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Management discussion
International Business Machines Corporation and Subsidiary Companies

Global Financing

Financial condition

Balance Sheet
($ in millions)
At December 31: 2007 2006

(a) Includes intercompany mark-up, priced on an arms-length basis, on products purchased from the company’s product divisions, which is eliminated in IBM’s consolidated results.

(b) Entire amount eliminated for purposes of IBM’s consolidated results and therefore does not appear in the “Consolidated Statement of Financial Position.”

(c) These assets, along with all other financing assets in this table, are leveraged at the value in the table using Global Financing debt.

(d) Global Financing debt is comprised of intercompany loans and external debt. A portion of Global Financing debt is in support of the company’s internal business, or related to intercompany mark-up embedded in the Global Financing assets. See table below.

Cash $ 755 $ 879
Net investment in sales-type leases 10,876 10,108
Equipment under operating leases:
External clients(a) 2,401 2,264
Internal clients(b)(c) 1,872 1,976
Client loans 10,667 9,267
Total client financing assets 25,816 23,615
Commercial financing receivables 6,375 5,844
Intercompany financing receivables(b)(c) 2,984 2,534
Other receivables 368 327
Other assets 1,288 746
Total financing assets $ 37,586 $ 33,945
Intercompany payables(b) $ 6,934 $ 5,858
Debt(d) 24,532 22,287
Other liabilities 2,672 2,590
Total financing liabilities 34,138 30,735
Total financing equity 3,448 3,211
Total financing liabilities and equity $ 37,586 $ 33,945
Sources and Uses of Funds

The primary use of funds in Global Financing is to originate client and commercial financing assets. Client financing assets for end users consist primarily of IBM hardware, software and services, but also include non-IBM equipment, software and services to meet IBM clients’ total solutions requirements. Client financing assets are primarily sales type, direct financing, and operating leases for equipment, as well as loans for hardware, software and services with terms generally for two to seven years. Global Financing’s client loans are primarily for software and services and are unsecured. These loans are subjected to additional credit analysis in order to mitigate the associated risk. Loan agreements include credit protective language and dollar limits on how much can be financed in order to minimize credit risk. Client financing also includes internal activity as described in the “Description of Business.”

Commercial financing receivables arise primarily from inventory and accounts receivable financing for dealers and remarketers of IBM and non-IBM products. Payment terms for inventory financing and accounts receivable financing generally range from 30 to 90 days. These short-term receivables are primarily unsecured and are also subject to additional credit actions in order to mitigate the associated risk.


The following are total external and internal financing originations.

($ in millions)
For the year ended December 31: 2007 2006 2005
Client financing:
External $ 14,171 $ 13,087 $ 12,249
Internal 1,040 1,214 1,167
Commercial financing 30,541 27,969 27,032
Total $ 45,752 $ 42,270 $ 40,448

New financing originations exceeded cash collections for both client and commercial financing in 2007, which resulted in a net increase in financing assets from December 31, 2006. The increase in originations in 2007 from 2006, as well as the increase in 2006 versus 2005, was due to improving volumes in both client and commercial financing.

Cash generated by Global Financing in 2007 was deployed to pay intercompany payables and dividends to IBM as well as to reduce intercompany debt.

Global Financing Receivables and Allowances

The following table presents external financing receivables, excluding residual values, and the allowance for doubtful accounts.

($ in millions)
At December 31: 2007 2006
Gross financing receivables $ 27,642 $ 24,926
Specific allowance for doubtful accounts 230 294
Unallocated allowance for doubtful accounts 138 76
Total allowance for doubtful accounts 368 370
Net financing receivables $ 27,274 $ 24,556
Allowance for doubtful account coverage 1.3% 1.5%
Roll-Forward of Financing Receivables Allowance for Doubtful Accounts
($ in millions)
Jan. 1, 2007 Allowance Used* Additions/ (reductions) A/R Provision Other** Dec. 31, 2007

* Represents reserved receivables, net of recoveries, that were disposed of during the period.

** Primarily represents translation adjustments.

$370 $(101) $70 $29 $368

The percentage of financing receivables reserved decreased from 1.5 percent at December 31, 2006, to 1.3 percent at December 31, 2007 primarily due to the decrease in the specific allowance for doubtful accounts. Specific reserves decreased 21.8 percent from $294 million at December 31, 2006 to $230 million at December 31, 2007 due to the disposition of reserved receivables during the period combined with lower requirements for additional specific reserves. This lower requirement is generally due to the credit quality of the portfolio, as well as portfolio management to reduce credit risk. Unallocated reserves increased 81.6 percent from $76 million at December 31, 2006, to $138 million at December 31, 2007 primarily due to the significant growth of the financing receivables portfolio. Global Financing’s provision expense was an addition of $70 million for the year ended December 31, 2007 and a reduction of $20 million for the year ended December 31, 2006. The increase was primarily attributed to the growth of the unallocated reserves.

Residual Value

Residual value is a risk unique to the financing business and management of this risk is dependent upon the ability to accurately project future equipment values at lease inception. Global Financing has insight into the product plans and cycles for the IBM products under lease. Based upon this information, Global Financing continually monitors projections of future equipment values and compares them with the residual values reflected in the portfolio. See note A, “Significant Accounting Policies,” for the company’s accounting policy for residual values.

Global Financing optimizes the recovery of residual values by selling assets sourced from end of lease, leasing used equipment to new clients or extending lease arrangements with current clients. Sales of equipment, which are primarily sourced from equipment returned at end of lease, represented 37.3 percent of Global Financing’s revenue in 2007 and 39.8 percent in 2006. The decrease was due to the decline in internal used equipment sales, partially offset by the increase in external used equipment sales. The gross margin on these sales was 43.7 percent and 38.1 percent in 2007 and 2006, respectively. The increase was driven primarily by higher margin internal used equipment sales.

The table below presents the recorded amount of unguaranteed residual value for sales-type and operating leases at December 31, 2006 and 2007. In addition, the table presents the residual value as a percentage of the original amount financed, and a schedule of when the unguaranteed residual value assigned to equipment on leases at December 31, 2007 is expected to be returned to the company. In addition to the unguaranteed residual value, on a limited basis, Global Financing will obtain guarantees of the future value of the equipment to be returned at end of lease. These third-party guarantees are included in minimum lease payments as provided for by accounting standards in the determination of lease classifications for the covered equipment and provide protection against risk of loss arising from declines in equipment values for these assets. The residual value guarantee increases the minimum lease payments that are utilized in determining the classification of a lease as a sales-type lease or an operating lease. The aggregate asset values associated with the guarantees were $682 million and $794 million for financing transactions originated during the years ended December 31, 2007 and 2006, respectively. In 2007, the residual value guarantee program resulted in the company recognizing approximately $483 million of revenue that would otherwise have been recognized in future periods as operating lease revenue. If the company had chosen to not participate in a residual value program in 2007 and prior years, overall revenues would not have been materially affected due to the relatively constant year-to-year aggregate asset value associated with the residual value guarantees. The associated aggregate guaranteed future values at the scheduled end of lease were $38 million each for financing transactions originated during the same time periods, respectively. The cost of guarantees was $5 million per year in 2007 and 2006.

Unguaranteed Residual Value
($ in millions)
Total Estimated Run Out of 2007 Balance
2006 2007 2008 2009 2010 2011 and Beyond
Sales-type leases $ 854 $ 915 $ 211 $ 286 $ 294 $ 124
Operating leases 342 421 148 123 117 33
Total unguaranteed residual value $ 1,196 $ 1,336 $ 359 $ 409 $ 411 $ 157
Related original amount financed $ 23,225 $ 24,517
Percentage 5.2% 5.4%
At December 31: 2007 2006
Debt-to-equity ratio 7.1x 6.9x

Global Financing funds its operations primarily through borrowings using a debt-to-equity ratio of approximately 7 to 1. The debt is used to fund Global Financing assets and is composed of intercompany loans and external debt. The terms of the intercompany loans are set by the company to substantially match the term and currency underlying the receivable and are based on arm’s-length pricing. Both assets and debt are presented in the Global Financing Balance Sheet above.

The Global Financing business provides funding predominantly for the company’s external clients but also provides intercompany financing for the company, as described in the “Description of Business.” As previously stated, the company measures Global Financing as if it were a standalone entity and accordingly, interest expense relating to debt supporting Global Financing’s external client and internal business is included in the “Global Financing Results of Operations” and in note V, “Segment Information.”

In the company’s Consolidated Statement of Earnings, however, the interest expense supporting Global Financing’s internal financing to the company is reclassified from Cost of Financing to Interest expense.

The following table provides additional information on debt. In this table, Intercompany activity is comprised of internal loans and leases at arm’s length pricing in support of Global Services’ long-term contracts and other internal activity. The company believes these assets should be appropriately levered in line with the overall Global Financing business model.

($ in millions)
December 31, 2007 December 31, 2006
Global Financing Segment   $ 24,532   $ 22,287
Debt to support external clients $ 21,072   $ 18,990  
Debt to support internal clients 3,460   3,297  
Non-Global Financing Segments   10,743   395
Debt supporting operations 14,203   3,692  
Intercompany activity (3,460)   (3,297)  
Total company debt   $ 35,274   $ 22,682
Liquidity and Capital Resources

Global Financing is a segment of the company and as such, is supported by the company’s overall liquidity position and access to capital markets. Cash generated by Global Financing was primarily deployed to reduce debt and pay dividends to the company in order to maintain an appropriate debt-to-equity ratio.

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