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 1, 2005
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:
COMMON STOCK, $100.00 PAR VALUE

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.................................................. 8
Item 3. Legal Proceedings........................................... 8
Item 4. Submission of Matters to a Vote of Security Holders......... 8
PART II.
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 8
Item 6. Selected Financial Data..................................... 9
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 10
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.................................. 56
Item 9A. Controls and Procedures..................................... 56
Item 9B. Other Information........................................... 56
PART III.
Item 10. Directors and Executive Officers of the Registrant.......... 57
Item 11. Executive Compensation...................................... 57
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 57
Item 13. Certain Relationships and Related Transactions.............. 57
Item 14. Principal Accounting Fees and Services...................... 57
PART IV.
Item 15. Exhibits, Financial Statement Schedules..................... 57

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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 middle-market companies that
manufacture or distribute finished goods, and provides factoring arrangements
primarily for freight companies; 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 offered through TBS Business Services, Inc.

All of Textron Financial's stock is owned by Textron Inc. (Textron), a
global multi-industry company with operations in five business segments: Bell,
Cessna, Fastening Systems, Industrial and Finance. At January 1, 2005, 21% 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's services
are offered primarily in North America. However, Textron Financial 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
finance receivable originations in these business markets, and continues to
actively manage the accounts to maximize value as the accounts are collected or
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 financial information regarding Textron Financial's business
segments, refer to Note 20 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 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 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.

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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 2004, 2003 and 2002,
Textron Financial paid Textron $0.9 billion, $0.9 billion and $1.0 billion,
respectively, for the sale of manufactured products to third parties that were
financed by the Company. In addition, the Company paid Textron $77 million in
2004, $56 million in 2003 and $104 million in 2002 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
million in 2004 and 2003, and $9 million in 2002, and operating lease revenues
of $24 million in 2004, $22 million in 2003, and $21 million in 2002.

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 $330 million at January 1, 2005 and $428 million at January 3,
2004, and operating leases of $136 million at January 1, 2005, and $126 million
at January 3, 2004, were subject to recourse to Textron or due from Textron.

Support Agreement with Textron

Under a Support Agreement with Textron dated as of May 25, 1994, Textron is
required to pay to Textron Financial, quarterly, 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"), as adjusted for the inclusion of required payments under the
Support Agreement, 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
2004, 2003 or 2002, when Textron Financial's fixed-charge coverage ratios (as
defined) were 189%, 167%, and 164%, 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 with Textron, Textron
Financial is allocated federal tax benefits and charges on the basis of
statutory U.S. tax rates applied to the Company's taxable income or loss
included in the consolidated returns. The benefits of general business credits,
foreign tax credits and any other tax credits are utilized in computing current
tax liability. Textron Financial is paid for tax benefits generated and utilized
in Textron's consolidated federal and unitary or combined state income tax
returns, whether or not the Company would have been able to utilize those
benefits on a separate tax return. Income tax assets or liabilities are settled
on a quarterly basis. Textron has agreed to loan Textron Financial, on a junior
subordinated interest-free basis, an amount equal to

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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 1, 2005, Textron Financial had 1,138 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 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;

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- 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, Senior Vice President
of Capital Markets and Treasurer, Group President of the Revolving Credit Group.

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 1, 2005. International receivables are generated mostly in
support of Textron product sales. At January 1, 2005, international receivables
represented 13% of Textron Financial's managed finance receivable portfolio. For
additional information regarding Textron Financial's concentrations, see Note 6
to the consolidated financial statements in Item 8 of this Form 10-K.

Asset/Liability Risk Management

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

- 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

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Financial executes a transaction, it designates the derivative to a specific
asset, liability, or set of cash flows and as either a fair value or cash flow
hedge. Textron Financial monitors the effectiveness of derivatives through a
review of the amounts and maturities of assets, liabilities and derivative
positions. The Company's Treasurer 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 credit exposure is monitored
by counterparty, and managed within prudent limits. At January 1, 2005, the
Company's largest single counterparty credit exposure was $29 million.

Interest Rate Risk Management

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

Foreign Exchange Risk Management

A portion of 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 has foreign currency receivables 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 and foreign currency interest rate exchange agreements in amounts
sufficient to substantially hedge its foreign 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 disruption. 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 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.

AVAILABLE INFORMATION

The Company makes available free of charge on its Internet website
(http://www.textronfinancial.com) our Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 as soon as reasonably practicable after the Company
electronically files such material with, or furnishes it to, the Securities and
Exchange Commission.
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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 $80
million, $114 million and $62 million were declared and paid in 2004, 2003, and
2002, 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 (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 million in 2000.

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

OVERVIEW

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

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receivables in securitizations, retaining an interest in the sold receivables
and continuing to service such receivables for a fee.

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
whole-loan sale transactions, where the Company has retained substantial 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 whole-loan portfolio
sales resulting in credit risk. As a result, the Company evaluates finance
receivables and leverage on a managed as well as an 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 2004, Textron Financial experienced continued improvements in
portfolio quality and growth in its 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 statistics in 2004
reflect the Company's successful efforts to resolve problem accounts.
Nonperforming assets as a percentage of total finance assets decreased to 2.18%
at January 1, 2005 from 2.80% at January 3, 2004, and delinquency as a
percentage of finance receivables decreased to 1.47% at January 1, 2005 from
2.39% at January 3, 2004, resulting in a 28% decline in provision for losses in
2004 as compared to 2003. The Company expects relative stability in these
statistics during 2005; however, the Company could experience an out-of-trend
result in any one quarter.

The liquidation of non-core finance receivables in the Other segment
continued in 2004, while growth increased in the core business portfolios.
Finance receivables in the Other segment decreased $303 million and finance
receivables in the core businesses increased $1.0 billion as compared to January
3, 2004. The decrease in non-core finance receivables was primarily related to
the franchise finance, syndicated bank loan and media finance portfolios. While
this trend is expected to continue in 2005, it will occur at a slower pace as
the Company's non-core finance receivables have been reduced to $420 million as
of January 1, 2005.

Operating efficiency (the ratio of selling and administrative expenses
divided by net interest margin) has continued to deteriorate over the last three
years, primarily as a consequence of higher legal and collection expenses
related to mitigating the impact of nonperforming accounts. During 2004, these
costs have begun to decrease, reflecting the significant decline in
nonperforming assets as a percentage of finance assets by the end of the year.
The Company has also realized reductions in selling and administrative expenses
as a result of ongoing process improvement initiatives and the restructuring
actions taken in the fourth quarter of 2003, partially offset by increases in
employee salaries and benefits expense on a per employee basis. However, a
decrease in net interest margin primarily resulting from lower average finance
receivables outstanding, has contributed to the decline in this ratio in 2004,
despite the overall reduction in selling and administrative expenses. The
Company expects the deterioration in operating efficiency to reverse in 2005
based on continuing process improvement initiatives and increases in net
interest margin due to strong growth in the core business portfolios.

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

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finance receivable collections, sales and securitizations as well as the
issuance of commercial paper and term debt in the public and private markets.
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 considers market
conditions, prevailing interest rates and credit spreads, and the maturity
profile of its assets and liabilities.

During 2004, Textron Financial's credit spreads continued to steadily
tighten as the result of a very strong corporate bond market and the Company's
improving credit profile. Term debt of $770 million was issued in 2004 at
historically narrow spreads.

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 currently total
$1.5 billion, of which $500 million expires in July 2005 and $1 billion expires
in 2008. The $500 million facility includes a one-year term out option,
effectively extending its expiration into 2006. Lines of credit not reserved as
support for outstanding commercial paper or letters of credit were $187 million
at January 1, 2005, compared to $966 million at January 3, 2004. In addition,
Textron Financial is permitted to borrow under Textron's $1.25 billion revolving
credit facilities, of which $250 million expires in March 2005 and $1.0 billion
expires in 2007. None of these lines of credit were used at January 1, 2005, or
January 3, 2004. At January 1, 2005, Textron Financial had a CAD 50 million
uncommitted credit facility, which remained unused. In February 2005, Textron
Financial expanded its Canadian uncommitted credit facilities to an aggregate
CAD 128 million, of which CAD 15 million remained unused. During the first
quarter of 2004, Textron Financial established an AUD 100 million committed
credit facility that was set to expire in 2005, of which AUD 88 million remained
unused at January 1, 2005. In February 2005, the facility was extended to 2006
and reduced to AUD 50 million. Textron Financial also has a $25 million
multi-currency committed credit facility, of which $17 million remained unused
at both January 1, 2005 and January 3, 2004. This facility expires in 2005 and
the Company expects to renew it prior to expiration.

Under a shelf registration statement filed with the Securities and Exchange
Commission, Textron Financial may issue public debt securities in one or more
offerings up to a total maximum offering of $4 billion. Under this registration
statement, Textron Financial issued $370 million of term notes during 2004. The
proceeds from these issuances were used to refinance maturing debt. At January
1, 2005, Textron Financial had $3.3 billion available under this registration
statement.

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The following table summarizes Textron Financial's contractual payments and
receipts as of January 1, 2005, for the specified periods:

Finance receivables are based on contractual cash flows. These amounts
could differ due to prepayments, charge-offs and other factors. Contractual
receipts and payments exclude finance charges and discounts from receivables,
debt interest payments, proceeds from sale of operating lease equipment and
other items.

At January 1, 2005, Textron Financial had unused commitments to fund new
and existing customers under $1.0 billion of committed revolving lines of credit
as compared to $1.1 billion at January 3, 2004. These loan commitments generally
expire within one year. 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.

Textron Financial's credit ratings are as follows: Standard & Poor's (A-
long-term, A2 short-term, outlook stable), Moody's Investors Service (A3
long-term, P2 short-term, outlook stable) and Fitch Ratings (A- long-term, F2
short-term, outlook stable). In August 2004, Moody's Investor Service and Fitch
Ratings affirmed these long- and short-term debt ratings and upgraded their
outlook to stable.

Cash provided by operating activities of continuing operations totaled $161
million in 2004, $242 million in 2003 and $206 million in 2002. The decrease in
the cash provided in 2004 was primarily due to the timing of accrued interest
and other liabilities, principally as a result of a $60 million income tax
payment in the first quarter of 2004. The increase in 2003 was 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 (used in) provided by investing activities of continuing operations
totaled $(756) million in 2004, $273 million in 2003 and $(499) million in 2002.
The decrease in cash flows in 2004 was largely the result of a $227 million
increase in finance receivable originations, net of cash collections, and a $768
million decrease in proceeds from receivable sales, including securitizations.
The reduction in proceeds from receivable sales was largely attributable to a
$329 million sale of a small-ticket equipment portfolio in December 2003, a $130
million increase in the utilization of the Distribution Finance conduit in 2003
as compared to 2004, and franchise portfolio sales of $123 million in 2003. The
2003 increase in cash flows was primarily the result of a

13

$389 million decrease in finance receivable originations, net of cash
collections, and $196 million of higher proceeds from receivable sales,
including securitizations.

Cash provided by (used in) financing activities of continuing operations
totaled $361 million in 2004, $(355) million in 2003 and $270 million in 2002.
The increase in cash flows during 2004 principally reflects a net increase in
debt outstanding to fund asset growth. 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 finance receivable sales in the fourth quarter. In
addition, the Company issued $2 billion of term debt in 2002 to refinance
maturing debt and repay a 2001 advance of $510 million from Textron.

Net cash provided by discontinued operations represents the small business
finance operation and totaled $175 million in 2003 and $27 million in 2002.

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 82% at January 1, 2005,
compared to 81% at January 3, 2004. Textron Financial's ratio of earnings to
fixed charges was 1.89x in 2004 (1.67x in 2003 and 1.64x in 2002). Commercial
paper and Other short-term debt as a percentage of total debt was 27% at January
1, 2005, compared to 12% at the end of 2003.

In 2004, Textron Financial declared and paid $80 million of dividends to
Textron, compared to $114 million of dividends declared and paid in 2003. The
higher level of dividends in 2003 was the result of the return of capital to
Textron associated with the sale of small business finance. Textron contributed
capital of $9 million to Textron Financial in both 2004 and 2003, 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 $394 million and $765
million in 2004 and 2003, respectively. Textron Financial has used the proceeds
from these arrangements to fund the origination of new finance receivables and
to retire commercial paper. Gains related to these transactions amounted to $56
million and $47 million in 2004 and 2003, respectively. Cash collections on
current and prior period securitization gains were $62 million and $46 million
for 2004 and 2003, 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 amounts 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.

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 retained interests are recorded in Other assets on the
Company's Consolidated Balance Sheets and amounted to $233 million and $270
million at January 1, 2005 and January 3, 2004, respectively.
14

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 exposes the Company to risks
similar to 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 1, 2005, was $42 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 $10 million. The Company has
valued this contingent liability based on assumptions for annual credit losses
and prepayment rates of 0.25% and 7.50%, respectively. An instantaneous 20%
adverse change in these rates would have an insignificant impact on the
valuation of this recourse liability.

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. The Company entered into a loss
sharing agreement related to the sale, which requires Textron Financial to
reimburse the purchaser for a portion of losses incurred on the portfolio above
a predetermined level. The Company originally recorded a liability of $14
million representing the estimated fair value of the guarantee, which expires in
2008. The remaining $13 million liability is recorded in Accrued interest and
other liabilities.

Managed Finance Receivables

Managed finance receivables consist of owned finance receivables, and
finance receivables that Textron Financial continues to service, but has sold in
securitizations or similar structures in which some risks of ownership are
retained. The managed finance receivables of our business segments are presented
in the following table.

15

Managed finance receivables within the Company's core businesses increased
$885 million, primarily as a result of growth in the private brands and
technology portfolios within Distribution Finance, the golf mortgage portfolio
within Golf Finance, Resort Finance, the leveraged lease portfolio within
Structured Capital and Asset-Based Lending. The growth within Resort Finance
reflected stronger originations within its portfolio of loans to developers of
vacation interval resorts, including a $132 million portfolio purchase in the
second quarter of 2004. The decrease in the Other segment represents the
continued portfolio collections, prepayments and sales of the liquidating
portfolios.

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 2004, 2003 and
2002 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.
Textron Financial experienced significant improvement in total nonperforming
assets with a $22 million decrease in 2004 and a $52 million decrease in 2003.
The decrease in 2004 was primarily attributable to the core businesses including
Aircraft Finance ($14 million) and Distribution Finance ($6 million), largely
related to improved general economic conditions, and Resort Finance ($2
million). The improvement in Resort Finance was related to its portfolio of
loans to developers of vacation interval resorts ($6 million), partially offset
by a decline in its land finance portfolio ($4 million). While the level of
nonperforming assets for the portfolio of loans to developers of vacation
interval resorts has improved, there has been a shift in nonperforming assets to
high-end, fractional shares from the more common weekly vacation ownership
interval product.

The improvements in core businesses were partially offset by increases in
nonperforming asset levels in Golf Finance ($4 million) and Asset-Based Lending
($1 million). Excluding an increase of $13 million in nonperforming assets
related to one customer within its golf mortgage portfolio, the Golf Finance
segment experienced improvements of $7 million within its golf mortgage
portfolio and $2 million in its golf equipment finance portfolio. This movement
was primarily attributable to improved general economic conditions that resulted
in a stabilization in golf rounds played in 2004 as compared to declines in golf
rounds played in 2003 and 2002.

The Other segment continued to decrease ($5 million) with reductions in
telecommunications ($5 million), media finance ($10 million) and other
liquidating portfolios ($7 million), partially offset by an increase in
franchise finance ($22 million), primarily related to one customer. The Other
segment continues to comprise a disproportionate amount of the Company's
nonperforming assets accounting for 27% of total nonperforming assets, yet
comprising only 7% of the total finance assets at January 1, 2005. Overall, the

16

Company expects continued modest improvement as these portfolios liquidate.
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 $31 million, $41 million and $85
million at the years ended 2004, 2003 and 2002, respectively, and were 9.3%,
9.6% and 13.9% of captive finance receivables with recourse, respectively.
Revenues recognized on 90 day or more delinquent accounts were $3 million, $6
million and $8 million for the years ended 2004, 2003 and 2002, 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 1, 2005, floating rate liabilities in excess of floating
rate assets were $421 million, net of $2.0 billion of interest rate exchange
agreements on fixed rate long-term debt and $168 million of interest rate
exchange agreements on fixed rate finance receivables. Classified within fixed
rate assets are $733 million of floating rate loans with index rate floors that
are, on average, 76 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. The
Company has benefited from these interest rate floor agreements in the recent
low rate environment. However, in a rising rate environment, this benefit will
dissipate until the prime rate exceeds the floor rates embedded in these
agreements. In addition, $581 million of floating rate receivables with index
rate floors have been sold into the Distribution Finance securitization conduit.
Since this conduit issues floating rate liabilities to investors, Textron
Financial currently benefits, in connection with the Company's ownership of the
conduit's residual interest, from the interest differential between the floor
rates and the index rates. On average, these securitized receivables have index
rate floors that are 77 basis points above the applicable index rate.

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 finance
receivables are generally tied to changes in the prime rate offered by major
U.S. banks. As a consequence, 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 contractual maturities of both debt and assets will result in issuances or
reductions of commercial paper. This shock test model, when applied to Textron
Financial's asset and liability position at January 1, 2005, 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 $1.6 million for the following
twelve-month period. The same model, when applied to the Company's asset and
liability position at January 3, 2004, would have shown a negative impact on the
Company'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. The fair values of interest rate exchange agreements are
recorded in either Other assets or Accrued interest and other liabilities on the
Company's Consolidated Balance Sheets. Textron Financial does not trade in
interest rate exchange agreements or enter into leveraged interest rate exchange
agreements. The
17

net effect of the interest rate exchange agreements designated as hedges of debt
decreased interest expense by $40 million, $43 million, and $20 million in 2004,
2003, and 2002, 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, liabilities and cash flows into functional currency
denominated assets, liabilities and cash flows. 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 any
remaining foreign currency exposures to changes in currency rates. The notional
amounts of outstanding foreign currency forward exchange contracts were $3
million and $34 million at January 1, 2005 and January 3, 2004, respectively.
The fair values of foreign currency forward exchange contracts are recorded in
either Other assets or Accrued interest and other liabilities on the Company's
Consolidated Balance Sheets. As the Company hedges all substantial foreign
currency exposures which could impact net income, likely future changes in
foreign currency rates would not have a significant impact on earnings.

CRITICAL ACCOUNTING POLICIES

Allowance for Losses on Finance Receivables

Management evaluates its allowance for losses on finance 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.

Provisions for losses on finance receivables are charged to income, in
amounts sufficient to maintain the allowance for losses on finance receivables
at a level considered adequate to cover existing losses in the owned finance
receivable portfolio, based on management's evaluation and analysis of this
portfolio. While management believes that its consideration of the factors and
assumptions referred to above results in an accurate evaluation of existing
losses in the portfolio based on prior trends and experience, changes in the
assumptions or trends within reasonable historical volatility may have a
material impact on our allowance for losses. A 10% variation in management's
estimate of allowance for loss adequacy would have a $10 million impact to
earnings. During the last five years, volatility in losses as a percentage of
finance receivables has exceeded 10%.

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

Textron Financial evaluates the recoverability of goodwill 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 might be impaired. Textron
Financial completed its annual impairment test in the fourth quarter of 2004
using the estimates from its long-term strategic plan. No adjustment was
required to the carrying value of goodwill 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 an extrapolation of the businesses' multi-year
strategic business plans. 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.

18

A compounded annual growth rate assumption of 5% was used in 2004 to
estimate cash flows beyond the multi-year business plan period. Other
significant assumptions utilized were an estimated cash flow discount rate of
11% and an effective tax rate of 34%. In 2003, similar discount rate and
effective tax rate assumptions were utilized and compounded growth rates ranged
from 2% to 5%. If different assumptions were used in these plans, the related
cash flows used in measuring impairment could be different potentially resulting
in an impairment charge. These assumptions involve significant levels of
judgment, however, a 10% adverse change in any one, or a combination of these
factors would not have resulted in an impairment charge. Management believes
that while future growth, discount rates and tax rates have the potential to
change with evolving market conditions, no significant, imminent changes in
these assumptions are likely.

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 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.

19

2004 vs. 2003

Finance charges and discounts declined in 2004 largely due to $269 million
of lower average finance receivables ($21 million) and a reduction of discount
earnings in Distribution Finance ($11 million). The decrease in average finance
receivables was primarily related to the continued liquidation of non-core
assets in the Other segment ($391 million), including portfolio sales of
franchise finance receivables and prepayments in the syndicated bank loan and
media finance portfolios, partially offset by growth in the Company's core
businesses, Structured Capital ($100 million) and Golf Finance ($98 million).
The increase in Securitization gains was primarily due to improved yield and a
$265 million increase in average finance receivables sold to the Distribution
Finance revolving conduit ($20 million), partially offset by a reduction in
Resort Finance gains of $6 million. The decrease in other income was mostly due
to impairment charges related to equity investments resulting from the
disposition of two syndicated bank loans ($10 million), late charges ($2
million) and syndication income ($2 million). These decreases were partially
offset by an increase in prepayment gains ($10 million) in Structured Capital.

Net interest margin decreased $10 million (3%) as compared to the
corresponding period in 2003 primarily due to $269 million of lower average
finance receivables ($12 million), a reduction of discount earnings ($11
million), and lower other income, partially offset by higher securitization
gains and a reduction in borrowing cost. The reduction in borrowing cost was
related to the maturity of higher rate debt. However, the Company's interest
margin percentage increased to 7.14% as compared to 6.92% during 2003, primarily
attributable to the aforementioned higher Securitization gains and reduction in
borrowing cost, partially offset by lower other income.

2003 vs. 2002

The decrease in finance charges and discounts 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 ($8 million), primarily resulting from a $9 million nonrecurring gain on
the sale of a franchise finance portfolio in 2002 and lower investment income
($5 million) from a decrease in earnings on retained securitization assets,
partially offset by higher servicing income ($9 million) from the revolving
securitization conduit for Distribution Finance receivables. Net interest margin
remained stable primarily as a result of a reduction in interest expense which
offset the decreases in revenues described above. 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.

SELLING AND ADMINISTRATIVE EXPENSES

2004 vs. 2003

The decrease in selling and administrative expenses was mostly due to
decreases in legal and collection expense ($6 million) and telecommunications
($1 million). These decreases were partially offset by an increase in employee
salaries and benefits expense ($4 million) primarily due to higher healthcare
and pension costs, and increased performance based compensation tied to the
Company's improved profitability. The decrease in legal and collection costs was
partly due to lower litigation reserves recorded in 2004.

20

2003 vs. 2002

The increase in 2003 selling and administrative expenses largely resulted
from higher legal and collection costs ($12 million), primarily related to the
continued resolution of nonperforming accounts and the accrual of settlement
costs associated with litigation during the year, and higher data processing
costs ($4 million) and healthcare ($3 million), and to a lesser extent, growth
in average managed and serviced finance receivables ($2 million).

PROVISION FOR LOSSES

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

2004 vs. 2003

Provision for losses decreased in 2004 largely reflecting an improvement in
portfolio quality. Nonaccrual finance receivables decreased $33 million as
compared to the corresponding period in 2003. The decrease in net charge-offs
was primarily attributable to the Other segment reflecting the Company's reduced
level of exposure to non-core assets. In addition, the Company experienced lower
net charge-offs in most of its core businesses including reductions in Aircraft
Finance, Distribution Finance and Asset-Based Lending. These decreases were
partially offset by an increase in Resort Finance related to the charge-off of
two accounts for which reserves had been previously provided.

The increase in the allowance for losses on finance receivables as a
percentage of nonaccrual finance receivables reflects the combination of a $702
million increase in finance receivables and a $33 million decrease in nonaccrual
finance receivables. As the level of the allowance for losses related to
homogeneous loan pools is based partially on historical loss experience,
decreases in nonaccrual finance receivable balances do not have an instantaneous
impact on the loss rates applied to these homogeneous pools of receivables.

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 finance receivables as a
percentage of nonaccrual finance receivables reflects a $63 million decrease in
under-collateralized nonaccrual finance receivables with identified reserve
requirements of $47 million at January 3, 2004 as compared to $110 million at
December 28, 2002.

OPERATING RESULTS BY SEGMENT

Segment income presented in the tables below represents income from
continuing operations before special charges, income taxes and distributions on
preferred securities.

Distribution Finance

Distribution Finance segment income increased in 2004 reflecting higher net
interest margin and lower provision for losses, partially offset by an increase
in selling and administrative expenses. The increase in net interest margin was
primarily the result of higher securitization gains ($20 million) due to
improved yield and a $265 million increase in average finance receivables sold
to the revolving conduit, partially offset by a decrease in discount earnings of
$11 million. The lower provision for losses reflected a change in reserving
requirements for this segment based on strong portfolio performance as supported
by improvements in 12- and 36- month loss to liquidation ratios. The increase in
selling and administrative expenses was proportional to growth in the segment's
managed finance assets.

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 million) mostly due to increased securitization activity.

22

Resort Finance

The decrease in Resort Finance segment income in 2004 was primarily the
result of a higher provision for losses and lower net interest margin, partially
offset by lower selling and administrative expenses. The increase in provision
for losses was primarily due to specific reserving actions taken on several
nonperforming accounts and higher levels of nonperforming assets in the land
finance portfolio. The decrease in net interest margin was primarily due to
lower securitization gains ($6 million), partially offset by higher other income
($2 million).

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 ($5 million), partially offset by higher average finance
receivables ($85 million).

Golf Finance

The decrease in segment income in 2004 was largely due to a lower net
interest margin and a higher provision for losses. The decrease in net interest
margin was primarily the result of lower securitization related income ($6
million) and a gain on sale related to a golf equipment portfolio ($4 million)
in 2003, partially offset by a $100 million increase in average net receivables
($3 million) and higher syndication income in the golf course mortgage portfolio
($2 million). The higher provision for losses reflected growth in the portfolio.

Golf Finance segment income improved in 2003 principally reflecting an
increase in net interest margin from higher other income ($7 million), mostly
related to a $4 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 golf equipment portfolio.

Aircraft Finance

23

Aircraft Finance segment income improved significantly in 2004 as a result
of a higher net interest margin and a lower provision for losses. Net interest
margin increased primarily due to higher securitization related income ($3
million), an increase in pricing ($2 million) as well as a reduction in
borrowing costs related to the maturity of higher rate debt ($3 million). These
increases were partially offset by a $108 million decrease in average finance
receivables ($2 million). The lower provision for losses largely reflected an
improvement in portfolio quality.

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 ($5 million), mostly
securitization gains and investment income, and a decrease in average finance
receivables ($87 million).

Asset-Based Lending

The decrease in Asset-Based segment income in 2004 reflected a decrease in
net interest margin and an increase in provision for losses, partially offset by
lower selling and administrative expenses. The lower net interest margin was
primarily the result of a decline in portfolio yields ($3 million) and a
decrease in other income ($2 million), partially offset by a $14 million
increase in average finance receivables ($1 million). The increase in provision
for losses reflected growth in the portfolio. The reduction in selling and
administrative expenses was mostly the result of a restructuring program
implemented during the fourth quarter of 2003.

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).

Structured Capital

The increase in Structured Capital segment income in 2004 was the result of
a higher net interest margin, primarily reflecting higher prepayment income ($10
million) and a $79 million increase in average finance receivables ($5 million).

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 money cost. Average
finance receivables are relatively unchanged.

24

Other Segment

The improvement in Other segment loss as compared to 2003 was primarily the
result of a significantly lower provision for losses and a decline in selling
and administrative expenses, partially offset by a lower net interest margin.
The decrease in the provision for losses reflects a declining level of
nonperforming assets and delinquencies within the portfolio and a decrease in
finance receivables during the year of $303 million. The lower net interest
margin reflects the continued liquidation of the finance receivables within
these non-core businesses through portfolio sales, prepayments and collections,
and lower other income primarily due to impairment charges related to equity
investments resulting from the disposition of two syndicated bank loans ($10
million).

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 million), principally syndication gains from the sale of
a franchise finance receivable portfolio in 2002, and the run-off of liquidating
portfolios.

INCOME FROM CONTINUING OPERATIONS

Income from continuing operations of $94 million for 2004 was $15 million
or 20% higher than 2003. The increase was due to a lower loss provision ($23
million), a decrease in operating expenses ($3 million) and a decrease in
special charges ($6 million), partially offset by a higher effective tax rate
($1 million) and lower interest margin ($10 million).

Income from continuing operations of $79 million for 2003 was $3 million or
3% higher than 2002. The increase was due to a lower loss provision ($30
million) and a lower effective tax rate ($4 million), partially offset by higher
operating expenses ($26 million), an increase in special charges ($6 million)
due to the restructuring of operations, and lower interest margin ($1 million).

NEW ACCOUNTING PRONOUNCEMENTS

In December 2003, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 03-3 "Accounting for Certain Loans or
Debt Securities Acquired in a Transfer." This SOP addresses accounting and
disclosure for differences between contractual and expected cash flows from
investments in loans acquired in a transfer if such differences are
attributable, at least in part, to deterioration in credit quality since
origination. It requires that the excess of contractual cash flows over expected
cash flows at the time of acquisition be accounted for as a nonaccretable
component of the loan balance and prohibits such amounts from being recognized
as an allowance for losses. The SOP is effective for loans acquired in fiscal
years beginning after December 15, 2004.

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 speak only as of the date on which
they are made, and we undertake no obligation to update or revise any
forward-looking statements. These forward-looking statements are subject to
risks and

25

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; (j) uncertainty in estimating contingent liabilities
and establishing reserves tailored to address such contingencies and; (k)
performance of acquisitions.

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 and "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Interest Rate Sensitivity," in Item 7 of this Form 10-K.

26

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF MANAGEMENT

Management is responsible for the integrity and objectivity of the
financial data presented in this Annual Report on Form 10-K. The consolidated
financial statements have been prepared in conformity with accounting principles
generally accepted in the United States and include amounts based on
management's best estimates and judgments. Management is also responsible for
establishing and maintaining adequate internal control over financial reporting
for Textron Financial Corporation, as such term is defined in Exchange Act Rules
13a-15(f). With the participation of our management, we conducted an evaluation
of the effectiveness of our internal control over financial reporting based on
the framework in Internal Control -- Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on our
evaluation under the framework in Internal Control -- Integrated Framework, we
have concluded that Textron Financial Corporation maintained, in all material
respects, effective internal control over financial reporting as of January 1,
2005.

The independent registered public accounting firm, Ernst & Young LLP, has
audited the consolidated financial statements of Textron Financial Corporation
and has issued an attestation report on our assessment of the effectiveness of
Textron Financial Corporation's internal control over financial reporting as of
January 1, 2005, as stated in its reports, which are included herein.

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

/s/ TED R. FRENCH
--------------------------------------
Ted R. French
Chairman and Chief Executive Officer

February 16, 2005

/s/ THOMAS J. CULLEN
--------------------------------------
Thomas J. Cullen
Executive Vice President and
Chief Financial Officer

February 16, 2005

27

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
INTERNAL CONTROL OVER FINANCIAL REPORTING

THE BOARD OF DIRECTORS
TEXTRON FINANCIAL CORPORATION

We have audited management's assessment, included in the accompanying
Report of Management, that Textron Financial Corporation maintained effective
internal control over financial reporting as of January 1, 2005, based on
criteria established in Internal Control -- Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (the COSO
criteria). Textron Financial Corporation's management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the company's internal control over financial
reporting based on our audit.

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

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

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

In our opinion, management's assessment that Textron Financial Corporation
maintained effective internal control over financial reporting as of January 1,
2005, is fairly stated, in all material respects, based on the COSO criteria.
Also, in our opinion, Textron Financial Corporation maintained, in all material
respects, effective internal control over financial reporting as of January 1,
2005, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheets of Textron Financial Corporation as of January 1, 2005 and January 3,
2004, 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
1, 2005 of Textron Financial Corporation and our report dated February 16, 2005
expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Boston, Massachusetts
February 16, 2005
28

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TO THE BOARD OF DIRECTORS
TEXTRON FINANCIAL CORPORATION

We have audited the accompanying consolidated balance sheets of Textron
Financial Corporation as of January 1, 2005 and January 3, 2004, 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 1, 2005. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Textron
Financial Corporation at January 1, 2005 and January 3, 2004 and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended January 1, 2005, in conformity with U.S. generally
accepted accounting principles.

We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of Textron
Financial Corporation's internal control over financial reporting as of January
1, 2005 based on criteria established in Internal Control -- Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated February 16, 2005 expressed an unqualified
opinion thereon.

/s/ Ernst & Young LLP

Boston, Massachusetts
February 16, 2005

29

CONSOLIDATED STATEMENTS OF INCOME

For each of the three years in the period ended January 1, 2005

See notes to consolidated financial statements.
30

CONSOLIDATED BALANCE SHEETS

See notes to consolidated financial statements.
31

CONSOLIDATED STATEMENTS OF CASH FLOWS

For each of the three years in the period ended January 1, 2005

See notes to consolidated financial statements.
32

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY

For each of the three years in the period ended January 1, 2005

See notes to consolidated financial statements.
33

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
middle-market companies that manufacture or distribute finished goods, and
provides factoring arrangements primarily for freight companies. 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 finances
Textron products worldwide, principally Bell helicopters and Cessna aircraft.

Textron Financial is a subsidiary of Textron Inc. (Textron), a global
multi-industry company with operations in five business segments: Bell, Cessna,
Fastening Systems, Industrial and Finance. At January 1, 2005 and January 3,
2004, 21% of Textron Financial's total managed finance receivables were related
to the financing of Textron's products. 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.

34

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 syndication gains on the sale of loans and leases,
late charges, prepayment gains, servicing fees, residual gains, 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 Finance Receivables

Management evaluates its allowance for losses on finance 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 finance receivables
at a level considered adequate to cover existing losses in the owned 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. In addition, the Company identifies loans that are considered
impaired due to the significant modification of the original loan terms to
reflect deferred principal payments generally at market interest rates, but
which continue to accrue finance charges since full collection of principal and
interest is not doubtful. 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, less selling costs. 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

Management evaluates the recoverability of goodwill 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 might be impaired. Goodwill is
considered to be impaired
35

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.

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 $1.1 million, $0.6 million and $2.1 million in 2004,
2003 and 2002, respectively. The cost of the defined benefit pension plan
amounted to approximately $7.7 million, $6.6 million and $4.6 million in 2004,
2003 and 2002, 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,

36

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 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
2004.

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 Pronouncement

In December 2003, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 03-3 "Accounting for Certain Loans or
Debt Securities Acquired in a Transfer." This SOP addresses accounting and
disclosure for differences between contractual and expected cash flows from
investments in loans acquired in a transfer if such differences are
attributable, at least in part, to deterioration in credit quality since
origination. It requires that the excess of contractual cash flows over expected
cash flows at the time of acquisition be accounted for as a nonaccretable
component of the loan balance and prohibits such amounts from being recognized
as an allowance for losses. The SOP is effective for loans acquired in fiscal
years beginning after December 15, 2004.

NOTE 2 OTHER INCOME

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

37

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 million. As of January 3,
2004, Textron Financial paid severance related benefits and other expenses of $2
million and utilized $1 million in fixed asset impairments, leaving a reserve
balance of $3 million. Textron Financial paid the remaining restructuring costs
in 2004.

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. The Company entered into a loss
sharing agreement related to the sale, which requires Textron Financial to
reimburse the purchaser for a portion of losses incurred on the portfolio above
a predetermined level. The Company originally recorded a liability of $14
million representing the estimated fair value of the guarantee, which expires in
2008. The remaining $13 million liability is recorded in Accrued interest and
other liabilities. 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.

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 affiliates (net of payments or reimbursements for interest
charged at more or less than market rates on Textron manufactured products) of
$6 million in 2004 and 2003, and $9 million in 2002, and operating lease
revenues of $24 million in 2004, $22 million in 2003, and $21 million in 2002.
In 2004, 2003, and 2002, Textron Financial paid Textron $0.9 billion, $0.9
billion, and $1.0 billion, respectively, relating to the sale of manufactured
products to third parties that were financed by the Company. In addition, the
Company paid Textron $77 million, $56 million, and $104 million, respectively,
for the purchase of operating 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 $330 million at January 1, 2005 and $428 million at January 3,
2004, and operating leases of $136 million at January 1, 2005 and $126 million
at January 3, 2004, were subject to recourse to Textron or due from Textron.

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 $14 million at January 1, 2005 ($21 million at January 3, 2004) 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

38

facilities to permit Textron Financial to borrow under these facilities. Textron
Financial had not utilized those facilities at January 1, 2005.

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 2004, 2003, or 2002.

The Company had income taxes receivable of $7 million at January 1, 2005
and income taxes payable of $79 million at January 3, 2004. 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 1,
2005, 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.

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. Contractual maturities of finance leases include residual values
expected to be realized at contractual maturity. Leases with no significant
residual value at the end of the contractual term have been classified as
Installment contracts, as their legal and economic substance is more equivalent
to a secured borrowing than a finance lease with a significant residual value.
Accordingly, contractual maturities of these contracts presented above represent
the minimum lease payments, net of the unearned income to be recognized over the
life of the lease. Total minimum lease payments and unearned income related to
these contracts were $708 million and $136 million, respectively, at January 1,
2005, and $670 million and $99 million, respectively, at January 3, 2004.
Minimum lease payments due under these contracts for each of the next five years
and the aggregate amounts due thereafter are as follows: $137 million in 2005,
$120 million in 2006, $101 million in 2007, $92 million in 2008, $92 million in
2009 and $166 million thereafter.

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 $798 million, consist of loans with
an average balance of $3.3 million and an average remaining contractual maturity
of four years. Resort mortgages, totaling $207 million, consist of loans with an
average balance of $3.9 million and an average remaining contractual maturity of
two years.

39

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 2004, such cash turnover was 8.2 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.

Concentrations

Textron Financial's finance receivables are diversified across geographic
region, borrower industry and type of collateral. The Company does not track
revenues by geographic region. As an alternative, the Company believes managed
finance receivables by geographic location is a more meaningful concentration
measurement. Textron Financial's geographic concentrations (as measured by
managed finance receivables) were as follows:

Textron Financial's industry concentrations (as measured by managed finance
receivables) were as follows:

40

Leveraged Leases

Approximately 27% of Textron Financial's investment in leveraged leases is
collateralized by real estate.

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: $83 million in
2005, $54 million in 2006, $47 million in 2007, $29 million in 2008, $10 million
in 2009 and $160 million thereafter.

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. In addition, the Company identifies loans that are considered
impaired due to the significant modification of the original loan terms to
reflect deferred principal payments generally at market interest rates, but
which continue to accrue finance charges since full collection of principal and
interest is not doubtful. 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, less selling costs. 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

41

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.

Nonaccrual finance receivables resulted in Textron Financial's finance
charges being reduced by $15 million, $16 million and $16 million for 2004, 2003
and 2002, respectively. No finance charges were recognized using the cash basis
method.

Captive finance receivables with recourse that were 90 days or more
delinquent amounted to $31 million, $41 million and $85 million at the years
ended 2004, 2003 and 2002, respectively, and were 9.3%, 9.6% and 13.9% of
captive finance receivables with recourse, respectively. Revenues recognized on
90 day or more delinquent accounts were $3 million, $6 million and $8 million
for years ended 2004, 2003 and 2002, respectively.

Allowance for Losses on Finance Receivables

The following table presents changes in the Allowance for losses on finance
receivables.

Managed and Serviced Finance Receivables

Textron Financial manages and services finance receivables for a variety of
investors, participants and third-party portfolio owners. Managed and serviced
finance receivables are summarized as follows:

42

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

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.

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 1, 2005 was $42 million, and in the event Textron Financial's credit
rating falls below BBB, the Company is required to pledge related equipment
residuals of $10 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 .25% and 7.5%, respectively. An instantaneous 20%
adverse change in these rates would have an insignificant impact on the
valuation of this recourse liability.

Owned receivables include approximately $82 million of finance receivables
that were unfunded at January 1, 2005, 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 2004, the Company securitized general aviation aircraft loans,
distribution finance receivables (dealer financing arrangements), and vacation
interval loans (timeshare notes receivable). The Company recognized pretax gains
as follows:

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 75 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 2004 were as
follows:

43

At January 1, 2005, 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:

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.

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 1, 2005, static pool losses related to term securitizations
in the general aviation aircraft loan portfolio are as follows:

These loss rates relate to 29% 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.

44

Historical loss and delinquency amounts for Textron Financial's securitized
portfolio and all similarly managed owned receivables for the year ended January
1, 2005, were as follows:

Data presented above for vacation interval loans represents only the
securitized portfolio. This portfolio is originated by resort developers and
serviced by the Company. Textron Financial does not directly own similar assets.
Credit losses reported in the above table are charged against the resort
developers' retained interests, which are subordinate to Textron Financial's
retained interests. These credit losses are often mitigated by the resort
developers who provide replacement loans to the trust for receivables which
become 90 days or more delinquent.

The table below summarizes certain cash flows received from and paid to
securitization trusts during the years ended January 1, 2005 and January 3,
2004, respectively. Proceeds from securitizations includes proceeds received
related to incremental increases in the level of Distribution finance
receivables sold and excludes amounts received related to the ongoing
replenishment of the outstanding sold balance of these receivables with short
durations.

NOTE 8 EQUIPMENT ON OPERATING LEASES

45

Initial lease terms of equipment on operating leases range from one year to
ten years. Future minimum rentals at January 1, 2005, are $27 million in 2005,
$19 million in 2006, $16 million in 2007, $12 million in 2008, $10 million in
2009 and $24 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 million ($23 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 sold the portfolio of its small business finance
operation on December 19, 2003. The sale resulted in a reduction of goodwill
amounting to $12 million. See Note 4 for additional information.

Goodwill totaled $110 million in the Resort Finance segment, $43 million in
the Asset-Based Lending segment and $16 million in the Aircraft Finance segment
at both January 1, 2005 and January 3, 2004.

NOTE 10 OTHER ASSETS

Textron Financial reviews all Other assets for potential impairment on a
periodic basis. As a result of these reviews, the Company recorded impairment
charges in other income of $5 million and $1 million on Retained interests in
securitizations in 2004 and 2003, respectively, and $13 million and $2 million
on Other long-term investments in 2004 and 2003, respectively.

The cost of fixed assets is being depreciated using the straight-line
method based on the estimated useful lives of the 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 December 2004, the Company legally
transferred ownership in $60 million of golf equipment residuals for $71 million
in cash proceeds. The proceeds received, net of the carrying value of the assets
transferred, are classified in Accrued interest and other liabilities. The
purchaser is entitled to the cash flows from the eventual disposition of the
equipment residuals and a contingent recourse obligation of up to 10% of the
purchase price maintained by Textron Financial.

Interest-only securities within retained interest in securitizations were
$62 million and $72 million at January 1, 2005 and January 3, 2004,
respectively.

46

The Other category primarily represents the fair value of derivative
instruments and debt acquisition costs.

NOTE 11 DEBT AND CREDIT FACILITIES

Textron Financial has committed bank lines of credit of $1.5 billion, of
which $500 million expires in 2005 and $1.0 billion expires in 2008. The $500
million facility includes a one-year term out option, effectively extending its
expiration into 2006. Lines of credit not reserved as support for outstanding
commercial paper or letters of credit were $187 million at January 1, 2005,
compared to $966 million at January 3, 2004. In addition, Textron Financial is
permitted to borrow under Textron's $1.25 billion revolving credit facilities,
of which $250 million expires in 2005 and $1.0 billion expires in 2007. None of
these lines of credit were used at January 1, 2005, or January 3, 2004. During
the first quarter of 2004, the Company established an Australian dollar (AUD)
100 million committed credit facility that expires in 2005, of which AUD 88
million remained unused at January 1, 2005. The Company also maintains a
Canadian dollar 50 million uncommitted credit facility. At January 1, 2005, the
Company had not used any portion of this facility. Textron Financial also has a
$25 million multi-currency committed credit facility, of which $17 million
remained unused at January 1, 2005. This facility expires in 2005. Textron
Financial generally pays fees in support of the committed lines.

The Company had interest rate exchange agreements related to the conversion
of fixed rate debt to variable rate debt at the time of issuance, of $2.2
billion and $1.9 billion at January 1, 2005 and January 3, 2004, respectively,
whereby the Company makes periodic floating rate payments in exchange for
periodic fixed rate receipts. During 2004, Textron Financial entered into $200
million of interest rate exchange agreements related to the conversion of
variable rate debt to fixed rate debt at the time of issuance.

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

47

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 1.57% in 2004, 1.47% in 2003 and 2.07% in 2002.
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 during the last three years before consideration of the
effect of interest rate exchange agreements, were 2.61% in 2004, 2.47% in 2003
and 2.58% in 2002.

Securitizations are an important source of liquidity for Textron Financial
and involve the periodic transfer of finance receivables to qualified special
purpose trusts. At both January 1, 2005, and January 3, 2004, the amount of debt
related to these securitization trusts was $1.9 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 1, 2005, $451 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%).

Cash payments made by Textron Financial for interest were $157 million in
2004, $182 million in 2003 and $196 million in 2002.

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. The
Company 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
2004 and 2003.

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 expense. At January 1, 2005, the Company had interest
rate exchange agreements with a fair value of $10.8 million designated as fair
value hedges, compared to a fair value of $8.1 million at January 3, 2004.

During 2004, the Company entered into interest rate exchange agreements to
convert variable rate debt to fixed rate debt to mitigate its risk to
variability in the cash flows attributable to certain future interest payments.
The Company has designated these instruments 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 1, 2005, the Company had interest rate exchange
agreements with a fair value of $1.3 million. The Company expects

48

$0.3 million of net of tax deferred losses to be reclassified to earnings
related to these hedge relationships in 2005.

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 1,
2005, these instruments had a fair value liability of $7.8 million, compared to
a fair value liability of $13.7 million at January 3, 2004. The Company expects
approximately $0.8 million of net of tax deferred gains to be reclassified to
earnings related to these hedge relationships in 2005.

At January 1, 2005, the Company had $6.2 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 38 months and expects approximately $1.9
million, net of income taxes, deferred losses to be reclassified to earnings in
2005.

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 U.S. dollar 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
1, 2005, these instruments had a fair value of $41.8 million, compared to a fair
value of $26.0 million at January 3, 2004. The Company expects approximately
$0.3 million of net of tax deferred gains to be reclassified to earnings related
to these hedge relationships in 2005.

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 1, 2005, these
instruments had a fair value liability of $6.4 million, compared to a fair value
liability of $1.1 million at January 3, 2004.

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 2004.

NOTE 13 JUNIOR SUBORDINATED DEBENTURES

On June 30, 2004, Textron Financial Corporation redeemed all of the $26
million Litchfield 10% Series A Junior Subordinated Debentures, due 2029. The
debentures were held by a trust sponsored and wholly-owned by Litchfield
Financial Corporation, a subsidiary of Textron Financial Corporation. The
proceeds from the redemption were used to redeem all of the $26 million
Litchfield Capital Trust I 10% Series A Trust Preferred Securities at par value
of $10 per share. There was no gain or loss on the redemption.

49

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 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 INCOME (LOSS)

Accumulated other comprehensive income (loss) is summarized as follows:

NOTE 16 INCOME TAXES

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

50

The components of income taxes were as follows:

Cash (received) paid for income taxes was $61 million in 2004, ($6) million
in 2003 and ($31) million in 2002.

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

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

51

At January 1, 2005, Textron Financial had state net operating loss
carryforwards of approximately $373 million available to offset future state
taxable income. The state net operating loss carryforwards will expire in years
2005 through 2024. 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.

Deferred income taxes have not been provided for the undistributed earnings
of foreign subsidiaries, which approximated $14 million at the end of 2004 as
management intends to reinvest those earnings for an indefinite period. If
foreign subsidiaries' earnings were distributed, 2004 taxes, net of foreign tax
credits, would be increased by approximately $5 million.

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
individually large balance 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 allowance for losses on finance receivables represents the credit risk
adjustment required to reflect the loan portfolios' fair value. It excludes the
allowance for losses attributable to finance lease portfolios. The fair values,
net of carrying amounts of Textron Financial's leveraged leases, finance leases
and operating leases ($539 million, $410 million and $237 million, respectively,
at January 1, 2005, and $513 million, $309 million and $210 million,
respectively, at January 3, 2004), 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 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.

52

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. Included in the revolving lines of credit are $30 million of
commitments where funding is dependent on compliance with customary financial
covenants. Advances under the remaining $980 million of committed facilities are
dependent on both compliance with customary financial covenants and the
availability of eligible collateral. 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 either floating rate loans based on a market index
or 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 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 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 1, 2005, are shown below:

Textron Financial's offices are occupied under noncancelable operating
leases expiring on various dates through 2012. Rental expense was $7 million in
2004 ($7 million in 2003 and $8 million in 2002). Future

53

minimum rental commitments for all noncancelable operating leases in effect at
January 1, 2005, approximated $5 million for 2005, $5 million for 2006, $4
million for 2007, $4 million for 2008, $2 million for 2009 and $3 million
thereafter. Of these amounts, $1 million is payable to Textron in years 2005
through 2008.

NOTE 19 CONTINGENCIES

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 financing of certain land purchases by consumers through a third-party
land developer commonly known as "Buyer's Source." Among other claims, the
purported class action alleges fraud in the financing of Buyer's Source and
seeks compensatory damages and punitive damages in excess of $10 million. The
Company intends to aggressively defend this claim. The Company believes that the
purported class action will not have a material effect on the Company's
financial position and results of operations.

Textron Financial is subject to challenges from tax authorities regarding
amounts of tax due. These challenges may alter the timing or amount of taxable
income or deductions, or the allocation of income among tax jurisdictions. The
Internal Revenue Service (IRS) is conducting an examination of the Company's
Federal income tax returns for the years 2001, 2000, 1999 and 1998, and has
issued a Notice of Proposed Adjustment that may affect certain leveraged lease
transactions with a total initial investment of approximately $77 million.
Resolution of these issues may result in an adjustment to the timing of taxable
income and deductions that reduce the effective yield of the leveraged lease
transactions and could result in a pretax adjustment to income. The resolution
of these issues and the impact on the Company's financial position and results
of operations cannot be reasonably estimated at this time. Management believes
that the proposed IRS adjustments are inconsistent with existing tax law and
intends to vigorously defend the Company's position.

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 FINANCIAL INFORMATION ABOUT OPERATING 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, syndicated bank loans and 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.

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

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NOTE 21 QUARTERLY FINANCIAL DATA (UNAUDITED)

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

Not applicable.

ITEM 9A. CONTROLS AND PROCEDURES

We have carried out an evaluation, under the supervision and the
participation of our management, including our Chairman and Chief Executive
Officer (our "CEO") and our Executive Vice President and Chief Financial Officer
(our "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
fiscal 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.

a) See Report of Management in Item 8 of this Form 10-K.

b) See the Reports of Independent Registered Public Accounting Firm in
Item 8 of this Form 10-K.

c) Changes in Internal Controls -- There has been no change in our
internal control over financial reporting during the fourth fiscal 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.

ITEM 9B. OTHER INFORMATION

Not applicable.

56

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.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Omitted per Instruction I of Form 10-K.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

The aggregate fees for professional services rendered by Ernst & Young LLP
during 2004 and 2003 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 $1.2 million and $1.0 million, in 2004 and 2003, 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 $0.2 million and $0.3
million in 2004 and 2003, respectively.

Tax Services -- Fees for tax services relating to consultations and
compliance were $18 thousand and $21 thousand in 2004 and 2003, respectively.

Other Services -- Other service fees relating to miscellaneous services
were $22 thousand and $89 thousand in 2004 and 2003, respectively.

No fees were paid to Ernst & Young LLP for financial information systems
design and implementation services during 2004 or 2003.

PART IV.

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(1) 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 for each of the years in the
three-year period ended January 1, 2005

2. Consolidated balance sheets at January 1, 2005 and January 3, 2004

3. Consolidated statements of cash flows for each of the years in the
three-year period ended January 1, 2005

4. Consolidated statements of changes in shareholder's equity for each of
the years in the three-year period ended January 1, 2005

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.

57

(2) 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.

58

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

** 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)

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.
59

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 23(rd) day of February 2005.

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 23(rd) day of February 2005, 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/ THOMAS N. NICHIPOR
------------------------------------
Thomas N. Nichipor
Vice President and Corporate
Controller (Principal Accounting
Officer)

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

60