John Deere 2011 Annual Report Download - page 49

Fair value is defined as the price that would be received
to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
In determining fair value, the company uses various methods
including market and income approaches. The company utilizes
valuation models and techniques that maximize the use of
observable inputs. The models are industry-standard models that
consider various assumptions including time values and yield
curves as well as other economic measures. These valuation
techniques are consistently applied.
The following is a description of the valuation
methodologies the company uses to measure financial
instruments and nonmonetary assets at fair value:
Marketable Securities – The portfolio of investments is
primarily valued on a market approach (matrix pricing model)
in which all significant inputs are observable or can be derived
from or corroborated by observable market data such as interest
rates, yield curves, volatilities, credit risk and prepayment speeds.
Derivatives – The company’s derivative financial
instruments consist of interest rate swaps and caps, foreign
currency forwards and swaps and cross-currency interest rate
swaps. The portfolio is valued based on an income approach
(discounted cash flow) using market observable inputs,
including swap curves and both forward and spot exchange
rates for currencies.
Financing Receivables – Specific reserve impairments are
based on the fair value of the collateral, which is measured using
an income approach (discounted cash flow) or a market
approach (appraisal values or realizable values). Inputs include
interest rates and selection of realizable values.
Goodwill – The impairment of goodwill is based on the
implied fair value measured as the difference between the fair
value of the reporting unit and the fair value of the unit’s
identifiable net assets. An estimate of the fair value of the
reporting unit is determined through a combination of an
income approach (discounted cash flows) and market values for
similar businesses, which includes inputs such as interest rates
and selections of similar businesses.
Property and Equipment Held for Sale – The impairment
of long-lived assets held for sale is measured at the lower of
the carrying amount, or fair value less cost to sell. Fair value is
based on the probable sale price. The inputs include estimates
of final sale price adjustments.
27. DERIVATIVE INSTRUMENTS
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
were in a liability position at October 31, 2011 and 2010 was
$23 million and $16 million, respectively. 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, prior
to considering applicable netting provisions.
Derivative instruments are subject to significant 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 financial 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. 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 $485 million and $520 million as
of October 31, 2011 and 2010, respectively. The amount of
collateral received at October 31, 2011 and 2010 to offset this
potential maximum loss was $25 million and $85 million,
respectively. 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 $59 million and $58 million as of
October 31, 2011 and 2010, respectively. None of the concen-
trations of risk with any individual counterparty was considered
significant at October 31, 2011 and 2010.
Cash Flow Hedges
Certain interest rate and cross-currency interest rate contracts
(swaps) were designated as hedges of future cash flows from
borrowings. The total notional amounts of the receive-variable/
pay-fixed interest rate contracts at October 31, 2011 and 2010
were $1,350 million and $1,060 million, respectively. The total
notional amounts of the cross-currency interest rate contracts
were $853 million and $849 million at October 31, 2011 and
2010, respectively. The effective portions of the fair value gains
or losses on these cash flow hedges were recorded in other
comprehensive income (OCI) and subsequently reclassified into
interest expense or other operating expenses (foreign exchange)
in the same periods during which the hedged transactions
affected earnings. These amounts offset the effects of interest
rate or foreign currency exchange rate changes on the related
borrowings. Any ineffective portions of the gains or losses on all
cash flow interest rate contracts designated as cash flow hedges
were recognized currently in interest expense or other operat-
ing expenses (foreign exchange) and were not material during
any years presented. The cash flows from these contracts were
recorded in operating activities in the statement of consolidated
cash flows.
The amount of loss recorded in OCI at October 31, 2011
that is expected to be reclassified to interest expense or other
operating expenses in the next twelve months if interest rates or
exchange rates remain unchanged is approximately $4 million
after-tax. These contracts mature in up to 35 months. There were
no gains or losses reclassified from OCI to earnings based on
the probability that the original forecasted transaction would
not occur.
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