IBM 2015 Annual Report Download - page 104

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies
102
lease and other financial assets and the interest rates associated
with its financing debt. Derivatives are also used to manage the
related cost of debt. For foreign currency exposures, derivatives
are used to better manage the cash flow volatility arising from for-
eign 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 arrange-
ments with most of its major derivative counterparties. These
arrangements require the company to hold or post collateral (cash
or U.S. Treasury securities) 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 instruments under these collateralized
arrangements that were in a liability position at December31, 2015
and 2014 was $28million and $21million, respectively, for which
no collateral was posted at either date. 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
positions as of December31, 2015 and 2014 was $994million
and $1,432 million, respectively. This amount represents the max-
imum exposure to loss at the reporting date as a result of the
counterparties failing to perform as contracted. This exposure
was reduced by $139million and $97million at December31,
2015 and 2014, respectively, of liabilities included in master netting
arrangements with those counterparties. Additionally, at Decem-
ber31, 2015 and 2014, this exposure was reduced by $90million
and $487million of cash collateral and $40million and $31million
of non-cash collateral in U.S. Treasury securities, respectively,
received by the company. At December31, 2015 and 2014, the net
exposure related to derivative assets recorded in the Statement
of Financial Position was $726million and $817million, respec-
tively. At December31, 2015 and 2014, the net amount related to
derivative liabilities recorded in the Statement of Financial Position
was $47million and $99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, 2015 and 2014
for the right to reclaim cash collateral. The amount recognized
in accounts payable for the obligation to return cash collateral
totaled $90million and $487million at December31, 2015 and
2014, 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, 2015 and 2014.
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 deriv-
ative instrument in order to manage the liquidity risk. Although not
designated as accounting hedges, the company may utilize deriv-
atives 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, cross-currency swaps and
options 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-ef-
fective 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, 2015 and 2014, the total notional amount of the company’s
interest rate swaps was $7.3billion and $5.8billion, respectively.
The weighted-average remaining maturity of these instruments
at December31, 2015 and 2014 was approximately 7.2years and
8.7years, respectively.