Item 1. Business
The registrant, Navistar Financial Corporation ("NFC"), was incorporated in Delaware in 1949 and is a wholly-owned subsidiary of Navistar International Transportation Corp. ("Transportation"), which is wholly-owned by Navistar International Corporation ("Navistar"). As used herein, the "Corporation" refers to Navistar Financial Corporation and its wholly-owned subsidiaries unless the context otherwise requires.
The Corporation provides wholesale, retail, and to a lesser extent, lease financing in the United States for sales of new and used trucks sold by Transportation and Transportation's dealers. The Corporation also finances wholesale accounts and selected retail accounts receivable of Transportation. Sales of new products (including trailers) of other manufacturers are also financed regardless of whether designed or customarily sold for use with Transportation's truck products. Harco National Insurance Company, NFC's wholly-owned insurance subsidiary, provides commercial physical damage and liability insurance coverage to Transportation's dealers and retail customers, and to the general public through the independent insurance agency system.
Item 2.

Item 2. Properties
The Corporation's properties principally consist of office equipment and leased office space in Rolling Meadows, Illinois; Columbus, Ohio; Atlanta, Georgia; Plano, Texas; Mt. Laurel, New Jersey; and San Ramon, California. The office equipment owned and in use by the Corporation is not significant in relation to the total assets of the Corporation.
Item 3.

Item 3. Legal Proceedings
During 1992, auditors of the Illinois Department of Revenue ("Department") began an income tax audit of NFC for the fiscal years ended October 31, 1989, 1990 and 1991. On February 1, 1994, the Department issued a Notice of Deficiency to NFC for approximately $11.9 million. The Department has taken the position that nearly 100% of NFC's income during these years should be attributed to and taxed by Illinois. NFC maintains that the Department's interpretation and application of the law is incorrect and improper, and that the Department's intended result is constitutionally prohibited. Based on discussions with outside counsel, NFC's management is of the opinion that it is more likely than not that NFC's position will prevail such that the Department's action will not have a material impact on NFC's earnings and financial position.
PART I (Continued)
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders
Intentionally omitted. See the index page of this Report for explanation.
PART II
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Financing Volume
The Corporation's serviced receivables portfolio, which includes sold receivables, totaled $3.3 billion at October 31, 1996, up from $3.2 billion and $2.5 billion at October 31, 1995 and 1994, respectively.
In fiscal 1996 customer demand for Class 5 through 8 trucks declined approximately 9% compared with 1995 and was slightly higher than 1994 demand. In spite of lower customer demand and the continued highly competitive commercial financing market, fiscal 1996 acquisitions of retail notes and leases of $1.1 billion, net of unearned finance income, were equal to 1995. The Corporation's finance market share of new trucks manufactured by Transportation and sold in the United States increased to 16.3% in 1996 from 14.4% in 1995. Acquisitions in 1995 were $.2 billion higher than 1994 due to increased demand offset in part by lower finance market share of 14.4% in 1995 compared with 15.3% in 1994. Serviced retail notes and lease financing balances were $2.2 billion at October 31, 1996, compared with $1.9 billion and $1.6 billion at October 31, 1995 and 1994, respectively.
During fiscal 1996, the Corporation supplied 94% of the wholesale financing of new trucks sold to Transportation's dealers, slightly higher than the 93% in 1995 and 1994. During 1996, Transportation dealers generally reduced inventory levels in response to lower customer demand. As a result, acquisitions of wholesale notes decreased $.3 billion, 9%, to $2.7 billion in 1996 after a 29% increase to $3.0 billion in 1995 from 1994. Serviced wholesale note balances were $685 million at October 31, 1996, compared to $854 million and $577 million at October 31, 1995 and 1994, respectively.
Owned finance receivables balances, including subordinated interests in retail and wholesale receivables, decreased to $1.4 billion at October 31, 1996, from $1.5 billion at October 31, 1995 due primarily to lower wholesale financing. Balances in 1995 were $.2 billion higher than 1994 as a result of the higher level of wholesale and retail financing. Receivable sales were a significant source of funding during fiscal 1996 and 1995 and, as a result, sold retail receivable balances increased to $1.4 billion at October 31, 1996 from $1.2 billion and $1.0 billion at October 31, 1995 and 1994, respectively. Sold wholesale note balances were $500 million at October 31, 1996 and 1995 and $300 million at October 31, 1994.
Results of Operations
The Corporation's after tax return on equity was a record 18.1% in 1996 compared with 15.0% and 15.1% in 1995 and 1994, respectively. Income before taxes in 1996 was $81 million, a 37% increase from $59 million in 1995, primarily as a result of higher gains on sales of retail notes, higher levels
Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Results of Operations (Continued)
of wholesale note balances during the first nine months of 1996 and higher retail and lease balances offset in part by a higher loss provision. Gains on sales of retail note receivables during 1996 were $20 million on sales of $985 million compared with gains of $5 million on sales of $740 million in 1995. The higher gains on sales resulted from higher margins on retail notes due to declining market interest rates prior to the sale in November 1995. During a declining interest rate environment, the Corporation's acquisition spreads improve as NFC's cost of borrowing differs from the time when interest rates are quoted to borrowers and the time when notes are acquired. In addition, the effective interest rate for each sale is based on a market interest rate at the time of the sale, which may be up to six months after the Corporation acquired the retail note. During fiscal 1995, the opposite impact was experienced by NFC on a sale in November 1994 as market interest rates were rising and a loss was recorded on that sale.
Income before taxes of $59 million in 1995 increased 6% from $55 million in 1994 as a result of higher finance receivables to support the demand for Transportation truck products and improvement in the Corporation's borrowing spread over market interest rates. This increase was partially offset by lower gains on sales of retail notes. Gains on the $740 million retail notes sold in 1995 were $5 million compared with $12 million on sales of $1,033 million in 1994.
The more significant elements of revenue and expense impacting net income for these years are discussed in the following paragraphs:
Retail note and lease financing revenue for 1996 was $98 million compared with $73 million and $71 million in 1995 and 1994, respectively. The 1996 improvement over 1995 is primarily due to higher gains on sold notes and higher average balances. The increase in 1995 revenues compared with 1994 is due to higher financing volume offset in part by lower gains on sold notes.
Wholesale note revenue increased 5% in 1996 to $57 million as a result of higher average outstanding note balances in the first nine months of the fiscal year offset in part by lower average yields relating to a lower prime interest rate. In 1995 revenue increased 38% compared with 1994 as the level of wholesale financing was higher to support increased demand for Transportation truck products and higher average yields due to higher prime interest rates.
Revenue from accounts decreased in 1996 to $27 million from $29 million in 1995 as the decline in customer demand caused a lower level of financing activity. Revenue in 1995 was 32% higher than 1994 due to higher outstanding balances in support of the increased demand for Transportation truck products and higher average yields due to higher prime interest rates.
Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Results of Operations (Continued)
Servicing fee income increased to $20 million in 1996 from $18 million in 1995 and $17 million in 1994 as a result of higher levels of sold note receivable balances which the Corporation continues to service.
Insurance premiums earned by Harco decreased 6% to $42 million in 1996 from $45 million in 1995 and 12% in 1995 from 1994. The decreases in 1996 and 1995 reflect reductions in written premiums of truck liability lines in response to adverse loss experience in those lines and to increased competition.
Borrowing costs decreased slightly in 1996 to $82 million from $84 million in 1995 after a significant increase in 1995 compared with $70 million in 1994. During 1996 the Corporation's weighted average interest rate on all debt declined to 6.5% from 7.4% in 1995 primarily due to the maturity of high fixed rate public debt during 1995 and 1996 and also due to lower market interest rates. The favorable rate impact was offset in part by higher debt balances to support receivable balances. The increase in 1995 from 1994 was primarily the result of higher debt balances to support increased wholesale note and account balances and higher market interest rates, offset in part by an improvement in the Corporation's borrowing spread over market interest rates as a result of the 1995 amendment to the revolving debt agreement and the asset-backed commercial paper ("ABCP") program. The ratio of debt to equity was 4.7:1, 5.2:1 and 4.8:1 at October 31, 1996, 1995, and 1994, respectively.
Credit collection and administrative expenses were $28 million in 1996 and 1995 compared with $26 million in 1994. The $2 million increase in 1995 compared with 1994 was due to retail marketing efforts and incentive programs.
The provision for losses on receivables totaled $9 million in 1996 compared with $3 million in 1995 and $2 million in 1994. As the trucking industry softened during 1996, the high level of new truck purchases in 1995 caused an over capacity in the trucking sector. This over capacity coupled with competitive freight rates and higher fuel costs impacted NFC's customers' abilities to meet obligations and has resulted in higher delinquencies, repossessions and credit losses. Notes and account write-offs (recoveries), including sold notes totaled $5 million in 1996, $(1) million in 1995 and $1 million in 1994. The Corporation's allowance for losses as a percentage of serviced finance receivables was .74%, .62% and .65% at October 31, 1996, 1995 and 1994, respectively.
Insurance claims and underwriting expenses decreased to $44 million in 1996 from $47 million and $54 million in 1995 and 1994, respectively. The decline resulted from decreases in losses incurred in Harco's truck liability insurance lines and lower commission costs associated with lower volumes of premiums written through general agents.
Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Liquidity and Funds Management
The Corporation's operations are substantially dependent upon the production and sale of Transportation's truck products. Navistar Financial has traditionally obtained the funds to provide financing to Transportation's dealers and retail customers from sales of receivables, commercial paper, short- and long-term bank borrowings, medium- and long-term debt issues and equity capital. The current debt ratings of the Corporation, detailed below, have made bank borrowings and sales of finance receivables the most economical sources of cash. The Corporation's insurance operation generates its funds through internal operations and has no external borrowings.
Operations used $29 million in cash in 1996 as the cash provided from net income of $49 million was offset by a decrease in accounts payable reflecting the timing of payments to Transportation. Investment activities provided $95 million in cash primarily due to a $163 million decline in wholesale note and account balances, offset in part by higher retail and equipment leasing activity. During 1996, the purchase of $1,108 million retail notes and lease receivables was funded with $982 million proceeds from the sale of the receivables and principal collections of $125 million. The cash provided from investing activities was used to lower debt funding and to pay dividends of $26 million. See also the "Statement of Consolidated Cash Flow" on page 12.
Over the last three years, operations provided $103 million in cash and proceeds from the sale of retail receivables totaled $2,704 million. These amounts were used mainly to fund receivable acquisitions of $2,747, net of principal collections on the receivables, and dividend payments of $61 million.
Receivable sales were a significant source of funding in 1996 and 1995. Through the asset-backed public market, the Corporation has been able to fund fixed rate retail note receivables at rates offered to companies with investment grade ratings. During fiscal 1996 and 1995, the Corporation sold $985 and $740 million, respectively, of retail notes, through Navistar Financial Retail Receivables Corporation ("NFRRC"), a wholly- owned subsidiary, to owner trusts which in turn sold notes and certificates to investors. At October 31, 1996, the remaining shelf registration available to NFRRC for issuance of asset- backed securities was $2.4 billion. The Corporation has a $500 million revolving wholesale note trust that provides for the continuous sale of eligible wholesale notes on a daily basis. The trust is funded by securities sold to the public comprised of three $100 million tranches of investor certificates maturing serially from 1997 to 1999 and a $200 million tranche of investor certificates maturing in 2004. See Note 5 to the Consolidated Financial Statements for further discussion.
The Corporation has a $925 million bank revolving credit facility and a $400 million asset-backed commercial paper ("ABCP") program supported by a bank liquidity facility, which mature in March 2001. See Note 10 to the Consolidated Financial Statements for further discussion.
Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Liquidity and Funds Management (Continued)
In March 1995, ratings on the Corporation's debt were upgraded by Moody's Investors Service, Inc. ("Moody's"). Moody's raised its ratings for the Corporation's debt from Ba3 to Ba2 for senior debt and from B2 to B1 for subordinated debt. In March 1995, Duff & Phelps confirmed its debt ratings of BB+ for senior debt and BB for subordinated debt. In October 1993, ratings on the Corporation's debt were reviewed by Standard and Poor's Corporation ("Standard and Poor's"). Standard and Poor's raised its ratings for the Corporation's debt from B- to BB for senior debt and from CCC to B+ for subordinated debt. The Corporation's commercial paper is rated "not prime" by Moody's.
In November 1996, the Corporation sold $487 million of retail notes, net of unearned finance income, through NFRRC to an owner trust which in turn sold notes and certificates to investors. A gain of $6.9 million was recognized on the sale.
The Corporation manages sensitivity to interest rate changes by funding floating rate assets with floating rate debt, primarily borrowings under the bank revolving credit agreement, and fixed rate assets with fixed rate debt, equity and floating rate debt. Management has limited the amount of fixed rate assets funded with floating rate debt by selling retail receivables on a fixed rate basis and, to a lesser extent, by utilizing derivative financial instruments. See notes 1 and 14 to the Consolidated Financial Statements. Corporate policy prohibits the use of derivatives for speculative purposes.
On February 1, 1994, the Illinois Department of Revenue ("Department") issued a Notice of Deficiency to the Corporation for approximately $12 million for the fiscal years 1989 throuth 1991. The Corporation maintains that the Department's interpretation and application of the law is incorrect and improper. Based on discussions with outside counsel, NFC's management is of the opinion that NFC's position will prevail and the Department's action will not have a material impact on NFC's financial condition. See Note 8 to the Consolidated Financial Statements for further discussion.
Pending Accounting Standards
In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125 ("SFAS No. 125"), "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" which the Corporation must adopt for all applicable transactions occurring after December 31, 1996. The Corporation will apply SFAS No. 125 to securitization transactions occurring on or after January 1, 1997. The new standard is not expected to have a material effect on the Corporation's net income or financial condition.
Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
Business Outlook
The demand for heavy trucks is forecast to continue to soften during fiscal 1997 and correspondingly NFC's profitability and wholesale and retail financing activity are anticipated to be lower. Competition will continue to put pressure on the Corporation's retail note acquisition activity and retail note margins.
Management believes that collections on the outstanding receivables portfolio plus cash available from the Corporation's various funding sources will permit Navistar Financial to meet the financing requirements of Transportation's dealers and retail customers through 1997 and beyond.
Navistar Financial Corporoation and Subsidiaries
Statement of Consolidated Income and Retained Earnings Millions of Dollars
See Notes to Consolidated Financial Statements.
Navistar Financial Corporation and Subsidiaries
Statement of Consolidated Financial Condition Millions of Dollars
See Notes to Consolidated Financial Statements.
Navistar Financial Corporation and Subsidiaries
Statement of Consolidated Cash Flow Millions of Dollars
See Notes to Consolidated Financial Statements.
NAVISTAR FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED OCTOBER 31, 1996
MILLIONS OF DOLLARS
1. SUMMARY OF ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Navistar Financial Corporation ("NFC") and its wholly-owned subsidiaries ("Corporation"). All significant intercompany accounts and transactions have been eliminated. All of the Corporation's capital stock is owned by Navistar International Transportation Corp. ("Transportation"), which is wholly owned by Navistar International Corporation ("Navistar").
Nature of Operations
The Corporation's primary business is the retail, wholesale, and to a lesser extent, lease financing of products sold by Transportation and its dealers within the United States. The Corporation also provides commercial physical damage and liability insurance coverage to Transportation's dealers and retail customers and to the general public through the independent insurance agency system.
Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue on Receivables
Finance charges on retail notes and finance leases are recognized as income over the terms of the receivables using the interest method. Interest from interest-bearing notes and accounts is taken into income on the accrual basis. Revenue on operating leases is recognized on a straight-line basis over the life of the lease. Recognition of revenue on receivables and leases is suspended when management determines the collection of future income is not probable. Income recognition is resumed if collection doubts are removed.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
1. SUMMARY OF ACCOUNTING POLICIES (Continued)
Allowance for Losses on Receivables
The allowance for losses on receivables is established through a charge to the provision for losses. The allowance is an estimate of the amount adequate to absorb losses on existing receivables that may become uncollectible. The allowance is maintained at an amount management considers appropriate in relation to the outstanding receivables portfolio based on such factors as overall portfolio quality, historical loss experience and current economic conditions.
Under various agreements, Transportation and its dealers may be liable for a portion of customer losses or may be required to repurchase the repossessed collateral at the receivable principal value. The Corporation's losses are net of these benefits. Receivables are charged off to the allowance for losses as soon as the receivable is determined to be uncollectible.
Receivable Sales
The Corporation securitizes and sells receivables to public and private investors with limited recourse. The Corporation continues to service the receivables, for which a servicing fee is received. Servicing fees are earned on a level yield basis over the terms of the related sold receivables and are included in servicing fee income. In a subordinated capacity, the Corporation retains excess servicing cash flows, a limited interest in the principal balances of the sold receivables and certain cash deposits provided as credit enhancements for investors. Gains or losses on sales of receivables are credited or charged to financing revenue in the period in which the sales occur.
Insurance Operations
Insurance premiums are earned on a pro rata basis over the terms of the policies. Commission costs and premium taxes incurred in acquiring business are deferred and amortized on the same basis as such premiums are earned. The liability for unpaid insurance claims includes provisions for reported claims and an estimate of unreported claims based on past experience. Such provisions include an estimate of loss adjustment expense. The estimated liability for unpaid insurance claims is regularly reviewed and updated. Any change in such estimate is reflected in current operations.
The Corporation's wholly-owned insurance subsidiary, Harco National Insurance Company ("Harco"), limits its exposure on any single loss occurrence by ceding reinsurance to other insurance enterprises. Reinsurance receivables including amounts related to unpaid insurance claims and prepaid reinsurance premiums are reported as assets in the Statement of Consolidated Financial Condition.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
1. SUMMARY OF ACCOUNTING POLICIES (Continued)
Income Taxes
Navistar and its subsidiaries file a consolidated Federal income tax return which includes Transportation and the Corporation. Federal income taxes for the Corporation are computed on a separate consolidated return basis and are payable to Transportation.
Cash and Cash Equivalents
Cash and cash equivalents include money market funds and marketable securities with original maturities of three months or less, except for such securities held by the insurance operations which are included in marketable securities.
Marketable Securities
Marketable securities are classified as available-for-sale and are reported at fair value.
Derivative Financial Instruments
The Corporation uses derivatives to reduce its exposure to interest rate volatility. All derivative financial instruments are held for purposes other than trading, and the Corporation's policy prohibits the use of derivatives for speculative purposes. Gains or losses related to hedges of anticipated sales of receivables are deferred and are recognized in income when the receivables are sold.
Pending Accounting Standards
In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125, ("SFAS No. 125") "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" which the Corporation must adopt for all applicable transactions occurring after December 31, 1996. The Corporation will apply SFAS No. 125 to securitization transactions occurring on or after January 1, 1997. The new standard is not expected to have a material effect on the Corporation's net income or financial condition.
Reclassification
Certain amounts for prior years have been reclassified to conform with the presentation used in the 1996 financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
2. TRANSACTIONS WITH AFFILIATED COMPANIES
Wholesale Notes, Wholesale Accounts and Retail Accounts
In accordance with the agreements between the Corporation and Transportation relating to financing of wholesale notes, wholesale accounts and retail accounts, the Corporation receives interest income from Transportation at agreed upon interest rates applied to the average outstanding balances less interest amounts paid by dealers on wholesale notes and wholesale accounts.
The Corporation purchases wholesale notes and accounts of dealers from Transportation at the principal amount of the receivables. An acquisition fee applicable to purchases of wholesale notes secured by new equipment is charged to Transportation. The retail accounts are accounts of Transportation customers. Revenue collected from Transportation was $49.8 in 1996, $55.7 in 1995 and $50.7 in 1994.
Retail Notes and Lease Financing
In accordance with agreements between the Corporation and Transportation, Transportation may be liable for certain losses on the finance receivables and may be required to repurchase the repossessed collateral at the receivable principal value. Losses recorded by Transportation were $9.5 in 1996 and $.6 in 1995 and 1994.
Support Agreements
Under provisions of certain public and private financing arrangements, agreements with Transportation and Navistar provide that the Corporation's consolidated income before interest expense and income taxes will be maintained at not less than 125% of its consolidated interest expense. Since 1984, no maintenance payments have been required under these agreements.
Administrative Expenses
The Corporation pays a fee to Transportation for data processing and other administrative services based on the actual cost of services performed. The amount of the fee was $2.4 in 1996, $2.4 in 1995 and $2.5 in 1994.
Short-Term Debt
The Corporation had daily average short-term borrowings from Transportation of $85 in 1996 and $93 in 1995 on which interest accrued at the Corporation's incremental short-term borrowing rate. These borrowings, including $5 and $6 of interest expense in 1996 and 1995, respectively, were repaid during each of the fiscal years.
Accounts Payable
Accounts payable include $24.5 and $89.5 payable to Transportation at October 31, 1996 and 1995, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
3. INDUSTRY SEGMENTS
Information by industry segment is summarized as follows:
4. MARKETABLE SECURITIES
The fair value of marketable securities is based on quoted market prices, when available. If a quoted price is not available, fair value is estimated using quoted market prices for similar financial instruments. The difference between amortized cost and fair value, net of deferred income taxes, is reflected as a separate component of shareowner's equity. Shareowner's equity was increased by net unrealized holding gains of $1.3 and $1.7 as of October 31, 1996 and 1995, respectively. The following table sets forth, by type of security issuer, the amortized cost and estimated market values at October 31, 1996 and 1995:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
4. MARKETABLE SECURITIES (Continued)
Contractual maturities of marketable debt securities at October 31, 1996, are as follows:
Actual maturities may differ from the contractual maturities because of prepayments by the issuers.
Proceeds from sales or maturities of marketable securities available for sale were $67.7 during 1996 and $67.3 during 1995. Gross gains of $1.8 and $.8 and gross losses of $.5 and $.6 were realized on those sales in 1996 and 1995, respectively.
All marketable securities at October 31, 1996 and 1995, were held by Harco, of which $16.7 and $23.2, respectively, were on deposit with various state departments of insurance or otherwise restricted as to use.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
5. FINANCE RECEIVABLES
Finance receivable balances, net of unearned finance income, at October 31 are summarized as follows:
Contractual maturities of finance receivables including unearned finance income at October 31, 1996, are summarized as follows:
The actual cash collections from finance receivables will vary from the contractual cash flows because of sales, prepayments, extensions and renewals. The contractual maturities, therefore, should not be regarded as a forecast of future collections.
The Corporation's primary business is to provide wholesale, retail and lease financing for new and used trucks sold by Transportation and Transportation's dealers, and as a result the Corporation's receivables and leases have significant concentration in the trucking industry. On a geographic basis, there is not a disproportionate concentration of credit risk in any area of the United States. The Corporation retains as collateral a security interest in the equipment associated with wholesale notes, retail notes and leases other than accounts.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
5. FINANCE RECEIVABLES (Continued)
The Corporation sells finance receivables to public and private investors with limited recourse provisions. Outstanding sold receivable net balances at October 31 are as follows:
Gains or losses from the sales of receivables are recognized in the period in which such sales occur. The allowance for credit losses is adequately provided prior to the receivable sales; therefore, gains from receivable sales are not reduced for expected credit losses. Included in "Retail notes and lease financing" revenue are gains totaling $20.2, $5.2 and $11.8 on retail note receivable sales of $985, $740 and $1,033 for the fiscal years ended October 31, 1996, 1995 and 1994, respectively. Gains on sales of wholesale receivables are not material as a result of their short maturities.
The Corporation has two wholly-owned subsidiaries, Navistar Financial Retail Receivables Corporation ("NFRRC") and Navistar Financial Securities Corporation ("NFSC"), which have a limited purpose of purchasing retail and wholesale receivables, respectively, and transferring an undivided ownership interest in such notes to investors in exchange for pass-through notes and certificates. These subsidiaries have limited recourse on the sold receivables and their assets are available to satisfy the claims of their creditors prior to such assets becoming available to the Corporation or affiliated companies. During fiscal 1996, in two separate sales, the Corporation sold a total of $985 of retail notes, net of unearned finance income, through NFRRC to two individual owner trusts. The owner trusts, in turn, sold $946 of notes and $39 of certificates to investors. The proceeds of $934, net of underwriting fees and credit enhancements, were used by the Corporation for general working capital purposes. At October 31, 1996, the remaining shelf registration available to NFRRC for issuance of asset-backed securities was $2.4 billion.
NFSC has in place a $500 revolving wholesale note trust that provides for the continuous sale of eligible wholesale notes on a daily basis. The issuance of a $200 tranche of investor certificates during fiscal 1995 increased NFSC's revolving wholesale note trust to $500. The trust is comprised of three $100 tranches of investor certificates maturing serially from 1997 to 1999 and a $200 tranche of investor certificates maturing in 2004.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
5. FINANCE RECEIVABLES (Continued)
The Corporation's retained interest in sold receivables and other related amounts are generally restricted and subject to limited recourse provisions. Holdback reserves were established pursuant to the limited recourse provisions of the retail note sales to private investors. The retail securitized sales structure requires the Corporation to maintain cash reserves with the trusts as credit enhancement for public sales. The cash reserves are held by the trusts and restricted for use by the securitized sales agreements.
The following is a summary of amounts included in "Amounts Due from Sales of Receivables" as of October 31:
6. INVESTMENT IN OPERATING LEASES
Operating leases at year-end were as follows:
Future minimum rentals on operating leases are as follows: 1997, $24.7; 1998, $22.2; 1999, $16.9; 2000, $11.1 and $5.3 thereafter. Each of these assets is depreciated on a straight- line basis over the term of the lease in an amount necessary to reduce the leased vehicle to its estimated residual value at the end of the lease term.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
7. ALLOWANCE FOR LOSSES
The allowance for losses on receivables is summarized as follows:
8. TAXES ON INCOME
Taxes on income are summarized as follows:
The effective tax rate of 38% differs from the statutory United States Federal tax rate of 35% primarily because of state and local income taxes. Deferred tax assets and liabilities at October 31, comprised the following:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
8.TAXES ON INCOME (Continued)
During 1992, auditors of the Illinois Department of Revenue ("Department") began an income tax audit of NFC for the fiscal years ended October 31, 1989, 1990 and 1991. On February 1, 1994, the Department issued a Notice of Deficiency to NFC for approximately $11.9 million. The Department has taken the position that nearly 100% of NFC's income during these years should be attributed to and taxed by Illinois. NFC maintains that the Department's interpretation and application of the law is incorrect and improper, and that the Department's intended result is constitutionally prohibited. Based on discussions with outside counsel, NFC's management is of the opinion that it is more likely than not that NFC's position will prevail such that the Department's action will not have a material impact on NFC's earnings and financial position.
9. SHORT-TERM DEBT
Commercial paper is issued by the Corporation with varying terms. The Corporation also has short-term borrowings with various banks on a non- committed basis. Compensating cash balances and commitment fees are not required under these agreements. Short-Term Debt outstanding at October 31 was comprised only of commercial paper. There were no short-term borrowings outstanding.
Information regarding short-term debt is as follows:
Unused commitments under the Corporation's bank revolving credit facility and bank liquidity facility supporting the asset- backed commercial paper program are used as backup for outstanding short-term borrowings. See also Note 10 to the Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
10. SENIOR AND SUBORDINATED DEBT
Senior and Subordinated Debt outstanding at October 31 is summarized as follows:
The weighted average interest rate on total debt, including short-term debt and the effect of discounts and related amortization, was 6.5%, 7.4% and 7.1% in 1996, 1995 and 1994, respectively. The aggregate annual maturities and required payments of debt are as follows: 1999, $100.0; and 2001, $1,106.4.
Effective March 29, 1996, the Corporation amended and restated its $900 million bank revolving credit facility and its $300 million asset-backed commercial paper ("ABCP") program supported by a bank liquidity facility, extending the maturity date of each facility to March 2001. In addition, the commitment of the bank revolving credit facility was expanded to $925 million, the ABCP facility was increased to $400 million and a new pricing and fee structure was established. The available funding under the ABCP program is $414 million which is comprised of the $400 million liquidity facility plus $14 million of trust certificates issued in connection with the formation of the ABCP Trust.
Under the terms of the ABCP program, a special purpose wholly-owned subsidiary of NFC purchases eligible receivables from NFC. All assets of the subsidiary are pledged to a Trust that funds the receivables with A1/P1 rated commercial paper. In addition, the assets may be sold to the Trust.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
10. SENIOR AND SUBORDINATED DEBT (Continued)
Available funding under the amended and restated credit facility and the ABCP program was $233, of which $99 provided funding backup for the outstanding short-term debt at October 31, 1996. The remaining $134 when combined with unrestricted cash and cash equivalents made $141 available to fund the general business purposes of the Corporation at October 31, 1996. Under the terms of the revolving credit facility, the Corporation is required to maintain tangible net worth at a minimum of $175 and a debt to tangible net worth ratio of no greater than 7 to 1. Consistent with the previous revolving credit agreement, the amended agreement grants security interests in substantially all of the Corporation's assets to the Corporation's debtholders. Compensating cash balances are not required under the restated revolving credit facility. Facility fees are paid quarterly regardless of usage.
11. RETIREMENT BENEFITS
The Corporation provides postretirement benefits to substantially all of its employees. Expenses associated with postretirement benefits include pension expense for employees, retirees and surviving spouses, and postretirement health care and life insurance expense for employees, retirees, surviving spouses and dependents.
Pension Benefits
Generally pension benefits are non-contributory with benefits related to an employee's length of service and compensation rate. Plan assets are primarily invested in a dedicated portfolio of long-term fixed income securities with the remainder invested in high quality equity securities.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
11. RETIREMENT BENEFITS (Continued)
Pension Expense
Net pension cost includes the following:
Pension Assets and Liabilities
The plans' funded status and reconciliation to the Statement of Consolidated Financial Condition as of October 31 were as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
11. RETIREMENT BENEFITS (Continued)
The weighted average rate assumptions used in determining the projected benefit obligation and pension expense were:
Other Postretirement Benefits
The components of expense for other postretirement benefits that are included in the Statement of Consolidated Income and Retained Earnings include the following:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
11. RETIREMENT BENEFITS (Continued)
The funded status of other postretirement benefits as of October 31, 1996 and 1995, were as follows:
The expected return on plan assets was 10.5% for 1996, 10% for 1995 and 9% for 1994. The weighted average of discount rates used to determine the accumulated postretirement benefit obligation was 8.1% and 7.7% at October 31, 1996 and 1995, respectively. For 1997, the weighted average rate of increase in the per capita cost of covered health care benefits is projected to be 8.1%. The rate is projected to decrease to 5.0% in the year 2004 and remain at that level each year thereafter. If the cost trend rate assumptions were increased by one percentage point for each year, the accumulated postretirement benefit obligation would increase by approximately $1.2 and the associated expense recognized for the year ended October 31, 1996, would increase by an estimated $.1.
12. LEASES
The Corporation is obligated under noncancelable operating leases for the majority of its office facilities and equipment. These leases are generally renewable and provide that property taxes and maintenance costs are to be paid by the lessee. At October 31, 1996, future minimum lease commitments under noncancelable operating leases with remaining terms in excess of one year are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
13. SHAREOWNER'S EQUITY
The number of authorized shares of capital stock as of October 31, 1996 and 1995, was 2,000,000 of which 1,600,000 shares were issued and outstanding. All of the issued and outstanding capital stock is owned by Transportation and no shares are reserved for officers and employees, or for options, warrants, conversions and other rights.
14. FINANCIAL INSTRUMENTS
Fair Value of Financial Instruments
The carrying amounts and estimated fair values of the Corporation's financial instruments were as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
14. FINANCIAL INSTRUMENTS (Continued)
The methods and assumptions used to estimate the fair value of each class of financial instruments are summarized as follows:
Cash and Cash Equivalents
The carrying amount approximates fair value as a result of the short maturity of these instruments.
Marketable Securities
Fair value is estimated based on quoted market price. The cost and fair value of marketable securities is disclosed in Note 4.
Finance Receivables
The fair value of truck retail notes is estimated by discounting the future cash flows using an estimated discount rate reflecting current rates paid to purchasers of similar types of receivables with similar credit, interest rate and prepayment risks. For other retail notes, primarily variable- rate notes that reprice frequently, and for wholesale notes and retail and wholesale accounts, the carrying amounts approximate fair value as a result of the short term nature of the receivables.
Amounts Due from Sales of Receivables
The fair values of excess servicing cash flows and other subordinated amounts due the Corporation arising from receivable sale transactions were derived by discounting expected cash flows at estimated current market rates. The fair value of cash deposits approximates their carrying value.
Senior and Subordinated Debt
For variable-rate borrowings under the bank revolving credit agreement that reprice frequently, the carrying amount approximates fair value. The fair values of notes and debentures are estimated based on quoted market prices where available and, where not available, on quoted market prices of debt with similar characteristics.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
14. FINANCIAL INSTRUMENTS (Continued)
Derivative Financial Instruments
The Corporation manages its exposure to fluctuations in interest rate changes by limiting the amount of fixed rate assets funded with variable rate debt by selling fixed rate retail receivables on a fixed rate basis and, to a lesser extent, by utilizing derivative financial instruments. These derivative financial instruments may include interest rate swaps, interest rate caps and forward interest rate contracts. The Corporation manages exposure to counterparty credit risk by entering into derivative financial instruments with major financial institutions that can be expected to fully perform under the terms of such agreements. Notional amounts are used to measure the volume of derivative financial instruments and do not represent exposure to credit loss.
The Corporation enters into forward interest rate contracts to manage its exposure to fluctuations in funding costs from the anticipated securitization and sale of retail notes. The Corporation locks into an interest rate by entering into a forward contract on a U.S. Treasury security whose terms approximate those used to determine the selling price of the anticipated sale of receivables. Gains or losses incurred with the closing of these agreements are included as a component of the gain or loss on sale of receivables.
During August through October 1996, the Corporation entered into $400 of forward interest rate lock agreements on a Treasury maturing in 1998 related to the anticipated November 1996 sale of retail receivables. See also Note 16. These hedge agreements, which were closed in conjunction with the pricing of the sale, resulted in a $1.9 loss which was deferred at October 31, 1996, and included in the gain on the sale of receivables recognized in November 1996.
The Corporation's wholly-owned insurance subsidiary has investments in Collateralized Mortgage Obligations ("CMO's") of $42 which are included in the Corporation's marketable securities at October 31, 1996. These securities have characteristics which reduce the Corporation's exposure to prepayment risk.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
15. LEGAL PROCEEDINGS
The Corporation and its subsidiaries are subject to various other claims arising in the ordinary course of business, and are parties to various legal proceedings which constitute ordinary routine litigation incidental to the business of the Corporation and its subsidiaries. In the opinion of the Corporation's management, none of these proceedings or claims are material to the business or the financial condition of the Corporation.
16. SUBSEQUENT EVENT
In November 1996, the Corporation sold $487 of retail notes, net of unearned finance income, through NFRRC to an owner trust which, in turn, sold notes and certificates to investors. A gain of $6.9 was recognized on the sale.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MILLIONS OF DOLLARS
17. QUARTERLY FINANCIAL INFORMATION (unaudited)
SUPPLEMENTARY FINANCIAL DATA
Five Year Summary of Financial and Operating Data
Dollar amounts in millions
SUPPLEMENTARY FINANCIAL DATA (Continued)
Gross Finance Receivables and Leases Acquired
SUPPLEMENTARY FINANCIAL DATA (Continued)
Analysis of Gross Retail Notes and Lease Financing With Installments Past Due Over 60 Days
SUPPLEMENTARY FINANCIAL DATA (Continued)
Analysis of Loss Experience
Includes loss experience on sold notes.
Navistar Financial Corporation and Subsidiaries
Statement of Financial Reporting Responsibility
Management of Navistar Financial Corporation and its subsidiaries is responsible for the preparation and for the integrity and objectivity of the accompanying financial statements and other financial information in this report. The financial statements have been prepared in accordance with generally accepted accounting principles and include amounts that are based on management's estimates and judgments.
The accompanying financial statements have been audited by Deloitte & Touche LLP, independent auditors. Management has made available to Deloitte & Touche LLP all the Corporation's financial records and related data, as well as the minutes of Directors' meetings. Management believes that all representations made to Deloitte & Touche LLP during its audit were valid and appropriate.
Management is responsible for establishing and maintaining a system of internal controls throughout its operations that provides reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use and the execution and recording of transactions in accordance with management's authorization. The system of internal controls which provides for appropriate division of responsibility is supported by written policies and procedures that are updated by management as necessary. The system is tested and evaluated regularly by the parent Company's internal auditors as well as by the independent auditors in connection with their annual audit of the financial statements. The independent auditors conduct their audit in accordance with generally accepted auditing standards and perform such tests of transactions and balances as they deem necessary. Management considers the recommendations of its internal auditors and independent auditors concerning the Corporation's system of internal controls and takes the necessary actions that are cost-effective in the circumstances to respond appropriately to the recommendations presented. Management believes that the Corporation's system of internal controls accomplishes the objectives set forth in the first sentence of this paragraph.
John J. Bongiorno President and Chief Executive Officer
Phyllis E. Cochran Vice President and Controller
Navistar Financial Corporation and Subsidiaries
Independent Auditors' Report
Navistar Financial Corporation:
We have audited the financial statements of Navistar Financial Corporation and its subsidiaries listed in Item 8.

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None
PART III
Items 10, 11, 12 and 13
Intentionally omitted. See the index page of this Report for explanation.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
Financial Statements
See Index to Financial Statements in Item 8.
Financial Statement Schedules
All schedules are omitted because of the absence of the conditions under which they are required or because information called for is shown in the financial statements and notes thereto.
Exhibits, Including Those Incorporated By Reference
Reports on Form 8-K
No reports on Form 8-K were filed for the three months ended October 31, 1996.
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NAVISTAR FINANCIAL CORPORATION (Registrant)
By: /s/PHYLLIS E. COCHRAN January 22, 1997 Phyllis E. Cochran Vice President and Controller (Principal Accounting Officer)