IBM 2012 Annual Report Download - page 96

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies
95
The company is also a party to collateral security arrangements
with most of its major counterparties. These arrangements require
the company to hold or post collateral (cash or U.S. Treasury securi-
ties) when the derivative fair values exceed contractually established
thresholds. Posting thresholds can be fixed or can vary based on
credit default swap pricing or credit ratings received from the major
credit agencies. The aggregate fair value of all derivative instru-
ments under these collateralized arrangements that were in a
liability position at December 31, 2012 and 2011 was $94 million and
$131 million, respectively, for which no collateral was posted at
December 31, 2012 and December 31, 2011. Full collateralization
of these agreements would be required in the event that the com-
pany’s credit rating falls below investment grade or if its credit
default swap spread exceeds 250 basis points, as applicable,
pursuant to the terms of the collateral security arrangements. The
aggregate fair value of derivative instruments in net asset posi-
tions as of December 31, 2012 and 2011 was $918 million and
$1,300 million, respectively. This amount represents the maximum
exposure to loss at the reporting date as a result of the counter-
parties failing to perform as contracted. This exposure was
reduced by $262 million and $324 million at December 31, 2012
and 2011, respectively, of liabilities included in master netting
arrangements with those counterparties. Additionally, at December
31, 2012 and 2011, this exposure was reduced by $69 million and
$466 million of cash collateral, respectively, received by the com-
pany. In addition to cash collateral, the company held $31 million in
non-cash collateral, in U.S. Treasury securities at December 31,
2012. Per accounting guidance, non-cash collateral is not recorded
on the Statement of Financial Position.
The company does not offset derivative assets against liabilities
in master netting arrangements nor does it offset receivables or
payables recognized upon payment or receipt of cash collateral
against the fair values of the related derivative instruments. No
amount was recognized in other receivables at December 31, 2012
and December 31, 2011 for the right to reclaim cash collateral. The
amount recognized in accounts payable for the obligation to return
cash collateral totaled $69 million and $466 million at December
31, 2012 and 2011, respectively. The company restricts the use of
cash collateral received to rehypothecation, and therefore reports
it in prepaid expenses and other current assets in the Consolidated
Statement of Financial Position. No amount was rehypothecated at
December 31, 2012 and December 31, 2011.
The company may employ derivative instruments to hedge the
volatility in stockholders’ equity resulting from changes in currency
exchange rates of significant foreign subsidiaries of the company
with respect to the U.S. dollar. These instruments, designated as
net investment hedges, expose the company to liquidity risk as the
derivatives have an immediate cash flow impact upon maturity
which is not offset by a cash flow from the translation of the under-
lying hedged equity. The company monitors this cash loss potential
on an ongoing basis, and may discontinue some of these hedging
relationships by de-designating the derivative instrument in order to
manage the liquidity risk. Although not designated as accounting
hedges, the company may utilize derivatives to offset the changes
in the fair value of the de-designated instruments from the date of
de-designation until maturity.
In its hedging programs, the company uses forward contracts,
futures contracts, interest-rate swaps and cross-currency swaps,
depending upon the underlying exposure. The company is not a
party to leveraged derivative instruments.
A brief description of the major hedging programs, categorized
by underlying risk, follows.
Interest Rate Risk
Fixed and Variable Rate Borrowings
The company issues debt in the global capital markets, principally
to fund its financing lease and loan portfolio. Access to cost-effec-
tive financing can result in interest rate mismatches with the
underlying assets. To manage these mismatches and to reduce
overall interest cost, the company uses interest rate swaps to con-
vert specific fixed-rate debt issuances into variable-rate debt (i.e.,
fair value hedges) and to convert specific variable-rate debt issu-
ances into fixed-rate debt (i.e., cash flow hedges). At December
31, 2012 and 2011, the total notional amount of the company’s inter-
est rate swaps was $4.3 billion and $5.9 billion, respectively. The
weighted-average remaining maturity of these instruments at
December 31, 2012 and December 31, 2011 was approximately 5.1
years and 5.5 years, respectively.
Forecasted Debt Issuance
The company is exposed to interest rate volatility on future debt
issuances. To manage this risk, the company may use forward-
starting interest rate swaps to lock in the rate on the interest
payments related to the forecasted debt issuance. These swaps
are accounted for as cash flow hedges. The company did not have
any derivative instruments relating to this program outstanding at
December 31, 2012 and 2011.
At December 31, 2012 and 2011, net gains of approximately
$1 million and net losses of approximately $5 million (before taxes),
respectively, were recorded in AOCI in connection with cash flow
hedges of the company’s borrowings. Within these amounts less
than $1 million of gains and $6 million of losses, respectively, are
expected to be reclassified to net income within the next 12 months,
providing an offsetting economic impact against the underlying
transactions.
Foreign Exchange Risk
Long-Term Investments in Foreign Subsidiaries
(Net Investment)
A large portion of the company’s foreign currency denominated debt
portfolio is designated as a hedge of net investment in foreign sub-
sidiaries to reduce the volatility in stockholders’ equity caused by
changes in foreign currency exchange rates in the functional cur-
rency of major foreign subsidiaries with respect to the U.S. dollar.
The company also uses cross-currency swaps and foreign
exchange forward contracts for this risk management purpose. At
December 31, 2012 and 2011, the total notional amount of derivative
instruments designated as net investment hedges was $3.3 billion
and $5.0 billion, respectively. The weighted-average remaining
maturity of these instruments at December 31, 2012 and 2011 was
approximately 0.4 years for both periods.