First Data 2007 Annual Report Download - page 113

FIRST DATA CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
coupon rates equal to the cap rates of the instruments per the agreements as described in Note 10. The fair market value of the remaining pre-merger long-
term debt was based upon quoted market values. The estimated fair value of derivative financial instruments is modeled in Bloomberg software using the
Bloomberg reported market data based on mid-market prices and the actual terms of the derivative contracts. While the Company believes its estimates result
in a reasonable reflection of the fair value of these instruments, the estimated values may not be representative of actual values that could have been realized
as of December 31, 2007 or that will be realized in the future.
DERIVATIVE FINANCIAL INSTRUMENTS
Accounting for Derivative Instruments and Hedging Activities
The Company utilizes certain derivative financial instruments to enhance its ability to manage risks that exist as part of its ongoing business operations.
The Company recognizes the fair value of all derivatives in the "Other assets" and "Accounts payable and other liabilities" captions in the Consolidated
Balance Sheets at their fair value.
Two events occurred during 2007 that caused a significant change in the use of derivatives. As discussed in Note 1 and in February 2007, the Company
announced its intent to gradually exit the official check and money order businesses. As of December 31, 2007, nearly all of the long-term instruments
associated with these businesses were converted into more liquid instruments of shorter duration. In conjunction with the repositioning of the portfolio, the
Company terminated all of the associated interest rate swaps that qualified as fair value hedges of the investments upon sale of the related investments.
As discussed in Note 2 and on September 24, 2007, the Company was acquired through a merger by an entity controlled by affiliates of KKR. As a
result of the merger and also on September 24, 2007, the Company repurchased a majority of its outstanding debt through a tender offer. The interest rate
swaps associated with this debt were terminated at the time the debt was repurchased. On September 24, 2007, the Company issued approximately $22 billion
of variable rate debt (though interest rates on $9 billion of the debt was subject to certain caps) and subsequently swapped $7.5 billion of this variable rate
debt to fixed rates.
As of December 31, 2007, the Company uses derivative instruments to mitigate (i) cash flow risks with respect to changes in interest rates (forecasted
interest payments on variable rate debt), foreign currency rates (forecasted transactions denominated in foreign currency) and market price risk related to an
equity security and (ii) to protect the initial net investment in certain foreign subsidiaries and/or affiliates with respect to changes in foreign currency rates.
Not all of these derivatives qualify for hedge accounting as discussed in more detail below.
With respect to derivative instruments that are afforded hedge accounting pursuant to Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities", on the date the derivative instrument is entered into, the Company designates the derivative
as a cash flow hedge, a fair value hedge or a hedge of a net investment depending on the asset, liability, forecasted transaction or net investment being hedged.
Changes in the fair value of a derivative that is designated and qualifies as a cash flow hedge are generally recorded in OCI and reclassified into earnings in
the same period or periods during which the hedged transaction affects earnings. Changes in the fair value of a derivative that is designated and qualifies as a
fair value hedge are recorded immediately in earnings along with the corresponding change in the carrying value of the hedged item. Changes in the fair value
of a net investment hedge are recorded as part of the cumulative translation adjustment in OCI.
The Company formally documents all relationships between hedging instruments and the underlying hedged items, as well as its risk management
objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as cash flow hedges to
forecasted transactions, fair value hedges to the related underlying instrument or net investment hedges to the underlying investment in a foreign subsidiary or
affiliate. The Company also formally assesses, both at inception of the hedge and on an ongoing basis, whether the hedge is highly effective in offsetting
changes in cash flows, fair value or foreign currency exposure of the underlying hedged items. The Company also performs an assessment of the probability
of the forecasted transaction on a periodic basis. If it is determined that a derivative ceases to be highly effective during the term of the hedge or if the
forecasted transaction is no longer probable, the Company will discontinue hedge accounting prospectively for such derivative.
In the predecessor periods, the Company used derivative instruments to mitigate cash flow risks with respect to forecasted transactions (commission
payments) that in certain periods did not meet the documentation requirements of Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133") to qualify for hedge accounting. Accordingly such derivative instruments were marked-to-
market through the Consolidated Statements of Income as part of the "Other income (expense)" line. By December 2006, the Company terminated all of these
interest rate swaps and entered into new interest rate swaps that qualified for hedge accounting.
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