Toyota Motor Credit (TM/28) 10-K2021 FY Annual report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended March 31, 2022

OR

For the transition period from _______ to _______

Commission file number 1-9961

TOYOTA MOTOR CREDIT CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (469) 486-9300

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

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

(Title of class)

None

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

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  ☒

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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.     ☐

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.     ☐

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

As of April 30, 2022, the number of outstanding shares of capital stock, no par value per share, of the registrant was 91,500, all of which shares were held by Toyota Financial Services International Corporation.

Documents incorporated by reference: None

Reduced Disclosure Format

The registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore filing this Form 10-K with the reduced disclosure format.

TOYOTA MOTOR CREDIT CORPORATION

FORM 10-K

For the fiscal year ended March 31, 2022

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PART I

ITEM 1. BUSINESS

GENERAL

Toyota Motor Credit Corporation (“TMCC”) was incorporated in California in 1982 and commenced operations in 1983.  References herein to the “Company”, “we”, “our”, and “us” denote Toyota Motor Credit Corporation and its consolidated subsidiaries.  We are wholly-owned by Toyota Financial Services International Corporation (“TFSIC”), a California corporation, which is a wholly-owned subsidiary of Toyota Financial Services Corporation (“TFSC”), a Japanese corporation.  TFSC, in turn, is a wholly-owned subsidiary of Toyota Motor Corporation (“TMC”), a Japanese corporation.  TFSC manages TMC’s worldwide financial services operations.  TMCC is marketed under the brands of Toyota Financial Services, Lexus Financial Services, and Mazda Financial Services.

We provide a variety of finance and voluntary vehicle and payment protection products and services to authorized Toyota and Lexus dealers or dealer groups, private label dealers or dealer groups, and to a lesser extent, other domestic and import franchise dealers (collectively referred to as “dealers”) and their customers in the United States of America (excluding Hawaii) (the “U.S.”) and Puerto Rico.  Our products and services fall primarily into the following categories:

We support growth in earning assets through funding obtained primarily in the global capital markets as well as funds provided by investing and operating activities.  Refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Liquidity and Capital Resources” for a discussion of our funding activities.

Our field operations consist of three regional dealer service centers (“DSCs”) located in Chandler, Arizona (serving the West region), Plano, Texas (serving the Central region) and Alpharetta, Georgia (serving the East region).  The regional DSCs acquire retail and lease contracts from dealers, and market our voluntary protection products to dealers.

The dealer lending function is centralized at the DSC located in Plano, Texas, and supports the dealers by providing wholesale financing and other dealer financing activities such as business acquisitions, facilities refurbishment, real estate purchases, and working capital requirements.

We currently service contracts through three regional customer service centers (“CSCs”) located throughout the U.S.  The CSCs support customer account servicing functions such as collections, lease terminations, and administration of both retail and lease contract customer accounts.  The Central region CSC also supports voluntary protection operations by providing contract and claims administrative services.  In fiscal 2021, we announced the restructuring of our customer service operations to better serve our customers by relocating and streamlining the customer service operation and investing in new technology.  The restructuring is in progress and over the next year, we plan to complete the process of moving our three regional CSCs to be co-located with the regional DSCs to become regional experience centers.

In fiscal 2021, TMCC began providing private label financial services to third-party automotive and mobility companies commencing with the provision of services to Mazda Motor of America, Inc. (“Mazda”).  We are currently leveraging our existing processes and personnel to originate and service the new assets; however, we will continue to evaluate the private label financial services business, which includes partnering with or transitioning a portion of the business to our affiliates, some of which are not consolidated with TMCC.  We have also made certain technology investments to support the Mazda program and future private label customers.

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On November 19, 2021, TMCC announced, in furtherance of its private label financial services initiative for third party automotive and mobility companies, that we entered into a nonbinding letter of intent with Great American Outdoors Group LLC, the parent company of Bass Pro Shops, Cabela’s and the White River Marine Group (“Bass Pro Shops”) to provide private label financial services for Bass Pro Shop’s boats, all-terrain vehicle products, and other mobility products.  The Company expects to provide inventory financing for Bass Pro Shops, its affiliates, and authorized independent dealers, starting in fiscal 2023, with additional private label services, including consumer financing and voluntary protection products and services, to be added over time.

Available Information

Our filings with the Securities and Exchange Commission (“SEC”) may be found by accessing the SEC website (http://www.sec.gov).  A link to the SEC website and certain of our SEC filings are contained on our website located at: www.toyotafinancial.com under “Investor Relations, SEC Filings”.

Investors and others should note that we announce material financial information using the investor relations section of our website.  We use our website, press releases, as well as social media to communicate with our investors, customers and the general public about our company, our services and other issues.  While not all of the information that we post on our website or on social media is of a material nature, some information could be material.  Therefore, we encourage investors, the media, and others interested in our company to review the information we post on the investor relations section of our website and our Twitter feed.  We are not incorporating any of the information set forth on our website or on social media channels into this filing on Form 10-K.

Seasonality

Revenues generated by our retail and lease contracts are generally not subject to seasonal variations.  Financing volume is subject to a certain degree of seasonality.  This seasonality does not have a significant impact on revenues as collections, generally in the form of fixed payments, occur over the course of several years.  We are subject to seasonal variations in credit losses, which are historically higher in the first and fourth calendar quarters of the year.

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FINANCE OPERATIONS

The table below summarizes our financing revenues, net of depreciation by product.

Retail and Lease Financing

Pricing

TMCC matches interest rates with customer risk as defined by credit bureau scores and other factors for a range of price and risk combinations.  Rates vary based on customer credit experience, contract term, loan-to-value and collateral, including whether a new or used vehicle is financed.  In addition, special rates may apply as a result of promotional activities.  We review and adjust interest rates based on competitive and economic factors and distribute the rates to dealers.

Underwriting

Dealers transmit customer credit applications electronically through our online system for contract acquisition.  The customer may submit a credit application directly to our website, in which case, the credit application is sent to the dealer of the customer’s choice and is considered by us for preapproval.  Upon receipt of the credit application, our loan origination system automatically requests a credit bureau report from one of the major credit bureaus.  We use a proprietary credit scoring system to evaluate an applicant’s risk profile.  Factors used by the credit scoring system (based on the applicant’s credit history) include the contract term, ability to pay, debt ratios, amount financed relative to the value of the vehicle to be financed, and credit bureau attributes such as number of trade lines, utilization ratio and number of credit inquiries.

Credit applications are subject to systematic evaluation.  Our loan origination system evaluates each application to determine if it qualifies for automatic approval or decline without manual intervention (“auto-decisioning”) using specific requirements, including internal credit score and other application characteristics.  Typically, the highest quality credit applications are approved automatically, and the lowest quality credit applications are automatically declined.

Credit analysts (working in our field operations) approve or decline all credit applications that are not auto-decisioned and may also approve an application that has been the subject of an automated decline.  Failure to be automatically approved through auto-decisioning does not mean that an application does not meet our underwriting guidelines.  A credit analyst decisions applications based on an evaluation that considers an applicant’s creditworthiness and projected ability to meet the monthly payment obligation, which is derived from, among other things, the amount financed and the contract term.  A credit analyst will verify information contained in the credit application if the application presents an elevated level of credit risk.  Our proprietary scoring system assists the credit analyst in the credit review process.  The credit analyst’s final credit decision is made based upon the degree of credit risk perceived by the credit analyst after assessing the strengths and weaknesses of the application.

Completion of the financing process is dependent upon whether the transaction is a retail or lease contract.  For a retail contract, we acquire the retail contract from the dealer and obtain a security interest in the vehicle.  We perfect our security interests in the financed retail vehicles through the applicable state department of motor vehicles (or equivalent) with certificate of title filings or with Uniform Commercial Code (“UCC”) filings, as appropriate.  For a lease contract, except as described below under “Servicing”, we acquire the lease contract and concurrently assume ownership of the leased vehicle.  We have the right to pursue collection actions against a delinquent customer, as well as repossess a vehicle if a customer fails to meet contractual obligations.  

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We regularly review and analyze our consumer portfolio to evaluate the effectiveness of our underwriting guidelines and purchasing criteria.  If external economic factors, credit losses, delinquency experience, market conditions or other factors change, we may adjust our underwriting guidelines and purchasing criteria in order to change the asset quality of our portfolio or to achieve other goals and objectives.

Subvention and Incentive Programs

Toyota Motor Sales, U.S.A., Inc. (“TMS”), a subsidiary of Toyota Motor North America, Inc. (“TMNA”), is the primary distributor of Toyota and Lexus vehicles in the United States.  In partnership with TMNA and certain non-affiliated third-party distributors, we may offer special promotional rates, which we refer to as subvention programs.  TMNA and third-party distributors pay us the majority of the difference between our standard rate and the promotional rate.  Amounts received in connection with these programs allow us to maintain yields at levels consistent with standard program levels.  The level of subvention program activity varies based on the marketing strategies of TMNA and third-party distributors, economic conditions, vehicle inventory levels, and volume of vehicle sales.  The amount of subvention received varies based on the mix of vehicles included in the promotional rate programs and the timing of the programs.  The majority of our lease contracts and a significant portion of our retail contracts are subvened.  We may also offer cash and contractual residual value support incentive programs in partnership with TMNA or third-party distributors.  Subvention and other cash incentive program payments offered in partnership with TMNA or third-party distributors are settled at the beginning of the retail or lease contract.  We may also offer our own cash incentives and other competitive rate programs.  We defer the payments and recognize them over the life of the contract as a yield adjustment for retail contracts and as rental income or a reduction to depreciation expense for lease contracts.

Servicing

Our CSCs are responsible for servicing the consumer portfolio.  A centralized department manages third-party vendor relationships responsible for bankruptcy administration, liquidation and post charge-off recovery activities, certain administrative activities, customer services activities and pre-charge-off collections with support from the CSCs.  

We use an online collection and auto dialer system that prioritizes collection efforts and signals our collections personnel to make telephone contact with delinquent customers.  We also use a behavioral-based collection strategy to minimize risk of loss and employ various collection methods based on behavioral scoring models (which analyze borrowers’ payment performance, vehicle valuation and credit bureau scores to predict future payment behavior).  We generally determine whether to commence repossession efforts after an account is approximately 80 days past due.  Repossessed vehicles are held for sale to comply with statutory requirements and then sold at private auctions unless public auctions are required by state law.  Any unpaid amounts remaining after the repossessed vehicle is sold or after taking the full balance charge-off are pursued by us to the extent practical and legally permissible.  Any surplus amounts remaining after recovery fees, disposition costs, and other expenses have been paid, and after any reserve charge-backs, dealer guarantees and optional product refunds have been credited to the customer’s account, are refunded to the customers.  Collections of post-sale deficiencies and full-balance charge-offs are handled by third-party vendors and the CSCs.  We charge-off uncollectible portions of accounts when an account is deemed to be uncollectible or when the account balance becomes 120 days contractually delinquent, whichever occurs first.  However, the CSCs will continue to collect or pursue recovery of the vehicle up to 190 days after the account is past due.

We may, in accordance with our customary servicing procedures, offer rebates or waive any prepayment charge, late payment charge, or any other fees that may be collected in the ordinary course of servicing the consumer portfolio.  In addition, we may defer a customer’s obligation to make a payment by extending the contract term.  Refer to Item 1A. Risk Factors, “Industry and Business Risk”-“We face various risks related to health epidemics and other outbreaks, which have had and may continue to have material adverse effects on our business, financial condition, results of operations and cash flows” and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Fiscal 2022 Operating Environment” for further discussion of payment relief programs offered to customers affected by the coronavirus.

Substantially all of our retail and lease contracts are purchased as non-recourse from the dealers.  This relieves the dealers of financial responsibility in the event of a customer default.

We may experience a higher risk of loss if customers fail to maintain required insurance coverage.  The terms of our retail contracts require customers to maintain physical damage insurance covering loss or damage to the financed vehicle in an amount not less than the full value of the vehicle and to provide evidence of such insurance upon our request.  The terms of each contract allow but do not require us to obtain any such insurance coverage on behalf of the customer.  In accordance with our customary servicing procedures, we do not exercise our right to obtain insurance coverage on behalf of the customer.  Our lease contracts require lessees to maintain minimum liability insurance and

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physical damage insurance covering loss or damage to the leased vehicle in an amount not less than the full value of the vehicle.  We currently do not monitor ongoing customer insurance coverage as part of our customary servicing procedures for the consumer portfolio.

Toyota Lease Trust, a Delaware business trust (the “Titling Trust”), acts as lessor and holds title to leased vehicles in the U.S.  This arrangement was established to facilitate lease securitizations.  TMCC services lease contracts acquired by the Titling Trust from Toyota and Lexus dealers.  TMCC holds an undivided interest in lease contracts owned by the Titling Trust, and these lease contracts are included in Investments in operating leases, net on our Consolidated Balance Sheets.

Remarketing

The lessee may purchase the leased vehicle at the contractual residual value or return the leased vehicle to the dealer.  If the leased vehicle is returned to the dealer, the dealer may purchase the leased vehicle or return it to us.  We are responsible for disposing of the leased vehicle if the lessee or dealer does not purchase the vehicle at lease maturity.

In order to minimize losses when vehicles are returned to us, we have developed remarketing strategies to maximize proceeds and minimize disposition costs on used vehicles.  We use various channels to sell vehicles returned at lease-end or repossessed prior to lease-end, including a dealer direct program (“Dealer Direct”) and physical auctions.

The goal of Dealer Direct is to increase dealer purchases of off-lease vehicles thereby reducing the disposition costs of such vehicles.  Through Dealer Direct, the dealer accepting return of the lease vehicle (the “grounding dealer”) has the option to purchase the vehicle at the contractual residual value, purchase the vehicle at an assessed market value, or return the vehicle to us.  Vehicles not purchased by the grounding dealer are made available to all Toyota and Lexus dealers through the Dealer Direct online auction.  Vehicles not purchased through Dealer Direct are sold at physical vehicle auction sites throughout the country.  Where deemed necessary, we recondition used vehicles prior to sale at auction in order to enhance the vehicle values.

Dealer Financing

Dealer financing is comprised of wholesale financing and other financing options designed to meet dealer business needs.

Wholesale Financing

We provide wholesale financing to dealers for inventories of new and used Toyota, Lexus, private label, and other domestic and import vehicles.  We acquire a security interest in the vehicle inventory, and/or other dealership assets, as appropriate, which we perfect through UCC filings. Wholesale financing may also be backed by corporate or individual guarantees from, or on behalf of, affiliated dealers, dealer groups, or dealer principals.  In the event of a dealer default under a wholesale loan agreement, we have the right to liquidate assets in which we have a perfected security interest and to seek legal remedies pursuant to the wholesale loan agreement and any applicable guarantees.

Additionally, TMNA and other manufacturers may be obligated by applicable law, or under agreements with us, to repurchase or to reassign new vehicle inventory we financed that meets certain mileage and model year parameters, curtailing our risk.  We also provide other types of wholesale financing to certain Toyota and Lexus dealers and other third parties, at the request of TMNA or private Toyota distributors, and TMNA or the applicable private distributor guarantees the payments by such borrowers.

Other Dealer Financing

We provide fixed and variable rate working capital loans, revolving lines of credit, and real estate financing to dealers and various multi-franchise organizations referred to as dealer groups for facilities construction and refurbishment, working capital requirements, real estate purchases, business acquisitions and other general business purposes.  These loans are typically secured with liens on real estate, vehicle inventory, and/or other dealership assets, as appropriate, and may be guaranteed by individual or corporate guarantees of affiliated dealers, dealer groups, or dealer principals.  Although the loans are typically collateralized or guaranteed, the value of the underlying collateral or guarantees may not be sufficient to cover our exposure under such agreements.  Our pricing reflects market conditions, the competitive environment, the level of support dealers provide our retail, lease and voluntary protection products and the creditworthiness of each dealer.

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Before establishing a wholesale loan or other dealer financing agreement, we perform a credit analysis of the dealer. During this analysis, we:

On the basis of this analysis, we may approve the issuance of a loan or financing agreement and determine the appropriate amount to lend.

As part of our monitoring processes, we require dealers to submit periodic financial statements.  We also perform periodic physical audits of vehicle inventory as well as monitor the timeliness of dealer inventory financing payoffs in accordance with the agreed-upon terms to identify possible risks.

Competition

We operate in a highly competitive environment and compete with other financial institutions including national and regional commercial banks, credit unions, savings and loan associations, online banks, and finance companies.  To a lesser extent, we compete with other automobile manufacturers’ affiliated finance companies that actively seek to purchase retail contracts through Toyota, Lexus, and private label dealers.  We also compete with national and regional commercial banks and other automobile manufacturers’ affiliated finance companies for dealer financing.  No single competitor is dominant in the industry.  We compete primarily through service quality, our relationship with TMNA and third-party automotive and mobility companies to whom we provide financial services, and financing rates.  We seek to provide exceptional customer service and competitive financing programs to our dealers and to their customers.  Our affiliation with TMNA and relationships with third-party automotive and mobility companies to whom we provide financial services offers an advantage in providing financing or leasing of Toyota, Lexus, and private label vehicles.

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VOLUNTARY PROTECTION OPERATIONS

TMIS offers voluntary protection products on Toyota, Lexus, and other domestic and import vehicles that are primarily sold by dealers as part of the dealer’s sale of a vehicle.  The majority of the voluntary protection products offered by TMIS are not regulated as insurance products.  However, certain states require the Company’s contracts be backed by policies issued by a regulated insurance company. To satisfy the aforementioned requirement, TMIS utilizes its insurance company subsidiaries to underwrite certain risks.  Vehicle service contracts offer vehicle owners and lessees mechanical breakdown protection for new and used vehicles secondary to the manufacturer’s new vehicle warranty.  Guaranteed auto protection contracts provide coverage for a lease or retail contract deficiency balance in the event of a total loss or theft of the covered vehicle.  Prepaid maintenance contracts provide maintenance services at manufacturer recommended intervals.  Excess wear and use contracts are available on leases and protect against excess wear and use charges that may be assessed at lease termination. Tire and wheel protection contracts provide coverage in the event that a covered vehicle’s tires or wheels become damaged as a result of a road hazard or structural failure due to a defect in material or workmanship, to the extent not covered by the manufacturer or the tire distributor warranties.  Certain tire and wheel protection contracts also cover expenses related either to replacing or reprogramming a vehicle key or vehicle key remote in the event of loss or damage.  Key replacement protection contracts provide stand-alone coverage for expenses related either to replacing or reprogramming a vehicle key or vehicle key remote in the event of loss or damage.  Used vehicle limited warranty contracts are included with the purchase of a used vehicle and provides for the repair or replacement of certain covered components that have mechanically failed on the covered used vehicle.

TMIS provides TMNA contractual indemnity insurance coverage for limited warranties on certified Toyota and Lexus pre-owned vehicles.  TMIS also provides umbrella liability insurance to TMNA and other affiliates covering certain dollar value layers of risk above various primary or self-insured retentions.  On all layers in which TMIS provides coverage, 99 percent of the risk is ceded to a reinsurer.  

Competition for the voluntary protection products is primarily from national and regional independent service contract providers.  We compete primarily through service quality, our relationship with TMNA and third-party automotive and mobility companies to whom we provide financial services and product benefits.  Our affiliation with TMNA provides an advantage in selling our voluntary protection products.

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RELATIONSHIPS WITH AFFILIATES

TMCC is party to agreements with TMNA and certain TMNA subsidiaries.  For ease of reference herein, we refer solely to the parent entity, TMNA.  As a result, all references to the agreements or activities of TMNA herein that are carried out by a TMNA subsidiary are deemed to also make reference to and include the applicable TMNA subsidiary.

TMNA sponsors subvention, cash and contractual residual value support incentive programs on certain new and used Toyota and Lexus vehicles.  The level of incentive program activity varies based on TMNA marketing strategies, economic conditions, vehicle inventory levels, and volume of vehicle sales.  

TMNA may be obligated by applicable law, or under agreements with us, to repurchase or to reassign new vehicle inventory we financed that meets certain mileage and model year parameters.  We also provide financing to certain Toyota and Lexus dealers and other third parties, at the request of TMNA or private Toyota distributors, and TMNA or the applicable private distributor guarantees the payments by such borrowers.

TMNA provides shared services to TMCC, including certain technological and administrative services, such as information systems support, facilities, insurance coverage, human resources and other corporate services.  TMCC also provides shared services to TMNA, including certain treasury and procurement services.  

TMCC is a participating employer in certain retirement and post-retirement medical care, life insurance and other benefits sponsored by TMNA, as discussed further in Note 10 – Pension and Other Benefit Plans of the Notes to Consolidated Financial Statements.

TMCC is party to agreements with TMNA and other affiliates relating to the team member vehicle benefit program, which allows team members to lease Toyota and Lexus vehicles on terms exclusive to the benefit program. TMNA serves as the chief administrator of the program.  TMCC acquires and services team member leases after origination.  A portion of the vehicles used for the team member vehicle benefit program are acquired from TMNA.  TMCC receives a per vehicle contribution from participating affiliates to assist with the costs of its contribution to the benefit program, and TMCC pays a per vehicle participation fee to TMNA to participate in the benefit program.

TMCC and Toyota Financial Savings Bank (“TFSB”), a Nevada thrift company owned by TFSIC, are parties to a master shared services agreement under which TMCC and TFSB provide certain services to each other.  TMCC and TFSB are also parties to an expense reimbursement agreement, which provides that TMCC will reimburse certain expenses incurred by TFSB in connection with providing certain financial products and services to TMCC’s customers and dealers in support of TMCC’s customer loyalty strategy and programs.

TMCC receives support from and provides support to TFSC and other affiliates in the form of promissory notes and various loan and credit facility agreements, including a revolving credit facility with TMS which may be used for general corporate purposes.  

Credit support agreements exist between TMCC and TFSC and between TFSC and TMC.  These agreements are further discussed in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Liquidity and Capital Resources.”

TMIS provides administrative services and various types of coverage to TMNA and other affiliates, including contractual indemnity coverage for limited warranties on TMNA’s certified pre-owned vehicle program and umbrella liability insurance.  

Refer to Note 12 – Related Party Transactions of the Notes to Consolidated Financial Statements for further information.

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REGULATORY ENVIRONMENT

Our finance and voluntary protection products are regulated under both federal and state law. 

Federal Consumer Finance Regulation

Our finance operations are governed by, among other federal laws, the Equal Credit Opportunity Act, the Truth in Lending Act, the Consumer Leasing Act, the Fair Credit Reporting Act, the Servicemembers Civil Relief Act, the unfair, deceptive and abusive practices (UDAAP) provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), and the consumer data privacy and security provisions of the Gramm-Leach Bliley Act.  

The Equal Credit Opportunity Act is designed to prevent credit discrimination on the basis of certain protected classes, requires the distribution of specified credit decision notices and limits the information that may be requested and considered in a credit transaction.  The Truth in Lending Act and the Consumer Leasing Act place disclosure and substantive transaction restrictions on consumer credit and leasing transactions.  The Fair Credit Reporting Act imposes restrictions and requirements regarding our use and sharing of credit reports, the reporting of data to credit reporting agencies including the accuracy and integrity of information reported, credit decision notices, consumer dispute handling procedures and identity theft prevention requirements.  The Servicemembers Civil Relief Act provides additional protections for certain customers in the military. For example, it requires us, in most circumstances, to reduce the interest rate charged to customers who have subsequently joined, enlisted, been inducted or called to active military duty, and also requires us to allow eligible servicemembers to terminate their lease agreements with us early without penalty.  UDAAP laws prohibit practices that are unfair, deceptive or abusive towards consumers.  

Federal privacy and data security laws place restrictions on our use and sharing of consumer data, impose privacy notice requirements, give consumers the right to opt out of certain uses and sharing of their data and impose safeguarding rules regarding the maintenance, storage, transmission and destruction of consumer data.  Cybersecurity and data privacy are areas of heightened legislative and regulatory focus.  The timing and effects of potential legislative or regulatory changes to data privacy regulations is uncertain.

In addition, the dealers who originate our retail and lease contracts also must comply with federal credit and trade practice statutes and regulations.  Failure of the dealers to comply with these statutes and regulations could result in remedies that could have an adverse effect on us. 

The Consumer Financial Protection Bureau (“CFPB”) has broad rulemaking, supervisory and enforcement authority over entities offering consumer financial services or products, including non-bank companies, such as TMCC (“Covered Entities”).  

The CFPB’s supervisory authority has focused on fair lending compliance, repossessions, debt collection, the treatment of customers during the COVID-19 pandemic, credit reporting, and the marketing and sale of certain optional products, including voluntary protection products we finance or sell through TMIS.  

The CFPB’s supervisory authority permits it to examine Covered Entities for compliance with consumer financial protection laws. These examinations could result in enforcement actions, regulatory fines and mandated changes to our business, products, policies and procedures.  

The CFPB’s enforcement authority permits it to conduct investigations (which may include a joint investigation with other agencies and regulators) of, and initiate enforcement actions related to, violations of federal consumer financial protection laws, including discriminatory practices not directly covered by the Equal Credit Opportunity Act.  The CFPB has the authority to obtain cease and desist orders (which can include orders for restitution or rescission of contracts, as well as other types of affirmative relief), or other forms of remediation, and/or impose monetary penalties.  The CFPB and the Federal Trade Commission (“FTC”) may investigate the products, services and operations of credit providers, including banks and other finance companies engaged in auto finance activities.  As a result of such investigations, both the CFPB and FTC have announced various enforcement actions against lenders in the past few years involving significant penalties, consent orders, cease and desist orders and similar remedies that, if applicable to us or the products, services and operations we offer, may require us to cease or alter certain business practices, which could have a material adverse effect on our results of operations, financial condition, and liquidity.

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State Regulation

A majority of states (and Puerto Rico) have enacted legislation establishing licensing requirements to conduct financing activities. We must renew these licenses periodically.  Most states also impose limits on the maximum rate of finance charges, while other state and federal legislatures are also discussing an all-in rate cap that would include finance charges plus charges on our ancillary products such as voluntary protection products.  In certain states, the margin between the present statutory maximum interest rates and borrowing costs is sufficiently narrow that, in periods of rapidly increasing or high interest rates, there could be an adverse effect on our operations in these states if we were unable to pass on increased interest costs to our customers.  Some state laws impose rate and other restrictions on credit transactions with customers in active military status in addition to those imposed by the Servicemembers Civil Relief Act.

State laws also impose requirements and restrictions on us with respect to, among other matters, required credit application and finance and lease disclosures, late fees and other charges, the right to repossess a vehicle for failure to pay or other defaults under the retail or lease contract, other rights and remedies we may exercise in the event of a default under the retail or lease contract, and other consumer protection matters.  Many states are also focusing on cybersecurity and data privacy as areas warranting consumer protection. Some states have passed complex legislation dealing with consumer information, which impacts companies such as TMCC.  In some jurisdictions, these laws and regulations provide a private right of action that would allow customers to bring suit directly against us for mishandling their data for certain violations of these laws and regulations.  

TMIS operations are subject to state regulations and licensing requirements.  State laws vary with respect to which products are regulated and what types of corporate licenses and filings are required to offer certain products.  Certain products offered by TMIS are covered by state privacy laws as well as new cybersecurity and data privacy legislation.  Our insurance company subsidiaries must be appropriately licensed in certain states in which they conduct business, must maintain minimum capital requirements and file annual financial information as determined by their state of domicile and the National Association of Insurance Commissioners.  Failure to comply with these requirements could have an adverse effect on voluntary protection operations in a particular state.  We actively monitor applicable laws and regulations in each state in order to maintain compliance.

State regulators are taking a more stringent approach to supervising and regulating providers of financial products and services subject to their jurisdiction.  In addition, we are subject to governmental and regulatory examinations, information-gathering requests and investigations from time to time.  We expect to continue to face greater supervisory scrutiny and enhanced supervisory requirements for the foreseeable future.  

Other Federal and International Regulation

Under the Volcker Rule, companies affiliated with U.S. insured depository institutions are generally prohibited from engaging in “proprietary trading” and certain transactions with certain privately offered funds.  The activities prohibited by the Volcker Rule are not core activities for us.  However, the federal financial regulatory agencies charged with implementing the Volcker Rule could further amend the rule or change their approach to administering, enforcing or interpreting the rule, which could negatively affect us and potentially require us to limit or change our activities or operations.

The Dodd-Frank Act amended the U.S. Commodity Exchange Act (“CEA”) to establish a comprehensive framework for the regulation of certain over-the-counter (“OTC”) derivatives referred to as swaps.  Under the Dodd-Frank Act, the Commodity Futures Trading Commission (“CFTC”) is required to adopt certain rules and regulations governing swaps.  The CFTC has completed almost all of its regulations in this area, most of which are in effect.

The OTC derivatives provisions of the CEA, as amended by the Dodd-Frank Act, impose clearing, trading and margin requirements on certain contracts.  At present, we qualify for exceptions from these requirements for the swaps that we enter into to hedge our commercial risks.  However, if we were to no longer qualify for such exceptions, we could become subject to some or all of these requirements, which would increase our cost of entering into and maintaining such hedging positions.  

If we reduce our use of OTC derivatives as a result of the Dodd-Frank Act and resulting regulations, our results of operations may become more volatile and our cash flows may be less predictable, which could adversely affect our ability to plan for and fund capital expenditures.

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We continually review our operations for compliance with applicable laws.  Future administrative rulings, judicial decisions, legislation, regulations and regulatory guidance, and supervision and enforcement actions may result in monetary penalties, increase our compliance costs, require changes in our business practices, affect our competitiveness, impair our profitability, harm our reputation or otherwise adversely affect our business.

Concern over climate change or other environmental matters may result in new or increased legal and regulatory requirements intended to mitigate factors contributing to, or intended to address the potential impacts of, climate change or other environmental concerns. Such regulations (including laws related to greenhouse gas emitting products or services) may require us to alter our proposed business plans, lead to increased compliance costs and changes to our operations and could have an adverse effect on our business, results of operations and financial condition.

Refer to Part 1, Item 1A. Risk Factors – “The regulatory environment in which we operate could have a material adverse effect on our business and results of operations.”

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HUMAN CAPITAL

Employees

At March 31, 2022, we had approximately 3,700 employees.  We consider our employee relations to be satisfactory.  We are not subject to any collective bargaining agreements with our employees.

Culture

Our human capital objective in managing our business is to attract, retain, and fully engage the talent of our team members.  Toyota’s corporate culture is driven by “The Toyota Philosophy”, our roadmap of the company we want to be, which is woven into our core values, including continuous improvement and respect for people.  Our team members are actively involved in Toyota’s transformation toward becoming a mobility company and promoting our mission of happiness for all and our vision of creating mobility for all.  We offer a variety of training opportunities to enhance the skills of our team members and encourage innovation.  We encourage teamwork and collaboration and know diverse backgrounds, experiences, and perspectives are the right thing not only for our team members, but also for our business.

Diversity and Inclusion

We envision a world made better by a future of boundless physical and economic mobility for all – driven by the power of engaged, diverse, and inclusive environments.  We believe in equality, respect, and the inclusive treatment of all people. We believe that our team members achieve higher levels of productivity, are more creative, and more innovative when we foster a company culture that activates inclusion and diversity at all levels.  Our Executive Diversity and Inclusion Committee endeavors to guide, endorse and support our diversity and inclusion strategic efforts. We have also appointed certain team members as Diversity Champions who are responsible for providing diversity and inclusion leadership and strategic support. These Diversity Champions serve as visible role models who create positive impact by helping apply diversity and inclusion subject matter to ongoing business priorities. Toyota’s external Diversity Advisory Board works in partnership with our executive and senior leaders who reinforce diversity and inclusion strategies to offer insight and perspective that helps Toyota cultivate a diversity and inclusion mindset across the enterprise.

Health and Safety

We recognize the health, safety, and well-being of our team members is a top priority.  Actively cultivating a culture, environment, and team member experience that embraces, empowers, and respects all people - including their health, wellbeing, and safety - drives innovation and relevancy.  For example, in response to the COVID-19 pandemic, we consulted with medical professionals and instituted policies and practices to protect our team members and their families.  During the pandemic, we transitioned nearly all of our workforce to a remote work arrangement to mitigate health risks.  Starting in June 2022, we plan on transitioning our team members to a hybrid or onsite work arrangements depending on business needs and safety protocols.

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ITEM 1A. RISK FACTORS

We are exposed to certain risks and uncertainties that could have a material adverse impact on our business, results of operations and financial condition.  There may be additional risks and uncertainties not presently known to us or that we currently consider immaterial that may also have a material adverse impact on our business, results of operations and financial condition.

INDUSTRY AND BUSINESS RISK

We face various risks related to health epidemics and other outbreaks, which have had and may continue to have material adverse effects on our business, financial condition, results of operations and cash flows.

We face various risks related to health epidemics and other outbreaks, including the global outbreak of coronavirus (“COVID-19”).  Although U.S. and global economies have begun to recover from the COVID-19 pandemic as many health and safety restrictions have been lifted and vaccine distribution has increased, the COVID-19 pandemic has led, and may continue to lead, to periodic disruption and volatility in the global capital markets and in the economies of many nations, including the United States.  

The negative economic conditions arising from the COVID-19 pandemic have continued to impact certain of our financial results during fiscal year 2022, including continued elevated allowance for credit losses on our retail loan portfolio primarily due to expected credit losses, and a decrease in financing volume due to lower dealer inventory levels, which has resulted in lower levels of subvention and incentives as well as increased competition from other financial institutions.  

The long-term and ultimate impacts of the social, economic and financial disruptions caused by the COVID-19 pandemic are unknown.  The ultimate duration or possible resurgence of the COVID-19 pandemic or similar public health issues are also uncertain.  Further, if new strains of COVID-19 develop or sufficient amounts of vaccines are not available, not widely administered for a significant period of time, not used by consumers, or otherwise prove ineffective, the impact of COVID-19 on the global economy, and, in turn, on our financial condition, liquidity and results of operations could be material.  The extension of curtailed economic activities as a result of further outbreak of COVID-19, extended or additional government restrictions intended to slow the spread of the virus, delayed consumer response as restrictions are lifted, or permanent behavior changes in consumer spending, could have further negative impact on consumer economics, dealerships, and auction sites, which could have a material adverse impact on our future results of operations.  In addition, a possible resurgence of the COVID-19 pandemic may subject us to, among several other things, increased delinquencies and defaults by our customers and dealers, the reinstatement of certain payment relief options, closures of plants by TMNA, and disruption among our supply chain and with other third-party vendors.

General business, economic, and geopolitical conditions, as well as other market events, may adversely affect our business, results of operations and financial condition.

Our results of operations and financial condition are affected by a variety of factors, including changes in the overall market for retail contracts, wholesale motor vehicle financing, leasing or dealer financing, the new and used vehicle market, changes in the level of sales of Toyota, Lexus, and private label vehicles, the rate of growth in the number and average balance of customer accounts, the U.S. regulatory environment, competition from other financiers, rate of default by our customers, the interest rates we are required to pay on the funding we require to support our business, amounts of funding available to us, changes in the U.S. and international wholesale capital funding markets, our credit ratings, the success of efforts to expand our product lines, levels of operating and administrative expenses including, but not limited to, personnel costs, technology costs and premises costs (including costs associated with reorganization or relocation), general economic conditions, inflation, consequences from changes in tax laws, and fiscal and monetary policies in the U.S., Europe and other countries in which we issue debt.  Further, a significant and sustained increase in fuel prices could lead to lower new and used vehicle purchases.  This could reduce the demand for retail, lease and wholesale financing.  In turn, lower used vehicle values could affect return rates, charge-offs and depreciation on operating leases.

Economic slowdown and recession in the United States may lead to diminished consumer and business confidence, inflation, lower household incomes, increases in unemployment rates, higher consumer debt levels as well as higher consumer and commercial bankruptcy filings, any of which could adversely affect vehicle sales and discretionary consumer spending.  These conditions may decrease the demand for our financing products, as well as increase our delinquencies and credit losses.  In addition, because our credit exposures are generally collateralized by vehicles, the severity of losses can be particularly affected by declines in used vehicle values.  Dealers are also affected by economic slowdown and recession, which increases the risk of default of certain dealers within our dealer portfolio.

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Elevated levels of market disruption and volatility globally or in the U.S. could increase our cost of capital and adversely affect our ability to access the global capital markets and fund our business in a similar manner, and at a similar cost to the funding raised in the past.  These market conditions could also have an adverse effect on our results of operations and financial condition by diminishing the value of our investment portfolio and increasing our cost of funding.  If as a result we increase the rates we charge to our customers and dealers, our competitive position could be negatively affected.

Challenging market conditions may result in less liquidity, greater volatility, widening of credit spreads and lack of price transparency in credit markets.  Changes in investment markets, including changes in interest rates, exchange rates and returns from equity, property and other investments, will affect (directly or indirectly) our financial performance.

During a continued and sustained period of market disruption and volatility:

Any of these developments could have an adverse effect on our results of operations and financial condition.

Geopolitical conditions and other market events may also impact our results of operations.  Restrictive exchange or import controls or other disruptive trade policies, disruption of operations as a result of systemic political or economic instability, adverse changes to tax laws and regulations, social unrest, outbreak of war or expansion of hostilities (including the current conflict in Ukraine), health epidemics and other outbreaks, climate-related risk, and acts of terrorism, could lead to among other things, declines in market liquidity and activity levels, volatile market conditions, a contraction of available credit, inflation, fluctuations in interest rates, weaker economic growth, and reduced business confidence on an international level, each of which could have a material adverse effect on our results of operations and financial condition.

Our results of operations and financial condition are substantially dependent upon the sale of Toyota, Lexus, and private label vehicles, as well as our ability to offer competitive financing and voluntary protection products.

We primarily provide a variety of finance and voluntary protection products to authorized Toyota, Lexus, and private label dealers and their customers in the U.S.  Accordingly, our business is substantially dependent upon the sale of Toyota, Lexus, and private label vehicles in the U.S.  Changes in the volume of sales may result from governmental action or changes in governmental regulation or trade policies, changes in consumer demand, new vehicle incentive programs, recalls, the actual or perceived quality, safety or reliability of Toyota, Lexus, and private label vehicles, economic conditions, inflation, increased competition, increases in the price of vehicles due to increased raw material costs, changes in import fees or tariffs on raw materials or imported vehicles, changes to or withdrawals from trade agreements, currency fluctuations, fluctuations in interest rates, decreased or delayed vehicle production due to extreme weather conditions, natural disasters, supply chain interruptions, including shortages of parts, components or raw materials, or other events.  For example, the COVID-19 pandemic and restrictions intended to slow the spread of COVID-19 have continued to adversely affect the business of our affiliate, TMNA, and our ultimate parent, TMC, in a number of ways, including a decrease in new inventory resulting from production halts and supply shortages.  Any negative impact on the volume of Toyota, Lexus, and private label vehicle sales in the U.S. could have a material adverse effect on our business, results of operations, and financial condition.

TMS, a subsidiary of TMNA, is the primary distributor of Toyota and Lexus vehicles in the U.S.  While TMNA conducts extensive market research before launching new or refreshed vehicles and introducing new services, many factors both within and outside TMNA’s control affect the success of new or existing products and services in the marketplace.  Offering vehicles and services that customers want and value can mitigate the risks of increasing price competition and declining demand, but products and services that are perceived to be less desirable (whether in terms of product mix, price, quality, styling, safety, overall value, fuel efficiency, or other attributes) and the level of availability of products and services that are desirable can exacerbate these risks.  With increased consumer interconnectedness through the internet, social media, and other media, mere allegations relating to quality, safety, fuel

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efficiency, corporate social responsibility, or other key attributes can negatively impact TMNA’s reputation or market acceptance of its products or services, even where such allegations prove to be inaccurate or unfounded.

In addition, the volume of TMNA sales may also be affected by Toyota’s ability to successfully grow through investments in the area of emerging opportunities such as mobility and connected services, vehicle electrification, fuel cell technology and autonomy, which depends on many factors, including advancements in technology, regulatory changes, and other factors that are difficult to predict.

We operate in a highly competitive environment and compete with other financial institutions and, to a lesser extent, other automobile manufacturers’ affiliated finance companies primarily through service, quality, our relationship with TMNA, and financing rates.  TMNA sponsors subvention, cash, and contractual residual value support incentive programs offered by us on certain new and used Toyota and Lexus vehicles.  Our ability to offer competitive financing and voluntary protection products in the U.S. depends in part on the level of TMNA sponsored subvention, cash, and contractual residual value support incentive program activity, which varies based on TMNA marketing strategies, economic conditions, and the volume of vehicle sales, among other factors.  Any negative impact on the level of TMNA sponsored subvention, cash, and contractual residual value support incentive programs could in turn have a material adverse effect on our business, results of operations, and financial condition.

Changes in consumer behavior could affect the automotive industry, TMNA and TMC, and, as a result, our business, results of operations and financial condition.

A number of trends are affecting the automotive industry. These include a market shift from cars to sport utility vehicles (“SUVs”) and trucks, high demand for incentives, the rise of mobility services such as vehicle sharing and ride hailing, the development of autonomous and alternative-energy vehicles, the impact of demographic shifts on attitudes and behaviors toward vehicle ownership and use, the development of flexible alternatives to traditional financing and leasing such as subscription service offerings, changing expectations around the vehicle buying experience, increased focus on climate-related initiatives and regulation, adjustments in the geographic distribution of new and used vehicle sales, and advancements in communications and technology. Any one or more of these trends could adversely affect the automotive industry, TMNA and TMC, and could in turn have an impact on our business, results of operations and financial condition.

Recalls and other related announcements by TMNA or private label companies could affect our business, results of operations and financial condition.

TMNA or other manufacturers of the vehicles we finance periodically conducts vehicle recalls which could include temporary suspensions of sales and production of certain Toyota, Lexus, and private label vehicle models. Because our business is substantially dependent upon the sale of Toyota and Lexus vehicles, such events could adversely affect our business.  A decrease in the level of sales, including as a result of the actual or perceived quality, safety or reliability of Toyota, Lexus, and private label vehicles or a change in standards of regulatory bodies will have a negative impact on the level of our financing and voluntary protection products volume, earning assets, Net financing revenues and Voluntary protection contract revenues and insurance earned premiums.  The credit performance of our dealer and consumer portfolios may also be adversely affected.  In addition, a decline in the values of used Toyota, Lexus, and private label vehicles would have a negative effect on residual values and return rates, which, in turn, could increase depreciation expense and credit losses.  Further, certain of TMCC’s affiliated entities are or may become subject to litigation and governmental investigations and have been or may become subject to fines or other penalties.  These factors could affect sales of Toyota, Lexus and private label vehicles and, accordingly, could have a negative effect on our business, results of operations and financial condition.

If we are unable to compete successfully or if competition increases in the businesses in which we operate, our results of operations could be negatively affected.

We operate in a highly competitive environment.  We compete with other financial institutions including national and regional commercial banks, credit unions, savings and loan associations, finance companies, and to a lesser extent, other automobile manufacturers’ affiliated finance companies.  In addition, online financing options provide consumers with alternative financing sources.  Increases in competitive pressures could have an adverse impact on our contract volume, market share, Net financing revenues, Voluntary protection contract revenues and insurance earned premiums.  Further, the financial condition and viability of our competitors and peers may have an adverse impact on the financial services industry in which we operate, resulting in a decrease in the demand for our products and services.  This could have an adverse impact on the volume of our business and our results of operations.

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A failure or interruption in our operations could adversely affect our results of operations and financial condition.

Operational risk is the risk of loss resulting from, among other factors, lack of established processes, inadequate or failed processes, systems or internal controls, theft, fraud, extreme weather conditions, natural disasters (such as wildfires, floods, tornadoes, earthquakes, hurricanes including an increase in the frequency of such conditions and disasters as the result of climate change) or other catastrophes (including without limitation, explosions, terrorist attacks, riots, civil disturbances and health epidemics and other outbreaks).  Operational risk can occur in many forms including, but not limited to, errors, business interruptions, failure of controls, failure of systems or other technology, deficiencies in our voluntary protection product operations risk management program, inappropriate behavior or misconduct by our employees or those contracted to perform services for us, and vendors that do not perform in accordance with their contractual agreements.  We have established business recovery plans to address interruptions in our operations, but we can give no assurance that these plans will be adequate to remediate all events that we may face.  A catastrophic event that results in the destruction or disruption of any of our critical business or information technology systems could harm our ability to conduct normal business operations.  These events can potentially result in financial losses or other damage to us, including damage to our reputation.

We rely on a framework of internal controls designed to provide a sound and well-controlled operating environment.  Due to the complexity of our business and the challenges inherent in implementing control structures across large organizations, control issues could be identified in the future that could have a material adverse effect on our operations.

We are currently in the process of restructuring our customer service operations to better serve our customers by relocating and streamlining the customer service operation, moving our three regional CSCs to be co-located with the regional DSCs, and investing in new technology.  We can give no assurance that the restructuring of our customer service operations will be completed as planned or within the expected timing or budget, and the expected benefits may not be fully realized due to associated disruption to customer service operations and personnel.

In addition, many parts of our business, including software, technology, marketing and finance, are dependent on key personnel.  Competition for such employees is intense, which may increase our operating and administrative expenses and lead to other changes including flexible work arrangements and other considerations.  Our future success depends on our ability to retain existing, and attract, hire and integrate new key personnel and other necessary employees.  Any failure to do so could adversely affect our business, results of operations and financial condition.

Our private label financial services for third-party automotive and mobility companies may expose us to additional risks that could adversely affect our business, results of operations and financial condition.

On April 1, 2020, we began providing private label financial services to third-party automotive and mobility companies commencing with the provision of services to Mazda Motor of America, Inc. (“Mazda”).  Pursuant to the agreement with Mazda, we currently offer exclusive private label automotive retail, lease, voluntary protection products and dealer financing products and services marketed under the brands Mazda Financial Services and Mazda Protection Products to Mazda customers and dealers in the United States.  The agreement with Mazda is for an initial term of approximately five years.  

On November 19, 2021, we announced that we entered into a nonbinding letter of intent with Great American Outdoors Group LLC, the parent company of Bass Pro Shops, Cabela’s and the White River Marine Group (“Bass Pro Shops”) to provide private label financial services for Bass Pro Shop’s boats, all-terrain vehicle products, and other mobility products.  The Company expects to provide inventory financing for Bass Pro Shops, its affiliates, and authorized independent dealers, starting in fiscal 2023, with additional private label services, including consumer financing and voluntary protection products and services, to be added over time.

We are currently leveraging our existing processes and personnel to originate and service the new assets; however, we will continue to evaluate the private label financial services business, which may include partnering with or transitioning the business to our affiliates, some of which are not consolidated with TMCC.

Although we intend to leverage our strengths and capabilities to serve and retain new private label customers, we may encounter additional costs and may fail to realize the anticipated benefits of our private label financial services program. The provision and or servicing of wholesale and retail financing to private label dealers and customers may result in additional credit risk exposure, which if we are unable to appropriately monitor and mitigate may result in an adverse effect on our results of operations and financial condition.  Our private label financial services may also expose us to additional operating risks related to consumer demand for private label vehicles or mobility products, the profitability and financial condition of private label companies, the level of the private label incentivized retail financing, recalls announced by the private label and the perceived quality, safety or reliability of the private label vehicles or mobility products, and changes in prices of the private label used vehicles and their effect on residual

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values of the private label off-lease vehicles and return rates, each of which may adversely affect our business, results of operations and financial condition.  

FINANCIAL MARKET AND ECONOMIC RISKS

Our borrowing costs and access to the unsecured debt capital markets depend significantly on the credit ratings of TMCC and its parent companies and our credit support arrangements.

The availability and cost of financing is influenced by credit ratings, which are intended to be an indicator of the creditworthiness of a particular company, security or obligation.  Our credit ratings depend, in large part, on the existence of the credit support arrangements with TFSC and TMC and on the financial condition and results of operations of TMC.  If these arrangements (or replacement arrangements acceptable to the rating agencies) become unavailable to us, or if the credit ratings of the credit support providers were lowered, our credit ratings would be adversely impacted.

Credit rating agencies which rate the credit of TMC and its affiliates, including TMCC, may qualify or alter ratings at any time.  Global economic conditions, including the ongoing impact of COVID-19 and other geopolitical factors may directly or indirectly affect such ratings.  Any downgrade in the sovereign credit ratings of the U.S. or Japan may directly or indirectly have a negative effect on the ratings of TMC and TMCC.  Downgrades or placement on review for possible downgrades could result in an increase in our borrowing costs as well as reduced access to the global unsecured debt capital markets.  These factors would have a negative impact on our competitive position, results of operations, liquidity and financial condition.

A disruption in our funding sources and access to the capital markets would have an adverse effect on our liquidity.

Liquidity risk is the risk arising from our ability to meet obligations in a timely manner when they come due. Our liquidity strategy is to maintain the capacity to fund assets and repay liabilities in a timely and cost-effective manner even in adverse market conditions.  A disruption in our funding sources may adversely affect our ability to meet our obligations as they become due.  An inability to meet obligations in a timely manner would have a negative impact on our ability to refinance maturing debt and fund new asset growth and would have an adverse effect on our results of operations and financial condition.

Refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Liquidity and Capital Resources” for further discussion of liquidity risk.

Our allowance for credit losses may not be adequate to cover actual losses, which may adversely affect our results of operations and financial condition.

We maintain an allowance for credit losses to cover lifetime expected credit losses as of the balance sheet date resulting from the non-performance of our customers and dealers under their contractual obligations.  The determination of the allowance involves significant assumptions, complex analyses, and management judgment and requires us to make significant estimates of current credit risks using existing qualitative and quantitative information. Actual results may differ from our estimates or assumptions.  For example, we review and analyze external factors, including changes in economic conditions, actual or perceived quality, safety and reliability of Toyota, Lexus, and private label vehicles, unemployment levels, the used vehicle market, and consumer behavior, among other factors.  Internal factors, such as purchase quality mix and operational changes are also considered.  A change in any of these factors would cause a change in estimated lifetime expected credit losses.  As a result, our allowance for credit losses may not be adequate to cover our actual losses.  In addition, changes in accounting rules and related guidance, new information regarding existing portfolios, and other factors, both within and outside of our control, may require changes to the allowance for credit losses.  A material increase in our allowance for credit losses may adversely affect our results of operations and financial condition.

Refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Critical Accounting Estimates” for further discussion of the estimates involved in determining the allowance for credit losses and Note 4 – Allowance for Credit Losses of the Notes to Consolidated Financial Statements for further discussion of the methodology used in determining the allowance for credit losses.

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Our business and operations make extensive use of quantitative models, estimates and assumptions. If our design, implementation or use of models is flawed or if actual results differ from our estimates or assumptions, our results of operations and financial condition could be materially and adversely affected.

We use quantitative models, estimates and assumptions to price products and services, measure risk, estimate asset and liability values, assess liquidity, manage our balance sheet, and otherwise conduct our business and operations.  If the design, implementation, or use of any of these models is flawed or if actual results differ from our estimates or assumptions, it may adversely affect our results of operations and financial condition.  In addition, to the extent that any inaccurate model outputs are used in reports to regulatory agencies or the public, we could be subjected to supervisory actions, litigation, and other proceedings that may adversely affect our business, results of operations and financial condition.

Assumptions and estimates often involve matters that require the exercise of management’s judgment, are inherently difficult to predict and are beyond our control (for example, macro-economic conditions).  In addition, such assumptions and estimates often involve complex interactions between a number of dependent and independent variables, factors, and other assumptions. As a result, 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 results of operations and financial condition.

Fluctuations in the valuation of investment securities or significant fluctuations in investment market prices could negatively affect our Net financing revenues and results of operations.

Investment market prices, in general, are subject to fluctuation, which may result from perceived changes in the underlying characteristics of the investment, the relative price of alternative investments, geopolitical conditions, or general market conditions.  Negative fluctuations in the fair value of equity investments and credit losses on available-for-sale debt securities may adversely affect our Net financing revenues and results of operations. Additionally, the amount realized in the subsequent sale of an investment may significantly differ from the reported market value and could negatively affect our Net financing revenues and other revenues.  

A decrease in the residual values of our off-lease vehicles and a higher number of returned lease assets could negatively affect our results of operations and financial condition.

We are exposed to residual value risk on the disposition of leased vehicles if sales proceeds realized upon the sale of returned lease assets are not sufficient to cover the residual value that was estimated at lease inception and if the number of returned lease assets is higher than anticipated.  To the extent the estimated end-of-term market value of a leased vehicle is lower than the residual value established at lease inception, the residual value of the leased vehicle is adjusted downward resulting in additional depreciation expense over the term of the lease contract so that the carrying value at lease-end will approximate the estimated end-of-term market value.  Among other factors, local, regional and national economic conditions, inflation, new vehicle pricing, new vehicle incentive programs, new vehicle sales, the actual or perceived quality, safety or reliability of our vehicles, future plans for new Toyota, Lexus, and private label product introductions, competitive actions and behavior, product attributes of popular vehicles, the mix of used vehicle supply, the level of current used vehicle values and inventory levels, and fuel prices heavily influence used vehicle values and thus the actual residual value of off-lease vehicles.  Differences between the actual residual values realized on leased vehicles and our estimates of such values at lease inception could have a negative impact on our results of operations and financial condition, due to the impact of higher-than-anticipated Depreciation on operating leases recorded in our Consolidated Statements of Income.  Actual return volumes may be higher than expected which can be impacted by higher contractual lease-end residual values relative to market values, a higher market supply of certain models of used vehicles, new vehicle incentive programs, and general economic conditions.   The return of a higher number of leased vehicles could also impact the amount of depreciation expense recorded in our Consolidated Statements of Income, which could adversely affect our results of operations and financial condition.

Refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Financial Condition – Residual Value Risk”, “Financial Condition – Disposition of Off-Lease Vehicles” and “Financial Condition – Depreciation on Operating Leases” for further discussion of current lease trends.

We are exposed to customer and dealer credit risk, which could negatively affect our results of operations and financial condition.

Credit risk is the risk of loss arising from the failure of a customer or dealer to meet the terms of any retail, lease or dealer financing contract with us or otherwise fail to perform as agreed.  An increase in credit risk would increase our provision for credit losses, which would have a negative impact on our results of operations and financial condition.

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There can be no assurance that our monitoring of credit risk and our efforts to mitigate credit risk are or will be sufficient to prevent an adverse effect on our results of operations and financial condition.

The level of credit risk in our retail loan portfolio is influenced primarily by two factors: the total number of contracts that experience default (“default frequency”) and the amount of loss per occurrence (“loss severity”), which in turn are influenced by various economic factors, the used vehicle market, purchase quality mix, contract term length, and operational changes.  The used vehicle market is impacted by the supply of, and demand for, used vehicles, interest rates, inflation, new vehicle incentive programs, the manufacturer’s actual or perceived reputation for quality, safety, and reliability, and the general economic outlook.

The level of credit risk in our dealer portfolio is influenced primarily by the financial strength of dealers within our portfolio, dealer concentration, collateral quality, and other economic factors.  The financial strength of dealers within our portfolio is influenced by general macroeconomic conditions, the overall demand for new and used vehicles, and the financial condition of automotive manufacturers, among other factors.  

Economic slowdown and recession in the U.S., extreme weather conditions, natural disasters, health epidemics, and other factors increase the risk that a customer or dealer may not meet the terms of a retail, lease or dealer financing contract with us or may otherwise fail to perform as agreed.  A weak economic environment evidenced by, among other things, unemployment, underemployment, and consumer bankruptcy filings, may affect some of our customers’ and dealers’ ability to make their scheduled payments.

Our results of operations, financial condition and cash flows may be adversely affected by changes in interest rates, foreign currency exchange rates and market prices.

Market risk is the risk that changes in interest rates and foreign currency exchange rates cause volatility in our results of operations, financial condition and cash flows.  An increase in interest rates (due to inflationary pressure or other factors) could have an adverse effect on our business, financial condition and results of operations by increasing our cost of capital and the rates we charge to our customers and dealers, which could, in turn, decrease our financing volumes and market share, thereby resulting in a decline in our competitive position.  We use various derivative instruments to manage our market risk.  However, changes in interest rates, foreign currency exchange rates and market prices cannot always be predicted or hedged.  Changes in interest rates or foreign currency exchange rates (due to inflationary pressure or other factors) could affect our interest expense and the value of our derivatives, which could result in volatility in our results of operations, financial condition, and cash flows. 

The transition away from the London Interbank Offered Rate (“LIBOR”) and the adoption of alternative reference rates could adversely impact our business and results of operations.

We are exposed to LIBOR-based financial instruments, including through our dealer financing activities, derivative contracts, secured and unsecured debt, and investment securities.

The publication of non-U.S. dollar LIBOR rates on a representative basis, as well as the publication of the lesser used 1-week and 2-month U.S. dollar LIBOR tenors, ceased as of the end of December 2021. While the most commonly used U.S. dollar LIBOR tenors are expected to continue to be published until June 30, 2023, U.S. banking agencies issued guidance that financial institutions should cease using U.S. dollar LIBOR as a reference rate in new contracts after December 31, 2021. A transition away from the widespread use of LIBOR to alternative rates and other potential interest rate benchmark reforms has begun and is continuing. These reforms have caused and may in the future cause such rates to perform differently than in the past, or to disappear entirely, or have other consequences which cannot be predicted.  

In June 2017, the New York Federal Reserve’s Alternative Reference Rates Committee announced the Secured Overnight Financing Rate (“SOFR”) as its recommended alternative to U.S. dollar LIBOR. The composition and characteristics of SOFR are not the same as those of LIBOR.  As a result, there can be no assurance that SOFR or any alternative reference rate will perform in the same way as LIBOR would have at any time, including, without limitation, as a result of changes in interest and yield rates in the market, market volatility or global or regional economic, financial, political, regulatory, judicial or other events. With limited operating history, it remains unknown whether SOFR will be broadly accepted, whether it will continue to evolve, and what the effects of its implementation may be on the markets for financial instruments.  If SOFR or another rate does not achieve wide acceptance as the alternative to LIBOR, there likely will be disruption to the markets relying on the availability of a broadly accepted reference rate.

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To facilitate an orderly transition from LIBOR to alternative reference rates, we have established an initiative led by senior management, with Board and committee oversight.  As a result of this initiative, we have committed to using SOFR linked rates in connection with various borrowing arrangements and Prime in connection with various lending arrangements, and we continue to evaluate other alternatives as potential alternative reference rates to LIBOR.  Even if an alternative reference rate becomes widely accepted, we may continue to be subject to risk on outstanding instruments which rely on LIBOR. Those risks arise in connection with transitioning such instruments to a new reference rate, the taking of discretionary actions (for example, under fallback provisions) or the negotiation of fallback provisions and final amendments to existing LIBOR based agreements.  If a contract or instrument is not transitioned to a new reference rate and LIBOR ceases to exist, we may experience increased interest rate risk. In addition, we may be dependent on third parties to upgrade their systems, software, and other critical functions to assist in our orderly transition from LIBOR. A failure to properly transition away from LIBOR could expose us to various financial, operational, and regulatory risks, which could have a significant impact on our financial condition and results of operations.

The failure or commercial soundness of our counterparties and other financial institutions may have an effect on our liquidity, results of operations or financial condition.

We have exposure to many different financial institutions, and we routinely execute transactions with counterparties in the financial industry.  Our debt, derivative and investment transactions, and our ability to borrow under committed and uncommitted credit facilities, could be adversely affected by the actions and commercial soundness of other financial institutions.  We cannot guarantee that our ability to borrow under committed and uncommitted credit facilities will continue to be available on reasonable terms or at all.  Deterioration of social, political, labor, or economic conditions in a specific country or region may also adversely affect the ability of financial institutions, including our derivative counterparties and lenders, to perform their contractual obligations.  Financial institutions are interrelated as a result of trading, clearing, lending and other relationships, and as a result, financial and political difficulties in one country or region may adversely affect financial institutions in other jurisdictions, including those with which we have relationships.  The failure of any financial institutions and other counterparties to which we have exposure, directly or indirectly, to perform their contractual obligations, and any losses resulting from that failure, may materially and adversely affect our liquidity, results of operations or financial condition.

Our voluntary protection operations could suffer losses if our reserves are insufficient to absorb actual losses.

Our voluntary protection operations are subject to the risk of loss if our reserves for unearned voluntary protection contract revenues and insurance earned premiums on contracts in force are not sufficient.  Using historical loss experience as a basis for recognizing revenue over the term of the contract or policy may result in the timing of revenue recognition varying materially from the actual loss development.  Our voluntary protection operations are also subject to the risk of loss if our reserves for reported losses, losses incurred but not reported, and loss adjustment expenses are not sufficient.  Because we use estimates in establishing reserves, actual losses may vary from amounts established in earlier periods as a result of changes in frequency and severity.

We are exposed to risk transfer credit risk which could negatively impact our voluntary protection operations.

Risk transfer credit risk is the risk that a reinsurer or other company assuming liabilities relating to our voluntary protection operations will be unable to meet its obligations under the terms of our agreement with them.  Such failure could result in losses to our voluntary protection operations.

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REGULATORY, LEGAL AND OTHER RISKS

Changes in accounting standards issued by the Financial Accounting Standards Board (“FASB”) could adversely affect our results of operations and financial condition.

Our accounting and financial reporting policies conform to accounting principles generally accepted in the U.S., which are periodically revised and/or expanded. The application of accounting principles is also subject to varying interpretations over time. Accordingly, we are required to adopt new or revised accounting standards or comply with revised interpretations that are issued from time to time by various parties, including accounting standard setters and those who interpret the standards, such as the FASB and the SEC and our independent registered public accounting firm. The FASB has proposed new financial accounting standards that may result in significant changes that could adversely affect our results of operations and financial condition.

Refer to Note 1 – Basis of Presentation and Significant Accounting Policies of the Notes to the Consolidated Financial Statements for further discussion of these new accounting standards, including the potential impact to TMCC’s consolidated financial statements.  

A failure or interruption of our information systems could adversely affect our business, results of operations and financial condition.

We rely on our own information systems and third-party information systems to manage our operations, which creates meaningful operational risk for us.  Any failure or interruption of our information systems or the third-party information systems on which we rely as a result of inadequate or failed processes or systems, human errors, employee misconduct, catastrophic events, security breaches, acts of vandalism, computer viruses, malware, ransomware, misplaced or lost data, or other events could disrupt our normal operating procedures, damage our reputation and have an adverse effect on our business, results of operations and financial condition.  These operational risks may be increased as a result of remote or hybrid work arrangements due to the COVID-19 pandemic.

In addition, we periodically upgrade or replace our existing transaction systems, which could have a significant impact on our ability to conduct our core business operations and increase our risk of loss resulting from disruptions of normal operating processes and procedures that may occur during and after the implementation of new systems. For example, the development and implementation of these new systems and any future upgrades related thereto may require significant expenditures and divert management’s attention and other resources from our core business operations.  There are no assurances that these new systems will provide us with the anticipated benefits and efficiencies.  There can also be no assurance that the time and resources our management will need to devote to implementation and upgrades, potential delays in the implementation or upgrade or any resulting service interruptions, or any impact on the reliability of our data from any upgrade of our legacy system, will not have a material adverse effect on our business, results of operations and financial condition.

A security breach or a cyber-attack could adversely affect our business, results of operations and financial condition.

We collect and store certain personal and financial information from customers, employees, and other third parties. Security breaches or cyber-attacks involving our systems or facilities, or the systems or facilities of third-party providers, could expose us to a risk of loss of personal information of customers, employees and third parties or other confidential, proprietary or competitively sensitive information, business interruptions, regulatory scrutiny, actions and penalties, litigation, reputational harm, a loss of confidence, and other financial and non-financial costs, all of which could potentially have an adverse impact on our future business with current and potential customers, results of operations and financial condition.

We rely on encryption and other information security technologies licensed from third parties to provide security controls necessary to help in securing online transmission of confidential information pertaining to customers, employees and other aspects of our business. Advances in information system capabilities, new discoveries in the field of cryptography or other events or developments may result in a compromise or breach of the technology that we use to protect sensitive data.  A party who is able to circumvent our security measures by methods such as hacking, fraud, trickery or other forms of deception could misappropriate proprietary information or cause interruption in our operations. We may be required to expend capital and other resources to protect against such security breaches or cyber-attacks or to remediate problems caused by such breaches or attacks. Our security measures are designed to protect against security breaches and cyber-attacks, but our failure to prevent such security breaches and cyber-attacks could subject us to liability, decrease our profitability and damage our reputation.  Even if a failure of, or interruption in, our systems or facilities is resolved timely or an attempted cyber incident or other security breach is successfully

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avoided or thwarted, it may require us to expend substantial resources or to take actions that could adversely affect customer satisfaction or behavior and expose us to reputational harm.

We could also be subjected to cyber-attacks that could result in slow performance and loss or temporary unavailability of our information systems.  Information security risks have increased because of new technologies, the use of the internet and telecommunications technologies (including mobile devices) to conduct financial and other business transactions, and the increased sophistication and activities of state-sponsored actors, organized crime, perpetrators of fraud, terrorists, and others.  In addition, we may have increased cyber-security risks and increased vulnerability to security breaches and other information technology disruptions as a result of the COVID-19 pandemic and increased remote or hybrid work arrangements among our colleagues.  We may not be able to anticipate or implement effective preventative measures against all security breaches of these types, especially because the techniques used change frequently and because attacks can originate from a wide variety of sources.  The occurrence of any of these events could have a material adverse effect on our business, results of operations and financial condition.

Our enterprise data practices, including the collection, use, sharing, disposal and security of personal and financial information of our customers, employees, and third-party individuals are subject to increasingly complex, restrictive, and punitive laws and regulations which could adversely affect our business, results of operations and financial condition.

Under these laws and regulations, the failure to maintain compliant data practices could result in consumer complaints, lawsuits and regulatory inquiry, resulting in civil or criminal penalties, as well as brand impact or other harm to our business.  In addition, increased consumer sensitivity to real or perceived failures in maintaining acceptable data practices could damage our reputation and deter current and potential customers from using our products and services.  For example, well-publicized allegations involving the misuse or inappropriate sharing of personal information have led to expanded governmental scrutiny of practices relating to the safeguarding of personal information and the use or sharing of personal data by companies in the U.S. and other countries.  That scrutiny has in some cases resulted in, and could in the future lead to, the adoption of stricter laws and regulations relating to the use and sharing of personal information.  For example, some states have enacted and others are considering enacting data protection regimes that grant consumers broad new rights including access to, deletion of, and limiting the sharing of personal information that is collected by businesses and requiring regulated entities to establish measures to identify, manage, secure, track, produce, update and delete personal information.  In some jurisdictions, these laws and regulations provide a private right of action that would allow customers to bring suit directly against us for certain violations of these laws and regulations.  These types of laws and regulations could prohibit or significantly restrict financial services providers such as TMCC from sharing information among affiliates or with third parties such as vendors, and thereby increase compliance costs, or could restrict TMCC’s use of personal data when developing or offering products or services to customers.  These restrictions could inhibit TMCC’s development or marketing of certain products or services or increase the costs of offering them to customers.  Because many of these laws and regulations are new, there is little clarity as to their interpretation, as well as a lack of precedent for the scope of enforcement.  In addition, these laws are state specific and have specific details that are not uniform state-to-state.  The cost of compliance with these laws and regulations will be high and is likely to increase in the future.  Any failure or perceived failure to comply with applicable privacy or data protection laws and regulations could result in requirements to modify or cease certain operations or practices, significant liabilities or fines, penalties or other sanctions.

The regulatory environment in which we operate could have a material adverse effect on our business and results of operations.

Regulatory risk includes risk arising from failure or alleged failure to comply with applicable regulatory requirements and risk of liability and other costs imposed under various laws and regulations, including changes in applicable law, regulation and regulatory guidance.

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Consumer Finance Regulation

As a provider of finance and voluntary protection products, we operate in a highly regulated environment. We are subject to state licensing requirements and state, and federal laws and regulations.  In addition, we are subject to governmental and regulatory examinations, information-gathering requests, and investigations from time to time at the state and federal levels.  Compliance with applicable law is costly and can affect our results of operations. Compliance requires forms, processes, procedures, controls and the infrastructure to support these requirements.  Compliance may create operational constraints and place limits on pricing, as the laws and regulations in the financial services industry are designed primarily for the protection of consumers.  Changes in laws and regulations could restrict our ability to operate our business as currently operated, could impose substantial additional costs or require us to implement new processes, which could adversely affect our business, prospects, financial performance or financial condition.  The failure to comply with applicable laws and regulations could result in significant statutory civil and criminal fines, penalties, monetary damages, attorney or legal fees and costs, restrictions on our ability to operate our business, possible revocation of licenses and damage to our reputation, brand and valued customer relationships. Any such costs, restrictions, revocations or damage could adversely affect our business, prospects, results of operations or financial condition.

Our principal consumer finance regulator at the federal level is the CFPB, which has broad regulatory, supervisory and enforcement authority over us.  The CFPB’s supervisory authority allows it, among other things, to conduct comprehensive and rigorous examinations to assess our compliance with consumer financial protection laws, which could result in enforcement actions, regulatory fines and mandated changes to our business products, policies and procedures.

The CFPB’s rulemaking authority includes the authority to promulgate rules regarding, among other practices, debt collection practices that would apply to third-party collectors and first-party collectors, such as ourselves, and rules regarding consumer credit reporting practices.  The timing and impact of these rules on our business remain uncertain.  In addition, the CFPB has focused on the area of auto finance, particularly with respect to indirect financing arrangements, dealer compensation and fair lending compliance, and questioned the value and increased scrutiny of the marketing and sale of certain ancillary or add-on products, including products similar to those we finance or sell through TMIS.

The CFPB and FTC may investigate the products, services and operations of credit providers, including banks and other finance companies engaged in auto finance activities.  As a result of such investigations, the CFPB and FTC have announced various enforcement actions against lenders in the past few years involving significant penalties, consent orders, cease and desist orders and similar remedies that, if applicable to us or the products, services and operations we offer, may require us to cease or alter certain business practices, which could have a material adverse effect on our results of operations, financial condition, and liquidity.  Supervision and investigations by these agencies  may result in monetary penalties, increase our compliance costs, require changes in our business practices, affect our competitiveness, impair our profitability, harm our reputation or otherwise adversely affect our business.  

Refer to Item 1. Business, “Regulatory Environment” for further discussion of the CFPB’s authority and activities.

At the state level, state regulators are taking a more stringent approach to supervising and regulating financial products and services subject to their jurisdiction.  For example, certain states have proposed rate cap bills that would put limits on the maximum rate of finance charges.  We expect to continue to face greater supervisory scrutiny and enhanced supervisory requirements for the foreseeable future.  

Other Federal Regulation

Under the Volcker Rule companies affiliated with U.S. insured depository institutions are generally prohibited from engaging in “proprietary trading” and certain transactions with certain privately offered funds.  The activities prohibited by the Volcker Rule are not core activities for us. However, the federal financial regulatory agencies charged with implementing the Volcker Rule could further amend the rule or change their approach to administering, enforcing or interpreting the rule, which could negatively affect us and potentially require us to limit or change our activities or operations.

The Dodd-Frank Act amended the CEA to establish a framework for the regulation of certain OTC derivatives referred to as swaps.  The OTC derivatives provisions of the CEA, as amended by the Dodd-Frank Act, impose clearing, trading and margin requirements on certain contracts.  At present, we qualify for exceptions from these requirements for the swaps that we enter into to hedge our commercial risks.  However, if we were to no longer qualify for such exceptions, we could become subject to some or all of these requirements, which would increase our cost of entering into and maintaining such hedging positions.  

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If we reduce our use of OTC derivatives as a result of the Dodd-Frank Act and resulting regulations, our results of operations may become more volatile and our cash flows may be less predictable, which could adversely affect our ability to plan for and fund capital expenditures.

Environmental Related Regulation  

Concern over climate change or other environmental matters may result in new or increased legal and regulatory requirements intended to mitigate factors contributing to, or intended to address the potential impacts of, climate change or other environmental concerns.  Such regulations (including laws related to greenhouse gas emitting products or services) may require us to alter our proposed business plans, lead to increased compliance costs and changes to our operations and could have an adverse effect on our business, results of operations and financial condition.

Refer to Item 1. Business, “Regulatory Environment” for additional information on our regulatory environment.

Adverse economic conditions or changes in state laws in states in which we have customer concentrations may negatively affect our results of operations and financial condition.

We are exposed to geographic customer concentration risk on our retail, lease, dealer, and voluntary protection products in certain states.  Factors adversely affecting the economies and applicable laws in the states where we have concentration risk could have an adverse effect on our results of operations and financial condition.

Refer to Note 1 – Basis of Presentation and Significant Accounting Policies of the Notes to Consolidated Financial Statements for additional information and disclosure about customer concentrations in certain states.

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ITEM 1B. UNRESOLVED STAFF COMMENTS

There are no unresolved SEC staff comments to report.

ITEM 2. PROPERTIES

Our headquarters operations are located in Plano, Texas, and our facilities are leased from TMNA.

Additional operations for both finance and voluntary protection products are located in three CSCs and three DSCs.  The Central region CSC is located in Cedar Rapids, Iowa, and is leased from TMNA.  The Western region CSC is located in Chandler, Arizona.  The Eastern region CSC is located in Owings Mills, Maryland.  The Central DSC is located in Plano, Texas.  The Western DSC is located in Chandler, Arizona.  The Eastern DSC is located in Alpharetta, Georgia.  Our dealer lending function is centralized at the Central DSC.  We also have a sales and operations office in Puerto Rico.  All premises are occupied under lease.

While we believe that our properties are suitable to meet the current requirements of our business, over the next year, we plan to complete the process of moving our three CSCs to be co-located with the regional DSCs to better serve our customers.  Refer to Item 1.  Business, “General” for further discussion of the field operations restructuring.

ITEM 3. LEGAL PROCEEDINGS

For a discussion of legal proceedings, see Note 9 – Commitments and Contingencies of the Notes to Consolidated Financial Statements - Litigation and Governmental Proceedings.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

TMCC is a wholly-owned subsidiary of TFSIC, and accordingly, all shares of TMCC’s stock are owned by TFSIC.  There is no market for TMCC's stock.

ITEM 6. [RESERVED]

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

Cautionary Statement Regarding Forward-Looking Information

Certain statements contained in this Form 10-K are “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  These statements are based on current expectations and currently available information.  However, since these statements are based on factors that involve risks and uncertainties, our performance and results may differ materially from those described or implied by such forward-looking statements.  Words such as “believe,” “anticipate,” “expect,” “estimate,” “project,” “should,” “intend,” “will,” “may” or words or phrases of similar meaning are intended to identify forward-looking statements.  We caution that the forward-looking statements involve known and unknown risks, uncertainties and other important factors such as the following that may cause actual results to differ materially from those stated:

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Forward-looking statements speak only as of the date they are made.  We will not update the forward-looking statements to reflect actual results or changes in the factors affecting the forward-looking statements.

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OVERVIEW

Key Performance Indicators and Factors Affecting Our Business

In our finance operations, we generate revenue, income, and cash flows by providing retail, lease, and dealer financing to dealers and their customers.  We measure the performance of our finance operations using the following metrics: financing volume, market share, Net financing revenues, Operating and administrative expense, residual value and credit loss metrics.

In our voluntary protection operations, we generate revenue primarily through marketing, underwriting, and providing claims administration for products that cover certain risks of customers.  We measure the performance of our voluntary protection operations using the following metrics: issued contract volume, average number of contracts in force, loss metrics and investment income.

Our financial results are affected by a variety of economic and industry factors including, but not limited to, new and used vehicle markets, Toyota, Lexus, and private label new vehicle production volume, vehicle inventory levels, vehicle sales and incentive programs, consumer behavior, employment levels, our ability to respond to changes in interest rates with respect to both contract pricing and funding, the actual or perceived quality, safety or reliability of Toyota, Lexus, and private label vehicles, the financial health of the dealers we finance, and competitive pressure.  Our financial results may also be affected by the regulatory environment in which we operate, including as a result of new legislation or changes in regulation and any compliance costs or changes we may be required to make to our business practices.  All of these factors can influence consumer contract and dealer financing volume, the number of consumer contracts and dealers that default and the loss per occurrence, our inability to realize originally estimated contractual residual values on leased vehicles, the volume and performance of our voluntary protection operations, and our Net financing revenues on consumer and dealer financing volume.  Changes in the volume of vehicle sales, sales of our voluntary protection products, or the level of voluntary protection expenses and insurance losses could materially and adversely impact our voluntary protection operations.  Additionally, our funding programs and related costs are influenced by changes in the global capital markets, prevailing interest rates, and our credit ratings and those of our parent companies, which may affect our ability to obtain cost effective funding to support earning asset growth.

Our primary competitors are other financial institutions including national and regional commercial banks, credit unions, savings and loan associations, independent voluntary protection product contract providers, online banks, finance companies and, to a lesser extent, other automobile manufacturers’ affiliated finance companies that actively seek to purchase consumer contracts through Toyota, Lexus, and private label dealers.  We strive to achieve the following:

Exceptional Customer Service:  Our relationship with Toyota, Lexus, and private label dealers and their customers offers us a competitive advantage.  We seek to leverage this opportunity by providing exceptional service to the dealers and their customers.  Through our DSCs and CSCs, we work closely with the dealers to improve the quality of service we provide to them.  We also focus on assisting the dealers with the quality of their customer service operations to enhance customer loyalty for the dealers and the Toyota, Lexus, and private label brands.  By providing consistent and reliable support, training, and resources to our dealer network, we continue to develop and improve our dealer relationships.  In addition to marketing programs targeted toward customer retention, we work closely with TMNA, private label companies, and other third-party distributors to offer special retail, lease, dealer financing, and voluntary protection products.  We also focus on providing a positive customer experience to existing retail, lease, and voluntary protection product customers through our CSCs.

Risk-Based Origination and Pricing:  We price and structure our retail and lease contracts to compensate us for the credit risk we assume.  The objective of this strategy is to maximize operating results and better match contract rates across a broad range of risk levels.  To achieve this objective, we evaluate our existing portfolio for key opportunities to expand volume in targeted markets.  We deliver timely strategic information to the dealers to assist them in benefiting from market opportunities.  We continuously strive to refine our strategy and methodology for risk-based pricing.

Liquidity:  Our liquidity strategy is to maintain the capacity to fund assets and repay liabilities in a timely and cost-effective manner even in adverse market conditions.  This capacity is primarily driven by our ability to raise funds in the global capital markets and through loans, credit facilities, and other transactions, as well as our ability to generate liquidity from our earnings assets.  Our pursuit of this strategy has led us to develop a diversified borrowing base that is distributed across a variety of markets, geographies, investors, and financing structures, among other factors.

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Fiscal 2022 Operating Environment

During the fiscal year ending March 31, 2022 (“fiscal 2022”), the U.S. economy continued to be impacted by the global pandemic of COVID-19 and related variants and the extraordinary governmental measures intended to slow its spread.  In conjunction with increases in vaccination rates and the easing of restrictive measures throughout fiscal 2022, there has been improvement in unemployment levels and consumer confidence from fiscal 2021 pandemic lows, but neither measure has returned to its pre-pandemic level.  There remains uncertainty around the duration and the severity of the COVID-19 pandemic, the timing and strength of the economy’s recovery, and the impacts of government support and lender relief programs ending.  In addition, during fiscal 2022, inflation has increased significantly from pandemic lows in fiscal 2021 and has remained at elevated levels.  The impact of the COVID-19 pandemic on our future operations is difficult to predict, but the curtailment of economic activities as a result of further outbreak of COVID-19, extended or additional government restrictions intended to slow the spread of the virus, ending of government support programs, delayed consumer response to the lifting of restrictive measures, or permanent behavior changes in consumer spending could have further negative impact on consumer economics, dealerships, and auction sites, which could have a material adverse impact on our business, financial condition, and future results of operations. In addition, changes in the economy that adversely impact the consumer, such as inflation, higher interest rates, elevated debt levels and an increase in unemployment from the current levels could adversely impact our results of operations.

Economic conditions caused by the COVID-19 pandemic, including production halts and supply shortages affecting the automotive industry and additional delays affecting the supply chain and logistics networks, have resulted in a decrease in dealer new vehicle inventory levels.  This includes the global shortage of semiconductor chips and other parts and raw materials the automotive industry continues to face.  The duration and severity of the supply chain disruptions and shortages, including but not limited to the semiconductor chips, are difficult to predict, but should these persist or become more severe, the negative impact to the manufacturers’ vehicle production and dealer new vehicle inventory levels could adversely impact our results of operations.  

Average used vehicle values further increased in fiscal 2022 compared to fiscal 2021 and remain elevated compared to historical levels, primarily due to the lack of availability of new vehicles. Future declines in used vehicle values resulting from increases in the supply of new and used vehicles and increases in new vehicle sales incentives could unfavorably impact return rates, residual values, depreciation expense and credit losses in the future.

Conditions in the global capital markets were generally stable during the first nine months of fiscal 2022; however, during the fourth quarter of fiscal 2022, credit spreads widened and markets experienced periods of volatility in response to the conflict in Ukraine, increases in the inflation rate, and uncertainty regarding the path of U.S. monetary policy.  While we continue to maintain broad global access to both domestic and international markets, these events could lead to cause further disruptions in the global capital markets and increases to our funding costs.  Future changes in interest rates in the U.S. and foreign markets could result in volatility in our interest expense, which could affect our results of operations.

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RESULTS OF OPERATIONS

Fiscal 2022 Compared to Fiscal 2021

Our consolidated net income was $2,535 million in fiscal 2022, compared to $2,017 million in fiscal 2021.  The increase in net income for fiscal 2022 compared to fiscal 2021 was primarily due to a $901 million decrease in interest expense, a $190 million decrease in provision for credit losses, a $121 million increase in total financing revenues, a $86 million decrease in depreciation on operating leases, partially offset by a $436 million decrease in investment and other income, net, a $210 million increase in operating and administrative expense, and a $157 million increase in provision for income taxes.

Our overall capital position increased $2.5 billion, bringing total shareholder’s equity to $18.1 billion at March 31, 2022, as compared to $15.6 billion at March 31, 2021.  Our debt decreased to $109.2 billion at March 31, 2022 from $109.7 billion at March 31, 2021.  Our debt-to-equity ratio decreased to 6.0 at March 31, 2022 from 7.0 at March 31, 2021.

Fiscal 2021 Compared to Fiscal 2020

Our consolidated net income was $2,017 million in fiscal 2021, compared to $913 million in fiscal 2020.  The increase in net income for fiscal 2021 compared to fiscal 2020 was primarily due to an $888 million decrease in depreciation on operating leases, a $532 million decrease in interest expense, a $164 million decrease in provision for credit losses, an $88 million increase in investment and other income, net, an $86 million decrease in voluntary protection contract expenses and insurance losses, and a $74 million decrease in operating and administrative expense, partially offset by a $521 million increase in provision for income taxes, and a $230 million decrease in total financing revenues.  

Our overall capital position, taking into account the payment of a $700 million dividend in March 2021 to TFSIC, increased $1.1 billion, bringing total shareholder’s equity to $15.6 billion at March 31, 2021, as compared to $14.5 billion at March 31, 2020.  The adoption of ASU 2016-13 resulted in a cumulative-effect adjustment to decrease opening retained earnings by approximately $218 million, net of taxes, resulting from a pretax increase to our allowance for credit losses on finance receivables of approximately $292 million.  Our debt increased to $109.7 billion at March 31, 2021 from $97.7 billion at March 31, 2020.  Our debt-to-equity ratio increased to 7.0 at March 31, 2021 from 6.7 at March 31, 2020.  

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Finance Operations

The following table summarizes key results of our Finance Operations:

Our finance operations reported net income of $2,416 million and $1,606 million during fiscal 2022 and 2021, respectively.  The increase in net income from finance operations for fiscal 2022 compared to fiscal 2021 was due to a $901 million decrease in interest expense, a $190 million decrease in provision for credit losses, a $121 million increase in total financing revenues, and an $86 million decrease in depreciation on operating leases, partially offset by a $253 million increase in provision for income taxes, a $187 million increase in operating and administrative expenses, and a $48 million decrease in investment and other income, net.

Financing Revenues

Total financing revenues increased 1 percent during fiscal 2022 compared to fiscal 2021 due to the following:

As a result of the above, our total portfolio yield, which includes operating lease, retail and dealer financing revenues, decreased to 5.0 percent for fiscal 2022, compared to 5.1 percent for fiscal 2021.

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Depreciation on Operating Leases

We recorded depreciation on operating leases of $5,846 million during fiscal 2022 compared to $5,932 million during fiscal 2021.  The decrease is primarily due to lower average operating lease units outstanding, partially offset by residual value losses.  The economic conditions caused by the COVID-19 pandemic and the current conflict in Ukraine, including production halts and supply shortages affecting the automotive industry and additional delays affecting the supply chain and logistics networks, have resulted in a decrease in the availability of new vehicles.  The lower levels of new vehicle inventory and higher off-lease vehicle purchases by dealers have led to historically high levels of average used vehicle values.  Declines in used vehicle values resulting from increases in the supply of new vehicles and increases in new vehicle sales incentives could unfavorably impact return rates, residual values, and depreciation expense in the future.

Interest Expense

Our liabilities consist mainly of fixed and variable rate debt, denominated in U.S. dollars and various other currencies, which we issue in the global capital markets, while our assets consist primarily of U.S. dollar denominated, fixed rate receivables.  We enter into interest rate swaps and foreign currency swaps to economically hedge the interest rate and foreign currency risks that result from the different characteristics of our assets and liabilities.  The following table summarizes the components of interest expense:

During fiscal 2022, total interest expense decreased to $1,401 million from $2,302 million in fiscal 2021. The decrease is attributable to a decrease in interest expense on debt and derivatives combined and higher gains on U.S. dollar interest rate swaps, partially offset by losses on foreign currency swaps net of gains from debt denominated in foreign currencies.  

Interest expense on debt and derivatives primarily represents contractual net interest settlements and changes in accruals on secured and unsecured notes and loans payable and derivatives, and includes amortization of discounts, premiums, and debt issuance costs.  During fiscal 2022, interest expense on debt and derivatives decreased to $1,605 million from $2,374 million in fiscal 2021.  The decrease in interest expense on debt is primarily due to decrease in weighted average interest rates. The decrease in interest expense on derivatives is primarily due to decrease in interest expense on pay fixed swaps.

Gains or losses on debt denominated in foreign currencies represent the impact of translation adjustments.  We use foreign currency swaps to economically hedge the debt denominated in foreign currencies. During fiscal 2022 and fiscal 2021, we recorded net losses of $380 million and $51 million, respectively, primarily due to increases in foreign currency swap rates across the various currencies in which our debt is denominated.  

Gains or losses on U.S. dollar interest rate swaps represent the change in the valuation of interest rate swaps.  During fiscal 2022 and fiscal 2021, we recorded gains of $584 million and $123 million, respectively, primarily due to increases in U.S. dollar swap rates and net interest income on our pay-fixed swaps exceeding losses on our pay-float swaps.  

Future changes in interest and foreign currency exchange rates could continue to result in significant volatility in our interest expense, thereby affecting our results of operations.

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Investment and Other Income, Net

We recorded investment and other income, net of $45 million for fiscal 2022, compared to $93 million for fiscal 2021.  The decrease in investment and other income, net for fiscal 2022 compared to fiscal 2021 was primarily due to lower average balances in our cash equivalents and investment in marketable securities portfolio.

Provision for Credit Losses

We recorded a provision for credit losses of $236 million for fiscal 2022, compared to $426 million for fiscal 2021.  In fiscal 2022, in conjunction with continued improved dealer financial performance and lower charge-offs, the lower volatility in the macroeconomic conditions resulted in a lower provision for credit losses for our retail loan portfolio. In contrast, in fiscal 2021, we increased the expected credit losses for our retail loan portfolio due to a decline in economic conditions caused by the COVID-19 pandemic and the restrictions designed to slow the spread of COVID-19, which resulted in stay-at-home orders, increased unemployment, and decreased consumer spending.

Operating and Administrative Expenses

We recorded operating and administrative expenses of $1,311 million during fiscal 2022 compared to $1,124 million during fiscal 2021.  The increase in operating and administrative expenses for fiscal 2022, compared to fiscal 2021, was primarily due to increases in employee expenses and general operating expenses.  

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Voluntary Protection Operations

The following table summarizes key results of our Voluntary Protection Operations:  

Our voluntary protection operations reported net income of $119 million for fiscal 2022 compared to $411 million for fiscal 2021.  The decrease in net income from voluntary protection operations for fiscal 2022 compared to fiscal 2021 was primarily due to a $388 million decrease in investment and other (loss) income, net, and a $36 million increase in voluntary protection contract expenses and insurance losses, partially offset by a $96 million decrease in provision for income taxes and a $59 million increase in voluntary protection contract revenues and insurance earned premiums.  

Contracts issued increased 16 percent primarily due to prepaid maintenance, vehicle service, and tire and wheel protection contracts during fiscal 2022 compared to fiscal 2021. The higher contract issuances for fiscal 2022, compared to fiscal 2021, was mainly due to the continued growth of our private label services and our issuances were negatively impacted in fiscal year 2021 by the decline in economic conditions caused by the COVID-19 pandemic and the restrictions designed to slow the spread of COVID-19. The average number of contracts in force increased 5 percent during fiscal 2022 compared to fiscal 2021, due to net growth in the voluntary protection portfolio in recent years, most notably in prepaid maintenance, guaranteed auto protection and vehicle service contracts.

Revenue from Voluntary Protection Operations

Our voluntary protection operations reported voluntary protection contract revenues and insurance earned premiums of $1,015 million for fiscal 2022 compared to $956 million for fiscal 2021.  Voluntary protection contract revenues and insurance earned premiums represent revenues from in force contracts and are affected by issuances as well as the level, age, and mix of in force contracts.  Voluntary protection contract revenues and insurance earned premiums are recognized over the term of the contracts in relation to the timing and level of anticipated claims.  The increase in voluntary protection contract revenues and insurance earned premiums in fiscal 2022 compared to fiscal 2021 was primarily due to an increase in our average in force contracts resulting from net growth in the voluntary protection portfolio in recent years.

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Investment and Other (Loss) Income, Net

Our voluntary protection operations reported investment and other loss, net of $71 million for fiscal 2022 compared to investment and other income, net of $317 million for fiscal 2021.  Investment and other (loss) income, net, consists primarily of dividend and interest income, realized gains and losses on investments in marketable securities, changes in fair value from equity and available-for-sale debt securities for which the fair value option was elected, and credit loss expense on available-for-sale debt securities, if any.  The decrease in investment and other income, net in fiscal 2022, compared to fiscal 2021, was primarily due to losses from the changes in fair value on our equity investments and available-for-sale debt securities for which the fair value option was elected as a result of market volatility, and a decrease in dividend income.  Should market volatility persist or become more severe, it could continue to negatively impact our results of operations.

Voluntary Protection Contract Expenses and Insurance Losses  

Our voluntary protection operations reported voluntary protection contract expenses and insurance losses of $405 million for fiscal 2022 compared to $369 million for fiscal 2021.  Voluntary protection contract expenses and insurance losses incurred are a function of the amount of covered risks, the frequency and severity of claims associated with in force contracts and the level of risk retained by our voluntary protection operations.  Voluntary protection contract expenses and insurance losses include amounts paid and accrued for reported losses, estimates of losses incurred but not reported, and any related claim adjustment expenses.  The increase in voluntary protection contract expenses and insurance losses in fiscal 2022 compared to fiscal 2021 was primarily due to an increase in frequency of claims in our prepaid maintenance, tire and wheel protection and vehicle service contracts.  These higher losses were partially offset by a decrease in losses on our guaranteed auto protection contracts in fiscal 2022, compared to fiscal 2021, which was driven by a decrease in frequency of claims.  Our voluntary protection contract expenses and insurance losses in fiscal 2021 were impacted by lower claims as a result of changes in consumer driving patterns caused by the COVID-19 pandemic, including restrictions and other changes in behavior.  

Operating and Administrative Expenses

Our voluntary protection operations reported operating and administrative expenses of $386 million for fiscal 2022 compared to $363 million for fiscal 2021.  The increase in operating and administrative expenses in fiscal 2022 as compared to fiscal 2021 was attributable to higher product expenses driven by the continued growth of our voluntary protection product business as well as higher dealer back-end expenses.  Dealer back-end program expenses are incentives or expense reduction programs we offer to dealers based on certain performance criteria.

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Provision for Income Taxes

We recorded a provision for income taxes of $789 million for fiscal 2022, compared to $632 million for fiscal 2021.  Our effective tax rate for both fiscal 2022 and fiscal 2021 was 24 percent.  The increase in the provision for income taxes for fiscal 2022, compared to fiscal 2021, was primarily due to an increase in income before income taxes.

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FINANCIAL CONDITION

Vehicle Financing Volume and Net Earning Assets

The composition of our vehicle contract volume and market share is summarized below:

Vehicle Financing Volume

The volume of our retail and lease contracts, which are acquired primarily from Toyota, Lexus, and private label dealers, is substantially dependent upon TMNA and private label sales volume, the level of TMNA, private label, and third-party sponsored subvention and other incentive programs, as well as TMCC competitive rate and other incentive programs.  

Our financing volume decreased 8 percent in fiscal 2022, compared to fiscal 2021, primarily due to lower new vehicles inventory levels.  The economic conditions caused by the COVID-19 pandemic and the current conflict in Ukraine, including production halts and supply shortages affecting the automotive industry and additional delays affecting the supply chain and logistics networks, have resulted in a decrease in the availability of new vehicles.  This has led to lower levels of incentives and subvention on new and used retail contracts and lease contracts, which has resulted in increased competition from other financial institutions.  

Our market share of TMNA sales decreased approximately 7 percentage points for fiscal 2022, compared to the same period in fiscal 2021, due to lower levels of incentives and subvention on new and used retail and lease contracts and increased competition from other financial institutions.  

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The composition of our net earning assets is summarized below:

Retail Contract Volume and Earning Assets

Our new retail contract volume decreased 7 percent during fiscal 2022, compared to fiscal 2021, primarily due to a decrease in the availability of new vehicles and lower levels of incentives and subvention on new contracts.  Economic conditions caused by the COVID-19 pandemic and the current conflict in Ukraine, including production halts and supply shortages affecting the automotive industry and additional delays affecting the supply chain and logistics networks, have resulted in a decrease in the availability of new vehicles.  

Our used retail contracts decreased 3 percent during fiscal 2022, compared to the same period in fiscal 2021, primarily due to increased competition in the used vehicle marketplace caused by the reduction in new vehicle inventory levels.

Our retail finance receivables, net increased 10 percent at March 31, 2022 as compared to March 31, 2021 due to higher retail contracts outstanding and higher average amount financed.

Lease Contract Volume and Earning Assets

Our lease contract volume decreased 15 percent during fiscal 2022, compared to fiscal 2021, primarily due to the decrease in the availability of new vehicles and lower levels of incentive and subvention programs.  Our investments in operating leases, net, decreased 4 percent at March 31, 2022 as compared to March 31, 2021, due to lower average operating lease units outstanding, partially offset by higher vehicle values.

Dealer Financing and Earning Assets

Dealer financing, net decreased 24 percent at March 31, 2022, as compared to March 31, 2021, primarily due to a decrease in dealer inventory and related financing.  Economic conditions caused by the COVID-19 pandemic and the current conflict in Ukraine, including production halts and supply shortages affecting the automotive industry and additional delays affecting the supply chain and logistics networks, have resulted in a decrease in dealer new vehicle inventory levels.

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Residual Value Risk

We are exposed to risk on the disposition of leased vehicles that are not purchased by lessees, dealers, or third parties at contractual residual value to the extent that sales proceeds realized upon the sale of returned lease vehicles are not sufficient to cover the contractual residual value that was estimated at lease inception.    

Factors Affecting Exposure to Residual Value Risk

Residual value represents an estimate of the end-of-term market value of a leased vehicle.  The primary factors affecting our exposure to residual value risk are the levels at which residual values are established at lease inception, current economic conditions and outlook, projected end-of-term market values, and the resulting impact on depreciation expense and lease return rates.  Higher average operating lease units outstanding and the resulting increase in future maturities, a higher supply of used vehicles, as well as further deterioration in actual and expected used vehicle values for Toyota, Lexus, and private label vehicles could unfavorably impact return rates, residual values, and depreciation expense.  The evaluation of these factors involves significant assumptions, complex analyses, and management judgment.  Refer to “Critical Accounting Estimates” for further discussion of the estimates involved in the determination of accumulated depreciation on investments in operating leases.

Residual Values at Lease Inception

Residual values of lease vehicles are estimated at lease inception by examining external industry data, the anticipated Toyota, Lexus, and private label product pipeline and our own experience.  Factors considered in this evaluation include, macroeconomic forecasts, historical portfolio trends, new vehicle pricing, new vehicle incentive programs, new vehicle sales, product attributes of popular vehicles, the mix and level of used vehicle supply, current and projected used vehicle values, the actual or perceived quality, safety or reliability of Toyota, Lexus, and private label vehicles, and fuel prices.  We use various channels to sell vehicles returned at lease-end.  Refer to Part 1, Item 1. Business, “Finance Operations – Retail and Lease Financing – Remarketing” for additional information on remarketing.

End-of-term Market Values

On a quarterly basis, we review the estimated end-of-term market values of leased vehicles to assess the appropriateness of our carrying values.  To the extent the estimated end-of-term market value of a leased vehicle is lower than the residual value established at lease inception, the residual value of the leased vehicle is adjusted downward so that the carrying value at lease end will approximate the estimated end-of-term market value.  Factors affecting the estimated end-of-term market value are similar to those considered in the evaluation of residual values at lease inception discussed above.  These factors are evaluated in the context of their historical trends to anticipate potential changes in the relationship among these factors in the future.  For investments in operating leases, adjustments are made on a straight-line basis over the remaining terms of the lease contracts and are included in Depreciation on operating leases in our Consolidated Statements of Income as a change in accounting estimate.

Lease Return Rate

The lease return rate represents the number of leased vehicles returned to us for sale as a percentage of lease contracts that were originally scheduled to mature in the same period less certain qualified early terminations.  When the market value of a leased vehicle at contract maturity is less than its contractual residual value (i.e., the price at which the lease customer or dealer may purchase the leased vehicle), there is a higher probability that the vehicle will be returned to us.  In addition, a higher market supply of certain models of used vehicles generally results in a lower market value for those vehicles, resulting in a higher probability that the vehicle will be returned to us.  A higher rate of vehicle returns exposes us to greater residual value risk which impacts depreciation expense at lease termination.

Impairment of Operating Leases

We evaluate our investment in operating leases portfolio for potential impairment when we determine a triggering event has occurred.  When a triggering event has occurred, we perform a test of recoverability by comparing the expected undiscounted future cash flows (including expected residual values) over the remaining lease terms to the carrying value of the asset group.  If the test of recoverability identifies a possible impairment, the asset group’s fair value is measured in accordance with the fair value measurement framework.  An impairment charge is recognized for the amount by which the carrying value of the asset group exceeds its estimated fair value and would be recorded in our Consolidated Statements of Income.  As of March 31, 2022, 2021, and 2020 and during the years then ended, there was no impairment in our investment in operating leases portfolio.

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Disposition of Off-Lease Vehicles

The following table summarizes scheduled maturities on our operating lease portfolio and off-lease vehicles sold at lease termination:

Scheduled maturities decreased 1 percent in fiscal 2022 compared to fiscal 2021, primarily due to lower operating lease units outstanding.  Total vehicles sold at lease termination decreased 80 percent in fiscal 2022, compared to fiscal 2021, due to lower units being processed through the dealer direct program and physical auction.  Higher average used vehicle values as well as lower new vehicle inventory during fiscal 2022 resulted in an increase of off-lease vehicles purchased by lessees and dealers at contractual residual value prior to an authorized dealer securing the vehicle.  Refer to Part 1, Item 1. Business, “Finance Operations – Retail and Lease Financing - Remarketing” for additional information on disposal of lease vehicles.

Depreciation on Operating Leases

Depreciation expense is recorded on a straight-line basis over the lease term and is based upon the depreciable basis of the leased vehicle. The depreciable basis is originally established as the difference between a leased vehicle’s original acquisition cost and its residual value established at lease inception. Changes to residual values have an effect on depreciation expense. To the extent the estimated end-of-term market value of a leased vehicle is lower than the residual value established at lease inception, the residual value of the leased vehicle is adjusted downward so that the carrying value at lease-end will approximate the estimated end-of-term market value. Refer to “Critical Accounting Estimates” for a further discussion of the assumptions involved in the determination of residual values.

In conjunction with the adoption of ASU 2016-13 in fiscal 2021, we updated our depreciation policy for operating leases and changed our presentation for reporting early termination expenses related to our investments in operating leases.  We now present the effects of operating lease early terminations in Depreciation on operating leases.  The information for the comparative period continues to be reported within the provision for credit losses.

Depreciation on operating leases and average operating lease units outstanding are as follows:

We recorded depreciation expense on operating leases of $5,846 million for fiscal 2022, compared to $5,932 million for fiscal 2021.  The decrease is primarily due to lower average operating lease units outstanding, partially offset by residual value losses.  The economic conditions caused by the COVID-19 pandemic and the current conflict in Ukraine, including production halts and supply shortages affecting the automotive industry and additional delays affecting the supply chain and logistics networks, have resulted in a decrease in the availability of new vehicles.  The lower levels of new vehicle inventory and higher off-lease vehicle purchases by dealers have led to historically high levels of average used vehicle values.  Declines in used vehicle values resulting from increases in the supply of new vehicles and increases in new vehicle sales incentives could unfavorably impact return rates, residual values, and depreciation expense in the future.

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Credit Risk

We are exposed to credit risk on our retail loans and dealer portfolios.  Credit risk on our finance receivables is the risk of loss arising from the failure of consumers or dealers to make contractual payments.  The level of credit risk on our retail loan portfolio is influenced by two factors: default frequency and loss severity, which in turn are influenced by various factors such as economic conditions, the used vehicle market, purchase quality mix, and operational changes.

The level of credit risk on our dealer portfolio is influenced by the financial strength of dealers within our portfolio, dealer concentration, collateral quality, and other economic factors.  The financial strength of dealers within our portfolio is influenced by, among other factors, general economic conditions, the overall demand for new and used vehicles and the financial condition of automotive manufacturers in general.

Factors Affecting Retail Loan Portfolio Credit Risk

Economic Factors

General economic conditions such as changes in unemployment rates, housing values, bankruptcy rates, consumer debt levels, fuel prices, consumer credit performance, interest rates, inflation, household disposable income, US Government stimulus and relief programs, and unforeseen events such as natural disasters, severe weather, health epidemics or geopolitical conflicts, among other factors, can influence both default frequency and loss severity.

Used Vehicle Market

Changes in used vehicle values directly affect the proceeds from sales of repossessed vehicles, and accordingly, the level of loss severity we experience.  The supply of, and demand for, used vehicles, interest rates, inflation, new vehicle inventory, the level of manufacturer incentive programs on new vehicles, the manufacturer’s actual or perceived reputation for quality, safety, or reliability, and general economic outlook are some of the factors affecting the used vehicle market.

Purchase Quality Mix

A change in the mix of contracts acquired at various risk levels may change the amount of credit risk we assume.  An increase in the number of contracts acquired with lower credit quality (as measured by scores that establish a consumer’s creditworthiness based on present financial condition, experience, and credit history) can increase the amount of credit risk.  Conversely, an increase in the number of contracts with higher credit quality can lower credit risk.  An increase in the mix of contracts with lower credit quality can also increase operational risk unless appropriate controls and procedures are established.  We strive to price contracts to achieve an appropriate risk adjusted return on our investment.

The average original contract term of retail loan contracts influences credit losses.  Longer term contracts generally experience a higher rate of default and thus affect default frequency.  In addition, the carrying values of vehicles under longer term contracts decline at a slower rate, resulting in a longer period during which we may be subject to used vehicle market volatility, which may in turn lead to increased loss severity.

The types and models of the vehicles in our retail loan portfolio has an effect on loss severity.  Vehicle product mix can be influenced by factors such as customer preferences, fuel efficiency and fuel prices.  These factors impact the demand for and values of used vehicles and consequently, loss severity.

Operational Changes

Operational changes and ongoing implementation of new information and transaction systems and improved methods of consumer evaluation are designed to have a positive effect on the credit risk profile of our retail loan portfolio.  Customer service improvements in the management of delinquencies and credit losses increase operational efficiency and effectiveness. We remain focused on our service operations and credit loss mitigation methods.  We are exposed to operational risk related to potential changes in the regulatory landscape which may limit our ability to conduct pre and post charge-off collections activity.

In an effort to mitigate credit losses, we regularly evaluate our purchasing practices.  We limit our risk exposure by limiting approvals of lower credit quality contracts and requiring certain loan-to-value ratios.

We continue to refine our credit risk management and analysis to ensure that the appropriate level of collection resources are aligned with portfolio risk, and we adjust capacity accordingly.  We continue to focus on early and late stage delinquencies to increase the likelihood of resolution.  We have also increased efficiency in our collections through the use of technology.

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Factors Affecting Dealer Portfolio Credit Risk

The financial strength of dealers to which we extend credit directly affects our credit risk.  Lending to dealers with lower credit quality, or a negative change in the credit quality of existing dealers, increases the risk of credit loss we assume.  Extending a substantial amount of financing or commitments to a specific dealer or group of dealers creates a concentration of credit risk, particularly when the financing may not be secured by fully realizable collateral assets.  Collateral quality influences credit risk in that lower quality collateral increases the risk that in the event of default and subsequent liquidation of collateral, the value of the collateral may be less than the amount owed to us.

We assign risk classifications to each of our dealers and dealer groups based on their financial condition, the strength of the collateral, and other quantitative and qualitative factors including input from our field personnel.  Our monitoring processes of the dealers and dealer groups are based on these risk classifications.  We periodically update the risk classifications based on changes in financial condition.  As part of our monitoring processes, we require dealers to submit periodic financial statements.  We also perform periodic physical audits of vehicle inventory as well as monitor the timeliness of dealer inventory financing payoffs in accordance with the agreed-upon terms in order to identify possible risks.  We continue to enhance our risk management processes to mitigate dealer portfolio risk and to focus on higher risk dealers through enhanced risk governance, inventory audits, and credit watch processes.  Where appropriate, we increase the frequency of our audits and examine more closely the financial condition of the dealer or dealer group.  We continue to be diligent in underwriting dealers and have conducted targeted personnel training to address dealer credit risk.

Additionally, TMNA and other manufacturers may be obligated by applicable law, or under agreements with us, to repurchase or to reassign new vehicle inventory we financed that meets certain mileage and model year parameters, curtailing our risk.  We also provide other types of financing to certain Toyota and Lexus dealers and other third parties at the request of TMNA or private Toyota distributors, and the credit risk associated with such financing is mitigated by guarantees from TMNA or the applicable private distributors.

We also provide financing for some dealerships which sell products not distributed by TMNA or any of its affiliates.  A significant adverse change in a non-Toyota/Lexus manufacturer such as restructuring or bankruptcy may increase the risk associated with the dealers we have financed that sell these products.

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Origination, Credit Loss, and Delinquency Experience

Our credit loss experience may be affected by a number of factors including the economic environment, our purchasing, servicing, and collections practices, used vehicle market conditions and subvention.  Changes in the economy that impact the consumer such as increasing interest rates, and a rise in the unemployment rate as well as higher debt balances, coupled with deterioration in actual and expected used vehicle values, could increase our credit losses.  In addition, a decline in the effectiveness of our collection practices could also increase our credit losses.  We continuously evaluate and refine our purchasing practices and collection efforts to minimize risk.  In addition, subvention contributes to our overall portfolio quality, as subvened contracts typically have higher credit scores than non-subvened contracts.  For information regarding the potential impact of current market conditions, refer to Part I. Item 1A. Risk Factors.

The following table provides information related to our origination experience:

While we have included the average origination FICO score to illustrate origination trends, we also use a proprietary credit scoring system to evaluate an applicant’s risk profile.  Refer to Part I. Item 1. Business “Finance Operations” for further discussion of the proprietary manner in which we evaluate risk.

The following table provides information related to our consumer finance receivables and investment in operating leases:

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Management considers historical credit loss information when assessing the allowance for credit losses.  Historical credit losses are primarily driven by two factors: default frequency and loss severity.  Net charge-offs as a percentage of average finance receivables decreased to 0.22 percent at March 31, 2022 from 0.29 percent at March 31, 2021 and default frequency as a percentage of outstanding finance receivables contracts decreased to 0.72 percent for fiscal 2022 compared to 0.90 percent for fiscal 2021.  Our average finance receivables loss severity per unit for fiscal 2022 decreased to $9,012 from $10,035 in fiscal 2021.  The changes in our net charge-offs, default frequency, and loss severity per unit were primarily due to historically high levels of average used vehicle values, which reduced net charge-offs, default frequency, and loss per unit.

Our aggregate balances for accounts 60 or more days past due on finance receivables increased to 0.43 percent at March 31, 2022, compared to 0.27 percent at March 31, 2021.  Our aggregate balances for accounts 60 or more days past due on operating leases increased to 0.26 percent at March 31, 2022, compared to 0.20 percent at March 31, 2021.  The finance receivables delinquency rate in fiscal 2021 was positively impacted by the retail payment extension programs offered to our customers and dealers impacted by COVID-19, as well as influenced by government stimulus and other external programs in fiscal 2021, which are no longer available.  In addition, for a portion of fiscal 2021, as a result of a decline in economic conditions caused by the COVID-19 pandemic, there were government restrictions on repossession activities in certain states for which we have a high percentage of lease contracts which had a negative impact on our operating lease payments delinquency.  If the negative economic conditions caused by the COVID-19 pandemic and the conflict in Ukraine continue, delinquencies and charge-offs could increase.

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Allowance for Credit Losses

We maintain an allowance for credit losses which is measured by an impairment model that reflects lifetime expected losses.

The allowance for credit losses for our retail loan portfolio is measured on a collective basis when loans have similar risk characteristics such as loan-to-value ratio, book payment-to-income ratio, FICO score at origination, collateral type, contract term, and other relevant factors.  We use statistical models to estimate lifetime expected credit losses of our retail loan portfolio segment by applying probability of default and loss given default to the exposure at default on a loan level basis.  Probability of default models are developed from internal risk scoring models which consider variables such as delinquency status, historical default frequency, and other credit quality indicators.  Other credit quality indicators include loan-to-value ratio, book payment-to-income ratio, FICO score at origination, collateral type (new or used, Lexus, Toyota, or private label), and contract term.  Loss given default models forecast the extent of losses given that a default has occurred and consider variables such as collateral, trends in recoveries, historical loss severity, and other contract structure variables.  Exposure at default represents the expected outstanding principal balance, including the effects of expected prepayment when applicable.  The lifetime expected credit losses incorporate the probability-weighted forward-looking macroeconomic forecasts for baseline, favorable, and adverse scenarios.  The loan lifetime is regarded by management as the reasonable and supportable period.  We use macroeconomic forecasts from a third party and update such forecasts quarterly.  On an ongoing basis, we review our models, including macroeconomic factors, the selection of macroeconomic scenarios and their weighting to ensure they reflect the risk of the portfolio.  

For the allowance for credit losses for our dealer portfolio, an allowance for credit losses is established for both outstanding dealer finance receivables and certain unfunded off-balance sheet lending commitments.  The allowance for credit losses is measured on a collective basis when loans have similar risk characteristics such as dealer group internal risk rating and loan-to-value ratios.  We measure lifetime expected credit losses of our dealer products portfolio segment by applying probability of default and loss given default to the exposure at default on a loan level basis.  Probability of default is primarily established based on internal risk assessments.  The probability of default model also considers qualitative factors related to macroeconomic outlooks.  Loss given default is established based on the nature and market value of the collateral, loan-to-value ratios and other credit quality indicators.  Exposure at default represents the expected outstanding principal balance.  The lifetime of the loan or lending commitment is regarded by management as the reasonable and supportable period.  On an ongoing basis, we review our models, including macroeconomic outlooks, to ensure they reflect the risk of the portfolio.  

If management does not believe the models reflect lifetime expected credit losses, a qualitative adjustment is made to reflect management judgment regarding observable changes in recent or expected economic trends and conditions, portfolio composition, and other relevant factors.

The following table provides information related to our allowance for credit losses for finance receivables and certain off-balance sheet lending commitments: