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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTER ENDED MARCH 31, 2020

000-55786

(Commission file number)

IBM CREDIT LLC

(Exact name of registrant as specified in its charter)

Delaware		22-2351962
(State or Other Jurisdiction of Incorporation or Organization)		(IRS employer identification number)

One North Castle Drive, Armonk, New York		10504
(Address of principal executive offices)		(Zip Code)

914-765-1900

(Registrant’s telephone number)

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

None.

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.

Large accelerated filer ☐		Accelerated filer ☐

Non-accelerated filer ☒		Smaller reporting company ☐

		Emerging growth company ☐

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 is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

All of the limited liability company interests ("Interests") in the registrant are held by an affiliate of the registrant. None of the Interests are publicly traded.

REDUCED DISCLOSURE FORMAT

IBM Credit LLC, an indirect, wholly owned subsidiary of International Business Machines Corporation (IBM), meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this form with the reduced disclosure format.

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Index

		Page
Part I - Financial Information:

Item 1. Consolidated Financial Statements (Unaudited):

Consolidated Income Statement for the three months ended March 31, 2020 and 2019		3

Consolidated Statement of Comprehensive Income for the three months ended March 31, 2020 and 2019		4

Consolidated Balance Sheet at March 31, 2020 and December 31, 2019		5

Consolidated Statement of Cash Flows for the three months ended March 31, 2020 and 2019		6

Consolidated Statement of Changes in Member’s Interest for the three months ended March 31, 2020 and 2019		7

Notes to Consolidated Financial Statements		8

Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition		30

Item 4. Controls and Procedures		44

Part II - Other Information:

Item 1. Legal Proceedings		45

Item 6. Exhibits		45

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Part I— Financial Information

Item 1. Consolidated Financial Statements:

IBM CREDIT LLC AND SUBSIDIARY COMPANIES

CONSOLIDATED INCOME STATEMENT

(UNAUDITED)


	Three Months Ended March 31,
(Dollars in millions)	2020		2019
Revenue
Financing revenue	$	278	$	404
Operating lease revenue		58		78
Total revenue	$	337	$	482
Financing cost (related party cost of $49 in 2020 and $74 in 2019)	$	105	$	160
Depreciation of equipment under operating lease		31		45
Net margin	$	201	$	277
Expense and other (income)
Selling, general and administrative	$	74	$	97
Provision for credit losses		19		4
Other (income) and expense		(21)		(18)
Total expense and other (income)	$	72	$	83
Income before income taxes	$	128	$	193
Provision for/(benefit from) income taxes		(13)		150
Net income	$	141	$	43

(Amounts may not add due to rounding.)

(The accompanying notes are an integral part of the financial statements.)

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Consolidated Financial Statements — (continued)

IBM CREDIT LLC AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)


	Three Months Ended March 31,
(Dollars in millions)	2020		2019
Net income	$	141	$	43
Other comprehensive income/(loss), before tax:
Foreign currency translation		(156)		3
Retirement-related benefit plans (1)		1		0
Other comprehensive income/(loss), before tax		(155)		3
Income tax (expense)/benefit related to items of other comprehensive income		(17)		3
Other comprehensive income/(loss), net of tax	$	(173)	$	6
Total comprehensive income/(loss)	$	(31)	$	49

(1)	Amounts represented relate to multiple-employer plans.

(Amounts may not add due to rounding.)

(The accompanying notes are an integral part of the financial statements.)

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Consolidated Financial Statements — (continued)

IBM CREDIT LLC AND SUBSIDIARY COMPANIES

CONSOLIDATED BALANCE SHEET

(UNAUDITED)


	At March 31,		At December 31,
(Dollars in millions)	2020		2019
Assets:
Cash and cash equivalents	$	1,601	$	1,687
Financing receivables		14,638		17,365
(net of allowances of $158 in 2020 and $148 in 2019)
Equipment under operating leases		177		212
(net of accumulated depreciation of $220 in 2020 and $238 in 2019)
Financing receivables from IBM		3,771		3,870
Receivables purchased/participated from IBM		4,258		4,359
(net of allowances of $21 in 2020 and $8 in 2019)
Other receivables from IBM		742		513
Other assets		514		406
Total assets	$	25,700	$	28,412

Liabilities:
Accounts payable	$	142	$	434
Accounts payable to IBM		813		336
Debt		6,709		7,150
Debt payable to IBM		14,727		16,945
Taxes		633		637
Other liabilities		231		224
Total liabilities	$	23,255	$	25,726
Member’s interest:
Member's interest		2,601		2,601
Retained earnings		48		116
Accumulated other comprehensive income/(loss)		(204)		(31)
Total member's interest	$	2,445	$	2,686
Total liabilities and member’s interest	$	25,700	$	28,412

(Amounts may not add due to rounding.)

(The accompanying notes are an integral part of the financial statements.)

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Consolidated Financial Statements — (continued)

IBM CREDIT LLC AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)


	Three Months Ended March 31,
(Dollars in millions)	2020		2019
Cash flows from operating activities:
Net income	$	141	$	43
Adjustments to reconcile net income to cash provided by operating activities:
Provision for credit losses		19		4
Depreciation		31		45
Deferred taxes		(42)		(2)
Net (gain)/loss on asset sales and other		(17)		(6)
Change in operating assets and liabilities:
Other assets/other liabilities		(48)		4
Net cash provided by operating activities	$	84	$	88

Cash flows from investing activities:
Originations of financing receivables	$	(2,975)	$	(4,219)
Collection of financing receivables		4,068		4,023
Short-term financing receivables - net (1)		1,444		46
Purchase of equipment under operating leases		(13)		(20)
Proceeds from disposition of equipment under operating lease		17		13
Other receivables from IBM - net		(304)		1,738
Other investing activities - net		119		(10)
Net cash provided by investing activities	$	2,356	$	1,572

Cash flows from financing activities:
Proceeds from issuance of debt from IBM	$	2,424	$	2,545
Principal payments on debt from IBM		(2,641)		(2,388)
Proceeds from issuance of debt		296		300
Principal payments on debt		(389)		(196)
Short-term borrowings from/(repayments to) IBM - net (1)		(1,711)		(1,299)
Short-term borrowings/(repayments) - net (1)		(315)		(500)
Distributions to IBM		(169)		(370)
Net cash used in financing activities	$	(2,505)	$	(1,910)

Effect of exchange rate changes on cash and cash equivalents	$	(22)	$	(5)
Net change in cash and cash equivalents	$	(86)	$	(255)

Cash and cash equivalents at January 1		1,687		1,828
Cash and cash equivalents at March 31	$	1,601	$	1,573

(1)	Short-term represents original maturities of 90 days or less.

(Amounts may not add due to rounding.)

(The accompanying notes are an integral part of the financial statements.)

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Consolidated Financial Statements — (continued)

IBM CREDIT LLC AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CHANGES IN MEMBER'S INTEREST

(UNAUDITED)


					Accumulated
					Other		Total
	Member's		Retained		Comprehensive		Member’s
(Dollars in millions)	Interest		Earnings		Income/(Loss)		Interest
Member’s Interest, January 1, 2020	$	2,601	$	116	$	(31)	$	2,686
Cumulative effect of change in accounting principle (1)				(41)				(41)
Net income plus other comprehensive income/(loss):
Net income				141				141
Other comprehensive income/(loss), net of tax						(173)		(173)
Total comprehensive income/(loss)							$	(31)
Distributions to IBM				(169)				(169)
Member’s Interest, March 31, 2020	$	2,601	$	48	$	(204)	$	2,445

(1) Reflects the adoption of the FASB guidance on current expected credit losses. Refer to note 2, "Accounting Changes."

(Amounts may not add due to rounding.)

(The accompanying notes are an integral part of the financial statements.)


					Accumulated
					Other		Total
	Member's		Retained		Comprehensive		Member’s
(Dollars in millions)	Interest		Earnings		Income/(Loss)		Interest
Member’s Interest, January 1, 2019	$	3,216	$	238	$	(33)	$	3,420
Net income plus other comprehensive income/(loss):
Net income				43				43
Other comprehensive income/(loss), net of tax						6		6
Total comprehensive income/(loss)							$	49
Contributions from IBM (1)		64						64
Distributions to IBM		(88)		(282)				(370)
Member’s Interest, March 31, 2019	$	3,191	$	—	$	(27)	$	3,164

(1) In accordance with the previously executed Tax Sharing Agreement, $64 million was settled through a non-cash contribution. Refer to note 14, "Relationship with IBM and Related Party Transactions."

(Amounts may not add due to rounding.)

(The accompanying notes are an integral part of the financial statements.)

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Notes to Consolidated Financial Statements:

1. Basis of Presentation:

The accompanying Consolidated Financial Statements and footnotes of IBM Credit LLC (IBM Credit or the company) have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial statements and footnotes are unaudited. In the opinion of the company’s management, these statements include all adjustments, which are only of a normal recurring nature, necessary to present a fair statement of the company’s results of operations, financial position and cash flows.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amount of assets, liabilities, revenue, costs, expenses and other comprehensive income/(loss) that are reported in the Consolidated Financial Statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events, historical experience, actions that the company may undertake in the future and on various other assumptions that are believed to be reasonable under the circumstances. As a result, actual results may be different from these estimates.

Member’s interest in the Consolidated Balance Sheet represents the accumulation of the company’s net income over time and contributions from IBM and distributions to IBM. Distributions by the company to IBM are considered first to be a return of profit as reflected in retained earnings in the Consolidated Balance Sheet. Any amount distributed to IBM in excess of the company’s available balance in retained earnings is considered a return of a portion of Member’s interest as reflected in the Consolidated Balance Sheet.

Income tax expense is based on reported income before income taxes. Whereas the majority of non-U.S. entities are separate legal tax filers, the company’s U.S. federal and certain state and foreign operations are included in various IBM consolidated tax returns. In such cases, the income taxes for these entities are calculated using a separate return method modified to apply the benefits-for-loss approach, which is consistent with the company’s Tax Sharing Agreement with IBM. Under this approach, the provision for income taxes is computed as if the company filed tax returns on a separate tax return basis and is then adjusted, as necessary, to reflect IBM’s reimbursement for any tax benefits generated by the company.

The amount of restricted cash included in the Consolidated Balance Sheet and Consolidated Statement of Cash Flows is immaterial for the periods presented.

All significant intracompany transactions between IBM Credit’s businesses have been eliminated. All significant intercompany transactions between IBM Credit and IBM have been included in these Consolidated Financial Statements.

Interim results are not necessarily indicative of financial results for a full year. The information included in this Form 10-Q should be read in conjunction with the company’s 2019 Form 10-K.

Within the financial statements and tables presented, certain columns and rows may not add due to the use of rounded numbers for disclosure purposes. Percentages presented are calculated from the underlying whole-dollar amounts.

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Notes to Consolidated Financial Statements — (continued)

2. Accounting Changes:

New Standards to be Implemented

Any current pending standards to be implemented are either not applicable or not material to the company.

Standards Implemented

Reference Rate Reform

Standard/Description–Issuance date: March 2020. This guidance provides optional expedients and exceptions for applying GAAP to contract modifications, hedging relationships, and other transactions that reference London Interbank Offered Rate (LIBOR) or another reference rate expected to be discontinued, subject to meeting certain criteria.

Effective Date and Adoption Considerations–The guidance is effective as of March 12, 2020 through December 31, 2022.

Effect on Financial Statements or Other Significant Matters–The company made a policy election in the first quarter of 2020 to adopt the practical expedient which allows for the continuation of fair value hedge accounting for interest rate derivative contracts upon the transition from LIBOR to Secured Overnight Financing Rate (SOFR) or another reference rate alternative, without any impact to the Consolidated Income Statement. However, it is still uncertain when the transition from LIBOR to another reference rate will occur or whether SOFR will become the accepted market alternative to LIBOR. The company is continuing to evaluate the potential impact of the replacement of the LIBOR benchmark on its interest rate risk management activities.

Financial Instruments-Credit Losses

Standard/Description–Issuance date: June 2016, with amendments in 2018, 2019 and 2020. This changes the guidance for credit losses based on an expected loss model rather than an incurred loss model. It requires the consideration of all available relevant information when estimating expected credit losses, including past events, current conditions and forecasts and their implications for expected credit losses. It also expands the scope of financial instruments subject to impairment, including off-balance sheet commitments and residual value.

Effective Date and Adoption Considerations–The guidance was effective January 1, 2020, with one-year early adoption permitted. The company adopted the guidance as of the effective date using the transition option whereby prior comparative periods were not retrospectively presented in the Consolidated Financial Statements.

Effect on Financial Statements or Other Significant Matters–At January 1, 2020, an increase in the allowance for credit losses of $56 million was recorded for financing receivables (inclusive of its related off-balance sheet commitments). Additionally, net deferred taxes were reduced by $16 million in the Consolidated Balance Sheet, resulting in a cumulative-effect net decrease to retained earnings of $41 million. Refer to note 6, “Financing Receivables, Receivables Purchased/Participated from IBM,” and note 9, “Commitments,” for additional information.

3. Segments:

The company’s operations consist of two business segments: Client Financing and Commercial Financing. The segments represent components of the company for which separate financial information is available that is utilized on a regular basis by the chief operating decision maker in determining how to allocate resources and evaluate performance. The company is organized on the basis of its financing offerings. The company’s reportable segments are business units that offer different financing solutions based upon clients’ needs.

Client Financing provides leases and loan financing to end-user clients, acquires installment payment plans offered to end-user clients by IBM, and acquires participation interests in IBM financing receivables for which the company assumes the IBM client’s credit risk from IBM. End-user clients are primarily IBM clients that elect to finance their

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Notes to Consolidated Financial Statements — (continued)

acquisition of IBM’s hardware, software, and services, as well as Original Equipment Manufacturer (OEM) IT hardware, software and services, to meet their total solution requirements. In addition, the company provides loans to IBM, primarily in support of IBM’s Global Technology Services segment’s acquisition of IT assets, which IBM uses in external, revenue-producing services contracts.

Commercial Financing provides working capital financing for suppliers, distributors and resellers of IBM and OEM IT products and services. The decline in revenue in the first quarter of 2020 primarily reflects the wind down of the company’s OEM IT Commercial Financing operations which began in the second quarter of 2019.

The segment’s expense includes an allocation of interest expense and selling, general and administrative (SG&A) expense by the company to each of its operating segments. Interest expense is allocated based on the average assets in each segment. SG&A expense is allocated based on a measurable financial driver, such as net margin.

IBM Credit and its consolidated subsidiaries are reported by the company’s parent, IBM, as part of IBM’s Global Financing segment, which also includes IBM’s remanufacturing and remarketing business.

SEGMENT INFORMATION


	Client		Commercial		Total
(Dollars in millions)	Financing		Financing		Segments
For the three months ended March 31, 2020:
Total revenue	$	279	$	58	$	337
Pre-tax income		95		33		128
Depreciation of equipment under operating lease		31		—		31
Interest expense		82		13		94
Provision for credit losses		18		1		19

For the three months ended March 31, 2019:
Total revenue	$	322	$	160	$	482
Pre-tax income		117		76		193
Depreciation of equipment under operating lease		45		—		45
Interest expense		97		53		150
Provision for/(benefit from) credit losses		(1)		5		4

4. Divestiture:

In the first quarter of 2019, IBM sold certain commercial financing capabilities and assigned a number of its commercial financing contracts, excluding related receivables which were collected as they became due in the normal course of business to a third party and recorded a pre-tax gain of $16 million.

5. Financial Assets and Liabilities:

Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The company classifies certain assets and liabilities based on the following fair value hierarchy:

●

Level 1—Quoted prices (unadjusted) in active markets for identical assets or liabilities that can be accessed at the measurement date;

●

Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and

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Notes to Consolidated Financial Statements — (continued)

●

Level 3—Unobservable inputs for the asset or liability.

When available, the company uses unadjusted quoted market prices in active markets to measure the fair value and classifies such items as Level 1. If quoted market prices are not available, fair value is based upon internally developed models that use current market-based or independently sourced market parameters such as interest rates and currency rates. Items valued using internally generated models are classified according to the lowest level input or value driver that is significant to the valuation.

The determination of fair value considers various factors, including interest rate yield curves and time value, underlying the financial instruments. For derivatives and debt securities, the company uses a discounted cash flow analysis using discount rates commensurate with the duration of the instrument.

In determining the fair value of financial instruments, the company considers certain market valuation adjustments to the “base valuations” calculated using the methodologies described below for several parameters that market participants would consider in determining fair value:

●

Counterparty credit risk adjustments are applied to financial instruments, taking into account the actual credit risk of a counterparty as observed in the credit default swap market to determine the true fair value of such an instrument.

●

Credit risk adjustments are applied to reflect the company’s own credit risk when valuing all liabilities measured at fair value. The methodology is consistent with that applied in developing counterparty credit risk adjustments, but incorporates the company’s own credit risk as observed in the credit default swap market.

The company may hold investments in time deposits, certificates of deposit, U.S. government and agency debt, and corporate debt securities that are designated as available-for-sale. The primary objective of the company’s debt investment portfolio is to maintain principal by investing in short-term highly liquid securities with a credit rating of investment grade Aa2 or higher.

Available-for-sale securities are measured for impairment on a recurring basis by comparing the security’s fair value with its amortized cost basis. Effective January 1, 2020 with the adoption of the new standard on credit losses, if the fair value of the security falls below its amortized cost basis, the change in fair value is recognized in the period the impairment is identified when the loss is due to credit factors. The change in fair value due to non-credit factors is recorded in other comprehensive income when the company does not intend to sell and has the ability to hold the investment. The company’s standard practice is to hold all of its debt security investments classified as available-for-sale until maturity. No impairment for credit losses and no non-credit impairment was recorded for the three months ended March 31, 2020. Prior to the adoption of the new standard, available-for-sale securities were measured for impairment using an other-than-temporary impairment model. No impairment was recorded for the three months ended March 31, 2019.

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Notes to Consolidated Financial Statements — (continued)

The following table presents the company’s financial assets and financial liabilities that are measured at fair value on a recurring basis at March 31, 2020 and December 31, 2019.



	Fair Value
	Hierarchy	At March 31, 2020				At December 31, 2019
(Dollars in millions)	Level	Assets		Liabilities		Assets		Liabilities
Cash equivalents (1)
Time deposits and certificates of deposit	2	$	576	$	N/A	$	788	$	N/A
Money market funds	1		—		N/A		5		N/A
Total cash equivalents		$	576	$	N/A	$	793	$	N/A
Derivatives designated as hedging instruments (2)
Interest rate contracts with IBM	2		79		—		45		—
Foreign exchange contracts with IBM	2		—		14		—		18
Total		$	655	$	14	$	838	$	18

(1)	Included within cash and cash equivalents in the Consolidated Balance Sheet.

(2)	Included within other assets and other liabilities in the Consolidated Balance Sheet.

N/A – not applicable

Financial Assets and Liabilities Not Measured at Fair Value

Short-Term Receivables and Payables

Short-term financing receivables are financial assets with carrying values that approximate fair value. Accounts payable, other accrued expenses and short-term debt (including debt payable to IBM) are financial liabilities with carrying values that approximate fair value. If measured at fair value in the financial statements, these financial instruments would be classified as Level 3 in the fair value hierarchy, except for short-term debt, which would be classified as Level 2.

Long-Term Receivables

Fair values are based on discounted future cash flows using current interest rates offered for similar loans to clients with similar credit ratings for the same remaining maturities. At March 31, 2020 and December 31, 2019, the difference between the carrying amount and estimated fair value for long-term receivables was immaterial. If measured at fair value in the financial statements, these financial instruments would be classified as Level 3 in the fair value hierarchy.

Long-Term Debt

Fair value of publicly traded long-term debt is based on quoted market prices for the identical liability when traded as an asset in an active market. For other long-term debt, which includes debt payable to IBM, for which a quoted market price is not available, an expected present value technique that uses rates currently available to the company for debt with similar terms and remaining maturities is used to estimate fair value. The carrying amount of long-term debt (including debt payable to IBM) was $14,956 million and $15,268 million and the estimated fair value was $14,757 million and $15,409 million at March 31, 2020 and December 31, 2019, respectively. If measured at fair value in the financial statements, long-term debt (including the current portion) would be classified as Level 2 in the fair value hierarchy.

6. Financing Receivables, Receivables Purchased/Participated from IBM:

Financing receivables primarily consist of client loan and installment payment receivables (loans) and investment in sales-type and direct financing leases (collectively referred to as Client Financing receivables) and Commercial Financing receivables. Loans are provided primarily to clients to finance the purchase of hardware, software and services. Payment terms on these financing arrangements are generally for terms up to seven years. Investment in sales-type and direct financing leases relate principally to the company’s Systems products and are for terms ranging generally from two to six years. Commercial Financing receivables relate primarily to working capital financing for dealers and remarketers of IBM products. Payment terms for working capital financing generally range from 30 to 90 days.

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Notes to Consolidated Financial Statements — (continued)

The company participates in receivables from IBM for certain long-term financing receivables generated from IBM’s Total Solution Offerings in certain countries as well as for certain government and other contracts. These receivables are included in the Client Financing segment. The company also purchases interests in certain of IBM’s short-term receivables. These receivables are included within the Commercial Financing segment. The company carries the credit risk of IBM’s clients for all purchased and participated receivables from IBM.

Effective January 1, 2020, the company adopted the new accounting standard related to credit losses, using the transition option whereby prior comparative periods were not retrospectively presented in the Consolidated Financial Statements. Refer to note 2, “Accounting Changes,” for additional information. Under this new guidance, the amortized cost basis of a financial asset represents the original amount of the financing receivable (including residual value) adjusted for unearned income, deferred initial direct costs, cash collected, write-offs and any foreign exchange adjustments. The allowance for credit losses represents future expected credit losses over the life of the receivables based on past experience, current information and forward-looking economic considerations. Prior to the effective date, financing receivables were measured at recorded investment, which does not include residual value. As a result of the company’s transition option, all prior periods are presented at recorded investment, while current period information is presented at amortized cost.

A summary of the components of the company’s financing receivables is presented as follows:


					Client Loan and
					Installment
			Commercial		Payment
(Dollars in millions)	Investment in		Financing		Receivables
At March 31, 2020:	Leases		Receivables		(Loans)		Total
Financing receivables, gross	$	4,081	$	2,008	$	8,742	$	14,831
Unearned income		(337)		(3)		(330)		(669)
Deferred initial direct costs		28		—		64		93
Residual value*		542		—		—		542
Amortized cost	$	4,314	$	2,005	$	8,476	$	14,796
Allowance for credit losses		(64)		(9)		(85)		(158)
Total financing receivables, net	$	4,250	$	1,996	$	8,391	$	14,638

* Includes guaranteed and unguaranteed residual value


					Client Loan and
					Installment
			Commercial		Payment
(Dollars in millions)	Investment in		Financing		Receivables
At December 31, 2019:	Leases		Receivables		(Loans)		Total
Financing receivables, gross	$	4,626	$	3,400	$	9,566	$	17,592
Unearned income		(384)		(4)		(373)		(761)
Deferred initial direct costs		32		—		71		103
Recorded investment	$	4,274	$	3,396	$	9,264	$	16,934
Allowance for credit losses		(56)		(9)		(82)		(148)
Unguaranteed residual value		531		—		—		531
Guaranteed residual value		47		—		—		47
Total financing receivables, net	$	4,796	$	3,387	$	9,181	$	17,365

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Notes to Consolidated Financial Statements — (continued)

Purchased and participated receivables from IBM


	At March 31,		At December 31,
(Dollars in millions)	2020		2019
Short-term purchased receivables from IBM	$	72	$	56
Allowance for credit losses		0		0
Total short-term purchased receivables from IBM, net	$	72	$	56

Long-term participated receivables from IBM	$	4,206	$	4,310
Allowance for credit losses		(21)		(7)
Total long-term participated receivables from IBM, net	$	4,186	$	4,303

Total purchased and participated receivables from IBM, net	$	4,258	$	4,359

The company utilizes certain of its financing receivables as collateral for nonrecourse borrowings. Financing receivables pledged as collateral for borrowings were $914 million and $1,062 million at March 31, 2020 and December 31, 2019, respectively.

The company did not have any financing receivables held for sale at March 31, 2020 and December 31, 2019.

Allowance for Credit Losses - Financing Receivables

Refer to note A, “Significant Accounting Policies,” in the company’s 2019 Annual Report for a full description of its accounting policies for financing receivables and related allowances. The descriptions below include any changes to those policies due to the new standard.

Effective with the adoption of the new credit losses standard, the company’s estimates of its allowances for expected credit losses include consideration of: past events, including any historical default, historical concessions and resulting troubled debt restructurings, current economic conditions, taking into account any non-freestanding mitigating credit enhancements, and certain forward-looking information, including reasonable and supportable forecasts.

Collectively Evaluated Financing Receivables

The company determines its allowance for credit losses based on two portfolio segments: Client Financing receivables and Commercial Financing receivables, and further segments the portfolio into three classes: Americas, Europe/Middle East/Africa (EMEA) and Asia Pacific.

For Client Financing receivables, the company uses a credit loss model to calculate allowances based on its internal loss experience and current conditions and forecasts by class of financing receivable. The company records an unallocated reserve that is calculated by applying a reserve rate to its portfolio, excluding accounts that have been individually evaluated and specifically reserved. This reserve rate is based upon credit rating, probability of default, term and loss history. The allowance is adjusted quarterly for expected recoveries of amounts that were previously written off or are expected to be written off. Recoveries cannot exceed the aggregated amount of the previous write-off or expected write-off.

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Notes to Consolidated Financial Statements — (continued)

Macroeconomic variables attributed to the expected credit losses for Client Financing receivables may vary by class of financing receivables based on historical experiences, portfolio composition, and current environment. In addition to a qualitative review of credit risk factors across the portfolio, the company considers forward-looking macroeconomic variables such as gross domestic product, unemployment rates, equity prices and corporate profits when quantifying the impact of economic forecasts on its Client Financing receivables expected allowance for credit losses. The company also considers the impact of current conditions and economic forecasts relating to specific industries, geographical areas, and client-specific exposures on the portfolio. Under this approach, forecasts of these variables over two years are considered reasonable and supportable. Beyond two years, the company reverts to long-term average loss experience. Forward-looking estimates require the use of judgment, particularly in times of economic uncertainty. With evolving global impacts from the COVID-19 pandemic, external economic models have been revised with increased frequency and with alternative scenarios. The company’s allowances at March 31, 2020, reflect the qualitative process described above. Any changes to economic models that occurred after the balance sheet date will be reflected in future periods.

The allowance for Commercial Financing receivables is estimated based on a combination of write-off history and current economic conditions, excluding any individually evaluated accounts.

At January 1, 2020, upon adoption of the new standard on credit losses, the company recorded an additional allowance for Client and Commercial Financing receivables (including related off-balance sheet commitments) of $56 million. This was primarily driven by an increase in the Client Financing receivables allowance. Refer to note 9, “Commitments,” for additional information regarding off-balance sheet commitments.

Client Financing Receivables

The following tables present the amortized cost basis or recorded investment for the Client Financing receivables portfolio segment at March 31, 2020 and December 31, 2019, respectively, further segmented by three classes: Americas, Europe/Middle East/Africa (EMEA) and Asia Pacific. The Commercial Financing receivables portfolio segment is excluded from this presentation as it is short term in nature and the current estimated risk of loss and resulting impact to the company’s financing results is not material.

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Notes to Consolidated Financial Statements — (continued)


(Dollars in millions)
At March 31, 2020:	Americas		EMEA		Asia Pacific		Total
Amortized cost
Lease receivables	$	3,338	$	601	$	376	$	4,314
Loan receivables		5,657		2,219		600		8,476
Participated receivables from IBM		631		1,715		1,860		4,206
Ending balance	$	9,626	$	4,534	$	2,836	$	16,997

Allowance for credit losses
Beginning balance at December 31, 2019	$	98	$	36	$	11	$	146
Adjustment for adoption of new standard		21		13		4		39
Beginning balance at January 1, 2020
Lease receivables	$	38	$	22	$	9	$	69
Loan receivables		78		18		3		98
Participated receivables from IBM		4		10		4		18
Total	$	120	$	50	$	16	$	185
Write-offs	$	(14)	$	(1)	$	(1)	$	(16)
Recoveries		0		—		0		0
Provision		5		8		1		14
Other*		(12)		(1)		0		(13)
Ending balance at March 31, 2020	$	99	$	56	$	15	$	170
Lease receivables	$	37	$	20	$	7	$	64
Loan receivables	$	57	$	24	$	4	$	85
Participated receivables from IBM	$	4	$	12	$	4	$	21

* Primarily represents translation adjustments.

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Notes to Consolidated Financial Statements — (continued)


(Dollars in millions)
At December 31, 2019:	Americas		EMEA		Asia Pacific		Total
Recorded investment
Lease receivables	$	3,160	$	710	$	404	$	4,274
Loan receivables		6,173		2,415		676		9,264
Participated receivables from IBM		717		1,671		1,922		4,310
Ending balance	$	10,049	$	4,796	$	3,003	$	17,848
Recorded investment collectively evaluated for impairment	$	9,957	$	4,770	$	2,993	$	17,720
Recorded investment individually evaluated for impairment	$	92	$	26	$	10	$	128

Allowance for credit losses
Beginning balance at January 1, 2019
Lease receivables	$	38	$	17	$	10	$	65
Loan receivables		66		28		5		98
Participated receivables from IBM		3		8		3		14
Total	$	107	$	53	$	17	$	177
Write-offs	$	(14)	$	(10)	$	(4)	$	(29)
Recoveries		0		0		0		1
Provision		7		(6)		(2)		(2)
Foreign currency translation adjustment		(1)		0		0		(1)
Other		0		0		0		0
Ending balance at December 31, 2019	$	98	$	36	$	11	$	146
Lease receivables	$	27	$	21	$	8	$	56
Loan receivables	$	68	$	12	$	2	$	82
Participated receivables from IBM	$	3	$	3	$	1	$	7

Related allowance, collectively evaluated for impairment	$	23	$	11	$	3	$	36
Related allowance, individually evaluated for impairment	$	75	$	26	$	9	$	110

Write-offs of lease receivables and loan receivables were $17 million and $11 million, respectively, for the year ended December 31, 2019. Provisions for credit losses recorded for lease receivables and participated receivables from IBM were an addition of $5 million and a release of $6 million, respectively, for the year ended December 31, 2019.

Past Due Financing Receivables

The company considers a client’s financing receivable balance past due when any installment is aged over 90 days. The following tables summarize information about the amortized cost basis or recorded investment in lease and loan financing receivables and participated receivables from IBM, including amortized cost or recorded investment aged over 90 days and still accruing, billed invoices aged over 90 days and still accruing, and amortized cost or recorded investment not accruing.

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Notes to Consolidated Financial Statements — (continued)


					Amortized		Billed		Amortized
	Total		Amortized		Cost		Invoices		Cost
(Dollars in millions)	Amortized		Cost		> 90 Days and		> 90 Days and		Not
At March 31, 2020:	Cost		> 90 Days (1)		Accruing (1)		Accruing		Accruing (2)
Americas	$	3,338	$	136	$	106	$	7	$	35
EMEA		601		19		6		0		15
Asia Pacific		376		9		3		0		6
Total lease receivables	$	4,314	$	164	$	115	$	7	$	56

Americas	$	5,657	$	97	$	60	$	10	$	38
EMEA		2,219		55		7		3		50
Asia Pacific		600		7		5		0		1
Total loan receivables	$	8,476	$	158	$	72	$	14	$	90

Americas	$	631	$	7	$	5	$	1	$	3
EMEA		1,715		1		0		0		1
Asia Pacific		1,860		4		4		1		0
Total participated receivables from IBM	$	4,206	$	12	$	9	$	2	$	4

Total	$	16,997	$	333	$	195	$	23	$	149

(1)	At a contract level, which includes total billed and unbilled amounts for financing receivables aged greater than 90 days.

(2)	Of the amortized cost not accruing, there was a related allowance of $95 million. Financing income recognized on these receivables was immaterial for the three months ended March 31, 2020.


					Recorded		Billed		Recorded
	Total		Recorded		Investment		Invoices		Investment
(Dollars in millions)	Recorded		Investment		> 90 Days and		> 90 Days and		Not
At December 31, 2019:	Investment		> 90 Days (1)		Accruing (1)		Accruing		Accruing (2)
Americas	$	3,160	$	179	$	143	$	10	$	37
EMEA		710		24		11		1		16
Asia Pacific		404		9		2		0		7
Total lease receivables	$	4,274	$	213	$	156	$	11	$	59

Americas	$	6,173	$	107	$	66	$	10	$	56
EMEA		2,415		51		3		1		51
Asia Pacific		676		3		1		0		2
Total loan receivables	$	9,264	$	161	$	69	$	11	$	110

Americas	$	717	$	8	$	8	$	1	$	0
EMEA		1,671		7		7		1		1
Asia Pacific		1,922		6		5		1		1
Total participated receivables from IBM	$	4,310	$	21	$	20	$	3	$	2

Total	$	17,848	$	394	$	245	$	25	$	171

(1)	At a contract level, which includes total billed and unbilled amounts for financing receivables aged greater than 90 days.

(2)	Of the recorded investment not accruing, $128 million was individually evaluated for impairment with a related allowance of $110 million.

Credit Quality Indicators

The company’s credit quality indicators, which are based on rating agency data, publicly available information and information provided by customers, are reviewed periodically based on the relative level of risk. The resulting indicators are a numerical rating system that maps to Moody’s Investors Service credit ratings as shown below. The company uses information provided annually by Moody’s, where available, as one of many inputs in its determination of customer

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Notes to Consolidated Financial Statements — (continued)

credit ratings. The credit quality of the customer is evaluated based on these indicators and would be assigned the same risk rating whether the receivable is a lease, loan or participated from IBM.

The following tables present the amortized cost basis or recorded investment for financing receivables, excluding the Commercial Financing receivables portfolio segment, by credit quality indicator at March 31, 2020 and December 31, 2019, respectively. Receivables with a credit quality indicator ranging from Aaa to Baa3 are considered investment grade. All others are considered non-investment grade. Effective January 1, 2020, under the new guidance for credit losses, the company discloses its credit quality by year of origination. Additionally, under the new guidance, the amortized cost is presented on a gross basis, whereas under the prior guidance, the company presented the recorded investment net of allowance for credit losses. The credit quality indicators do not reflect any mitigation actions taken to transfer credit risk to third parties.


(Dollars in millions)	Americas				EMEA				Asia Pacific
At March 31, 2020:	Aaa – Baa3		Ba1 – D		Aaa – Baa3		Ba1 – D		Aaa – Baa3		Ba1 – D
Vintage year:
2020	$	1,406	$	871	$	609	$	766	$	228	$	134
2019		2,182		1,587		919		988		1,485		585
2018		1,136		732		371		342		193		50
2017		709		382		140		183		61		30
2016		289		300		86		55		34		11
2015 and prior		17		17		40		35		19		7
Total	$	5,738	$	3,888	$	2,164	$	2,370	$	2,020	$	817


	Lease Receivables						Loan Receivables						Participated Receivables from IBM
(Dollars in millions)					Asia						Asia						Asia
At December 31, 2019	Americas		EMEA		Pacific		Americas		EMEA		Pacific		Americas		EMEA		Pacific
Credit Ratings:
Aaa – Aa3	$	305	$	55	$	31	$	732	$	89	$	89	$	440	$	88	$	89
A1 – A3		700		88		124		1,166		178		237		71		271		934
Baa1 – Baa3		949		153		83		1,756		907		107		104		762		500
Ba1 – Ba2		733		206		61		1,461		532		159		49		442		245
Ba3 – B1		196		137		62		444		455		46		43		88		126
B2 – B3		236		45		32		513		228		33		4		18		26
Caa – D		13		5		2		32		15		3		2		0		2
Total	$	3,133	$	689	$	396	$	6,105	$	2,403	$	674	$	714	$	1,668	$	1,921

Troubled Debt Restructurings

The company did not have any significant troubled debt restructurings during the three months ended March 31, 2020 or for the year ended December 31, 2019.

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Notes to Consolidated Financial Statements — (continued)

7. Leases:

Accounting for Leases as a Lessor

The following table presents amounts included in the Consolidated Income Statement related to lessor activity:


(Dollars in millions)
For the three months ended March 31:	2020		2019
Financing lease revenue	$	50	$	55
Operating lease revenue		58		78
Variable lease revenue		11		11
Total lease revenue	$	119	$	144

8. Borrowings:

Short-Term Debt


	Balance		Balance
(Dollars in millions)	3/31/2020		12/31/2019
Commercial paper	$	—	$	304
Short-term loans		31		49
Secured borrowings		240		280
Debt	$	271	$	633
Debt payable to IBM		6,210		8,194
Total	$	6,480	$	8,827

The weighted-average interest rate for commercial paper was 1.6 percent at December 31, 2019. The weighted-average interest rate for short-term loans was 3.2 percent and 5.2 percent at March 31, 2020 and December 31, 2019, respectively. The weighted-average interest rate for secured borrowings was 3.1 percent and 3.6 percent at March 31, 2020 and December 31, 2019, respectively. Short-term financing receivables pledged as collateral for short-term secured borrowings were $240 million at March 31, 2020 and $280 million at December 31, 2019. The weighted-average interest rate for short-term debt payable to IBM was 0.6 percent and 1.6 percent at March 31, 2020 and December 31, 2019, respectively.

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Notes to Consolidated Financial Statements — (continued)

Long-Term Debt


		Balance		Balance
(Dollars in millions)	Maturities	3/31/2020		12/31/2019
Long-term notes (weighted-average interest rate at March 31, 2020)
2.8%	2020	$	1,500	$	1,500
2.4%	2021		2,850		2,850
2.2%	2022		500		500
3.0%	2023		750		750
		$	5,600	$	5,600

Long-term loans (4.3% weighted-average interest rate at March 31, 2020)	2020-2021		93		113
Secured borrowings (4.5% weighted-average interest rate at March 31, 2020)	2020-2025		674		781
Long-term debt		$	6,367	$	6,495
Less: net unamortized discount			1		1
Less: net unamortized debt issuance costs			4		5
Add: fair value adjustment*			76		28
Debt		$	6,438	$	6,517
Debt payable to IBM (1.4% weighted-average interest rate at March 31, 2020)			8,517		8,751
Total		$	14,956	$	15,268

The portion of the company's fixed-rate debt obligations that is hedged is reflected in the Consolidated Balance Sheet as an amount equal to the sum of the debt's carrying value and a fair value adjustment representing changes in the fair value of the hedged debt obligations attributable to movements in benchmark interest rates.

The company utilizes certain of its financing receivables as collateral. Long-term financing receivables pledged as collateral for long-term secured borrowings were $674 million at March 31, 2020 and $781 million at December 31, 2019.

The company’s indenture governing its debt securities contains significant covenants which obligate the company to promptly pay principal and interest, limit the aggregate amount of liens (other than permitted liens as such term is defined under the indenture) to 15 percent of the company’s consolidated net tangible assets, and restrict the company’s ability to merge or consolidate unless certain conditions are met.

Pre-swap annual contractual obligations of long-term debt and long-term debt payable to IBM outstanding at March 31, 2020 are as follows:


	2020										2025 and
(Dollars in millions)	(Q2-Q4)		2021		2022		2023		2024		beyond		Total
Long-term debt	$	1,839	$	3,133	$	603	$	786	$	5	$	0	$	6,367
Debt payable to IBM		3,210		2,615		1,761		675		201		56		8,517
Total	$	5,049	$	5,748	$	2,365	$	1,461	$	205	$	56	$	14,884

Interest on Debt

The company recognized interest expense of $94 million for the three months ended March 31, 2020, of which $49 million was interest expense on debt payable to IBM. The company recognized interest expense of $150 million for the three months ended March 31, 2019, of which $74 million was interest expense on debt payable to IBM.

Lines of Credit

IBM and the company have a $2.5 billion, 364-Day Credit Agreement and a $2.5 billion Three-Year Credit Agreement (together, the Credit Agreements) with maturity dates of July 16, 2020 and July 20, 2022, respectively.

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Notes to Consolidated Financial Statements — (continued)

As of March 31, 2020, the company had no borrowings outstanding against the Credit Agreements.

The company’s Credit Agreements each contain significant debt covenants, which obligate the company to promptly pay principal and interest, limit the aggregate amount of secured indebtedness and sale and leaseback transactions to 10 percent of IBM’s consolidated net tangible assets, and restrict the ability of the company or IBM to merge or consolidate with a third party, unless certain conditions are met. The Credit Agreements also include several financial covenants, including that (i) IBM will not permit the consolidated net interest expense ratio, for any period of four consecutive fiscal quarters taken as a single accounting period, to be less than 2.20 to 1.0; (ii) the company will not permit its tangible net worth to be less than $50 million as of the end of the fiscal year and (iii) the company’s leverage ratio cannot be greater than 11 to 1 as of the last day of the fiscal quarter. The Credit Agreements each contain a cross default provision with respect to other defaulted indebtedness of at least $500 million.

The company is in compliance with its debt covenants, and provides periodic certifications to its lenders. The failure to comply with its debt covenants could constitute an event of default. If certain events of default were to occur, the principal and interest on the debt to which such event of default applied would become immediately due and payable. The Borrowers are also restricted from amending, modifying or terminating the Support Agreement in any manner materially adverse to the lenders. For additional information on the Support Agreement, see note 14, “Relationship with IBM and Related Party Transactions.”

9. Commitments:

The company’s extended lines of credit to third-party entities include unused amounts of $1.9 billion and $1.8 billion at March 31, 2020 and December 31, 2019, respectively. A portion of these amounts was available to the company’s business partners to support their working capital needs. In addition, the company has committed to provide future financing to its clients in connection with client purchase agreements for $5.9 billion and $5.4 billion at March 31, 2020 and December 31, 2019, respectively. Effective January 1, 2020, the company adopted the new standard on credit losses, which resulted in the recognition of a related allowance for non-cancellable off-balance sheet commitments. Refer to note 2, “Accounting Changes,” for additional information. The allowance for these commitments is recorded in other liabilities in the Consolidated Balance Sheet and was not material at March 31, 2020. The company collectively evaluates the allowance for these arrangements using a provision methodology consistent with the portfolio of the commitments. Refer to note 6, “Financing Receivables, Receivables Purchased/Participated from IBM,” for additional information.

10. Contingencies:

The company is, or may be, involved, either as plaintiff or defendant, in a variety of ongoing claims, demands, suits, investigations, tax matters and proceedings that arise in the ordinary course of its business. Certain of these actions and proceedings are similar to suits filed against other financial institutions and captive finance companies. These may include collection and bankruptcy proceedings related to its leases and loans and proceedings concerning client allegations of wrongful repossession or defamation of credit.

The company reviews claims, suits, investigations and proceedings at least quarterly, and decisions are made with respect to recording or adjusting provisions and disclosing reasonably possible losses or range of losses (individually or in the aggregate). In addition, the company also discloses matters based on its consideration of other matters and qualitative factors, including the experience of other companies in the industry, and investor, client and employee relations considerations.

The company records a provision with respect to a claim, suit, investigation or proceeding when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Any recorded liabilities, including any changes to such liabilities for the quarter ended March 31, 2020 were not material to the Consolidated Financial Statements.

In accordance with the relevant accounting guidance, the company provides disclosures of matters for which the likelihood of material loss is at least reasonably possible. As of March 31, 2020, there were no such matters.

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Notes to Consolidated Financial Statements — (continued)

11. Equity Activity:

IBM Credit had no unrealized gains or (losses) on cash flow hedges and gains and losses on available-for-sale securities were immaterial during the periods presented in the following tables:

Reclassifications and Taxes Related to Items of Other Comprehensive Income


(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the three months ended March 31, 2020:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	(156)	$	(17)	$	(174)
Retirement-related benefit plans (1):
Net (losses)/gains arising during the period	$	0	$	0	$	0
Curtailments and settlements		—		—		—
Amortization of prior service (credits)/costs		0		0		0
Amortization of net (gains)/losses		1		0		1
Total retirement-related benefit plans	$	1	$	0	$	1
Other comprehensive income/(loss)	$	(155)	$	(17)	$	(173)

(1)	These accumulated other comprehensive income (AOCI) components are included in the computation of net periodic pension cost. (See note 13, "Retirement-Related Benefits," for additional information.)

Reclassifications and Taxes Related to Items of Other Comprehensive Income


(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the three months ended March 31, 2019:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	3	$	3	$	6
Retirement-related benefit plans (1):
Net (losses)/gains arising during the period	$	0	$	0	$	0
Curtailments and settlements		—		—		—
Amortization of prior service (credits)/costs		0		0		0
Amortization of net (gains)/losses		0		0		0
Total retirement-related benefit plans	$	0	$	0	$	0
Other comprehensive income/(loss)	$	3	$	3	$	6

(1)	These AOCI components are included in the computation of net periodic pension cost. (See note 13, "Retirement-Related Benefits," for additional information.)

Accumulated Other Comprehensive Income/(Loss) (net of tax)


			Net Change
	Foreign		Retirement-		Accumulated
	Currency		Related		Other
	Translation		Benefit		Comprehensive
(Dollars in millions)	Adjustments*		Plans		Income/(Loss)
January 1, 2020	$	(12)	$	(19)	$	(31)
Other comprehensive income before reclassification		(174)		0		(174)
Amount reclassified from accumulated other comprehensive income		—		1		1
Total change for the period		(174)		1		(173)
March 31, 2020	$	(186)	$	(18)	$	(204)

* Foreign currency translation adjustments are presented gross except for any associated hedges which are presented net of tax.

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Notes to Consolidated Financial Statements — (continued)


			Net Change
	Foreign		Retirement-		Accumulated
	Currency		Related		Other
	Translation		Benefit		Comprehensive
(Dollars in millions)	Adjustments*		Plans		Income/(Loss)
January 1, 2019	$	(23)	$	(10)	$	(33)
Other comprehensive income before reclassification		6		0		6
Amount reclassified from accumulated other comprehensive income		—		0		0
Total change for the period		6		0		6
March 31, 2019	$	(17)	$	(10)	$	(27)

* Foreign currency translation adjustments are presented gross except for any associated hedges which are presented net of tax.

12. Derivative Financial Instruments:

The company operates in multiple currencies and is a lender and issuer in the capital markets and a borrower from IBM. In the normal course of business, the company may be exposed to the impact of interest rate changes and foreign currency fluctuations. The company limits its exposure to core market risks by following established risk management policies and procedures, and through the use of match-funding with IBM and third parties. Although the company seeks to substantially match-fund the terms, currency and interest rate variability of its debt against its underlying financial assets, risks may arise between assets and the related liabilities used for funding. The company may also choose to mitigate any remaining exposure relating to interest rate changes and foreign currency fluctuations through the use of interest rate or foreign exchange derivatives.

Derivative assets and liabilities are recorded in other assets and other liabilities in the Consolidated Balance Sheet and are presented on a gross basis. The notional amounts of the derivative instruments do not necessarily represent amounts exchanged by the company with IBM and third parties, and are not necessarily a direct measure of the financial exposure. The company also enters into master netting agreements with certain counterparties that allow for netting of exposures in the event of default or breach. However, in the Consolidated Balance Sheet, the company does not offset derivative assets against liabilities in master netting arrangements. If derivatives exposures covered by a qualifying master netting agreement with IBM had been netted in the Consolidated Balance Sheet at March 31, 2020 and December 31, 2019, the total derivative asset and liability positions would each have been reduced by $14 million and $18 million, respectively.

Interest Rate Risk

Fixed and Variable Rate Borrowings

The company issues debt in the capital markets to fund its operations. Access to cost-effective financing can result in interest rate mismatches with the underlying assets. To manage these mismatches and to reduce overall interest cost, the company may enter into interest-rate swaps with IBM to convert specific fixed-rate debt issuances into variable-rate debt (i.e., fair value hedges) and to convert variable-rate debt issuances into fixed-rate debt (i.e., cash flow hedges). At March 31, 2020 and December 31, 2019, the total notional amount of the company's interest rate swap contracts with IBM was $2,550 million at both periods. The weighted average remaining maturity of these instruments at March 31, 2020 and December 31, 2019, was approximately 1.7 years and 2.0 years, respectively. These interest rate contracts were accounted for as fair value hedges. The company did not have any cash flow hedges relating to this program outstanding at March 31, 2020 and December 31, 2019.

Foreign Exchange Risk

Long-Term Investments in Foreign Subsidiaries (Net Investment)

The company enters into foreign exchange derivatives with IBM as a hedge of net investment of its foreign subsidiaries to reduce the volatility in member's interest caused by changes in foreign currency exchange rates in the functional currency of major foreign subsidiaries with respect to the U.S. dollar. At March 31, 2020 and December 31, 2019, the total notional amount of derivative contracts with IBM designated as net investment hedges was $1,027 million and

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Notes to Consolidated Financial Statements — (continued)

$1,229 million, respectively. The weighted average remaining maturity of these instruments was 0.2 years at both periods.

Foreign Currency Asset/Liability Management

The company enters into foreign exchange derivative contracts to manage foreign currency exposures associated with the company’s funding from IBM and third parties. These derivatives are not designated as hedges for accounting purposes. However, these derivatives represent economic hedges which provide an economic offset to the underlying foreign currency exposure. The terms of these derivative contracts are generally less than one year. The gains and losses recognized on economic hedges are recorded in other (income) and expense in the Consolidated Income Statement, and the associated cash flows are included in other investing activities-net, in the Consolidated Statement of Cash Flows.

There were no foreign exchange derivative contracts with third parties outstanding at March 31, 2020 and December 31, 2019.

The following tables provide a quantitative summary of the derivative instrument-related risk management activity at March 31, 2020 and December 31, 2019, as well as for the three months ended March 31, 2020 and 2019, respectively.

Cumulative Basis Adjustments for Fair Value Hedges

At March 31, 2020 and December 31, 2019, the following amounts were recorded in the Consolidated Balance Sheet related to cumulative basis adjustments for fair value hedges:


(Dollars in millions)
Line Item in the Consolidated Balance Sheet	At March 31,		At December 31,
in which the Hedged Item is Included:	2020		2019
Debt:
Carrying amount of the hedged item	$	(2,623)	$	(2,574)
Cumulative hedging adjustments included in the carrying amount - assets/(liabilities)		(76)		(28)

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Notes to Consolidated Financial Statements — (continued)

The Effect of Derivative Instruments in the Consolidated Income Statement

The total amounts of income and expense line items presented in the Consolidated Income Statement in which the effects of fair value hedges, net investment hedges and derivatives not designated as hedging instruments are recorded and the total effect of hedge activity on these income and expense line items, are as follows:


					Gains/(Losses) of
(Dollars in millions)	Total				Total Hedge Activity
For the three months ended March 31:	2020		2019		2020		2019
Financing cost	$	105	$	160	$	9	$	4
Other (income) and expense		(21)		(18)		—		—


	Gain/(Loss) Recognized in Consolidated Income Statement
	Consolidated	Recognized on				Attributable to Risk
(Dollars in millions)	Income Statement	Derivatives				Being Hedged (2)
For the three months ended March 31:	Line Item	2020		2019		2020		2019
Derivative instruments in fair value hedges (1):
Interest rate contracts with IBM	Financing cost	$	51	$	20	$	(48)	$	(25)

Total		$	51	$	20	$	(48)	$	(25)


	Gain/(Loss) Recognized in Consolidated Income Statement and Other Comprehensive Income
					Consolidated
					Income	Reclassified				Amounts Excluded from
(Dollars in millions)	Recognized in OCI				Statement	from AOCI				Effectiveness Testing (3)
For the three months ended March 31:	2020		2019		Line Item	2020		2019		2020		2019
Derivative instruments in net investment hedges:
Foreign exchange contracts with IBM	$	67	$	(10)	Financing cost	$	—	$	—	$	6	$	10

Total	$	67	$	(10)		$	—	$	—	$	6	$	10

(1)	The amount includes changes in clean fair values of the derivative instruments in fair value hedging relationships and the periodic accrual for coupon payments required under these derivative contracts.

(2)	The amount includes basis adjustments to the carrying value of the hedged item recorded during the period.

(3)	The company's policy is to recognize all fair value changes in amounts excluded from effectiveness testing in net income each period.

For the three months ending March 31, 2020 and 2019, there were no material gains or losses excluded from the assessment of hedge effectiveness (for fair value hedges); nor are there any anticipated in the normal course of business.

13. Retirement-Related Benefits:

IBM Credit employees are eligible to participate in IBM’s retirement plans. Retirement-related plans are accounted for as multiemployer, multiple-employer or defined contribution plans, as required by local regulations.

Multiemployer and Defined Contribution Plans:

IBM charges the company for multiemployer and defined contribution costs based on number of employees. The charges are recorded in the company’s operating results in the Consolidated Income Statement. The amounts of (income) or expense attributed to the company by IBM for the three months ended March 31, 2020 and 2019 were not material.

Charges from IBM to the company in relation to these plans (including non-pension, post-retirement benefits) are limited to service costs and defined contribution cost. Contributions to multiemployer and defined contribution plans and any other types of cost are the responsibility of IBM.

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Notes to Consolidated Financial Statements — (continued)

Multiple-employer Plans:

For multiple-employer plans (mainly in Germany, Spain and Japan), assets and obligations are based on actuarial valuations or allocations and are recorded in the Consolidated Balance Sheet.

Any gains or losses recorded to AOCI in the three months ended March 31, 2020 and 2019 were not material.

Costs related to multiple-employer plans are recorded in the company’s operating results in the Consolidated Income Statement. The total costs for multiple-employer plans for the three months ended March 31, 2020 and 2019 were not material.

14. Relationship with IBM and Related Party Transactions:

IBM Credit is a captive finance company and an indirect, wholly owned subsidiary of IBM. IBM Credit generally conducts its financing activities with IBM on an arm’s-length basis, subject in certain cases, particularly with respect to originations, to commercial factors, including IBM’s relationship with a client. The following is a description of certain material relationships between IBM Credit and IBM, regarding support, operating, borrowing, licensing, service and other arrangements.

Support Agreement

Pursuant to a Support Agreement between IBM and IBM Credit, IBM has agreed to retain, directly or indirectly, beneficial ownership of at least 51 percent of the equity voting interests in the company at all times. IBM has also agreed to cause the company to have a minimum consolidated tangible net worth of at least $50 million on the last day of each of the company’s fiscal years (with consolidated tangible net worth for purposes of this discussion of the Support Agreement understood to mean (a) the total assets of IBM Credit and its consolidated subsidiaries less (b) the intangible assets and total liabilities of IBM Credit and its consolidated subsidiaries). IBM has also agreed to cause the company to maintain a leverage ratio not to exceed 11 to 1 for each of the company’s fiscal quarters. Leverage ratio for purposes of this discussion of the Support Agreement is understood to mean, for any calendar quarter, IBM Credit’s debt-to-equity ratio as reported in, and calculated in the manner set forth in, IBM Credit’s periodic report covering such fiscal quarter (refer to page 30 of this Form 10-Q). In the event that the company’s leverage ratio at the end of any fiscal quarter is higher than 11 to 1, then, upon demand by the company, IBM has agreed to make or cause to be made a capital contribution to the company in an amount sufficient to cause the company’s leverage ratio to not exceed 11 to 1. The Support Agreement is not a guarantee by IBM of any indebtedness, other obligation, or liability of any kind of IBM Credit.

Operating Relationship

The company originates financing with end-user clients, which are primarily IBM customers that elect to finance their acquisition of IBM’s hardware, software, and services.

The company participates in receivables from IBM for certain long-term financing receivables generated from IBM’s Total Solution Offerings in certain countries as well as for certain government and other contracts. The company carries the credit risk of IBM’s clients for all participated receivables from IBM. These receivables earned interest income of $51 million in the three months ended March 31, 2020, an increase of $1 million as compared to the same period in 2019. The interest income is included in the Consolidated Income Statement as financing revenue. For additional information, see note 6, “Financing Receivables, Receivables Purchased/Participated from IBM.”

Within the Commercial Financing segment, the company purchases interests in certain short-term receivables at a discount for which IBM Credit LLC assumes the associated credit risk of IBM’s clients. In the second quarter of 2019, the company suspended the program under which it purchases interests in IBM's trade accounts receivable. As a result, for the three months ended March 31, 2020, finance income earned from these receivables was $4 million, a decrease of $11 million as compared to the same period in 2019.

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Notes to Consolidated Financial Statements — (continued)

In certain countries, the company provides loans to IBM, primarily in support of IBM’s Global Technology Services segment’s acquisition of IT assets, which it uses in external, revenue-producing services contracts. This financing is included in the Consolidated Balance Sheet as financing receivables from IBM. For the three months ended March 31, 2020, the interest income earned from these receivables was $34 million, a decrease of $10 million as compared to the same period in 2019. Interest income is included in financing revenue in the Consolidated Income Statement. The amount of such financings outstanding was $3,771 million at March 31, 2020 and $3,870 million at December 31, 2019.

The amount of other receivables from IBM of $742 million and $513 million at March 31, 2020 and December 31, 2019, respectively, primarily relate to the investment of a portion of the company's excess cash in short-term interest bearing accounts with IBM, which can be withdrawn upon demand. The company's investment of excess cash with IBM was $736 million at March 31, 2020 and $509 million at December 31, 2019. The investment of excess cash with IBM is presented in other receivables from IBM in the Consolidated Balance Sheet and in the investing section of the Consolidated Statement of Cash Flows. Interest income earned from these investments was $2 million and $8 million in the three months ended March 31, 2020 and 2019, respectively. The interest income is included in financing revenue in the Consolidated Income Statement.

In addition, within Commercial Financing, the company provides financing which includes an interest free period to suppliers, distributors and resellers of IBM products and services, which is funded by IBM. Fee income earned from these arrangements for the three months ended March 31, 2020 was $41 million, a decrease of $7 million as compared to the same period in 2019. These fees are included in financing revenue in the Consolidated Income Statement and are deferred and recognized over the term of the financing arrangement.

Borrowing Relationship

The company has a credit facility with IBM that allows the company to obtain short-term and long-term funding. These loans are included in the Consolidated Balance Sheet as debt payable to IBM. Interest expense incurred on loans from IBM was $49 million and $74 million for the three months ended March 31, 2020 and 2019, respectively. Interest expense is included in financing cost in the Consolidated Income Statement. For additional information on short-term and long-term funding, see note 8, “Borrowings.”

Services and Other Arrangements

The company sources a number of services from IBM, including functional support for treasury, accounting, legal, tax, human resources, marketing and IT. In certain instances, IBM acts as IBM Credit’s billing and collection agent and forwards the financing payments to IBM Credit. The company also has the right to use certain IBM intangible assets in its business. In addition, the company conducts its global operations primarily from IBM leased or IBM owned facilities. For these support services and occupancy expenses, IBM charged the company $34 million and $48 million in the three months ended March 31, 2020 and 2019, respectively.

The company participates in the various IBM stock-based compensation plans, including awards of Restricted Stock Units and Performance Share Units. In addition, the company participates in certain multiemployer retirement-related and defined contribution plans that are sponsored by IBM. Amounts charged by IBM to the company related to stock-based compensation, multiemployer retirement-related and defined contribution plans during the periods reported were not material.

Expenses related to the services discussed above are included in selling, general and administrative expense in the Consolidated Income Statement. These expenses may not be indicative of the expenses that IBM Credit will incur in the future, or would have incurred if the company had obtained these services from a third party.

The outstanding amount of accounts payable to IBM of $813 million at March 31, 2020, and $336 million at December 31, 2019, primarily relate to unsettled purchases of equipment or receivables/loans (for software and services) from IBM. This payable account is non-interest bearing, short term in nature and is expected to be settled in the normal course of business.

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Notes to Consolidated Financial Statements — (continued)

The company sells equipment returned from lease to IBM at cost, which approximates fair value. In addition, IBM may migrate a client to new technology. In the event this migration results in an early termination of a lease, IBM will purchase the returned equipment at a pre-negotiated price, which is a function of the discounted value of the scheduled future lease payments and the residual value. The company's net profit from sales of returned equipment to IBM was $3 million and $2 million for the three months ended March 31, 2020 and 2019, respectively. These sales are recorded net in other (income) and expense in the Consolidated Income Statement.

Tax Sharing Agreement

The company’s U.S. federal and certain state and foreign operations are included in various IBM consolidated tax returns; and, in such cases, IBM makes payments to tax authorities on the company’s behalf. IBM and the company maintain a Tax Sharing Agreement for any operations included in an IBM consolidated tax return, pursuant to which IBM charges the company for any taxes owed and reimburses the company for any tax attributes generated. Such charges or reimbursements are based upon a calculation of the company’s relevant pro forma stand-alone tax return.

In the first quarter of 2020, the company reported a benefit from income taxes of $13 million and an effective tax rate of negative 10.1 percent, compared to a provision of $150 million and an effective tax rate of 77.5 percent in the first quarter of 2019. The year-to-year change in the effective tax rate was primarily driven by a $40 million discrete tax benefit in the first quarter of 2020, attributable to a valuation allowance release on deferred tax assets, as compared to an additional tax expense of $116 million in the first quarter of 2019 related to U.S. tax reform.

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Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

FOR THE THREE MONTHS ENDED MARCH 31, 2020

Financial Results Summary - Three Months Ended March 31:


							Yr.-to-Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended March 31:	2020			2019			Change
Revenue	$	337		$	482		(30.2)	%
Net margin	$	201		$	277		(27.6)	%
Net margin percentage		59.6	%		57.4	%	2.2	pts.
Total expense and other (income)	$	72		$	83		(13.7)	%
Income before income taxes	$	128		$	193		(33.6)	%
Provision for/(benefit from) income taxes	$	(13)		$	150

IBM CREDIT LLC 10-Q