Financial Instruments

6 Months Ended

Jun. 30, 2022

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Financial Instruments

Financial Instruments:

Overview

PMI operates in markets outside of the United States of America, with manufacturing and sales facilities in various locations around the world. PMI utilizes certain financial instruments to manage foreign currency and interest rate exposures. Derivative financial instruments are used by PMI principally to reduce exposures to market risks resulting from fluctuations in foreign currency exchange and interest rates by creating offsetting exposures. PMI is not a party to leveraged derivatives and, by policy, does not use derivative financial instruments for speculative purposes. Substantially all of PMI's derivative financial instruments are subject to master netting arrangements, whereby the right to offset occurs in the event of default by a participating party. While these contracts contain the enforceable right to offset through close-out netting rights, PMI elects to present them on a gross basis in the consolidated balance sheets. Collateral associated with these arrangements is in the form of cash and is unrestricted. Financial instruments qualifying for hedge accounting must maintain a specified level of effectiveness between the hedging instrument and the item being hedged, both at inception and throughout the hedged period. PMI formally documents the nature and relationships between the hedging instruments and hedged items, as well as its risk-management objectives, strategies for undertaking the various hedge transactions and method of assessing hedge effectiveness. Additionally, for hedges of forecasted transactions, the significant characteristics and expected terms of the forecasted transaction must be specifically identified, and it must be probable that each forecasted transaction will occur. If it were deemed probable that the forecasted transaction would not occur, the gain or loss would be recognized in earnings.

PMI uses deliverable and non-deliverable forward foreign exchange contracts, foreign currency swaps and foreign currency options, collectively referred to as foreign exchange contracts ("foreign exchange contracts"), and interest rate contracts to mitigate its exposure to changes in exchange and interest rates from third-party and intercompany actual and forecasted transactions. Both foreign exchange contracts and interest rate contracts are collectively referred to as derivative contracts ("derivative contracts"). The primary currencies to which PMI is exposed include the Euro, Indonesian rupiah, Japanese yen, Mexican peso, Philippine peso, Russian ruble and Swiss franc. At June 30, 2022, PMI had contracts with aggregate notional amounts of $29.1 billion of which $5.0 billion related to cash flow hedges, $6.7 billion related to hedges of net investments in foreign operations, $1.0 billion related to fair value hedges and $16.4 billion related to other derivatives that primarily offset currency exposures on intercompany financing and anticipated acquisition related transactions.

The fair value of PMI’s derivative contracts included in the condensed consolidated balance sheets as of June 30, 2022 and December 31, 2021, were as follows:

	Derivative Assets					Derivative Liabilities
		Fair Value					Fair Value
		At		At			At		At
(in millions)	Balance Sheet Classification	June 30, 2022		December 31, 2021		Balance Sheet Classification	June 30, 2022		December 31, 2021
Derivative contracts designated as hedging instruments	Other current assets	$	388	$	173	Other accrued liabilities	$	8	$	34
	Other assets	297		22		Income taxes and other liabilities	75		190
Derivative contracts not designated as hedging instruments	Other current assets	111		37		Other accrued liabilities	151		75
	Other assets	4		—		Income taxes and other liabilities	19		—
Total gross amount derivatives contracts presented in the condensed consolidated balance sheets		$	800	$	232		$	253	$	299
Gross amounts not offset in the condensed consolidated balance sheets
Financial instruments		(148)		(126)			(148)		(126)
Cash collateral received/pledged		(636)		(93)			(68)		(151)
Net amount		$	16	$	13		$	37	$	22

PMI assesses the fair value of its foreign exchange contracts and interest rate contracts using standard valuation models that use, as their basis, readily observable market inputs. The fair value of PMI’s foreign exchange forward contracts, foreign currency swaps and interest rate contracts is determined by using the prevailing foreign exchange spot rates and interest rate differentials, and the respective maturity dates of the instruments. The fair value of PMI’s currency options is determined by using a Black-Scholes methodology based on foreign exchange spot rates and interest rate differentials, currency volatilities and maturity dates. PMI’s derivative contracts have been classified within Level 2 at June 30, 2022 and December 31, 2021.

For the six months ended June 30, 2022 and 2021, PMI's derivative contracts impacted the condensed consolidated statements of earnings and comprehensive earnings as follows:

(pre-tax, in millions)	For the Six Months Ended June 30,
	Amount of Gain/(Loss) Recognized in Other Comprehensive Earnings/(Losses) on Derivatives				Statement of Earnings Classification of Gain/(Loss) on Derivatives	Amount of Gain/(Loss) Reclassified from Other Comprehensive Earnings/(Losses) into Earnings				Amount of Gain/(Loss) Recognized in Earnings
	2022		2021			2022		2021		2022		2021
Derivative contracts designated as hedging instruments:
Cash flow hedges	$	355	$	89
					Net revenues	$	81	$	17
					Cost of sales	—		—
					Marketing, administration and research costs	(10)		(12)
					Interest expense, net	(7)		(7)
Fair value hedges					Interest expense, net					$	(57)	$	—
Net investment hedges (a)	530		192		Interest expense, net (b)					68		82
Derivative contracts not designated as hedging instruments:					Interest expense, net					43		25
					Marketing, administration and research costs (c)					65		196
Total	$	885	$	281		$	64	$	(2)	$	119	$	303

(a) Amount of gains (losses) on hedges of net investments principally related to changes in exchange and interest rates between the Euro and U.S. dollar.

(b) Represent the gains for amounts excluded from the effectiveness testing

(c) The gains (losses) from these contracts attributable to changes in foreign currency exchange rates are primarily offset by the (losses) and gains generated by the underlying intercompany and third-party loans being hedged

For the three months ended June 30, 2022 and 2021, PMI's derivative contracts impacted the condensed consolidated statements of earnings and comprehensive earnings as follows:

(pre-tax, in millions)	For the Three Months Ended June 30,
	Amount of Gain/(Loss) Recognized in Other Comprehensive Earnings/(Losses) on Derivatives				Statement of Earnings Classification of Gain/(Loss) on Derivatives	Amount of Gain/(Loss) Reclassified from Other Comprehensive Earnings/(Losses) into Earnings				Amount of Gain/(Loss) Recognized in Earnings
	2022		2021			2022		2021		2022		2021
Derivative contracts designated as hedging instruments:
Cash flow hedges	$	225	$	(1)
					Net revenues	$	64	$	17
					Cost of sales	—		—
					Marketing, administration and research costs	(7)		6
					Interest expense, net	(4)		(4)
Fair value hedges					Interest expense, net					$	(20)	$	—
Net investment hedges (a)	425		(126)		Interest expense, net (b)					35		40
Derivative contracts not designated as hedging instruments:					Interest expense, net					35		14
					Marketing, administration and research costs (c)					66		(91)
Total	$	650	$	(127)		$	53	$	19	$	116	$	(37)

(a) Amount of gains (losses) on hedges of net investments principally related to changes in exchange and interest rates between the Euro and U.S. dollar

(b) Represent the gains for amounts excluded from the effectiveness testing

(c) The gains (losses) from these contracts attributable to changes in foreign currency exchange rates are primarily offset by the (losses) and gains generated by the underlying intercompany and third-party loans being hedged

Cash Flow Hedges

PMI has entered into derivative contracts to hedge the foreign currency exchange and interest rate risks related to certain forecasted transactions. Gains and losses associated with qualifying cash flow hedge contracts are deferred as components of accumulated other comprehensive losses until the underlying hedged transactions are reported in PMI’s condensed consolidated statements of earnings. As of June 30, 2022, PMI has hedged forecasted transactions for periods not exceeding the next eighteen months with the exception of one derivative contract that expires in May 2024. The impact of these hedges is primarily included in operating cash flows on PMI’s condensed consolidated statements of cash flows.

Fair Value Hedges

PMI has entered into fixed-to-floating interest rate contracts, designated as fair value hedges to minimize exposure to changes in the fair value of fixed rate U.S. dollar-denominated debt that results from fluctuations in benchmark interest rates. For derivative contracts that are designated and qualify as fair value hedges, the gain or loss on the derivative, as well as the offsetting gain or loss on the hedged items attributable to the hedged risk, is recognized in current earnings. The carrying amount of the debt hedged, which includes the cumulative adjustment for fair value gains/losses, as of June 30, 2022 was $938 million, and is recorded in long-term debt in the condensed consolidated balance sheets. The cumulative amount of fair value gains/(losses) included in the carrying amount of the debt hedged was $56 million as of June 30, 2022.

Hedges of Net Investments in Foreign Operations

PMI designates derivative contracts and certain foreign currency denominated debt instruments as net investment hedges, primarily of its Euro net assets. For the six months ended June 30, 2022 and 2021, the amount of pre-tax gain/(loss) related to these debt instruments, that was reported as a component of accumulated other comprehensive losses within currency translation adjustments, was $258 million and $110 million, respectively. For the three months ended June 30, 2022 and 2021, the amount of pre-tax gain/(loss) related to these debt instruments, that was reported as a component of accumulated other comprehensive losses within currency translation adjustments, was $192 million and $(71) million, respectively. The premiums paid for, and settlements of, net investment hedges are included in investing cash flows on PMI’s condensed consolidated statements of cash flows.

Other Derivatives

PMI has entered into derivative contracts to hedge the foreign currency exchange and interest rate risks related to intercompany loans between certain subsidiaries, third-party loans and anticipated acquisition related transactions. While effective as economic hedges, no hedge accounting is applied for these contracts; therefore, the gains (losses) relating to these contracts are reported in PMI’s condensed consolidated statements of earnings. Acquisition related transactions are included in investing cash flows on PMI’s condensed consolidated statements of cash flows.

Qualifying Hedging Activities Reported in Accumulated Other Comprehensive Losses

Derivative gains or losses reported in accumulated other comprehensive losses are a result of qualifying hedging activity. Transfers of these gains or losses to earnings are offset by the corresponding gains or losses on the underlying hedged item. Hedging activity affected accumulated other comprehensive losses, net of income taxes, as follows:

(in millions)	For the Six Months Ended June 30,				For the Three Months Ended June 30,
	2022		2021		2022		2021
Gain/(loss) as of beginning of period	$	4	$	(85)	$	105	$	12
Derivative (gains)/losses transferred to earnings	(55)		2		(46)		(19)
Change in fair value	301		77		191		1
Gain/(loss) as of June 30,	$	250	$	(6)	$	250	$	(6)

At June 30, 2022, PMI expects $141 million of derivative gains that are included in accumulated other comprehensive losses to be reclassified to the condensed consolidated statement of earnings within the next 12 months. These gains are expected to be substantially offset by the statement of earnings impact of the respective hedged transactions.

Contingent Features

PMI’s derivative instruments do not contain contingent features.

Credit Exposure and Credit Risk

PMI is exposed to credit loss in the event of non-performance by counterparties. While PMI does not anticipate non-performance, its risk is limited to the fair value of the financial instruments less any cash collateral received or pledged. PMI

actively monitors its exposure to credit risk through the use of credit approvals and credit limits and by selecting and continuously monitoring a diverse group of major international banks and financial institutions as counterparties.

Other Investments

A PMI investment, which is comprised primarily of money market funds, has been classified within Level 1 and had a fair value of $94 million at June 30, 2022. For the six months and three months ended June 30, 2022, the unrealized pre-tax gains on these investments were immaterial.