The Group is exposed to the following financial risks connected with its operations: credit risk, regarding its normal business relations with customers and dealers, and its financing activities; liquidity risk, with particular reference to the availability of funds and access to the credit market and to financial instruments in general; market risk (principally relating to exchange rates, interest rates), since the Group operates at an international level in different currencies and uses fi nancial instruments which generate interest.
As described in the section “Risk management”, the Group constantly monitors the financial risks to which it is exposed, in order to detect those risks in advance and take the necessary action to mitigate them.
The following paragraphs provide qualitative and quantitative disclosures on the effect that these risks may have upon the Group.
The quantitative data reported in the following do not have any predictive value, in particular the sensitivity analysis on market risks cannot refl ect the complexity of the market or the associated market reaction which may result from any of the assumed changes.
The maximum credit risk to which the Group is theoretically exposed at December 31, 2014 is represented by the carrying amounts stated for financial assets in the statement of financial position and the nominal value of the guarantees provided on liabilities or commitments of third parties as discussed in Note 30.
Dealers and fi nal customers are subject to specifi c assessments of their creditworthiness under a detailed scoring system; in addition to carrying out this screening process, the Group also obtains financial and non-financial guarantees for risks arising from credit granted for the sale of trucks and commercial vehicles and agricultural and construction equipment. These guarantees are further strengthened where possible by retention of title clauses or specifi c guarantees on fi nanced vehicle sales to the sales network and on vehicles assigned under fi nance lease agreements.
Balances which are objectively uncollectible either in part or for the whole amount are written down on a specifi c basis if they are individually signifi cant. The amount of the write-down takes into account an estimate of the recoverable cash fl ows and the date of receipt, the costs of recovery and the fair value of any guarantees received. Impairment losses are recognized for receivables which are not written down on a specifi c basis, determined on the basis of historical experience and statistical information.
Receivables for financing activities amounting to $21,472 million at December 31, 2014 ($21,986 million at December 31, 2013) include balances totaling $128 million ($106 million at December 31, 2013) that have been written down on an individual basis. Of the remainder, balances totaling $405 million ($494 million at December 31, 2013) are past due by up to one month, while balances totaling $375 million are past due by more than one month ($582 million at December 31, 2013). In the event of installment payments, even if only one installment is overdue, the whole amount of the receivable is classifi ed as such.
Trade receivables and Other current receivables totaling $2,318 million at December 31, 2014 ($3,038 million at December 31, 2013) include balances totaling $85 million ($73 million at December 31, 2013) that have been written down on an individual basis. Of the remainder, balances totaling $28 million ($139 million at December 31, 2013) are past due by up to one month, while balances totaling $239 million ($308 million at December 31, 2013) are past due by more than one month.
The signifi cant decrease in the past due component in receivables from fi nancing activities is primarily attributable to a reduction in EMEA past dues related to the Commercial vehicles related portfolio.
Liquidity risk arises if the Group is unable to obtain the funds needed to carry out its operations under economic conditions.
The two main factors that determine the Group’s liquidity situation are on the one hand the funds generated by or used in operating and investing activities and on the other the debt lending period and its renewal features or the liquidity of the funds employed and market terms and conditions.
CNH Industrial has adopted a series of policies and procedures whose purpose is to optimize the management of funds and to reduce the liquidity risk, as follows: centralizing the management of receipts and payments, where it may be economical in the context of the local statutory, currency and fi scal regulations of the countries in which the Group is present; maintaining an adequate level of available liquidity; diversifying the means by which funds are obtained and maintaining a continuous and active presence on the capital markets; obtaining adequate credit lines; and monitoring future liquidity on the basis of business planning.
Details as to the repayment structure of the Group’s financial assets and liabilities are provided in Note 19 “Current receivables and Other current assets” and in Note 27 “Debt”. Details of the repayment structure of derivative financial instruments are provided in Note 21.
Management believes that the funds currently available, together with the funds that will be generated from operating and fi nancing activities, will enable the Group to satisfy its requirements resulting from its investing activities and its working capital needs and to fulfi ll its obligations to repay its debts at their natural due date.
The Group is exposed to risk resulting from changes in exchange rates, which can affect its earnings and equity. In particular:
- Where a Group company incurs costs in a currency different from that of its revenues, any change in exchange rates can affect the operating profi t/(loss) of that company. In 2014, the total net trade fl ows exposed to currency risk amounted to the equivalent of 18% of the Group’s turnover (19% in 2013). The principal exchange rates to which the Group is exposed are the following:
- US$/EUR, in relation to the production/purchases of Agricultural Equipment and Construction Equipment in the Euro area and to sales in dollars made by Commercial Vehicles;
- US$/BRL and EUR/BRL, in relation to production in Brazil and the respective import/export flows;
- US$/AUD, mainly in relation to sales made by Agricultural Equipment and Construction Equipment in Australia; US$/GBP, in relation to the production/purchases of Agricultural Equipment and Construction Equipment in the UK;
- EUR/GBP, predominately in relation to sales made by Commercial Vehicles on the UK market and purchases made by Agricultural Equipment and Construction Equipment in the Euro area.
Taken overall trade fl ows exposed to changes in these exchange rates in 2014 made up approximately 72% of the exposure to currency risk from trade transactions.
- It is the Group’s policy to use derivative fi nancial instruments to hedge a certain percentage, on average between 55% and 85%, of the forecast trading transaction exchange risk exposure for the coming 12 months (including such risk beyond that date where it is believed to be appropriate in relation to the characteristics of the business) and to hedge completely the exposure resulting from fi rm commitments.
- Group companies may fi nd themselves with trade receivables or payables denominated in a currency different from the functional currency of the company itself. In addition, in a limited number of cases, it may be convenient from an economic point of view, or it may be required under local market conditions, for companies to obtain fi nancing or use funds in a currency different from their functional currency. Changes in exchange rates may result in exchange gains or losses arising from these situations. It is the Group’s policy to hedge fully, whenever possible, the exposure resulting from receivables, payables and securities denominated in foreign currencies different from the company’s functional currency.
- Certain of the Group’s subsidiaries are located in countries not adopting the U.S. dollar as local currency, such as the members of the European monetary union, the United Kingdom, Brazil, Australia, Canada, India, China, Argentina and Poland. As the Group’s reference currency is the U.S. dollar, the income statements of those countries are converted into U.S. dollar using the average exchange rate for the period, and while revenues and margins are unchanged in local currency, changes in exchange rates may lead to effects on the converted balances of revenues, costs and the result in U.S. dollar.
- The assets and liabilities of consolidated companies whose functional currency is different from the U.S. dollar may acquire converted values in U.S. dollar which differ as a function of the fl uctuation in exchange rates. The effects of these changes are recognized directly in the Cumulative Translation Adjustments reserve, included in Other comprehensive income (see Note 24).
The Group monitors its principal exposure to translation exchange risk, although there was no specifi c hedging in this respect at the balance sheet date.
There were no substantial changes in 2014 in the nature or structure of exposure to currency risk or in the Group’s hedging policies.
The potential loss in fair value of derivative fi nancial instruments held for currency risk management (currency swaps/forwards, currency options, interest rate and currency swaps) at December 31, 2014 resulting from a hypothetical, unfavorable and instantaneous change of 10% in the exchange rates amounts to approximately $255 million ($281 million at December 31, 2013).
Receivables, payables and future trade fl ows whose hedging transactions have been analyzed were not considered in this analysis. It is reasonable to assume that changes in exchange rates will produce the opposite effect, of an equal or greater amount, on the underlying transactions that have been hedged.
Interest rate risk
The manufacturing companies and treasuries of the Group make use of external funds obtained in the form of fi nancing and invest in monetary and fi nancial market instruments. In addition, Group companies make sales of receivables resulting from their trading activities on a continuing basis. Changes in market interest rates can affect the cost and return of the various forms of fi nancing, including the sale of receivables, and the employment of funds, causing an impact on the level of net fi nancial expenses incurred by the Group.
In addition, Financial Services companies provide loans (mainly to customers and dealers), financing themselves primarily using various forms of direct debt or asset-backed financing (e.g. securitization of receivables). Where the characteristics of the variability of the interest rate applied to loans granted differ from those of the variability of the cost of the financing obtained, changes in the current level of interest rates can affect the operating profit/(loss) of those companies and the Group as a whole.
In order to manage these risks, the Group uses interest rate derivative financial instruments, mainly interest rate swaps and forward rate agreements, with the object of mitigating, under economically acceptable conditions, the potential variability of interest rates on net profit/ (loss).
In assessing the potential impact of changes in interest rates, the Group separates out fixed rate financial instruments (for which the impact is assessed in terms of fair value) from floating rate financial instruments (for which the impact is assessed in terms of cash flows).
The fixed rate financial instruments used by the Group consist principally of part of the portfolio of the Financial Services companies (basically customer financing and financial leases) and part of debt (including subsidized loans and bonds).
The potential loss in fair value of fixed rate financial instruments (including the effect of interest rate derivative financial instruments) held at December 31, 2014 resulting from a hypothetical, unfavorable and instantaneous change of 10% in market interest rates, would have been approximately $25 million (approximately $34 million at December 31, 2013).
Floating rate financial instruments consist principally of cash and cash equivalents, loans provided by the Financial Services companies to the sales network and part of debt. The effect of the sale of receivables is also considered in the sensitivity analysis as well as the effect of hedging derivative instruments.
A hypothetical, unfavorable and instantaneous change of 10% in short-term interest rates at December 31, 2014, applied to floating rate financial assets and liabilities, operations for the sale of receivables and derivative financial instruments, would have caused increased net expenses before taxes, on an annual basis, of approximately $5 million (approximately $5 million at December 31, 2013).
This analysis is based on the assumption that there is a general and instantaneous change of 10% in interest rates across homogeneous categories. A homogeneous category is defined on the basis of the currency in which the financial assets and liabilities are denominated.
Other risks on derivative financial instruments
The Group has entered derivative contracts linked to commodity prices to hedge specific exposures on supply contracts.
In the event of a hypothetical, unfavorable and instantaneous change of 10% in the underlying raw materials prices, the potential loss in fair value of outstanding derivative financial instruments at December 31, 2014 linked to commodity prices would have been not significant (not significant at December 31, 2013).