27. DERIVATIVE INSTRUMENTS

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 28, 2018 and October 29, 2017 were $3,050 million and $1,700 million, respectively. The total notional amounts of the cross-currency interest rate contracts were none and $22 million at October 28, 2018 and October 29, 2017, respectively. The effective portions of the fair value gains or losses on these cash flow hedges were recorded in 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 operating 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 gain recorded in OCI at October 28, 2018 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 26 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 28, 2018 and October 29, 2017 were $8,479 million and $8,661 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 losses of $2 million in both 2018 and 2016, and a gain of $3 million in 2017. 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:


	2018		2017		2016
Interest rate contracts*	$	(294)	$	(284)	$	7
Borrowings**		292		287		(9)

* Includes changes in fair values of interest rate contracts excluding net accrued interest income of $11 million, $79 million, and $146 million during 2018, 2017, and 2016, respectively.

** Includes adjustments for fair values of hedged borrowings excluding accrued interest expense of $246 million, $243 million, and $290 million during 2018, 2017, and 2016, 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, purchases or sales of inventory, and below market retail financing programs. The total notional amounts of the interest rate swaps at October 28, 2018 and October 29, 2017 were $8,075 million and $6,757 million, the foreign exchange contracts were $6,842 million and $8,499 million, and the cross-currency interest rate contracts were $81 million and $66 million, respectively. The increase in the total notional amount of interest rate swaps primarily relates to the equipment operation’s economic hedge of announced retail financing programs. The decrease in the total notional amounts of foreign exchange contracts primarily relates to the Wirtgen acquisition, which closed in December 2017 (see Note 4). At October 28, 2018 and October 29, 2017, there were also $66 million and $253 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 consolidated balance sheet at October 28, 2018 and October 29, 2017 in millions of dollars follow:


	2018		2017
Other Assets
Designated as hedging instruments:
Interest rate contracts	$	29	$	74
Cross-currency interest rate contracts				5
Total designated		29		79
Not designated as hedging instruments:
Interest rate contracts		51		42
Foreign exchange contracts		83		108
Cross-currency interest rate contracts		5		6
Total not designated		139		156
Total derivative assets	$	168	$	235
Accounts Payable and Accrued Expenses
Designated as hedging instruments:
Interest rate contracts	$	321	$	112
Total designated		321		112
Not designated as hedging instruments:
Interest rate contracts		29		19
Foreign exchange contracts		49		26
Cross-currency interest rate contracts				1
Total not designated		78		46
Total derivative liabilities	$	399	$	158

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:


	2018		2017		2016
Fair Value Hedges
Interest rate contracts – Interest expense	$	(283)	$	(205)	$	153

Cash Flow Hedges
Recognized in OCI
(Effective Portion):
Interest rate contracts – OCI (pretax)*		17		4		(3)
Foreign exchange contracts – OCI (pretax)*		2		(1)		1

Reclassified from OCI
(Effective Portion):
Interest rate contracts – Interest expense*		5		(2)		(7)
Foreign exchange contracts – Other expense*		1		(1)		1

Recognized Directly in Income
(Ineffective Portion)		**		**		**

Not Designated as Hedges
Interest rate contracts – Net sales	$	3
Interest rate contracts – Interest expense*		(4)	$	11	$	(1)
Foreign exchange contracts – Cost of sales		(24)		(12)		(15)
Foreign exchange contracts – Other expense*		195		(106)		74
Total not designated	$	170	$	(107)	$	58

* Includes interest and foreign exchange gains (losses) from cross-currency interest rate contracts.

** The amounts are not significant.

Counterparty Risk and Collateral

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.

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 October 28, 2018 and October 29, 2017, was $350 million and $132 million, respectively. In accordance with the limits established in these agreements, the company posted $59 million in cash collateral at October 28, 2018. No cash collateral was posted at October 29, 2017.

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 paid at October 28, 2018 and October 29, 2017 in millions of dollars follows:


	Gross Amounts		Netting		Collateral		Net
	Recognized		Arrangements		Paid		Amount
2018
Assets	$	168	$	(65)			$	103
Liabilities		399		(65)	$	(59)		275
2017
Assets	$	235	$	(65)			$	170
Liabilities		158		(65)				93