Finance receivables

Finance receivables are receivables of our financial services operations, which generally can be repaid without penalty prior to contractual maturity. Total finance receivables reported on the Consolidated Balance Sheets are net of an allowance for doubtful accounts. Total on-balance sheet assets of our financial services operations net of intercompany balances are $3.2 billion and $3.3 billion, as of July 31, 2011 and October 31, 2010, respectively. Included in total assets are on-balance sheet finance receivables of $2.8 billion and $2.9 billion as of July 31, 2011 and October 31, 2010, respectively.

In March 2010, we entered into a three-year operating agreement (with one-year automatic extensions and subject to early termination provisions) with GE Capital Corporation and GE Capital Commercial, Inc. (collectively “GE”). Under the terms of the agreement, GE became our preferred source of retail customer financing for equipment offered by us and our dealers in the U.S. We provide GE a loss sharing arrangement for certain credit losses. The primary features of the loss sharing arrangement include us reimbursing GE for credit losses in excess of the first 10% of the original value of a financed contract. The Company’s exposure to loss is mitigated since receivables financed under the operating agreement are secured by the financed equipment. We do not carry the receivables financed under the operating agreement on our Consolidated Balance Sheets. There were $588 million and $144 million of outstanding finance receivables as of July 31, 2011 and October 31, 2010, respectively, financed through the operating agreement and subject to the loss sharing arrangement. The related originations of these outstanding finance receivables were $655 million and $159 million as of July 31, 2011 and October 31, 2010, respectively.

Based on our historic experience of losses on similar finance receivables and GE’s first loss position, we do not believe our share of losses related to balances currently outstanding will be material. Historically our losses, representing the entire loss amount, on similar finance receivables, measured as a percentage of the average balance of the related finance receivable, ranged from 0.3% to 2.1%. While under limited circumstances NFC retains the rights to originate retail customer financing, we expect retail finance receivables and retail finance revenues will decline as our retail portfolio pays down.

Pursuant to the adoption of new accounting guidance relating to disclosures about the allowance for losses and credit quality of finance receivables, we determined that we have two portfolio segments of finance receivables based on the type of financing inherent to each portfolio. The retail portfolio segment represents loans or leases to end-users for the purchase or lease of vehicles. The wholesale portfolio segment represents loans to dealers to finance their inventory.

Our finance receivables by major classification are as follows:



	July 31, 2011		October 31, 2010
(in millions)
Retail portfolio	$	1,617	$	1,917
Wholesale portfolio	1,217		1,006
Amounts due from sales of receivables	—		53
Total finance receivables	2,834		2,976
Less: Allowance for doubtful accounts	39		61
Total finance receivables, net	2,795		2,915
Less: Current portion, net^(A)	1,996		1,770
Noncurrent portion, net	$	799	$	1,145

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(A)	The current portion of finance receivables is computed based on contractual maturities. Actual cash collections typically vary from the contractual cash flows because of prepayments, extensions, delinquencies, credit losses, and renewals.

Securitizations

Our financial services operations transfer wholesale notes, retail accounts receivable, retail notes, finance leases, and operating leases through SPEs, which generally are only permitted to purchase these assets, issue asset-backed securities, and make payments on the securities. In addition to servicing receivables, our continued involvement in the SPEs includes an economic interest in the transferred receivables and, historically, managing exposure to interest rates using interest rate swaps, interest rate caps, and forward contracts. In 2010, certain sales of retail accounts receivables were considered to be sales in accordance with guidance on accounting for transfers and servicing of financial assets and extinguishment of liabilities, and were accounted for off-balance sheet. For sales that do qualify for off-balance sheet treatment, an initial gain (loss) is recorded at the time of the sale while servicing fees and excess spread income are recorded as revenue when earned over the life of the finance receivables.

Effective July 31, 2010, our Financial Services segment amended the wholesale trust agreement with the Navistar Financial Dealer Note Master Trust (“Master Trust”). The amendment disqualified the Master Trust as a QSPE and therefore required the Master Trust to be evaluated for consolidation as a VIE. As we are the primary beneficiary of the Master Trust, the Master Trust’s assets and liabilities are consolidated into the assets and liabilities of the Company. Components of available wholesale note trust funding facilities were as follows:



	Maturity	As of
	Maturity	July 31, 2011		October 31, 2010
(in millions)
Variable funding notes (“VFN”)	July 2012	$	500	$	500
Investor notes	October 2012	350		350
Investor notes	January 2012	250		250
Total wholesale note funding		$	1,100	$	1,100

Unutilized funding related to the variable funding facilities was $390 million and $500 million at July 31, 2011 and October 31, 2010, respectively.

TRAC, our consolidated SPE, utilizes a $100 million funding facility arrangement that provides for the funding of eligible retail accounts receivables. Subsequent to the adoption of new accounting guidance on accounting for transfers of financial assets, transfers of finance receivables from our Financial Services segment to the TRAC funding facility completed prior to November 1, 2010 retained their sale accounting treatment while transfers of finance receivables subsequent to November 1, 2010 no longer receive sale accounting treatment. There were no remaining outstanding retained interests as of July 31, 2011.

The funding facility has been refinanced with a maturity date of March 2012. The facility is secured by $124 million of retail accounts and $23 million of cash equivalents as of July 31, 2011 and $54 million of retail accounts and $21 million of cash equivalents as of October 31, 2010. There was $39 million and $78 million of unutilized funding at July 31, 2011 and October 31, 2010, respectively. As of July 31, 2011, all pledged receivables of the SPE are consolidated.

Retained Interests in Off-Balance Sheet Securitizations

Retained interests in off-balance sheet securitizations of $53 million at October 31, 2010, represented our over-collateralization of the TRAC conduit funding facility. As of July 31, 2011, all retail accounts sold into the conduit prior to November 1, 2010 were liquidated; therefore there were no retained interests in off-balance sheet securitizations.

When retained interests are recorded, we estimate the payment speeds for the receivables sold, the discount rate used to determine the fair value of our retained interests, and the anticipated net losses on the receivables in order to calculate the initial gain or loss on the sale of the receivables. Estimates are based on historical experience, anticipated future portfolio performance, market-based discount rates and other factors and are made separately for each securitization transaction. The fair value of our retained interests is based on these assumptions. We re-evaluate the fair value of our retained interests on a monthly basis and recognize changes in current income as required. Our retained interests are recognized as an asset in Finance receivables, net.

The key economic assumptions related to the valuation of our retained interests related to our retail account securitization are as follows:



	October 31, 2010
Discount rate	7.3	%
Estimated credit losses	—
Payment speed (percent of portfolio per month)	88.5	%

The sensitivity of our retained interests to an immediate adverse change of 10% and 20% in each assumption is not material. The effect of a variation of a particular assumption on the fair value of the retained interests is calculated based upon changing one assumption at a time. Oftentimes however, changes in one factor may result in changes in another, which in turn could magnify or counteract these sensitivities.

Finance Revenues

Finance revenues derived from receivables that are both on and off-balance sheet consist of the following:



	Three Months Ended July 31,					Nine Months Ended July 31,
	2011		2010			2011		2010
(in millions)
Finance revenues from on-balance sheet receivables:
Retail notes and finance leases revenue	$	32	$	46		$	108	$	144
Operating lease revenue	8		8			23		25
Wholesale notes interest	25		9			76		18
Retail and wholesale accounts interest	8		5			20		14
Total finance revenues from on-balance sheet receivables	73		68			227		201
Revenues from off-balance sheet securitization:
Fair value adjustments	—		14			1		35
Excess spread income	—		10			—		30
Servicing fees revenue	—		2			—		6
Gain (loss) on sale of finance receivables	—		(12		)	1		(39		)
Securitization income	—		14			2		32
Gross finance revenues	73		82			229		233
Less: Intercompany revenues	26		23			75		70
Finance revenues	$	47	$	59		$	154	$	163

As a result of the adoption of new accounting guidance, substantially all of our securitization activity in 2011 results in the receivables being carried on our Consolidated Balance Sheet. Cash flows from off-balance sheet securitization transactions for the three and nine months ended July 31, 2010 are as follows:



	Three Months Ended July 31, 2010		Nine Months Ended July 31, 2010
(in millions)
Proceeds from finance receivables	$	665	$	2,692
Servicing fees	2		6
Cash from net excess spread	10		31
Net cash from securitization transactions	$	677	$	2,729