Discover 2010 Annual Report Download - page 154

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will be reclassified to interest income as interest payments are received on certain of its floating rate credit card loan
receivables. During the next 12 months, the Company estimates it will reclassify to earnings $7.9 million of pretax gains
related to its derivatives designated as cash flow hedges.
Fair Value Hedges. The Company is exposed to changes in fair value of certain of its fixed rate debt obligations due to
changes in interest rates. During the year ended November 30, 2010, the Company used an interest rate swap to
manage its exposure to changes in fair value of fixed rate senior notes attributable to changes in LIBOR, a benchmark
interest rate as defined by ASC 815. The interest rate swap involves the receipt of a fixed rate amount from a
counterparty in exchange for the Company making payments of a variable rate amount over the life of the agreement
without exchange of the underlying notional amount. This interest rate swap qualifies as a fair value hedge in accordance
with ASC 815. Changes in both the fair value of the derivative and the hedged fixed rate senior note relating to the risk
being hedged were recorded in interest expense and provided substantial offset to one another. Ineffectiveness related to
this fair value hedge was recorded in interest expense. The basis difference between the fair value and the carrying
amount of the fixed rate debt as of the inception of the hedging relationship is amortized and recorded in interest
expense.
The Company has previously used interest rate swaps to manage its exposure to changes in fair value on certain
interest-bearing deposits attributable to changes in LIBOR. In March 2010, the last of these interest-rate swaps matured,
and at November 30, 2010, the Company had no derivatives that hedged deposits.
Derivatives not designated as Hedges
Foreign Exchange Forward Contracts. The Company has derivatives that are economic hedges and are not designated
as hedges for accounting purposes. The Company enters into foreign exchange forward contracts to manage foreign
currency risk. Foreign exchange forward contracts involve the purchase or sale of a designated currency at an agreed
upon rate for settlement on a specified date. Changes in the fair value of these contracts are recorded in other income.
Interest Rate Swaps. The Company also may have from time to time interest rate swap agreements that are not
designated as hedges or that were partially de-designated to the extent that differences in the notional amounts of the
derivatives and the outstanding amount of the hedged liabilities subsequently arose. Such agreements are not speculative
and are also used to manage interest rate risk but are not designated for hedge accounting. Changes in the fair value of
these contracts are recorded in other income.
The following table summarizes the fair value (including accrued interest) and related outstanding notional amounts of
derivative instruments, as well as the location they are reported in the statement of financial condition as of
November 30, 2010 and November 30, 2009. See Note 22: Fair Value Disclosures for a description of the valuation
methodologies of derivatives. (Dollars in thousands):
November 30, 2010 November 30, 2009
Balance Sheet Location Balance Sheet Location
Notional
Amount
Number of
Transactions
Other
Assets
(At Fair
Value)
Accrued
Expenses and
Other
Liabilities
(At Fair
Value)
Notional
Amount
Other
Assets
(At Fair
Value)
Accrued
Expenses and
Other
Liabilities
(At Fair
Value)
Derivatives designated as hedges:
Interest rate swaps – Cash Flow hedge ........................ $2,000,000 8 $4,989 $ 0 $ 0 $ 0 $0
Interest rate swaps – Fair Value hedge......................... $ 400,000 1 $ 0 $6,587 $16,048 $400 $0
Derivatives not designated as hedges:
Foreign exchange forward contracts(1) ......................... $ 7,800 2 $ 6 $ 7 $ 0 $ 0 $0
Interest rate swaps.................................................... $ 0 0 $ 0 $ 0 $46,952 $969 $0
(1) The foreign exchange forward contracts have notional amounts of EUR 4 million and GBP 1.675 million as of November 30, 2010.
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