John Deere 2009 Annual Report Download - page 46

27. DERIVATIVE INSTRUMENTS
It is the company’s policy that derivative transactions are
executed only to manage exposures arising in the normal course
of business and not for the purpose of creating speculative
positions or trading. The company’s credit operations manage
the relationship of the types and amounts of their funding
sources to their receivable and lease portfolio in an effort to
diminish risk due to interest rate and foreign currency fl uctua-
tions, while responding to favorable fi nancing opportunities.
The company also has foreign currency exposures at some of its
foreign and domestic operations related to buying, selling and
fi nancing in currencies other than the local currencies.
All derivatives are recorded at fair value on the balance
sheet. Each derivative is designated as a cash fl ow hedge, a fair
value hedge, or remains undesignated. All designated hedges are
formally documented as to the relationship with the hedged
item as well as the risk-management strategy. Both at inception
and on an ongoing basis the hedging instrument is assessed as to
its effectiveness, when applicable. If and when a derivative is
determined not to be highly effective as a hedge, or the
underlying hedged transaction is no longer likely to occur, or the
hedge designation is removed, or the derivative is terminated,
hedge accounting is discontinued. Any past or future changes
in the derivative’s fair value, which will not be effective as an
offset to the income effects of the item being hedged, are
recognized currently in the income statement.
Certain of the company’s derivative agreements contain
credit support provisions that require the company to post
collateral based on reductions in credit ratings. The aggregate
fair value of all derivatives with credit-risk-related contingent
features that are in a liability position at October 31, 2009 was
$13 million. The company, due to its credit rating, has not
posted any collateral. If the credit-risk-related contingent features
were triggered, the company would be required to post full
collateral for this liability position.
Derivative instruments are subject to signifi cant concen-
trations of credit risk to the banking sector. The company
manages individual counterparty exposure by setting limits that
consider the credit rating of the counterparty and the size of
other fi nancial commitments and exposures between the
company and the counterparty banks. All interest rate derivatives
are transacted under International Swaps and Derivatives
Association (ISDA) documentation. Some of these agreements
include collateral support arrangements or mutual put options at
fair value. Each master agreement permits the net settlement of
amounts owed in the event of early termination. The maximum
amount of loss that the company would incur if counterparties
to derivative instruments fail to meet their obligations, not
considering collateral received or netting arrangements, was
$740 million as of October 31, 2009. The amount of collateral
received at October 31, 2009 to offset this potential maximum
loss was $81 million. The netting provisions of the agreements
would reduce the maximum amount of loss the company
would incur if the counterparties to derivative instruments fail
to meet their obligations by an additional $88 million as of
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October 31, 2009. None of the concentrations of risk with
any individual counterparty was considered signifi cant at
October 31, 2009.
Cash Flow Hedges
Certain interest rate contracts (swaps) were designated as hedges
of future cash fl ows from variable interest rate borrowings.
The total notional amount of these receive-variable/pay-fi xed
interest rate contracts at October 31, 2009 was $2,492 million.
The effective portions of the fair value gains or losses on these
cash fl ow hedges were recorded in other comprehensive income
(OCI) and subsequently reclassifi ed into interest expense as
payments were accrued and the contracts approached maturity.
These amounts offset the effects of interest rate changes on the
related borrowings. Any ineffective portions of the gains or
losses on all cash fl ow interest rate contracts designated as hedges
were recognized currently in interest expense and were not
material during any years presented. The cash fl ows from these
contracts were recorded in operating activities in the consolidated
statement of cash fl ows.
The amount of loss recorded in OCI at October 31, 2009
that is expected to be reclassifi ed to interest expense in the next
twelve months if interest rates remain unchanged is approxi-
mately $38 million after-tax. These contracts mature in up to
19 months. There were no signifi cant gains or losses reclassifi ed
from OCI to earnings based on the probability that the original
forecasted transaction would not occur.
Fair Value Hedges
Certain interest rate contracts (swaps) were designated as fair
value hedges of fi xed-rate, long-term borrowings. The total
notional amount of these receive-fi xed/pay-variable interest rate
contracts at October 31, 2009 was $6,912 million. The effective
portions of the fair value gains or losses on these contracts were
offset by fair value gains or losses on the hedged items (fi xed-rate
borrowings). Any ineffective portions of the gains or losses were
recognized currently in interest expense and were not material
during any years presented. The cash fl ows from these contracts
were recorded in operating activities in the consolidated
statement of cash fl ows.
The gains (losses) including interest on these contracts and
the underlying borrowings recorded in interest expense were as
follows in millions of dollars:
2009
Interest rate contracts ................................................................... $ 453
Bor rowings ................................................................................... ( 6 17 )
Derivatives Not Designated as Hedging Instruments
The company has certain interest rate contracts (swaps and caps),
foreign exchange contracts (forwards and swaps) and cross-
currency interest rate contracts (swaps), which were not formally
designated as hedges. These derivatives were held as economic
hedges for underlying interest rate or foreign currency exposures
primarily for certain borrowings and purchases or sales of
inventory. The total notional amount of the interest rate swaps