ANNUAL REPORT 2011 for the year ended March 31, 2011

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Notes To Consolidated Financial Statements

Credit Saison Co., Ltd. and Consolidated Subsidiaries
For the Years Ended March 31, 2011 and 2010

12. FINANCIAL INSTRUMENTS AND RELATED DISCLOSURES

THE CONDITIONS OF FINANCIAL INSTRUMENTS

(A) POLICY FOR FINANCIAL INSTRUMENTS

The Companies engage in the credit service business; lease business; finance business including guarantees and loans businesses; real estate related business; and entertainment business. To conduct such businesses, the Companies, by observing the market circumstances and adjusting the balance of long-term and short-term debt, seek financing through indirect financing such as bank loans and through direct financing such as issuance of corporate bonds, commercial paper and securitized receivables. Through such activities, the Companies hold financial assets and financial liabilities that are mostly accompanied by interest rate risks and the Company conducts asset and liability management (ALM) to prevent disadvantageous effects from such interest rate risks. As part of ALM, the Company also conducts derivative transactions that leverage interest rate swaps, etc.

(B) NATURE AND EXTENT OF RISKS ARISING FROM FINANCIAL INSTRUMENTS

The financial assets held by the Companies are mainly accounts receivable—installments from credit card members. The Companies are exposed to credit risk such as the potential deterioration of the member's repayment situation. As of the end of the current fiscal year, accounts receivable—installment included a large component of receivables related to credit service business and credit cards members' repayments according to the contract depend on changes of business circumstances including the economic environment surrounding the said business (employment environment in the fallout of the economic recession, household disposable income, personal consumption).

Also, (operational) investment securities are mainly stocks, bonds, investment trusts and partnership investments. Such securities are held for the purpose of either trading or business promotion. Each of these securities is exposed to the issuer's credit risks, interest rate fluctuation risks and market price fluctuation risks.

The Companies are exposed to liquidity risks relating to interest-bearing debt such as loans, corporate bonds and commercial paper whereby they may be unable to execute payments of such liabilities on the payment dates in cases, for example, where the Companies are unable to use the market under certain environments such as a greater than expected fluctuations in financial conditions or a downgrading of the Companies' credit rating. Furthermore, the Companies also borrow funds by variable interest loans and although they are exposed to interest fluctuation risks those risks are partly mitigated by conducting interest swap transactions.

Among the derivative transactions conducted by the Companies are interest swap transactions conducted as part of ALM. Using these interest swap transactions as the hedge instruments, the Company applies hedge accounting to interest fluctuation risk related to borrowings that are the hedged item. The hedge is assessed based on the cumulative total of cash flow fluctuations and determined to actually have been highly effective throughout the financial reporting periods for which the hedge is designated.

In addition, the interest rate swaps which qualify for hedge accounting of long-term loans and meet specific matching criteria are not remeasured at market value but the differential paid or received under the swap agreements is recognized and included in interest expence or income.

(C) RISK MANAGEMENT FOR FINANCIAL INSTRUMENTS

(i) Credit risk management

The Companies manage their credit risk in accordance with the Companies' credit risk management rules by ensuring the ongoing soundness of receivables and maintaining a system for credit risk management including credit limits, management of creditworthiness information, and internal ratings. The Company holds regular Board of Directors' meetings in order to discuss and report matters relating to credit risk management. (Operational) investment securities are managed by periodically ascertaining creditworthiness information and fair values at the ALM committee meetings.

Also, with regard to long-term loans receivable, the relevant departments periodically monitor the credit risk of the obligors. With regard to counterparty risk of derivative transactions, in order to avoid credit risk arising from defaults on contractual obligations, the Company chooses Japanese and overseas banks and securities firms with high creditworthiness as the counterparty to contracts.

(ii) Market risk management

Management of fluctuation risk of interest rates

The Companies manage interest rate fluctuation risks by applying ALM. The rules related to ALM state the details of risk management methods, procedures and so forth. Based on policies determined at the ALM committee meetings, the Board of Directors ascertains the status of implementation and discusses matters concerning future responses at the meetings. As part of its regular routine, the Treasury & Account Department maintains an overall grasp of the interest rates and terms of financial assets and liabilities and conducts monitoring such as by performing an interest rate gap analysis. When conducting interest rate swap derivative transactions for the purpose of hedging interest rate variable risk, the Companies apply ALM to this also.

Management of fair value fluctuation risk

With regard to financial investment products including (operational) investment securities, pursuant to ALM policy, in addition to examining each investment project before investment and establishing limit amounts for the investment, continuous monitoring is also conducted for the purpose of mitigating the price fluctuation risk. Moreover, with regard to stock held for the purpose of business promotion, including business and capital tie-ups, the market environment and the financial condition of the transaction counterparty are also monitored through relevant departments.

This information is periodically reported through the relevant departments to the ALM committee meetings and other meetings.

Derivatives

The Treasury & Account Department executes derivative transactions in accordance with internal management regulations set by the Board of Directors, keeping within the scope of the overall transaction framework and hedge ratio approved beforehand by the Board of Directors. The status of the derivative transactions is reported to the Board of Directors on a quarterly basis.

The derivative transactions of consolidated subsidiaries are conducted in accordance with the internal management regulations that have been set by the respective company. During the term of the transactions, the subsidiary reports to the Company on a quarterly basis the status of hedges between the derivative transactions and corresponding assets or liabilities, the counterparty to contracts, the transaction amounts, the period remaining in the terms, and the transaction fair values.

Quantitative information regarding market risk

The main financial instruments of the Companies exposed to interest rate risk as the main risk are accounts receivable— installment, short-term loans, long-term debt, corporate bonds, securitized receivables, and interest rate swap transactions.

The Companies estimate the impact of a reasonable fluctuation in interest rates on profit and loss a year or so from the end of an accounting period for the purpose of quantitative analysis in managing their variable risk on interest rates. In estimating this impact, the financial assets and financial liabilities subject to the analysis are grouped into subsets of fixed interest assets and liabilities and variable-interest assets and liabilities. The Companies then calculate the net estimated impact of interest rate fluctuation on variable-interest assets and variable-interest liabilities as the interest rate gap.

As of March 31, 2012 and 2011, the Companies calculated that their income (loss) before income taxes and minority interests would decrease (increase) ¥33 million (US$404 thousand) in 2012 and ¥44 million in 2011 if the benchmark interest rate rose 1 basis point (0.01 percentage point), and increase (decrease) ¥33 million (US$404 thousand) in 2012 and ¥44 million in 2011 if this interest rate fell 1 basis point. The impact was calculated holding risk variables other than interest rate constant and in the absence of correlations between the other risk variables and the interest rate. Fluctuations in interest rates greater than those reasonably estimated may result in an impact larger than the aforementioned calculations.

(iii) Liquidity risk management

The Companies manage their liquidity risk by applying ALM. In addition to ensuring fund management is conducted with appropriate timeliness, they ensure a multiplicity of fund procurement methods, secure commitment lines from multiple financial institutions and maintain a balance of long-term and short-term procurement that is adjusted to reflect the current market environment.

(D) SUPPLEMENTARY EXPLANATION RELATING TO FAIR VALUE OF FINANCIAL INSTRUMENTS AND OTHERS

The fair value of financial instruments is either an amount based on market prices or, in the case of no market value, the value calculated based on rational grounds. In the case of the latter, established assumptions and conditions are adopted. Accordingly, if different assumptions and preconditions are adopted, the calculated amount may also be different. Moreover, with regard to contractual value or notional principal amount that relate to derivative transactions in Note 20, the amount itself does not reflect market risk related to the derivative transaction.

Fair value of financial instruments and others

The following presents the amount presented in the consolidated balance sheet for the years ended March 31, 2012 and 2011, the fair value, and the difference between the carrying amount and fair value. Immaterial amounts in the consolidated balance sheets have been omitted from disclosure.


ASSETS

  Millions of yen
2012
Carrying
amount
Allowance for
doubtful
accounts
Total Fair value Difference
Cash and deposits ¥ 60,085¥- ¥ 60,085 ¥ 60,085¥-
Accounts receivable-installment 1,379,776 (82,426) 1,297,350 1,343,783 46,433
Lease investment assets 218,390 (11,638) 206,752 220,087 13,335
Short-term loans receivable 6,310 (282) 6,028 6,028
Operational investment securities 9,997 9,997 9,997
Securities
Investment securities 32,625 32,625 32,625
Investments in unconsolidated subsidiaries and
  affiliated companies
5,908 5,908 9,052 3,144
Long-term loans receivable 10,237 (2) 10,235 10,235

  Millions of yen
2011
Carrying
amount
Allowance for
doubtful
accounts
Total Fair value Difference
Cash and deposits ¥ 64,112 ¥- ¥ 64,112 ¥ 64,112 ¥-
Accounts receivable-installment 1,491,108 (103,807) 1,387,301 1,452,058 64,757
Lease investment assets 219,895 (13,527) 206,368 219,894 13,526
Short-term loans receivable 10,144 (483) 9,661 9,661
Operational investment securities 865 865 865
Securities 982 982982
Investment securities 30,104 30,104 30,104
Investments in unconsolidated subsidiaries and
  affiliated companies
5,722 5,722 9,333 3,611
Long-term loans receivable 15,166 (4,426) 10,740 10,740

Thousands of U.S. dollars
2012
Carrying
amount
Allowance for
doubtful
accounts
Total Fair value Difference
Cash and deposits $ 731,499$- $731,499 $ 731,499 $-
Accounts receivable-installment 16,797,853 (1,003,492) 15,794,361 16,359,661 565,300
Lease investment assets 2,658,748 (141,685) 2,517,063 2,679,413 162,350
Short-term loans receivable 76,820 (3,428) 73,392 73,392
Operational investment securities 121,710 121,710 121,710
Securities
Investment securities 397,184 397,184397,184
Investments in unconsolidated subsidiaries and
  affiliated companies
71,932 71,932 110,208 38,276
Long-term loans receivable 124,631 (25) 124,606124,606

(A) CASH AND DEPOSITS

For deposits with no maturity, as fair value approximates the carrying value, the carrying value is deemed to be the fair value.

(B) ACCOUNTS RECEIVABLE—INSTALLMENT

Accounts receivable-installment items with variable interest rates have interest rates that reflect the market interest rate in the short term and because the fair value approximates the carrying value provided that the creditworthiness of the obligor does not significantly change after a loan is executed, the carrying value is deemed to be the fair value. The fair value of accounts receivable—installment with fixed interest rates are determined by discounting the cash flow related to the financial assets reflecting credit risk at the risk-free rate. With respect to doubtful claims, because the amount obtained by deducting the current estimated irrecoverable balance from the amount stated on the balance sheet as of the end of the current year is assumed to approximate the fair value, this amount is deemed to be the fair value.

Because the fair value of a part of accounts receivable—installment is assumed to approximate the carrying value for reasons such as the estimated repayment period and the interest rate conditions, the carrying value is deemed to be the fair value.

Note that the fair value calculations stated above do not reflect future interest repayments.

(C) LEASE INVESTMENT ASSETS

The fair value of lease investment assets is determined by discounting the cash flows reflecting credit risk at the risk-free rate.

(D) OPERATIONAL INVESTMENT SECURITIES, SECURITIES, INVESTMENT SECURITIES AND INVESTMENTS IN
UNCONSOLIDATED SUBSIDIARIES AND AFFILIATED COMPANIES

The fair value of listed stock depends on the listed price on the stock exchange and the fair value of debentures depends on the price disclosed by the listed price on the stock exchange or the price made available by the transacting financial institutions or, in the case of no market value, the value calculated based on rational grounds. The fair value of investment trusts is based on a reference price that has been publicly released. Concerning the investments in investment limited partnerships or similar associations, the fair value of the association’s assets shall be the fair value appraisal in cases where a fair value appraisal of the association’s assets is possible and the corresponding equity share of the aforesaid fair value shall be deemed to be the fair value of the investment in the association.

Financial instruments with no market price such as unlisted stocks whose fair values cannot be reliably determined are indicated in the table below and are not included in the fair value disclosure.


  Millions of yen   Thousands of
U.S. dollars
2012 2011   2012
Carrying
amount
Carrying
amount
  Carrying
amount
Unlisted stocks¥9,257¥ 10,485 $112,699
Investments in unconsolidated subsidiaries and affiliated companies37,08423,668 451,472
Unlisted debentures2,800 
Other6,1118,206 74,391

For notes concerning available-for-sale securities for each holding purpose, refer to Note 13, "AVAILABLE-FOR-SALE SECURITIES."

(E) SHORT-TERM LOANS RECEIVABLE

Because short-term loans receivable will be settled within the short term, the fair value approximates the carrying value and the carrying value is deemed to be the fair value.

(F) LONG-TERM LOANS RECEIVABLE

Long-term loans receivable items with variable interest rates have interest rates that reflect the market interest rate in the short-term and because the fair value approximates the carrying value provided that the creditworthiness of the obligor does not significantly change after a loan is executed, the carrying value is deemed to the be the fair value. With respect to doubtful claims, because the amount obtained by deducting the current estimated irrecoverable balance from the amount stated on the balance sheet as of the end of the current year is assumed to approximate the fair value, this amount is deemed to the fair value.


LIABILITIES

  Millions of yen   Thousands of U.S. dollars
2012 2011   2012
Carrying
amount
Fair value Difference Carrying
amount
Fair value Difference   Carrying
amount
Fair value Difference
Notes and accounts payable ¥240,950 ¥240,950 ¥- ¥171,066 ¥171,066 ¥-   $2,933,400 $2,933,400 $-
Short-term loans 234,190 234,190 248,029 248,029   2,851,108 2,851,108
Commercial paper 32,000 32,000 110,000 110,000   389,579 389,579
Long-term debt:                    
Long-term loans payable 811,846 820,509 (8,663) 830,595 837,532 (6,937)   9,883,686 9,989,155 (105,469)
Bonds 220,887 225,165 (4,278) 256,112 259,713 (3,601)   2,689,159 2,741,236 (52,077)
Long-term loans payable on under securitized loans 85,952 86,296 (344) 94,169 94,800 (631)   1,046,404 1,050,594 (4,190)
Lease obligations 4,927 4,927 5,528 5,528   59,983 59,983
Guarantee contracts 9,277 9,277 6,508 6,508   112,941 112,941

(A) NOTES AND ACCOUNTS PAYABLE, SHORT-TERM LOANS, AND COMMERCIAL PAPER

Because these items will be settled within the short term, the fair value approximates the carrying value and the carrying value is deemed to be the fair value.

(B) LONG-TERM LOANS PAYABLE

Because the rate of long-term loans payable at a variable interest rate reflects the market interest rate, long-term loans payable at a variable interest rate are valued considering only the fluctuation of credit spreads. The fair value of long-term loans payable with fixed interest rates is determined by discounting the cash flows related to the debt at rates assumed for the same borrowing.

(C) BONDS

For corporate bonds issued by the Company as public-offering bonds, the fair value is decided by the market price (over-the-counter selling and buying reference statistics for public and corporate bonds decided by the Japan Securities Dealers Association). Private placement bonds issued by the Company are underwritten by the Company’s major banks based on negotiated transactions and the fair value of such items is calculated using the same method as for (B) long-term loans payable.

(D) LONG-TERM LOANS PAYABLE ON UNDER SECURITIZED LOANS

Because the rate of long-term loans payable on under securitized loans with a variable interest rate is not affected by changes in the Companies’ creditworthiness, the items are valued at changes in the market interest rate. The fair value of long-term loans payable on under securitized loans with a fixed interest rate is determined by discounting the cash flows related to the debt at the rate assumed for the same borrowing.

(E) LEASE OBLIGATIONS

As the fair value of lease obligations approximates the carrying values, the carrying value is deemed to be the fair value.

(F) GUARANTEE CONTRACTS

The fair value of guarantee contracts is determined by discounting the cash flows related to the contracts reflecting credit risk at the risk-free rate.

As of March 31, 2012 and 2011, the guarantee contract amounts of contingent liabilities are ¥168,662 million (US$2,053,348 thousand) in 2012 and ¥157,791 million in 2011 and the amounts that are recorded as the allowance for losses on guarantees in the consolidated balance sheets are ¥4,068 million (US$49,525 thousand) in 2012 and ¥5,464 million in 2011.

Note: Maturity analysis for financial assets and securities with contractual maturities subsequent to March 31, 2012 is as follows:


Year ending March 31 Millions of yen
2012
Due in one
year or less
Due after one
year through
two years
Due after two
years through
three years
Due after
three years
through four
years
Due after four
years through
five years
Due after five
years
Cash and deposits ¥ 60,085 ¥- ¥- ¥- ¥- ¥-
Accounts receivable-installment 955,722 182,617 48,391 17,879 6,991 19,888
Lease investment assets 55,680 51,451 44,139 33,385 19,925 9,983
Short-term loans receivable 6,310
Investment securities
Available-for-sale securities with
contractual maturities
596 867 4,232 600 2,911 888
Long-term loans receivable 19 36 18 18 18 129

Year ending March 31 Thousands of U.S. dollars
2012
Due in one
year or less
Due after one
year through
two years
Due after two
years through
three years
Due after
three years
through four
years
Due after four
years through
five years
Due after five
years
Cash and deposits $ 731,499 $- $- $- $- $-
Accounts receivable-installment 11,635,284 2,223,240 589,131 217,670 85,105 242,121
Lease investment assets 677,870 626,383 537,364 406,444 242,580 121,535
Short-term loans receivable 76,820
Investment securities
Available-for-sale securities with
contractual maturities
7,255 10,557 51,527 7,305 35,439 10,813
Long-term loans receivable 230 433 219 219 219 1,570

¥162,114 million (US$1,973,615 thousand) in 2012, and ¥204,549 million in 2011 of estimated uncollectible amounts are not included.
Please see Note 10 for annual maturities of long term debt.

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