UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

Commission file number 001-15515

 

Textron Financial Corporation

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Registrant’s telephone number, including area code: (401) 621-4200

 

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

 

 

 

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

Common Stock, $100.00 par value

 

 

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

 

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

 

 

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

 

 

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

 

 

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

 

 

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

(Do not check if a smaller reporting company)

 

 

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

 

 

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

 

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

 

 

TABLE OF CONTENTS

 

 

 

General

 

Textron Financial Corporation (Textron Financial, TFC or the Company) is a commercial finance business. In the fourth quarter of 2008, Textron Inc. (Textron) announced a plan to exit the non-captive portion of our commercial finance business, while retaining the captive portion of the business that supports customer purchases of products which Textron manufactures. The decision was made to exit this business in order to address Textron’s long-term liquidity position in light of the disruption and instability in the capital markets. During 2009, we transitioned to operating our business in two segments, the Captive Finance segment, which is our ongoing finance business that supports customer purchases of Textron-manufactured products, and the Non-Captive Finance segment, which we are continuing to liquidate.

 

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

 

The Non-captive Finance segment includes the Distribution Finance, Golf Mortgage, Structured Capital, Timeshare and Other Liquidating product lines. Historically, Distribution Finance has offered inventory finance programs for dealers of Textron manufactured products and for dealers of a variety of other household, housing, leisure, agricultural and technology products; Golf Mortgage has historically made mortgage loans for the acquisition and refinancing of golf courses and also includes the former Hotel product line, which provided mortgage loans for the construction and refinancing of hotels; the Timeshare product line has historically extended loans to developers of vacation interval resorts, secured principally by notes receivable and interval inventory; and Structured Capital has primarily engaged in long-term leases of large-ticket equipment and real estate, primarily with investment grade lessees.

 

Textron Financial’s financing activities are offered primarily in North America. However, we finance certain Textron products worldwide, principally Bell helicopters and Cessna aircraft. All of Textron Financial’s stock is owned by Textron, a global multi-industry company with operations in five business segments: Cessna, Bell, Textron Systems, Industrial and Finance. At January 1, 2011 and January 2, 2010, 46% and 40% of Textron Financial’s total finance receivables represented finance receivables originated in support of Textron manufactured products, respectively. For further information on Textron Financial’s relationship with Textron, see Note 3 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 15 to the Consolidated Financial Statements in Item 8 of this Form 10-K.

 

Available Information

 

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

 

Forward-looking Information

 

Certain statements in this report and other oral and written statements made by us from time to time are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements, which may describe strategies, goals, outlook or other non-historical matters, or

project revenues, income, returns or other financial measures, often include words such as “believe,” “expect,” “anticipate,” “intend”, “plan,” “estimate,” “guidance”, “project”, “target”, “potential”, “will”, “should”, “could”, “likely” or “may” and similar expressions intended to identify forward-looking statements. These statements are only predictions and involve known and unknown risks, uncertainties, and other factors that may cause our actual results to differ materially from those expressed or implied by such forward-looking statements. Given these uncertainties, you should not place undue reliance on these forward-looking statements. 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. In addition to those factors described herein under “Risk Factors”, among the factors that could cause actual results to differ materially from past and projected future results are the following:

 

 

 

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

 

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

 

In the fourth quarter of 2008, we announced a plan to exit all of the commercial finance business other than that portion of the business supporting customer purchases of products manufactured by Textron. The exit plan is being implemented through a combination of orderly liquidation and selected sales. We cannot be certain that we will be able to continue to accomplish the orderly liquidation of our portfolio on a timely or successful basis or in a manner that will generate cash sufficient to service our debt. We may encounter delays and difficulties in effecting the continued orderly liquidation of our various receivable portfolios as a result of many factors, including the inability of our customers to find alternative financing, which could expose us to increased credit losses. We may have greater difficulty in selling the remaining receivables that have been designated for sale or transfer, assets that have been acquired upon foreclosure of receivables and/or other non-operating assets at the pricing that we

anticipate or in the time frame that we anticipate. We may be required to make additional mark-to-market or other adjustments against the assets that we intend to sell or to take additional reserves against assets that we intend to retain. We may change our current strategy based on either our performance and liquidity position or changes in external factors affecting the value and/or marketability of our assets, which could result in changes in the classification of assets we intend to hold for investment and additional mark-to-market adjustments. We may incur higher costs than anticipated as a result of this exit plan or be subject to claims made by third parties, and the exit plan may result in increased credit losses. We expect that our portfolio quality will continue to deteriorate as we proceed through the liquidation and that our cash conversion ratio on liquidation will decrease as the asset mix changes; this deterioration could be more severe and the cash conversion ratio lower than we anticipate, resulting in greater losses. Significant delay or difficulty in executing the continued liquidation and/or substantial losses could result in the failure of our portfolio to generate the cash necessary to service our indebtedness, resulting in continuing or increased adverse effects on our financial condition and results of operations.

 

Difficult conditions in the financial markets have adversely affected the quality of our finance asset portfolios, and our losses may increase if we are unable to successfully collect our finance receivables or realize sufficient value from collateral.

 

Our financial performance depends on the quality of loans, leases and other assets in our portfolio. Portfolio quality may be adversely affected by several factors, including finance receivable underwriting procedures, collateral quality, geographic or industry concentrations and the effect of the recent economic downturn on our customers’ businesses, as well as the broader deterioration of the financial markets. As a result of the tumultuous conditions in the financial markets over the past two years, many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers. These conditions have led to an increased level of commercial and consumer delinquencies and defaults, lack of consumer confidence, increased market volatility, widespread reduction of business activity and bankruptcy filings. Valuations of the types of collateral securing our timeshare and other portfolios have been and may continue to be adversely affected by increased consumer delinquencies, the reduction in business activity and bankruptcy proceedings involving our borrowers. Valuations of the types of collateral securing our captive finance portfolio, particularly valuations of used aircraft, have decreased significantly over the past two years and may continue to decrease if weak economic conditions continue. Declining collateral values could result in greater delinquencies and foreclosures as customers elect to discontinue payments on loan balances which exceed asset values. Bankruptcy proceedings involving our borrowers may prevent or delay our ability to exercise our rights and remedies and realize the full value of our collateral. Our losses may increase if our collateral cannot be realized or is liquidated at prices not sufficient to recover the full amount of our finance receivable portfolio. If these negative market conditions persist or worsen, we may experience further deterioration in our ability to successfully collect our finance receivables or realize sufficient value from collateral which may adversely affect our cash flow, profitability and financial condition.

 

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

 

The major rating agencies regularly evaluate Textron and Textron Financial for purposes of assigning credit ratings. Our ability to access the credit markets, and the cost of these borrowings, is affected by the strength of our credit ratings and current market conditions. Failure to maintain investment grade credit ratings that are acceptable to investors may adversely affect the cost and other terms upon which we are able to obtain other financing, as well as our access to the capital markets.

 

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

 

Our ability to continue to offer customer financing for the products which Textron manufactures, and the long-term viability and profitability of the Captive Finance segment, is largely dependent on our ability to obtain funding, whether directly from third-party funding sources or through Textron, at a reasonable cost. This ability and cost, in turn, are dependent on our credit ratings as well as the credit ratings of Textron and are subject to credit market volatility. If we are unable to continue to offer competitive customer financing, it could adversely affect our results of operations, financial condition and our long-term viability.

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

 

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

 

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

 

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

 

We may need to obtain financing in order to meet our debt obligations in the future; such financing may not be available to us on satisfactory terms, if at all.

 

We may periodically need to obtain financing in order to meet our debt obligations as they come due. Although we currently have access to the capital markets, we may not be able to refinance our credit facilities or maturing debt at the time that such financing is necessary at terms that are acceptable to us, or at all. If we cannot obtain adequate sources of credit on favorable terms, or at all, our business, operating results, and financial condition could be adversely affected.

 

The levels of our reserves are subject to many uncertainties and may not be adequate to cover writedowns or losses.

 

We establish reserves to cover uncollectible finance receivables and fair market value writedowns on used aircraft and golf cars. These reserves are subject to adjustment from time to time depending on actual experience and/or current market conditions and are subject to many uncertainties, including bankruptcy or other financial problems at key customers, as well as changing market conditions. We use estimates and various assumptions in determining the fair value of certain of our assets, including finance receivables held-for-sale which do not have active, quoted market prices. We also use estimates and assumptions in determining our allowance for losses on finance receivables held for investment and in determining the residual values of leased equipment and the value of repossessed assets and properties and operating assets received in satisfaction of troubled finance receivables. It is difficult to determine the accuracy of these estimates and assumptions, and our actual experience may differ materially from these estimates and assumptions. A material difference between our estimates and assumptions and our actual experience may adversely affect our cash flow, profitability, and financial condition.

We are subject to legal proceedings and other claims.

 

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

 

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

 

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

 

 

None.

 

 

Textron Financial leases office space from a Textron affiliate for its corporate headquarters at 40 Westminster Street, Providence, Rhode Island 02903. The Company leases other offices throughout the U.S. For additional information regarding Textron Financial’s lease obligations, see Note 13 to the Consolidated Financial Statements in Item 8 of this Form 10-K.

 

 

On February 9, 2010 an amended complaint to a purported shareholder class action lawsuit by the City of Roseville Employees’ Retirement System was filed in the United States District Court in Rhode Island against TFC and three of its present and former officers. The original complaint, filed on August 13, 2009, contained claims only against Textron, its Chairman and former Chief Executive Officer and its former Chief Financial Officer. The suit alleges that the defendants violated the federal securities laws by making material misrepresentations or omissions related to Cessna and Textron Financial. The complaint seeks unspecified compensatory damages. Automotive Industries Pension Trust Fund has been appointed lead plaintiff in the case. On April 6, 2010, the court entered a stipulation agreed to by the parties in which plaintiffs voluntarily dismissed, without prejudice, certain causes of action in the amended complaint. On April 9, 2010, all defendants moved to dismiss the remaining counts of the amended complaint, and that motion is still pending. Textron Financial believes that this lawsuit is without merit and intends to defend it vigorously.

 

We are also subject to actual and threatened legal proceedings and other claims against Textron Financial and its subsidiaries arising out of the conduct of our business. These proceedings include claims and counterclaims relating to commercial and financial transactions; lack of compliance with applicable laws and regulations; disputes with syndication partners; loan servicing contracts; employment disputes; and environmental, safety and health matters. Some of these suits and proceedings seek compensatory, treble or punitive damages, fines or penalties in substantial amounts or remediation of environmental contamination. These suits and proceedings are being defended by, or contested on behalf of, Textron Financial and its subsidiaries. On the basis of information presently available, we do not believe that existing proceedings and claims will have a material effect on our financial position or results of operations.

 

 

The common stock of Textron Financial is owned entirely by Textron and, therefore, there is no trading of Textron Financial’s stock. Dividends of $514 million, $358 million and $151 million were declared and paid in 2010, 2009 and 2008, respectively. For additional information regarding restrictions as to dividend availability, see Note 7 to the Consolidated Financial Statements in Item 8 of this Form 10-K.

 

 

Omitted per Instruction I of Form 10-K.

 

 

 

Financial Condition

 

Liquidity and Capital Resources

 

In light of our plan to exit the Non-captive Finance business, we expect to substantially rely on cash from finance receivable collections to fund maturing debt obligations. During 2010, we liquidated $2.6 billion of managed finance receivables, net of originations. These managed finance receivable reductions occurred in both of our segments and all of our product lines, but were primarily driven by Non-captive Finance reductions, including $956 million in Distribution Finance, $408 million in Timeshare and $239 million in Golf Mortgage. These reductions resulted from the combination of scheduled finance receivable collections, sales, discounted payoffs, repossession of collateral, charge-offs and impairment charges recorded as Portfolio losses, net of gains, in our Consolidated Statements of Operations. Finance receivable reductions in the Distribution Finance product line included sales of $375 million of finance receivables. In addition, the reduction in finance receivables included $795 million of liquidations in the Captive Finance segment primarily as a result of reduced loan and lease originations and a sale of $84 million of finance receivables. The originations of the Captive Finance segment exclude finance receivables serviced on behalf of other finance subsidiaries of Textron.

 

In order to meet our capital needs, we could access either secured or unsecured debt markets. During 2010, we issued $166 million of securitized on-balance sheet debt supporting our aviation finance business. In addition, we have borrowed available cash from Textron during 2010 through an intercompany borrowing arrangement as it has been in the collective economic interest of Textron Financial and Textron to do so. We decreased our outstanding intercompany loan balance with Textron to $242 million at January 1, 2011 from $447 million at January 2, 2010. In addition, during 2010, we repaid $1,730 million of long-term debt, $225 million of securitized on-balance sheet debt and $300 million of our bank credit line.

 

We measure the progress of our exit plan related to the Non-captive Finance segment, in part, based on the percentage of finance receivable and other finance asset reductions converted to cash. During 2010, the Non-captive Finance segment achieved a 93% cash conversion ratio as compared to 95% for the year ended January 2, 2010. This performance during 2010 was primarily driven by sales of $375 million of finance receivables in the Distribution Finance product line at prices equivalent to or greater than our carrying value and the liquidation of $408 million of Timeshare finance receivables at a 95% cash conversion ratio. We expect this ratio to continue to decline over the duration of our exit plan due to the change in mix from shorter term assets in the Distribution Finance product line to longer term assets in our Timeshare, Golf Mortgage and Structured Finance product lines and the existence of a higher concentration of nonaccrual finance receivables.

 

Under a Support Agreement between Textron Financial and Textron, Textron is required to ensure that Textron Financial maintains fixed charge coverage of no less than 125% and consolidated shareholder’s equity of no less than $200 million. In 2010 and 2009, Textron Financial’s fixed charge coverage ratio dropped below the required 125%. As a result, Textron made cash payments of $308 million and $270 million to Textron Financial in 2010 and 2009, respectively, and additional payments of $63 million on January 11, 2011 related to 2010, and $75 million on January 12, 2010 related to 2009. These cash payments were reflected as capital contributions to

maintain compliance with the fixed charge coverage ratio required by the Support Agreement and certain of Textron Financial’s credit agreements.

 

Results of Operations

 

Revenues

 

Revenues decreased $153 million in 2010 as compared to 2009 primarily due to the following:

 

 

Loss before Income Taxes and Noncontrolling Interest

 

Loss before income taxes and noncontrolling interest increased $36 million in 2010 as compared to 2009 primarily due to the following:

 

 

The provision for loan losses decreased during 2010 as compared to 2009 primarily due to a decrease in accounts identified as nonaccrual during the period and less of a decline in aircraft collateral values as compared to 2009. During 2009, nonaccrual finance receivables increased from $277 million to $1.0 billion and in 2010 nonaccrual finance receivables decreased to $850 million.

 

Portfolio losses, net of gains decreased during 2010 as compared to 2009 primarily as a result of lower impairment charges in the Structured Capital product line ($40 million), a $21 million decrease in discounts taken on the sale or early termination of finance receivable assets associated with the liquidation of Distribution Finance receivables and $23 million of gains on the sale of two Distribution finance receivable portfolios in the first and third quarters of 2010. These decreases were partially offset by an $11 million increase in impairment charges on owned aircraft that are subject to operating leases or have been repossessed.

Operating and administrative expenses decreased during 2010 as compared to 2009 as a result of our plan to exit the non-captive finance business, primarily due to lower salaries and benefits expense associated with the reduction in workforce. This decrease was partially offset by higher net expenses related to operating golf course assets.

 

The increase in special charges during 2010 as compared to 2009 includes a $91 million non-cash pre-tax charge to reclassify the subsidiary’s cumulative currency translation adjustment account within Other comprehensive loss to the Consolidated Statements of Operations in connection with the substantial liquidation of one of the Company’s wholly-owned Canadian subsidiaries. The reclassification of this amount resulted in a $74 million after-tax charge that did not have an impact on Shareholder’s equity.

 

 

Risk Management

 

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

 

 

Proper management of these risks is essential. Accordingly, the Company has designed risk management systems and procedures to identify and quantify these risks. Textron Financial has established appropriate policies and set prudent limits in these areas. The Company’s management of these risks, and levels of compliance with its policies and limits, is continuously monitored by means of administrative and information systems.

 

Credit Risk Management

 

Textron Financial manages credit risk through:

 

 

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

 

 

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

 

Depending on transaction size and complexity, transactions outside of the segment’s authority require the approval of the Captive Finance segment President and Group Credit Officer. Transactions exceeding segment authority require one or more of the Executive Vice President and Chief Credit Officer, the President and Chief Executive Officer or Textron Financial’s Credit Committee depending on the size of the transaction, and in some cases approvals are required by Textron up to and including its Board of Directors. As of March 1, 2011, Textron Financial’s Credit Committee is comprised of its President and Chief Executive Officer, Executive Vice President and Chief Credit Officer, Executive Vice President and Chief Risk Officer, Executive Vice President and Chief

Financial Officer, Executive Vice President, General Counsel and Secretary, Textron’s Assistant Treasurer, Corporate Finance, the Distribution Finance product line President and the Timeshare product line President.

 

The Company controls the credit risk associated with its portfolio by limiting transaction sizes, as well as diversifying transactions by industry, geographic area, property type and borrower. Through these practices, Textron Financial identifies and limits exposure to unfavorable risks and seeks favorable financing opportunities. Management reviews receivable aging trends and watch list reports and conducts regular business reviews in order to monitor portfolio performance.

 

Geographic Concentration

 

Textron Financial continuously monitors its portfolio to avoid any undue geographic concentration in any region of the U.S. or in any foreign country. At both January 1, 2011 and January 2, 2010, the largest concentration of domestic finance receivables was in the Southeastern U.S., representing 24% and 23% of Textron Financial’s finance receivable portfolio, respectively. At January 1, 2011 and January 2, 2010, international finance receivables represented 28% and 30% of Textron Financial’s finance receivable portfolio, respectively. For additional information regarding Textron Financial’s concentrations, see Note 4 to the Consolidated Financial Statements in Item 8 of this Form 10-K.

 

Asset/Liability Risk Management

 

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

 

 

The Company does not use derivative financial instruments for the purpose of generating earnings from changes in market conditions. Before entering into a derivative transaction, the Company determines that there is a high correlation between the change in value of, or the cash flows associated with, the hedged asset or liability and the value of, or the cash flows associated with, the derivative instrument. When Textron Financial executes a transaction, it designates the derivative to a specific asset, liability, or set of cash flows. Textron Financial monitors the effectiveness of derivatives through a review of the amounts and maturities of assets, liabilities and derivative positions. The Company’s Chief Financial Officer and Textron’s Assistant Treasurer, Corporate Finance 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, 2011, the Company’s largest single counterparty credit exposure was $10 million.

 

Interest Rate Risk Management

 

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

 

Foreign Exchange Risk Management

 

A portion of the finance assets owned by Textron Financial are located outside of North America. These finance receivables are generally in support of Textron’s overseas product sales and are predominantly denominated in U.S. Dollars. Textron Financial has foreign currency finance receivables primarily denominated in Canadian Dollars. In order to minimize the effect of fluctuations in foreign currency exchange rates on the Company’s

financial results, we enter into forward exchange contracts and foreign currency interest rate exchange agreements in amounts sufficient to substantially hedge our foreign currency exposures.

 

Liquidity Risk Management

 

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

 

 

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, 2011, floating-rate liabilities in excess of floating-rate assets were $591 million after considering interest rate exchange agreements and the treatment of $640 million of floating-rate loans with index rate floors as fixed-rate loans. These loans have index rates that are, on average, 198 basis points above the applicable index rate (predominately the Prime rate). The Company has benefited from these interest rate floor agreements in the recent low rate environment. However, in a rising rate environment, this benefit will dissipate until the Prime rate exceeds the floor rates embedded in these agreements.

 

We assess our exposure to interest rate changes using an analysis that measures the potential loss in net income, over a twelve-month period, resulting from a hypothetical change in all interest rates of 100 basis points across all maturities occurring at the outset of the measurement period (sometimes referred to as a “shock test”). The analysis also assumes that prospective receivable additions will be match-funded, existing portfolios will not prepay and contractual maturities of both debt and assets will result in increases or reductions in intercompany borrowing from Textron. This shock test model, when applied to our asset and liability position at January 1, 2011, indicates that an increase in interest rates of 100 basis points would have a negative $2 million impact on net income and cash flows for the following twelve-month period, respectively.

 

 

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, 2011.

 

The independent registered public accounting firm, Ernst & Young LLP, has audited the Consolidated Financial Statements of Textron Financial Corporation and has issued an attestation report on our internal control over financial reporting as of January 1, 2011, as stated in its reports, which are included herein.

 

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

 

Warren R. Lyons

President and Chief Executive Officer

March 1, 2011

 

 

Thomas J. Cullen

Executive Vice President and

Chief Financial Officer

March 1, 2011

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors

Textron Financial Corporation

 

We have audited Textron Financial Corporation’s internal control over financial reporting as of January 1, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Textron Financial Corporation’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

 

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

 

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

 

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

 

In our opinion, Textron Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of January 1, 2011, 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, 2011 and January 2, 2010, and the related Consolidated Statements of Operations, Cash Flows and Changes in Equity for each of the three years in the period ended January 1, 2011 of Textron Financial Corporation and our report dated March 1, 2011 expressed an unqualified opinion thereon.

 

Boston, Massachusetts

March 1, 2011

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors

Textron Financial Corporation

 

We have audited the accompanying Consolidated Balance Sheets of Textron Financial Corporation as of January 1, 2011 and January 2, 2010, and the related Consolidated Statements of Operations, Cash Flows and Changes in Equity for each of the three years in the period ended January 1, 2011. 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, 2011 and January 2, 2010 and the consolidated results of its operations and its cash flows for each of the three years in the period ended January 1, 2011, 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), Textron Financial Corporation’s internal control over financial reporting as of January 1, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2011 expressed an unqualified opinion thereon.

 

Boston, Massachusetts

March 1, 2011

CONSOLIDATED STATEMENTS OF OPERATIONS

 

For each of the three years in the period ended January 1, 2011:

 

 

See Notes to the Consolidated Financial Statements.

 

CONSOLIDATED BALANCE SHEETS

 

 

See Notes to the Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

For each of the three years in the period ended January 1, 2011:

 

 

See Notes to the Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

 

For each of the three years in the period ended January 1, 2011:

 

 

⁽¹⁾ Includes the $74 million non-cash reclassification of the cumulative currency translation adjustments related to one of the Company’s wholly-owned Canadian subsidiaries within Other comprehensive loss, to Special charges in the Consolidated Statements of Operations.

 

See Notes to the Consolidated Financial Statements.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 Summary of Significant Accounting Policies

 

Nature of Operations

 

Textron Financial Corporation (Textron Financial, TFC or the Company) is a commercial finance business. In the fourth quarter of 2008, Textron Inc. (Textron) announced a plan to exit the non-captive portion of our commercial finance business, while retaining the captive portion of the business that supports customer purchases of products which Textron manufactures. The decision was made to exit this business in order to address Textron’s long-term liquidity position in light of the disruption and instability in the capital markets. During 2009, we transitioned to operating our business in two segments, the Captive Finance segment, which is our ongoing finance business that supports customer purchases of Textron-manufactured products, and the Non-Captive Finance segment, which we are continuing to liquidate.

 

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

 

The Non-captive Finance segment now includes the Distribution Finance, Golf Mortgage, Structured Capital, Timeshare and Other Liquidating product lines. Historically, Distribution Finance has offered inventory finance programs for dealers of Textron manufactured products and for dealers of a variety of other household, housing, leisure, agricultural and technology products; Golf Mortgage has historically made mortgage loans for the acquisition and refinancing of golf courses and also includes the former Hotel product line, which provided mortgage loans for the construction and refinancing of hotels; the Timeshare product line has historically extended loans to developers of vacation interval resorts, secured principally by notes receivable and interval inventory; and Structured Capital has primarily engaged in long-term leases of large-ticket equipment and real estate, primarily with investment grade lessees.

 

Textron Financial’s financing activities are offered primarily in North America. However, Textron Financial finances certain Textron products worldwide, principally Bell helicopters and Cessna aircraft. All of Textron Financial’s stock is owned by Textron, a global multi-industry company with operations in five business segments: Cessna, Bell, Textron Systems, Industrial and Finance. At January 1, 2011 and January 2, 2010, 46% and 40%, respectively, of Textron Financial’s total finance receivables represent finance receivables originated in support of Textron manufactured 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 majority-owned subsidiaries. All significant intercompany transactions have been eliminated. In the first quarter of 2009, we sold a 51% residual interest in the Aviation Finance securitization trust to Textron Inc., which is reflected as a Noncontrolling interest on our Consolidated Statements of Changes in Equity. In the fourth quarter of 2009, we repurchased the residual interest.

 

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

 

Finance charges include interest on loans, capital lease earnings, leveraged lease earnings and discounts on certain revolving credit arrangements. Finance charges are recognized in revenues using the interest method to provide a constant rate of return over the terms of the finance assets. Accrual of interest income is suspended if credit quality indicators suggest full collection of principal and interest is doubtful. In addition, we automatically suspend accrual of interest income on accounts which are contractually delinquent by more than three months, unless collection of principal and interest is not doubtful. Cash payments on nonaccrual accounts, including finance charges, generally are applied to reduce the net investment balance. Accrual of interest is resumed when the loan becomes contractually current through payment according to the original terms of the loan or, if a loan has been modified, following a period of performance under the terms of the modification, provided we conclude that collection of all principal and interest is no longer doubtful. Previously suspended interest income is recognized at that time.

 

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

 

Allowance for Losses on Finance Receivables Held for Investment

 

We maintain the allowance for losses on finance receivables held for investment at a level considered adequate to cover inherent losses in the owned finance receivable held for investment portfolio, based on management’s evaluation and analysis by product line. For larger balance accounts specifically identified as impaired, including large accounts in homogeneous portfolios, a reserve is established based on comparing the expected future cash flows, discounted at the finance receivable’s effective interest rate, or the fair value if the finance receivable is collateral dependent, to its carrying amount. The expected future cash flows consider collateral value, the financial performance and liquidity of our borrower, the existence and strength of guarantors, estimated recovery costs, including legal expenses and costs associated with the repossession/foreclosure and eventual disposal of collateral. When there is a range of potential outcomes, we perform multiple discounted cash flow analyses and weight the outcomes based on their relative likelihood of occurrence. This evaluation is inherently subjective, as it requires estimates, including the amount and timing of future cash flows expected to be received on impaired finance receivables and the underlying collateral, which may differ from actual results. While this analysis is specific to each individual account, the most critical factors included in this analysis by product line are as follows:

 

Aviation

 

Industry valuation guides, physical condition of the aircraft, payment history, existence and strength of guarantors.

 

Golf Equipment

 

Age and condition of collateral.

 

Timeshare

 

Historical performance of consumer notes receivable collateral, real estate valuations, operating expenses of the borrower, the impact of potential bankruptcy court rulings on the value of our collateral, legal and other professional expenses and borrower’s access to capital.

 

Golf Mortgage

 

Historical golf course, hotel or marina cash flow performance, estimates of golf rounds and price per round or occupancy and room rates, market discount and capitalization rates and the existence and strength of guarantors.

 

Distribution Finance

 

Age and condition of primary collateral, the existence and strength of guarantors and the existence and value of additional forms of collateral.

 

The evaluation of impaired Revolving loans collateralized by timeshare notes receivable is performed utilizing internally developed cash flow models which incorporate the unique structural features of these loans. Timeshare notes receivables loans are loans to developers of resort properties which are collateralized by pools of consumer notes receivable. These notes receivable are originated by developers in connection with the sale of vacation intervals and typically bear interest at rates in excess of the rate on our loan to the developer. In addition to the interest differential between the consumer notes and our loan to the developers, there are several features of our loans which provide protection from credit losses in the pools of consumer notes. We have a priority interest in all cash flows from these pools of consumer notes, typically advance approximately 90% of the collateral value, have a security interest in either the underlying real estate or the right to use the resort property and often have personal guarantees from the principal(s) of the developer. Our impairment models incorporate management’s best estimate of credit losses in the pools of consumer notes based on historical trends as adjusted for our understanding of current trends in the developer’s underwriting practices and the developer’s ability to mitigate losses through the repurchase or replacement of defaulted notes.

 

We also establish an allowance for losses by product line to cover probable, but specifically unknown losses existing in the portfolio. For homogeneous portfolios, including Aviation, Golf Equipment and Distribution Finance, the allowance is established as a percentage of non-recourse finance receivables, which have not been identified as requiring specific reserves. The percentage is based on a combination of factors, including historical loss experience, current delinquency and default trends, collateral values and both general economic and specific industry trends. For non-homogeneous portfolios, including Timeshare and Golf Mortgage, the allowance is established as a percentage of watchlist balances. The percentage represents a combination of assumed default likelihood and loss severity based on historical experience, industry trends and collateral values. The most critical factors included in this analysis by product line are as follows:

 

Aviation

 

Collateral value of the portfolio, historical default experience and delinquency trends.

 

Golf Equipment

 

Historical loss experience and delinquency trends.

 

Timeshare

 

Evaluation of individual loan credit quality indicators such as borrowing base shortfalls for revolving notes receivable facilities, default rates of our notes receivable collateral and the borrower’s access to capital, historical progression from watchlist to nonaccrual status and estimates of loss severity based on analysis of impaired loans in the Timeshare product line.

 

Golf Mortgage

 

Evaluation of individual loan credit quality indicators such as delinquency, loan balance to collateral value, debt service coverage and the existence and strength of guarantors, historical progression from watchlist to nonaccrual status and historical loss severity.

 

Distribution Finance

 

Historical loss experience, trends in nonaccrual accounts as a percentage of the portfolio and trends in the industry mix of the collateral.

 

Finance receivables held for investment 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. Finance receivables held for investment are charged off when the remaining balance is deemed to be uncollectible.

 

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 finance receivables and credit lines using the interest method. Unamortized amounts are recognized in revenues when finance receivables are sold or paid in full.

 

Other (Loss) Income

 

Other (loss) income includes syndication gains on the sale of loans and leases, late charges, prepayment gains, servicing fees, residual gains, investment income and other miscellaneous fees, which are primarily recognized as income when received. It also includes adjustments to the valuation allowance for finance receivables held for sale.

 

Portfolio Losses, net of Gains

 

Portfolio losses, net of gains include impairment charges related to repossessed assets and properties, operating assets received in satisfaction of troubled finance receivables, other long-term investments and (losses) gains incurred on the sale or early termination of finance assets.

 

Fixed Assets

 

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

 

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.

 

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 $1.9 million, $3.3 million and $4.9 million in 2010, 2009 and 2008, respectively. The cost of the defined benefit pension plan amounted to approximately $9.3 million, $8.8 million and $11.3 million in 2010, 2009 and 2008, 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. Textron Financial’s current tax expense reflects statutory U.S. tax rates applied to taxable income or loss included in Textron’s consolidated returns. Deferred income tax balances reflect the effects of temporary differences between the financial reporting carrying amounts of assets and liabilities and their tax bases, as well as from net operating losses and tax credit carryforwards, and are stated at enacted tax rates expected to be in effect when taxes are actually paid or recovered. Deferred income tax assets represent amounts available to reduce income taxes payable on taxable income in future years. We evaluate the recoverability of these future tax deductions and credits by assessing the adequacy of future expected taxable income from all sources, including the future reversal of existing taxable temporary differences, taxable income in carryback years, available tax planning strategies and estimated

 

future taxable income. For those jurisdictions where the expiration date of tax carryforwards or the projected operation results indicate that realization is not likely, a valuation allowance is provided. We recognize net tax-related interest and penalties in income tax benefit in our Consolidated Statements of Operations.

 

Derivative Financial Instruments

 

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

 

Textron Financial recognizes the net interest differential on interest rate exchange agreements as adjustments to finance charges 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. At January 1, 2011, the Company’s largest single counterparty credit exposure was $10 million.

 

Fair Value of Financial Instruments

 

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

 

Finance Receivables Held for Sale

 

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

 

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

 

Cash and Equivalents

 

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

 

NOTE 2 Special Charges

 

Special charges are included in Loss before income taxes and noncontrolling interest, however, these charges are generally of a nonrecurring nature and are not included in Segment loss, which is our measure used for evaluating performance and for decision-making purposes. Special charges are summarized below by segment:

 

 

Restructuring Charges

 

In conjunction with the plan to exit our Non-captive Finance business, we announced a restructuring program to downsize and consolidate our operations in the fourth quarter of 2008. Restructuring charges incurred under this plan are summarized in the table below:

 

 

An analysis of our restructuring reserve is presented below:

 

 

Restructuring costs since the inception of the program through January 1, 2011 are summarized below by segment:

 

 

We expect to incur additional costs to exit the Non-captive Finance segment of our business over the next three to five years. These costs are expected to be within a range from $2 million to $5 million and be primarily attributable to severance and retention benefits. We expect to eliminate approximately 900 positions, representing approximately 90% of our total workforce over the life of the program. As of January 1, 2011, we have terminated approximately 740 employees under this program.

 

Other Special charges

 

In connection with the substantial liquidation of one of the Company’s wholly-owned Canadian subsidiaries in the third quarter of 2010, we recorded a $91 million non-cash pre-tax charge to reclassify the subsidiary’s cumulative currency translation adjustment account within Other comprehensive loss to the Consolidated Statements of Operations. The reclassification of this amount resulted in a $74 million after-tax charge that did not have an impact on Shareholder’s equity.

 

Valuation Allowance on Finance Receivables Held for Sale

 

As a result of the plan to exit the Non-captive Finance segment in the fourth quarter of 2008, we designated approximately $1.7 billion of our owned finance receivables as held for sale. The balance of the held for sale finance receivables at the end of 2008 reflected a $293 million pre-tax mark-to market adjustment, net of existing allowance for loan losses, required to adjust the previous carrying value of the finance receivables to fair value.

 

Goodwill Impairment

 

Based on market conditions that existed in the fourth quarter of 2008 and the plan to downsize our portfolio, we recorded a non-cash, pre-tax impairment charge of $169 million to eliminate the entire balance of goodwill.

 

NOTE 3 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 paid Textron $0.2 billion in 2010, $0.4 billion in 2009 and $1.0 billion in 2008 relating to the sale of manufactured products to third parties that were financed by us. In addition, we paid Textron $10 million, $13 million and $18 million, respectively, for the purchase of equipment on operating leases. 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 $3 million in 2010, $3 million in 2009 and $2 million in 2008, and operating lease revenues of $19 million in 2010, $20 million in 2009 and $29 million in 2008. Textron Financial and Textron are parties to several agreements, collectively referred to as operating agreements, which govern many areas of this 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 $44 million at January 1, 2011 and $56 million at January 2, 2010, and operating leases of $25 million at January 1, 2011 and $30 million January 2, 2010, were subject to recourse to Textron.

 

In 2010 and 2009, pursuant to the terms of an Intercompany Loan Facility Agreement, Textron agreed to lend funds to Textron Financial, with interest. As of January 1, 2011 and January 2, 2010, we had an outstanding balance due to Textron of $243 million and $447 million, respectively, and had paid interest of $32 million and $3 million in 2010 and 2009, respectively. The interest rate on this borrowing at both January 1, 2011 and January 2, 2010 was 7.00%. These borrowings are reflected in Amounts due to Textron Inc. on Textron Financial’s Consolidated Balance Sheets. 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 $11 million and $25 million at January 1, 2011 and January 2, 2010, respectively, under this arrangement.

 

A subsidiary of Textron has established a credit facility with Export Development Canada which provides funding for the financing of sales of Cessna Aircraft and Bell Helicopter products containing Canadian-manufactured content to non-Canadian buyers. A $145 million portion of the facility expires in June 2011 and the remaining $125 million expires in December 2011. Textron Financial originates and services loans and finance leases as servicer for this subsidiary, which is consolidated by Textron, and has provided a full guarantee of the debt obligations under this facility. These loans and finance leases totaled $69 million as of January 1, 2011.

 

A subsidiary of Textron has established a $500 million credit facility with the Export-Import Bank of the United States. The facility expires in June 2012. This facility provides funding for the financing of sales of Cessna Aircraft Company and Bell Helicopter products to non-U.S. buyers. Textron Financial originates and services loans and finance leases as servicer for this subsidiary, which is consolidated by Textron, and has provided a full guarantee of the debt obligations under this facility. These loans and finance leases totaled $288 million as of January 1, 2011 and $182 million as of January 2, 2010.

 

Under a Support Agreement between Textron Financial and Textron, Textron is required to maintain a controlling interest in Textron Financial. The agreement also requires Textron to ensure that Textron Financial maintains fixed charge coverage of no less than 125% and consolidated shareholder’s equity of no less than $200 million. In 2010 and 2009, Textron Financial’s fixed charge coverage ratio dropped below the required 125%. As a result, Textron made cash payments of $308 million and $270 million to Textron Financial in 2010 and 2009, respectively, and additional payments of $63 million on January 11, 2011 related to 2010, and $75 million on January 12, 2010 related to 2009. These cash payments were reflected as capital contributions to maintain

 

compliance with the fixed charge coverage ratio required by the Support Agreement and certain of Textron Financial’s credit agreements.

 

We had income taxes payable of $44 million and $182 million at January 1, 2011 and January 2, 2010, respectively. These accounts are settled with Textron as its consolidated federal and state tax position are managed.

 

NOTE 4 Finance Receivables and Allowance for Losses on Finance Receivables Held for Investment

 

Finance Receivables by Product Line / Receivable Class

 

Finance receivables by product line, which includes both finance receivables held for investment and finance receivables held for sale, are presented in the following table:

 

 

The Aviation product line primarily includes installment contracts and finance leases provided to purchasers of new Cessna aircraft and Bell helicopters and also includes installment contracts and finance leases secured by used Cessna aircraft and Bell helicopters and aircraft produced by other manufacturers. These agreements typically have initial terms ranging from five to ten years and amortization terms ranging from eight to fifteen years. The average balance of installment contracts and finance leases in the Aviation product line was $1 million at January 1, 2011. Finance leases with no significant residual value at the end of the contractual term are 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. The Golf Equipment product line primarily includes finance leases provided to purchasers of new E-Z-GO and Jacobsen golf and turf-care equipment. These Captive finance receivables are secured by the financed equipment and, in some instances, by the personal guarantee of the principals, typically have initial terms of three to five years and had an average balance of less than one-hundred thousand dollars.

 

The Non-captive segment includes five product lines and several finance receivable types. The Timeshare product line primarily includes revolving loans secured by pools of timeshare interval resort notes receivable and also includes construction/inventory mortgages secured by timeshare interval inventory, real property and in many instances, by the personal guarantee of the principals. Construction/inventory mortgages are typically cross-collateralized with revolving notes receivable loans to the same borrower. Loans in this portfolio typically have initial revolving terms of one to three years and final maturity terms of an additional one to five years. As of January 1, 2011, borrowers in the Timeshare product line have an average balance of $16 million and a weighted-average contractual maturity of two years.

 

Golf Mortgage primarily includes golf course mortgages, and also includes mortgages secured by hotels and marinas. Mortgages in this product line are secured by real property and are generally limited to 75% or less of the property’s appraised market value at loan origination. These mortgages typically have initial terms ranging from five to ten years with amortization periods from 20 to 30 years. As of January 1, 2011, loans in the Golf Mortgage product line have an average balance of $7 million and a weighted-average contractual maturity of three years.

 

Structured Capital primarily includes leveraged leases secured by the ownership of the leased equipment and real property. 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.

 

Finance Receivables 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 we believe finance receivables by geographic location is a more meaningful concentration measurement. Textron Financial’s geographic concentrations (which includes finance receivables held for investment and finance receivables held for sale) are as follows:

 

 

Textron Financial’s industry concentrations (which include finance receivables held for investment and finance receivables held for sale) are as follows:

 

 

Finance Receivables Held for Investment

 

Finance receivables held for investment include approximately $635 million and $629 million of finance receivables at January 1, 2011 and January 2, 2010, respectively, primarily in the Captive Aviation product line, that have been legally sold to special purpose entities (SPEs) which are consolidated subsidiaries of Textron Financial. The assets of the SPEs are pledged as collateral for $530 million and $559 million of debt as of January 1, 2011 and January 2, 2010, respectively, which has been reflected as securitized on-balance sheet debt. Third-party investors have no legal recourse to Textron Financial beyond the credit enhancement provided by the assets of the SPEs.

 

During the fourth quarter of 2010, we reclassified $219 million of Timeshare finance receivables, net of a $4 million allowance for loan losses, from held for investment to held for sale as a result of an unanticipated inquiry we have received to purchase these finance receivables. We determined a sale of these finance receivables would be consistent with our goal to maximize the economic value of our portfolio and accelerate cash collections.

 

During 2009, we reclassified $878 million of finance receivables, net of a $188 million valuation allowance, from held for sale to held for investment following efforts to market the portfolios and progress made through

 

orderly liquidation. We also reclassified $421 million of other finance receivable portfolios, net of a $43 million valuation allowance from held for investment to held for sale as a result of unanticipated purchase inquiries. Due to the nature of these inquiries, we determined a sale of these portfolios would be consistent with our goal to maximize the economic value of our portfolio and accelerate cash collections. During the fourth quarter of 2009, we recorded $720 million of finance receivables, previously sold to the Distribution Finance securitization trust, on our balance sheet. In connection with recording these finance receivables, $359 million were classified as held for sale and were sold prior to the end of the quarter.

 

Leveraged Leases