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DERIVATIVE INSTRUMENTS | 9 Months Ended
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Jul. 31, 2016
DERIVATIVE INSTRUMENTS |
DERIVATIVE INSTRUMENTS | (16) 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 financial services 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 fluctuations, while responding to favorable financing opportunities. The Company also has foreign currency exposures at some of its foreign and domestic operations related to buying, selling and financing in currencies other than the functional currencies. All derivatives are recorded at fair value on the balance sheet. Cash collateral received or paid is not offset against the derivative fair values on the balance sheet. Each derivative is designated as a cash flow 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. 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. 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 July 31, 2016, October 31, 2015 and July 31, 2015 were $1,850 million, $2,800 million and $2,800 million, respectively. The notional amounts of cross-currency interest rate contracts at July 31, 2016, October 31, 2015 and July 31, 2015 were $51 million, $60 million and $65 million, 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 changes on the related borrowings. Any ineffective portions of the gains or losses on all cash flow interest rate contracts designated as hedges were recognized currently in interest expense or other operating expenses (foreign exchange) and were not material during any periods 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 July 31, 2016 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 $2 million after-tax. These contracts mature in up to 29 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 these receive-fixed/pay-variable interest rate contracts at July 31, 2016, October 31, 2015 and July 31, 2015 were $9,551 million, $8,618 million and $8,694 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 gain of $2 million and none during the third quarter of 2016 and 2015, respectively, and were gains of $1 million during the first nine months of 2016 and 2015. 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:
|  | Three Months Ended |  | Nine Months Ended |
|  | July 31 |  | July 31 |
|  | 2016 |  | 2015 |  | 2016 |  | 2015 |
Interest rate contracts * |  | $ | 82 |  | $ | (10) |  | $ | 148 |  | $ | 45 |
Borrowings ** |  |  | (80) |  |  | 10 |  |  | (147) |  |  | (44) |
* Includes changes in fair values of interest rate contracts excluding net accrued interest income of $36 million and $42 million during the third quarter of 2016 and 2015, respectively, and $114 million and $131 million during the first nine months of 2016 and 2015, respectively. ** Includes adjustments for fair values of hedged borrowings excluding accrued interest expense of $75 million and $68 million during the third quarter of 2016 and 2015, respectively, and $217 million and $207 million during the first nine months of 2016 and 2015, respectively. Derivatives not designated as hedging instruments The Company has certain interest rate contracts (swaps and caps), foreign exchange contracts (futures, 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 these interest rate swaps at July 31, 2016, October 31, 2015 and July 31, 2015 were $6,087 million, $6,333 million and $5,912 million, the foreign exchange contracts were $3,959 million, $3,160 million and $3,040 million and the cross-currency interest rate contracts were $64 million, $76 million and $80 million, respectively. At July 31, 2016, October 31, 2015 and July 31, 2015, there were also $667 million, $1,069 million and $1,190 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. Fair values of derivative instruments in the condensed consolidated balance sheet in millions of dollars follow:
|  | July 31 |  | October 31 |  | July 31 |
Other Assets |  | 2016 |  | 2015 |  | 2015 |
Designated as hedging instruments: |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  | $ | 443 |  | $ | 299 |  | $ | 284 |
Cross-currency interest rate contracts |  |  | 12 |  |  | 14 |  |  | 14 |
Total designated |  |  | 455 |  |  | 313 |  |  | 298 |
Not designated as hedging instruments: |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  |  | 45 |  |  | 54 |  |  | 57 |
Foreign exchange contracts |  |  | 47 |  |  | 50 |  |  | 57 |
Cross-currency interest rate contracts |  |  | 12 |  |  | 11 |  |  | 13 |
Total not designated |  |  | 104 |  |  | 115 |  |  | 127 |
Total derivatives |  | $ | 559 |  | $ | 428 |  | $ | 425 |
Accounts Payable and Accrued Expenses |  |  |  |  |  |  |  |  |  |
Designated as hedging instruments: |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  | $ | 4 |  | $ | 8 |  | $ | 20 |
Total designated |  |  | 4 |  |  | 8 |  |  | 20 |
Not designated as hedging instruments: |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  |  | 43 |  |  | 52 |  |  | 63 |
Foreign exchange contracts |  |  | 48 |  |  | 18 |  |  | 26 |
Total not designated |  |  | 91 |  |  | 70 |  |  | 89 |
Total derivatives |  | $ | 95 |  | $ | 78 |  | $ | 109 |
The classification and gains (losses) including accrued interest expense related to derivative instruments on the statement of consolidated income consisted of the following in millions of dollars:
|  | Expense or |  | Three Months Ended |  | Nine Months Ended |
|  | OCI |  | July 31 |  | July 31 |
|  | Classification |  | 2016 |  | 2015 |  | 2016 |  | 2015 |
Fair Value Hedges: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  | Interest |  | $ | 118 |  | $ | 32 |  | $ | 262 |  | $ | 176 |
Cash Flow Hedges: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Recognized in OCI |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Effective Portion): |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  | OCI (pretax) * |  |  | (1) |  |  | (4) |  |  | (4) |  |  | (10) |
Foreign exchange contracts |  | OCI (pretax) * |  |  |  |  |  |  |  |  | 1 |  |  | 2 |
Reclassified from OCI |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Effective Portion): |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  | Interest * |  |  | (1) |  |  | (3) |  |  | (6) |  |  | (9) |
Foreign exchange contracts |  | Other operating * |  |  |  |  |  | 1 |  |  | 1 |  |  | 3 |
Recognized Directly in Income |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Ineffective Portion) |  |  |  |  | ** |  |  | ** |  |  | ** |  |  | ** |
Not Designated as Hedges: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  | Interest * |  | $ | (5) |  | $ | (6) |  | $ | (2) |  | $ | (18) |
Foreign exchange contracts |  | Cost of sales |  |  | 18 |  |  | 43 |  |  | (11) |  |  | 69 |
Foreign exchange contracts |  | Other operating * |  |  | 97 |  |  | 81 |  |  | 36 |  |  | 281 |
Total not designated |  |  |  | $ | 110 |  | $ | 118 |  | $ | 23 |  | $ | 332 |
* Includes interest and foreign exchange gains (losses) from cross-currency interest rate contracts. ** The amount is not significant. Counterparty Risk and Collateral Certain of the Company’s derivative agreements contain credit support provisions that may require the Company to post collateral based on the size of the net liability positions and credit ratings. The aggregate fair value of all derivatives with credit risk related contingent features that were in a net liability position at July 31, 2016, October 31, 2015 and July 31, 2015, was $29 million, $41 million and $60 million, respectively. The Company, due to its credit rating and amounts of net liability position, has not posted any collateral. If the credit risk related contingent features were triggered, the Company would be required to post collateral up to an amount equal to this liability position, prior to considering applicable netting provisions. Derivative instruments are subject to significant concentrations of credit risk to the banking sector. The Company manages individual counterparty exposure by setting limits that consider the credit rating of the counterparty, the credit default swap spread of the counterparty and 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 or termination. Derivatives are recorded without offsetting for netting arrangements or collateral. The impact on the derivative assets and liabilities related to netting arrangements and any collateral received or paid in millions of dollars follows:
|  | Gross Amounts |  | Netting |  | Collateral |  |  |  |
July 31, 2016 |  | Recognized |  | Arrangements |  | Received |  | Net Amount |
Assets |  | $ | 559 |  | $ | (53) |  | $ | (44) |  | $ | 462 |
Liabilities |  |  | 95 |  |  | (53) |  |  |  |  |  | 42 |
|  | Gross Amounts |  | Netting |  | Collateral |  |  |  |
October 31, 2015 |  | Recognized |  | Arrangements |  | Received |  | Net Amount |
Assets |  | $ | 428 |  | $ | (62) |  |  |  |  | $ | 366 |
Liabilities |  |  | 78 |  |  | (62) |  |  |  |  |  | 16 |
|  | Gross Amounts |  | Netting |  | Collateral |  |  |  |
July 31, 2015 |  | Recognized |  | Arrangements |  | Received |  | Net Amount |
Assets |  | $ | 425 |  | $ | (78) |  | $ | (1) |  | $ | 346 |
Liabilities |  |  | 109 |  |  | (78) |  |  |  |  |  | 31 |

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