John Deere 2012 Annual Report Download - page 50

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 credit support provisions. Each master agreement
permits the net settlement of amounts owed in the event of
default. 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 $637 million and $485 million as of October
31, 2012 and 2011, respectively. The amount of collateral
received at October 31, 2012 and 2011 to offset this potential
maximum loss was $102 million and $25 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 $92 million and $59 million as of
October 31, 2012 and 2011, respectively. None of the concen-
trations of risk with any individual counterparty was considered
significant at October 31, 2012 and 2011.
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, 2012 and 2011
were $2,850 million and $1,350 million, respectively. The total
notional amounts of the cross-currency interest rate contracts
were $923 million and $853 million at October 31, 2012 and
2011, 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, 2012
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 $10 million
after-tax. These contracts mature in up to 71 months. There were
no gains or losses reclassified 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 borrowings. The total notional amounts of the
receive-fixed/pay-variable interest rate contracts at October 31,
2012 and 2011 were $9,266 million and $7,730 million,
respectively. 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 (fixed-rate borrowings). Any ineffective
portions of the gains or losses were recognized currently in
interest expense. The ineffective portions were a loss of
$2 million in 2012 and a loss of $5 million in 2011. The cash
flows from these contracts were recorded in operating activities
in the statement of consolidated cash flows.
The gains (losses) on these contracts and the underlying
borrowings recorded in interest expense follow in millions of
dollars:
2012 2011
Interest rate contracts* ........................................... $ 180 $ 16
Borrowings** .......................................................... (182) (21)
* Includes changes in fair values of interest rate contracts excluding net accrued
interest income of $155 million and $172 million during 2012 and 2011, respectively.
** Includes adjustments for fair values of hedged borrowings excluding accrued interest
expense of $282 million and $277 million during 2012 and 2011, respectively.
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 amounts of
the interest rate swaps at October 31, 2012 and 2011 were
$4,400 million and $3,216 million, the foreign exchange
contracts were $3,999 million and $3,058 million and the
cross-currency interest rate contracts were $78 million and
$52 million, respectively. At October 31, 2012 and 2011, there
were also $1,445 million and $1,402 million, respectively, of
interest rate caps purchased and the same amounts sold at the
same capped interest rate to facilitate borrowings through
securitization of retail notes. The fair value gains or losses from
the interest rate contracts were recognized currently in interest
expense and the gains or losses from foreign exchange contracts
in cost of sales or other operating expenses, generally offsetting
over time the expenses on the exposures being hedged.
The cash flows from these non-designated contracts were
recorded in operating activities in the statement of consolidated
cash flows.
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