Fitch Affirms IBM and IBM Credit Ratings

Business Editors

NEW YORK--(BUSINESS WIRE)--Sept. 10, 2001

Fitch has affirmed International Business Machines Corporation's (IBM) and IBM Credit Corp.'s (Credit) `AA-' senior unsecured debt ratings, IBM's `A ' preferred stock rating, and IBM's and Credit's `F1 ' commercial paper ratings.

The Rating Outlook is Stable. Approximately $22.1 billion of public debt securities are covered by Fitch's action.

IBM continues to benefit from industry-leading positions across a diversity of information technology (IT) businesses, a global revenue base, an increasing annuity component of revenues, prolific research program, strong cash flows, and the strength of its balance sheet, despite large financing operations.

With trailing 12-month revenues of $90.0 billion, IBM is well diversified by geography and by product, offering a full range of computer hardware, IT services, software, and financing. A third of revenues, which generate nearly half of IBM's profits, have strong annuity-type characteristics. The diversity and repeatability of IBM's business currently provide some resilience to the broad technology downturn. However, Fitch recognizes the competitive landscape has potentially intensified with the recent merger announcement of Hewlett-Packard and Compaq.

Revenues for the 12 months through June 30, 2001 grew 4% over the corresponding year-before period despite a difficult environment. Growth has been led by IBM Global Services, the world's largest IT services provider and IBM's largest segment in the last quarter with 41% of revenues, surpassing the hardware segment, which was still the largest revenue contributor for the full 12 months. Services contributed over 40% of pretax income over the past 12 months, Hardware and Software each about a quarter, and IBM Global Financing (IGF) the balance. Services and financing revenues are predominately under long-term contracts, and software and hardware also have substantial elements of repeatability. These factors help explain IBM's current relatively steady performance. Gross profit grew 6% over the past 12 months while operating expenses declined fractionally, resulting in a 13% increase in pretax income and a 10% increase in EBITDA.

Although IGF contributes a modest portion of IBM's earnings, it constitutes the largest component of IBM's balance sheet, with 59% of segment assets at the end of 2000. As of the second quarter of 2001, IBM had $27.3 billion of total debt, down $1.3 billion from year-end 2000 and down $1.9 billion from the same period in 2000. Of the $27.3 billion of debt, $26.1 billion supported IGF's end-user and business-partner financing operations and $1.2 billion supported IBM's core operations.

The reduced debt combined with the improved EBITDA resulted in June debt to trailing-12-month-EBITDA leverage of 1.5 times and trailing-12-month interest coverage of 12.4 times, providing IBM flexibility in the face of the continued severe IT downturn. In core operations, debt to invested capital was just 6% and debt/EBITDA leverage just 0.01 times (x). IBM redeemed all outstanding preferred stock on July 3, 2001.

Fitch views Credit as being a mild net positive to IBM due to the strategic advantage inherent in an in-house financing capability. Global financing facilitates core revenue generation and is part of the whole package IBM can offer customers -- hardware from PCs to mainframes; software to make it run; services to make it work, and financing to defer or smooth out the costs.

Credit is IBM's domestic captive finance subsidiary and the largest IGF operating unit. Like other IGF global operations, Credit provides end-user financing of IBM equipment, software and services, and equipment of other information technology manufacturers, on a selective basis. Additionally, Credit provides inventory and receivables financing to IBM-authorized remarketers. While Credit was established to help facilitate the sale of IBM products, it maintains complete authority over the loan/lease approval process and pricing, setting it apart from most other captive finance subsidiaries of large industrial companies.

Credit's debt ratings reflect the company's close operating relationship and strategic importance to its parent. Additional rating strengths include Credit's consistent long-term operating track record, solid asset quality, and good capitalization. Rating concerns center on the increased content of software and services as collateral versus traditional hardware, trends in financial leverage and loan loss reserves, and the impact of the economic weakness in the U.S.

Historically managed in a conservative manner, credit has selectively diversified into new business segments within the technology industry, and has increased its focus on balance sheet efficiency.

Despite the shift to higher yielding assets, asset quality has remained solid. Net chargeoffs have remained below 0.40% in each of the last three years. With the emphasis on originating higher yielding assets, some weakening in asset quality could occur in future periods as these assets begin to season and/or the U.S. economy remains weak. Additionally, with the reduction of equipment spending by U.S. corporations, estimated residual values could be adversely impacted by lower equipment demand in secondary markets. As a partial offset to this, the profitability of the operating lease portfolio may be substantial as equipment replacement slows. Over the last three years, the company had allowed the loss reserve to decline to 0.81% of owned finance loans and leases at year-end 2000 from 1.45% at year-end 1998. Credit has aggressively provisioned for future loan losses in 2001.

Since hitting its five-year low of 4.84x at Dec. 31, 1999, leverage, defined as debt divided by equity, rose to 6.05x at Dec. 31, 2000. The rise in leverage has been principally due to a $772 million dividend paid to IBM in 2000. During the first half of 2001, Credit paid approximately $418 million in dividends. The large dividend payout rates in 2000 and the first half of 2001 of over 180% and 200%, respectively, well above Credit's historical rate of generally below 20%, was to assist the company in returning its leverage back to historical ranges. Credit's leverage, defined as debt/equity, at June 30, 2001 was 6.48x, which was below Fitch's comfort ceiling of 7.00x.