Honda 2009 Annual Report Download - page 61

The provision for credit losses increased by ¥4.9 billion, or
11%, refl ecting the continued deterioration of the U.S.
economy which has negatively affected certain customers’
ability to meet their contractual obligations despite the effect of
exchange rate changes. Net charge-offs increased by ¥4.5
billion, or 11%. The ending allowance balance increased by
¥3.0 billion, or 11%, refl ecting the higher estimate of losses
incurred despite the effect of exchange rate changes.
Losses due to customer defaults on operating leases are not
recognized in the provision for credit losses. These losses are
recognized as a component of impairment losses on operating
leases. Impairment losses recognized totaled ¥8.7 billion and
¥5.8 billion for fi scal years 2009 and 2008, respectively. Higher
losses are due to the increasing volume of leases that are
accounted for as operating leases.
(Losses on Lease Residual Values)
End-customers of leased vehicles typically have an option to
buy the leased vehicle for the contractual residual value of the
vehicle or to return the vehicle to our fi nance subsidiaries
through the dealer at the end of the lease term. Likewise,
dealers have the option to buy the vehicle returned by the
customer or to return the vehicle to our fi nance subsidiaries.
The likelihood that the leased vehicle will be purchased varies
depending on the difference between the actual market value
of the vehicle at the end of the lease term and the contractual
value determined at the inception of the lease. Our fi nance
subsidiaries in North America have historically accounted for all
leases as direct fi nancing leases. However, starting in the year
ended March 31, 2007, some of the leases which do not
qualify for direct fi nancing leases accounting treatment are
accounted for as operating leases.
We initially determine the contract residual values by using
our estimate of future used vehicle values, taking into
consideration data obtained from third parties. We are exposed
to risk of loss on the disposition of returned lease vehicles
when the proceeds from the sale of the vehicles are less than
the contractual residual values at the end of the lease term. We
periodically review the estimate of residual values. Downward
adjustments are made for declines in estimated residual values
that are deemed to be other-than-temporary. For direct
fi nancing leases, our fi nance subsidiaries in North America
purchase insurance to cover a portion of the estimated residual
value. The adjustments on the uninsured portion of the
vehicle’s residual value are recognized as a loss in the period in
which the estimate changed. For vehicle leases accounted for
as operating leases, the adjustments to estimated residual
values result in changes to the remaining depreciation expense
to be recognized prospectively on a straight-line basis over the
remaining term of the lease.
The primary components in estimating losses on lease
residual values are the expected frequency of returns, or the
percentage of leased vehicles we expect to be returned by
customers at the end of the lease term, and the expected loss
severity, or the expected difference between the residual value
and the amount we receive through sales of returned vehicles
plus proceeds from insurance, if any. We estimate losses on
lease residual values by evaluating several different factors,
including trends in historical and projected used vehicle values
and general economic measures.
We also periodically test our operating leases for impairment
under Statement of Financial Accounting Standards (SFAS) No.
144, “Accounting for the Impairment or Disposal of Long-Lived
Assets”.
Recoverability of operating leases to be held is measured by
a comparison of the carrying amount of operating leases to
future net cash fl ows (undiscounted and without interest
charges) expected to be generated by the operating leases. If
such operating leases are considered to be impaired, the
impairment to be recognized is measured by the amount by
which the carrying amount of the operating leases exceeds the
estimated fair value of the operating leases.
We believe that our estimated losses on lease residual values
is a “critical accounting estimate” because it is highly
susceptible to market volatility and requires us to make
assumptions about future economic trends and lease residual
values, which are inherently uncertain. We believe that the
assumptions used are appropriate. However actual losses
incurred may differ from original estimates.
If future auction values for all Honda and Acura vehicles in
our North American direct fi nancing lease portfolio as of March
31, 2009, were to decrease by approximately ¥10,000 per unit
from our present estimates, holding all other assumption
constant, the total impact would be an increase in losses on
lease residual values by approximately ¥0.6 billion. Similarly, if
future return rates for our existing portfolio of all Honda and
Acura vehicles were to increase by one percentage point from
our present estimates, the total impact would be an increase in
losses on lease residual values by approximately ¥0.1 billion.
With the same prerequisites shown above, the impacts to the
operating lease portfolio would be approximately ¥2.5 billion
and ¥0.6 billion, which would be recognized over the remaining
lease terms. Note that this sensitivity analysis may be
asymmetric, and are specifi c to the base conditions in fi scal
2009. Also, declines in auction values are likely to have a
negative effect on return rates which could affect the
sensitivities.
(Fiscal Year 2009 Compared with Fiscal Year 2008)
Despite a declining portfolio of direct fi nancing leases and the
effect of exchange rate changes, losses on lease residual
values increased by ¥11.1 billion or 94% as a result of the
declines in used vehicle prices. Despite the effect of exchange
rate changes, incremental depreciation increased by ¥11.6
billion or 545% due to the increase in operating lease assets
and declines in estimated residual values.
Impairment losses of ¥9.7 billion were recognized in
accordance with Statement of Financial Accounting Standards
(SFAS) No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets” during the year.
Annual Report 2009 59