John Deere Capital Corporation PDF

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John Deere Capital Corporation

Youssef Elnowaihy Austin Fritz Alex Heglin Skyler Mickelson Brandon Ness

BADM 415 Financial Institutions November 15th, 2016

Part I. Organizational Structure According to Bloomberg’s company overview of the John Deere Capital Corporation, the firm “provides and administers financing for retail purchases of new and used agriculture and turf equipment, and construction and forestry equipment manufactured by John Deere.” John Deere Capital Corp, or JDCC, purchases retail installment sales and loan contracts, also known as retail notes. JDCC does finance a limited amount of non-John Deere retail notes. JDCC finances and services revolving charge accounts primarily acquired from and offered through merchants in industries requiring heavy machinery operation, typically related to agriculture or construction. JDCC provides wholesale financing for merchant’s inventories of their new and used equipment. In addition, JDCC extends “credit enhanced international export” financing to select customers and dealers in the business of buying and selling John Deere products. The Corporation’s main operations are located in the United States, New Zealand, and Australia, though several smaller operations occur in Asia, Europe, Latin America, and Africa. JDCC is based in Reno, Nevada and was founded in 1958. The company primarily generates revenue by financing the sale John Deere equipment from its dealers and collecting interest payments. A breakdown of their revenue from their most recent annual report can be seen here:

In their 2015 Annual Report, the Company states: “On a geographic basis, there is not a disproportionate concentration of credit risk in any area.” A breakdown of JDCC’s revenue by geographic region can be seen below:

When analyzing these statements, one can see that revenue has been increasing over the years in the United States but has decreased in foreign markets. This can most likely be attributed to increased competition from international competitors as well as an amplified focus domestically. John Deere Capital Corp. is a subsidiary of Deere & Company (John Deere), and has no branches of banks or similar financial institutions.

Part II: Financial Statement Analysis Every lending company must deal with credit risk when lending money to customers, and John Deere Capital Corporation is no different. JDCC accounts for credit risk by creating an allowance account that is based upon historical losses, portfolio duration, delinquency trends, economic conditions and credit risk quality. By doing this, they attempt to predict the amount of bad debt before it happens. In 2015, 2014, and 2013, Deere had $198 million, $230 million, and $240 million respectively for an allowance for bad debt. John Deere Capital Corporation faces market risk in terms of interest rate and foreign currency risk. Deere uses a combination of cash flow models to determine its sensitivity to interest rate exposure to market interest rates. In regards to foreign currency risk, Deere is

threatened by a high US dollar value. This is because when the US dollar is high in value foreign customer’s purchasing power decreases. Deere manages its risks by using derivatives to hedge away certain exposures, not to make speculative positions. This reduces their overall risk and allows them to focus on running their business as their main objective. To hedge its foreign currency exposures, the company hypothetically uses an increase and decrease in the US Dollar value by 10%. By doing so, Deere can determine the effects of changing interest rate and be able to properly hedge against the changing market rates. Deere’s company policy is to hedge foreign currency risk if the company’s borrowings do not match the currency of the receivable. This ensures the 10% swings will not have a material effect on the company.

Ratio

ROA

ROE

Net interest

Non-Current loans to

Margin

Total Assets

Banks Average

1.0%

8.85%

3.05%

.90%

JDCC

0.44%

4.31%

2.65%

.32%

The ROA is an indicator of how profitable a firm is compared to its total assets. The ROA is calculated by net income divided by total assets. The return on assets for John Deere Capital Corporation is less than the bank average, most likely because they are a small bank and they have a lot of other services and products they profit from. JDCC’s ROA is positive, which means they are profitable compared to their total assets. The return on equity measures a corporation’s profitability by revealing how much profit the company generates with investor’s money. Compared to the bank average, John Deere

Capital Corporation didn’t perform as well because they are just a small part of a bigger corporation, implying banking is not their biggest business. The net interest margin examines how successful a firm is when it comes to investment decisions. A negative value means the firm made bad decisions, as interest expenses were higher than the investment returns. The net interest margin is calculated by investment returns minus interest expense divided by average earning assets. Deere’s net interest margin was close to the bank average and they maintained a positive net interest margin, indicating their management made positive investment decisions during the past fiscal year. The non-current loans to totals assets for JDCC were less than the bank average, meaning they had less customers in default than the average bank. Customers in default refers to borrowers who have stopped making payments on their outstanding loans. JDCC’s low noncurrent loans to total assets ratio could also be attributed to the small size of the firm, as they do not give out as many loans as the average bank.

Ratios

ROA

ROE

Net Interest

Non-current

Margin

loans to Total assets

2016

0.44%

4.31%

2.65%

.32%

2015

1.45%

13.41%

3.16%

.25%

2014

1.64%

14.73%

3.56%

.22%

2013

1.50%

13.57%

3.56%

.20%

The ROA and ROE have been decreasing over the years, which can be attributed to an overall drop in net income. John Deere Capital Corporation’s net income was $554,603,000 in 2014; in 2015 it dropped to $485,161,000. Another reason for the drop in ROA over the years is because JDCC’s total assets increased from $31,676,590,000 in 2013 to $35,453,189,000 in 2016. Other than the net income drop, the ROE also increased from $3,492,524,000 in 2013 to $3,649,134,000 in 2016. Net interest margin has also been decreasing over the years due to the drop in net income and the increase in the number of assets owned by John Deere Capital Corporation. The non-current loans to assets increased a small amount over these years, indicating the number of customers defaulting increased.

Part III: Derivatives Contracts John Deere Capital Corporation’s Bank Holding Company Performance Report states that John Deere has invested in the following derivatives (in thousands): DERIVATIVE CONTRACTS: Interest rate futures & forward contracts

2013 $

-

2014 $

-

2015 $

-

Written options contracts (int rate)

$ 1,535,323.00

$ 1,590,980.00

$ 1,774,266.00

Purchased options contracts (int rate)

$ 1,535,323.00

$ 1,590,980.00

$ 1,774,266.00

Interest rate swaps

$ 15,038,089.00

$ 13,987,763.00 $ 13,118,883.00

Futures and forward foreign exchange

$ 1,415,211.00

$ 1,141,267.00

$ 1,548,397.00

Written options contr (foreign exch)

$

-

$

-

$

-

Purchased options contr (foreign exch)

$

-

$

-

$

-

Foreign exchange rate swaps

$ 824,156.00

$ 90,559.00

$ 67,781.00

Commodity & other futures & forw

$

-

$

-

$

-

Written options contr (comm & other)

$

-

$

-

$

-

Purchased options contracts

$

-

$

-

$

-

Commodity & other swaps

$

-

$

-

$

-

The firm has by far the most money invested in swaps, and the JDCC annual report focuses on the company’s swaps likely because of this. As of 2015, John Deere Capital Corporation had $512 million worth of 2.75% notes due in 2022 that are swapped for $500 to a variable interest rate of 1.1%. This rate increased 0.2% from 2014 to 2015. The use of this swap hedges the firm from interest rate risk. In addition, the firm has swaps that function as fair value hedges against interest rate risk. The amount of these swaps has decreased from $8798 million to $8618 million from 2014 to 2015. JDCC also has $2800 million in cross currency interest rate swaps that hedge the firm against foreign exchange and interest rate risk. The value has also decreased from 2014 to 2015. The decrease in these amounts may be due to the poor performance of John Deere in 2015 due to the decrease in the S&P500’s farm equipment sector. The firm sets limits to its derivatives to limit its credit and counterparty risk. John Deere’s annual report states that it had a 5% loss in foreign sales revenue due to foreign currency translation in 2015, so they could benefit by hedging more against foreign exchange risk since they have been

interested in providing coverage over more European countries lately. Their foreign exchange rate swaps have decreased dramatically since 2013, which may explain why the firm lost so much money due to foreign currency exchanges. The firm’s hedges are reported in the following table (in millions):

2013

2014

2015

Fair Value Hedges Int rate contracts-int expense

$ (89.00)

$ 155.00

$ 277.00

Interest rate contracts-OCI

$ (15.00)

$ (10.00)

$ (16.00)

Foreign Exchange Contracts-OCI

$ 58.00

$ (4.00)

$ 4.00

Interest rate contracts-interest expense

$ (22.00)

$ (13.00)

$ (12.00)

Foreign Exchange Contracts-Other Expenses

$ 49.00

$ (6.00)

$ 4.00

Cash Flow Hedges

Derivatives Not Classified as Hedges Interest rate contracts-interest expense

$ (6.00)

$ 3.00

$ (17.00)

Foreign Exchange Contracts-Cost of Sales

$ 35.00

$ 25.00

$ 97.00

Foreign Exchange Contracts-Other expenses

$ 20.00

$ 79.00

$ 304.00...