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DERIVATIVE INSTRUMENTS | 9 Months Ended
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Jul. 29, 2018
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 29, 2018, October 29, 2017, and July 30, 2017 were $2,400 million, $1,700 million, and $1,700 million, respectively. The total notional amounts of the cross-currency interest rate contracts at July 29, 2018, October 29, 2017, and July 30, 2017 were $11 million, $22 million, and $32 million, 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 periods 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 July 29, 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 $9 million after-tax. These contracts mature in up to 23 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 July 29, 2018, October 29, 2017, and July 30, 2017 were $7,792 million, $8,661 million, and $7,716 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 $1 million and a gain of $1 million during the third quarter of 2018 and 2017, respectively, and a loss of $4 million and a gain of $3 million during the first nine months of 2018 and 2017, respectively. 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 29 |  | July 30 |  | July 29 |  | July 30 |
|  | 2018 |  | 2017 |  | 2018 |  | 2017 |
Interest rate contracts * |  | $ | (8) |  | $ | 5 |  | $ | (279) |  | $ | (197) |
Borrowings ** |  |  | 7 |  |  | (4) |  |  | 275 |  |  | 200 |
* Includes changes in fair values of interest rate contracts excluding net accrued interest expense of $2 million and net accrued interest income of $16 million during the third quarter of 2018 and 2017, respectively, and net accrued interest income of $15 million and $64 million during the first nine months of 2018 and 2017, respectively. ** Includes adjustments for fair values of hedged borrowings excluding accrued interest expense of $60 million and $56 million during the third quarter of 2018 and 2017, respectively, and $187 million and $182 million during the first nine months of 2018 and 2017, 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 29, 2018, October 29, 2017, and July 30, 2017 were $6,519 million, $6,757 million, and $6,715 million, the foreign exchange contracts were $7,752 million, $8,499 million, and $5,111 million, and the cross-currency interest rate contracts were $96 million, $66 million, and $80 million, respectively. The increase in the total notional amounts of foreign exchange contracts at October 29, 2017 primarily relates to the Wirtgen acquisition (see Note 18). At July 29, 2018, October 29, 2017, and July 30, 2017, there were also $92 million, $253 million, and $308 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 29 |  | October 29 |  | July 30 |
Other Assets |  | 2018 |  | 2017 |  | 2017 |
Designated as hedging instruments: |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  | $ | 24 |  | $ | 74 |  | $ | 104 |
Cross-currency interest rate contracts |  |  | 3 |  |  | 5 |  |  | 6 |
Total designated |  |  | 27 |  |  | 79 |  |  | 110 |
Not designated as hedging instruments: |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  |  | 44 |  |  | 42 |  |  | 38 |
Foreign exchange contracts |  |  | 50 |  |  | 108 |  |  | 32 |
Cross-currency interest rate contracts |  |  | 3 |  |  | 6 |  |  | 4 |
Total not designated |  |  | 97 |  |  | 156 |  |  | 74 |
Total derivative assets |  | $ | 124 |  | $ | 235 |  | $ | 184 |
Accounts Payable and Accrued Expenses |  |  |  |  |  |  |  |  |  |
Designated as hedging instruments: |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  | $ | 305 |  | $ | 112 |  | $ | 63 |
Total designated |  |  | 305 |  |  | 112 |  |  | 63 |
Not designated as hedging instruments: |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  |  | 25 |  |  | 19 |  |  | 18 |
Foreign exchange contracts |  |  | 52 |  |  | 26 |  |  | 95 |
Cross-currency interest rate contracts |  |  | 2 |  |  | 1 |  |  | 4 |
Total not designated |  |  | 79 |  |  | 46 |  |  | 117 |
Total derivative liabilities |  | $ | 384 |  | $ | 158 |  | $ | 180 |
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 29 |  | July 30 |  | July 29 |  | July 30 |
|  | Classification |  | 2018 |  | 2017 |  | 2018 |  | 2017 |
Fair Value Hedges: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  | Interest |  | $ | (10) |  | $ | 21 |  | $ | (264) |  | $ | (133) |
Cash Flow Hedges: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Recognized in OCI |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Effective Portion): |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  | OCI (pretax) * |  |  | 1 |  |  | (2) |  |  | 15 |  |  |  |
Foreign exchange contracts |  | OCI (pretax) * |  |  |  |  |  |  |  |  | 1 |  |  | (2) |
Reclassified from OCI |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Effective Portion): |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  | Interest * |  |  | 2 |  |  | (1) |  |  | 3 |  |  | (2) |
Foreign exchange contracts |  | Other operating * |  |  |  |  |  |  |  |  |  |  |  | (2) |
Recognized Directly in Income |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Ineffective Portion) |  |  |  |  | ** |  |  | ** |  |  | ** |  |  | ** |
Not Designated as Hedges: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest rate contracts |  | Interest * |  | $ | (3) |  | $ | 11 |  | $ | (3) |  | $ | 11 |
Foreign exchange contracts |  | Cost of sales |  |  | (10) |  |  | (29) |  |  | (22) |  |  | (41) |
Foreign exchange contracts |  | Other operating * |  |  | 144 |  |  | (192) |  |  | 92 |  |  | (205) |
Total not designated |  |  |  | $ | 131 |  | $ | (210) |  | $ | 67 |  | $ | (235) |
* 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. 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 July 29, 2018, October 29, 2017, and July 30, 2017, was $331 million, $132 million, and $85 million, respectively. In accordance with the limits established in these agreements, the Company posted $34 million in cash collateral at July 29, 2018. No cash collateral was posted or received at either October 29, 2017 or July 30, 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 received or paid in millions of dollars follows:
|  | Gross Amounts |  | Netting |  | Cash Collateral |  |  |  |
July 29, 2018 |  | Recognized |  | Arrangements |  | Received/Paid |  | Net Amount |
Assets |  | $ | 124 |  | $ | (67) |  |  |  |  | $ | 57 |
Liabilities |  |  | 384 |  |  | (67) |  | $ | (34) |  |  | 283 |
|  | Gross Amounts |  | Netting |  | Cash Collateral |  |  |  |
October 29, 2017 |  | Recognized |  | Arrangements |  | Received/Paid |  | Net Amount |
Assets |  | $ | 235 |  | $ | (65) |  |  |  |  | $ | 170 |
Liabilities |  |  | 158 |  |  | (65) |  |  |  |  |  | 93 |
|  | Gross Amounts |  | Netting |  | Cash Collateral |  |  |  |
July 30, 2017 |  | Recognized |  | Arrangements |  | Received/Paid |  | Net Amount |
Assets |  | $ | 184 |  | $ | (56) |  |  |  |  | $ | 128 |
Liabilities |  |  | 180 |  |  | (56) |  |  |  |  |  | 124 |

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- Definition The entire disclosure for derivative instruments and hedging activities including, but not limited to, risk management strategies, non-hedging derivative instruments, assets, liabilities, revenue and expenses, and methodologies and assumptions used in determining the amounts. + References Reference 1: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -URI http://asc.fasb.org/topic&trid=2229140 + Details
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