these suits and
proceedings seek compensatory, treble or punitive damages in substantial
amounts. These suits and proceedings are being defended by, or contested on
behalf of, Textron Financial and its subsidiaries. On the basis of information
presently available, Textron Financial believes any such liability would not
have a material effect on Textron Financial's financial position or results of
operations.

NOTE 20 SUBSEQUENT EVENTS

On January 22, 2004, Litchfield, and its former CFO, entered into a
memorandum of understanding, subject to court approval, relating to a pending
class action (DynaCorp litigation) arising from the sale of promissory notes
issued by, and the operation of, certain trusts organized by DynaCorp Financial
Strategies Inc. ("DFS"). This class action litigation, which was filed in 2001
in Superior Court in Marin County, California, alleged that DFS and the trusts
engaged in a variety of improper dealings with regard to the sale by the trusts
of notes and the operation of the trusts. During a portion of the time that the
allegedly improper activities occurred, Litchfield extended credit to DFS and
was a shareholder of DFS, and a Litchfield officer was a director on DFS' Board.
The preliminary settlement under the memorandum of understanding was

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accrued as part of legal costs and was reflected in Selling and administrative
expenses on the Consolidated Statements of Income for the year-ended January 3,
2004.

NOTE 21 FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS

The Company aligns its business units into six operating segments based on
the markets serviced and the products offered: Aircraft Finance, Asset-Based
Lending, Distribution Finance, Golf Finance, Resort Finance and Structured
Capital. In addition, the Company maintains an Other segment (non-core) that
includes franchise finance, media finance in addition to liquidating portfolios
related to a strategic realignment of the Company's business and product lines
into core and non-core businesses.

- ---------------
(1) Interest expense is allocated to each segment in proportion to its net
investment in finance assets. Net investment in finance assets includes
deferred income taxes, security deposits and other specifically identified
liabilities. The interest allocated matches, to the extent possible,
variable rate debt with variable rate finance assets and fixed rate debt
with fixed rate finance assets.

(2) Indirect expenses are allocated to each segment based on the use of such
resources. Most allocations are based on the segment's proportion of net
investment in finance assets, headcount, number of transactions, computer
resources and senior management time.

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(3) Finance assets include: finance receivables; equipment on operating leases,
net of accumulated depreciation; repossessed assets and properties; retained
interests in securitizations; interest-only securities; investment in
equipment residuals; ADC arrangements; and short and long-term investments
(some of which are classified in Other assets on Textron Financial's
Consolidated Balance Sheets).

NOTE 22 QUARTERLY FINANCIAL DATA (UNAUDITED)

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We have carried out an evaluation, under the supervision and with the
participation of our management, including our Chairman and Chief Executive
Officer (the "CEO") and our Executive Vice President and Chief Financial Officer
(the "CFO"), of the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the "Act")) as of the end of the
year covered by this report. Based upon that evaluation, our CEO and CFO
concluded that our disclosure controls and procedures are effective in providing
reasonable assurance that (a) the information required to be disclosed by us in
the reports that we file or submit under the Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms, and (b) such information is accumulated
and communicated to our management, including our CEO and CFO, as appropriate to
allow timely decisions regarding required disclosure.

There has been no change in our internal control over financial reporting
during the fourth quarter of the fiscal year covered by this report that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.

PART III.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Omitted per Instruction I of Form 10-K.

ITEM 11. EXECUTIVE COMPENSATION

Omitted per Instruction I of Form 10-K.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Omitted per Instruction I of Form 10-K.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Omitted per Instruction I of Form 10-K.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The aggregate fees for professional services rendered by Ernst & Young LLP
during 2003 and 2002 were as follows:

Audit Fees -- Fees for the audit of Textron Financial's annual financial
statements, the reviews of the financial statements in Textron Financial's Forms
10-Q, and other services in connection with statutory and regulatory filings and
engagements were $1.0 million and $0.9 million, in 2003 and 2002, respectively.

Audit Related Fees -- Audit related services include agreed upon procedures
relating to securitizations of finance receivables, attest services not required
by statute or regulation, and consultations concerning financial accounting and
reporting matters not classified as audit. Fees were $0.3 million and $0.3
million in 2003 and 2002, respectively.

Tax Services -- Fees for tax services relating to consultations and
compliance were $21 thousand and $36 thousand in 2003 and 2002, respectively.

Other Services -- Other service fees relating to miscellaneous services
were $0.1 million and $0.1 million in 2003 and 2002, respectively.

No fees were paid to Ernst & Young LLP for financial information systems
design and implementation services during 2003 or 2002.

PART IV.

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(A) LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES

The following consolidated financial statements of Textron Financial and
subsidiaries are included in Item 8:

1. Consolidated statements of income -- Years ended January 3, 2004,
December 28, 2002 and December 29, 2001

2. Consolidated balance sheets -- January 3, 2004 and December 28, 2002

3. Consolidated statements of cash flows -- Years ended January 3, 2004,
December 28, 2002 and December 29, 2001

4. Consolidated statements of changes in shareholder's equity -- Years
ended January 3, 2004, December 28, 2002 and December 29, 2001

5. Notes to consolidated financial statements

All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.

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EXHIBITS

The following is an Index of Exhibits required by Item 601 of Regulation
S-K filed with the Securities and Exchange Commission as part of this report.

- ---------------
Note: Instruments defining the rights of holders of certain issues of long-term
debt of Textron Financial have not been filed as exhibits to this Report
because the authorized principal amount of any one of such issues does
not exceed 10% of the total assets of Textron Financial and its
subsidiaries on a consolidated basis. Textron Financial agrees to furnish
a copy of each such instrument to the Commission upon request.

* Incorporated by reference to the Exhibit with the same number of Textron
Financial's Registration Statement on Form 10 (File No. 0-27559)

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** Incorporated by reference to Exhibit 3.1 of Textron Financial's quarterly
report on Form 10-Q dated August 11, 2000

*** Incorporated by reference to Exhibit 4.1 to Amendment No. 2 to Textron
Financial Corporation's Registration Statement on Form S-3 (No. 333-88509)

**** Incorporated by reference to Exhibit 4.2 to Amendment No. 1 to Textron
Financial Corporation's Registration Statement on Form S-3 (No.
333-108464)

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(B) REPORTS ON FORM 8-K

No reports on Form 8-K were filed during the quarter ended January 3, 2004.

Textron Financial, Textron, Bell Helicopter, Cessna, Cessna Finance Corporation,
Asset Control, LLC, Textron Business Services, Inc., Textron Golf, Turf and
Specialty Products, E-Z-GO, Jacobsen turf-care and their related trademark
designs and logotypes (and variations of the foregoing) are trademarks, trade
names or service marks of Textron Inc., its subsidiaries, affiliates or joint
ventures.
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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Annual Report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized on
this 26(th) day of February 2004.

Textron Financial Corporation
Registrant

By: *
------------------------------------
Ted R. French
Chairman and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below on this 26(th) day of February 2004, by the
following persons on behalf of the registrant and in the capacities indicated:

By: *
------------------------------------
Ted R. French
Chairman and Chief Executive
Officer, Director (Principal
Executive Officer)

By: *
------------------------------------
Buell J. Carter, Jr.
President and Chief Operating
Officer,
Director

By: *
------------------------------------
Mary F. Lovejoy
Director

By: /s/ THOMAS J. CULLEN
------------------------------------
Thomas J. Cullen
Executive Vice President and Chief
Financial Officer (Principal
Financial Officer)

By: /s/ ERIC SALANDER
------------------------------------
Eric Salander
Senior Vice President, Finance
(Principal Accounting Officer)

*By: /s/ ELIZABETH C. PERKINS
-----------------------------------
Elizabeth C. Perkins
Attorney-in-fact

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