3M 2012 Annual Report Download - page 98

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Fair Value Hedges:
For derivative instruments that are designated and qualify as fair value hedges, the gain or loss on the derivatives as well
as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in current earnings.
Fair Value Hedging - Interest Rate Swaps: The Company manages interest expense using a mix of fixed and floating rate
debt. To help manage borrowing costs, the Company may enter into interest rate swaps. Under these arrangements, the
Company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated
by reference to an agreed-upon notional principal amount. The mark-to-market of these fair value hedges is recorded as
gains or losses in interest expense and is offset by the gain or loss of the underlying debt instrument, which also is
recorded in interest expense. These fair value hedges are highly effective and, thus, there is no impact on earnings due to
hedge ineffectiveness. The dollar equivalent (based on inception date foreign currency exchange rates) gross notional
amount of the Company’s interest rate swaps at December 31, 2012 was $342 million.
At December 31, 2012, the Company had interest rate swaps designated as fair value hedges of underlying fixed rate
obligations. In July 2007, in connection with the issuance of a seven-year Eurobond for an amount of 750 million Euros,
the Company completed a fixed-to-floating interest rate swap on a notional amount of 400 million Euros as a fair value
hedge of a portion of the fixed interest rate Eurobond obligation. In August 2010, the Company terminated 150 million
Euros of the notional amount of this swap. As a result, a gain of 18 million Euros, recorded as part of the balance of the
underlying debt, will be amortized as an offset to interest expense over this debt’s remaining life. Prior to termination of
the applicable portion of the interest rate swap, the mark-to-market of the hedge instrument was recorded as gains or
losses in interest expense and was offset by the gain or loss on carrying value of the underlying debt instrument.
Consequently, the subsequent amortization of the 18 million Euros recorded as part of the underlying debt balance is not
part of gains on hedged items recognized in income in the tables below.
The Company also had two fixed-to-floating interest rate swaps with an aggregate notional amount of $800 million
designated as fair value hedges of the fixed interest rate obligation under the $800 million, three-year, 4.50% notes issued
in October 2008. These swaps and underlying note matured in the fourth quarter of 2011.
The location in the consolidated statements of income and amounts of gains and losses related to derivative instruments
designated as fair value hedges and similar information relative to the hedged items are as follows:
Year ended December 31, 2012
Gain (Loss) on Derivative
Gain (Loss) on Hedged Item
(Millions)
Recognized in Income
Recognized in Income
Derivatives in Fair Value Hedging Relationships
Location
Amount
Location
Amount
Interest rate swap contracts
Interest expense
$
(5)
Interest expense
$
5
Total
$
(5)
$
5
Year ended December 31, 2011
Gain (Loss) on Derivative
Gain (Loss) on Hedged Item
(Millions)
Recognized in Income
Recognized in Income
Derivatives in Fair Value Hedging Relationships
Location
Amount
Location
Amount
Interest rate swap contracts
Interest expense
$
(10)
Interest expense
$
10
Total
$
(10)
$
10
Year ended December 31, 2010
Gain (Loss) on Derivative
Gain (Loss) on Hedged Item
(Millions) Recognized in Income Recognized in Income
Derivatives in Fair Value Hedging Relationships
Location
Amount
Location
Amount
Interest rate swap contracts
Interest expense
$
(16)
Interest expense
$
16
Total
$
(16)
$
16
Net Investment Hedges:
As circumstances warrant, the Company uses cross currency swaps, forwards and foreign currency denominated debt to
hedge portions of the Company’s net investments in foreign operations. For hedges that meet the effectiveness
requirements, the net gains or losses attributable to changes in spot exchange rates are recorded in cumulative
translation within other comprehensive income. The remainder of the change in value of such instruments is recorded in
earnings. Recognition in earnings of amounts previously recorded in cumulative translation is limited to circumstances
such as complete or substantially complete liquidation of the net investment in the hedged foreign operation. At December
31, 2012, there were no cross currency swaps and foreign currency forward contracts designated as net investment
hedges.