Derivative Financial Instruments and Hedging Activities

12 Months Ended

Dec. 31, 2020

Derivative Instruments and Hedging Activities Disclosure [Abstract]

DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

In the normal course of business, our operations are exposed to global market risks, including the effect of changes in interest rates and foreign currency exchange rates. To manage these risks, we enter into highly effective derivative contracts:

•Interest rate contracts, including swaps, that are used to manage the effects of interest rate fluctuations;

•Foreign currency exchange contracts, including forwards, that are used to manage foreign exchange exposure; and

•Cross-currency interest rate swap contracts that are used to manage foreign currency and interest rate exposures on foreign-denominated debt.

We review our hedging program, derivative positions, and overall risk management strategy on a regular basis.

Derivative Financial Instruments and Hedge Accounting. Derivative assets and derivative liabilities are reported in Derivative financial instruments on our balance sheets.

Our derivatives are over-the-counter customized derivative transactions and are not exchange traded. We estimate the fair value of these instruments using industry-standard valuation models such as a discounted cash flow. These models project future cash flows and discount the future amounts to a present value using market-based expectations for interest rates, foreign exchange rates, and the contractual terms of the derivative instruments. The discount rate used is the relevant benchmark interest rate (e.g., LIBOR, SONIA) plus an adjustment for nonperformance risk. The adjustment reflects the full credit default swap (“CDS”) spread applied to a net exposure, by counterparty, considering the master netting agreements and any posted collateral. We use our counterparty’s CDS spread when we are in a net asset position and our own CDS spread when we are in a net liability position.

We have elected to apply hedge accounting to certain derivatives. Derivatives that are designated in hedging relationships are evaluated for effectiveness using regression analysis at the time they are designated and throughout the hedge period. Some derivatives do not qualify for hedge accounting; for others, we elect not to apply hedge accounting.

NOTE 7. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)

Fair Value Hedges. We use derivatives to reduce the risk of changes in the fair value of debt. We have designated certain receive-fixed, pay-float interest rate and cross-currency interest rate swaps as fair value hedges of fixed-rate debt. The risk being hedged is the risk of changes in the fair value of the hedged debt attributable to changes in the benchmark interest rate and foreign exchange. We report the change in fair value of the hedged debt related to the change in benchmark interest rate in Debt and Interest expense. We report the change in fair value of the hedged debt and hedging instrument related to foreign currency in Other income, net. Net interest settlements and accruals, and fair value changes on hedging instruments due to the benchmark interest rate change are reported in Interest expense. The cash flows associated with fair value hedges are reported in Net cash provided by / (used in) operating activities on our statements of cash flows.

When a fair value hedge is de-designated, or when the derivative is terminated before maturity, the fair value adjustment to the hedged debt continues to be reported as part of the carrying value of the debt and is recognized in Interest expense over its remaining life.

Derivatives Not Designated as Hedging Instruments. We report net interest settlements and accruals and changes in the fair value of interest rate swaps not designated as hedging instruments in Other income, net. Foreign currency revaluation on accrued interest along with gains and losses on foreign exchange contracts and cross-currency interest rate swaps are reported in Other income, net. Cash flows associated with non-designated or de-designated derivatives are reported in Net cash provided by / (used in) investing activities on our statements of cash flows.

Income Effect of Derivative Financial Instruments

The gains / (losses), by hedge designation, reported in income for the years ended December 31 were as follows (in millions):

	2018		2019		2020
Fair value hedges
Interest rate contracts
Net interest settlements and accruals on hedging instruments	$	10	$	(16)	$	290
Fair value changes on hedging instruments	(155)		706		986
Fair value changes on hedged debt	153		(694)		(985)
Cross-currency interest rate swap contracts
Net interest settlements and accruals on hedging instruments	—		—		(2)
Fair value changes on hedging instruments	—		—		38
Fair value changes on hedged debt	—		—		(37)
Derivatives not designated as hedging instruments
Interest rate contracts	(84)		(13)		(100)
Foreign currency exchange contracts (a)	163		52		(82)
Cross-currency interest rate swap contracts	(244)		(229)		486
Total	$	(157)	$	(194)	$	594

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(a)Reflects forward contracts between Ford Credit and an affiliated company.

NOTE 7. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)

Balance Sheet Effect of Derivative Financial Instruments

Derivative assets and liabilities are reported on the balance sheets at fair value and are presented on a gross basis. The notional amounts of the derivative instruments do not necessarily represent amounts exchanged by the parties and are not a direct measure of our financial exposure. We also enter into master agreements with counterparties that may allow for netting of exposures in the event of default or breach of the counterparty agreement. Collateral represents cash received or paid under reciprocal arrangements that we have entered into with our derivative counterparties, which we do not use to offset our derivative assets and liabilities.

The fair value of our derivative instruments and the associated notional amounts at December 31 were as follows (in millions):

	2019						2020
	Notional		Fair Value of Assets		Fair Value of Liabilities		Notional		Fair Value of Assets		Fair Value of Liabilities
Fair value hedges
Interest rate contracts	$	26,577	$	702	$	19	$	26,924	$	1,331	$	4
Cross-currency interest rate swaps	—		—		—		885		46		—
Derivatives not designated as hedging instruments
Interest rate contracts	68,914		275		191		70,318		663		439
Foreign currency exchange contracts	5,540		17		79		4,378		4		80
Cross-currency interest rate swap contracts	5,849		134		67		6,849		557		1
Total derivative financial instruments, gross (a) (b)	$	106,880	$	1,128	$	356	$	109,354	$	2,601	$	524

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(a)At December 31, 2019 and 2020, we held collateral of $18 million and $9 million, and we posted collateral of $78 million and $96 million, respectively.

(b)At December 31, 2019 and 2020, the fair value of assets and liabilities available for counterparty netting was $169 million and $204 million, respectively. All derivatives are categorized within Level 2 of the fair value hierarchy.