IBM 2013 Annual Report Download - page 104

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies
103
The company is also a party to collateral security arrangements
with most of its major derivative counterparties. These arrange-
ments require the company to hold or post collateral (cash or U.S.
Treasury securities) when the derivative fair values exceed contrac-
tually 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 instruments under these collateralized arrangements
that were in a liability position at December 31, 2013 and 2012 was
$216 million and $94 million, respectively, for which no collateral
was posted at either date. Full collateralization of these agreements
would be required in the event that the company’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 col-
lateral security arrangements. The aggregate fair value of derivative
instruments in net asset positions as of December 31, 2013 and
2012 was $719 million and $918 million, respectively. This amount
represents the maximum exposure to loss at the reporting date as
a result of the counterparties failing to perform as contracted. This
exposure was reduced by $251 million and $262 million at Decem-
ber 31, 2013 and 2012, respectively, of liabilities included in master
netting arrangements with those counterparties. Additionally, at
December 31, 2013 and 2012, this exposure was reduced by $29
million and $69 million of cash collateral, respectively, received by
the company. At December 31, 2013 and 2012, the net exposure
related to derivative assets recorded in the Statement of Financial
Position was $439 million and $587 million, respectively. At Decem-
ber 31, 2013 and 2012, the net amount related to derivative liabilities
recorded in the Statement of Financial Position was $250 million
and $242 million, respectively.
In the Consolidated 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, 2013 and 2012 for the right to
reclaim cash collateral. The amount recognized in accounts payable
for the obligation to return cash collateral totaled $29 million and
$69 million at December 31, 2013 and 2012, respectively. The com-
pany 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, 2013 and 2012. At
December 31, 2013 and 2012 the company held $0 million and $31
million in non-cash collateral in U.S. Treasury securities. Per account-
ing guidance, non-cash collateral is not recorded on the Statement
of Financial Position.
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 or terminating the derivative instru-
ment 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,
2013 and 2012, the total notional amount of the company’s interest
rate swaps was $3.1 billion and $4.3 billion, respectively. The
weighted-average remaining maturity of these instruments at
December 31, 2013 and 2012 was approximately 10.6 years and
5.1 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, 2013 and 2012.
At December 31, 2013 and 2012, net gains of approximately
$1 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, respectively,
are expected to be reclassified to net income within the next 12
months, providing an offsetting economic impact against the
underlying transactions.