IBM 2014 Annual Report Download - page 107

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies
106
related cost of debt. For foreign currency exposures, derivatives
are used to better manage the cash flow volatility arising from
foreign exchange rate fluctuations.
As a result of the use of derivative instruments, the company
is exposed to the risk that counterparties to derivative contracts
will fail to meet their contractual obligations. To mitigate the coun-
terparty credit risk, the company has a policy of only entering
into contracts with carefully selected major financial institutions
based upon their overall credit profile. The company’s established
policies and procedures for mitigating credit risk on principal
transactions include reviewing and establishing limits for credit
exposure and continually assessing the creditworthiness of coun-
terparties. The right of set-off that exists under certain of these
arrangements enables the legal entities of the company subject
to the arrangement to net amounts due to and from the counter-
party reducing the maximum loss from credit risk in the event of
counterparty default.
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 con-
tractually 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, 2014 and 2013 was
$21 million and $216 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 collateral security arrangements. The aggregate fair value of
derivative instruments in net asset positions as of December31,
2014 and 2013 was $1,432 million and $719 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 $97 million and $251
million at December31, 2014 and 2013, respectively, of liabilities
included in master netting arrangements with those counterpar -
ties. Additionally, at December31, 2014 and 2013, this exposure
was reduced by $487 million and $29 million of cash collateral,
respectively, received by the company. At December31, 2014 and
2013, the net exposure related to derivative assets recorded in the
Statement of Financial Position was $817 million and $439 mil-
lion, respectively. At December31, 2014 and 2013, the net amount
related to derivative liabilities recorded in the Statement of Finan-
cial Position was $99 million and $250 million, respectively.
In the Consolidated Statement of Financial Position, the com-
pany 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, 2014 and 2013
for the right to reclaim cash collateral. The amount recognized
in accounts payable for the obligation to return cash collateral
totaled $487 million and $29 million at December31, 2014 and
2013, 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 Decem-
ber31, 2014 and 2013. At December31, 2014 the company held
$31 million in non-cash collateral in U.S. Treasury securities, and
at December31, 2013, no non-cash collateral was held.
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 matu-
rity which is not offset by a cash flow from the translation of the
underlying 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 deriva-
tive instrument in order to manage the liquidity risk. Although not
designated as accounting hedges, the company may utilize deriva-
tives 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-
effective 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
convert specific fixed-rate debt issuances into variable-rate debt
(i.e., fair value hedges) and to convert specific variable-rate debt
issuances into fixed-rate debt (i.e., cash flow hedges). At Decem-
ber31, 2014 and 2013, the total notional amount of the company’s
interest rate swaps was $5.8 billion and $3.1 billion, respectively.
The weighted-average remaining maturity of these instruments
at December31, 2014 and 2013 was approximately 8.7years and
10.6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, 2014 and 2013.