Derivatives and Hedging Activities

6 Months Ended

Jun. 30, 2016

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivatives and Hedging Activities

4. Derivatives and Hedging Activities

Credco uses derivative financial instruments (derivatives) to manage exposures to various market risks. These instruments derive their value from an underlying variable or multiple variables, including interest rates and foreign exchange rates, and are carried at fair value on the Consolidated Balance Sheets. These instruments enable end users to increase, reduce or alter exposure to various market risks and, for that reason, are an integral component of Credco’s market risk management. Credco does not transact in derivatives for trading purposes.

In relation to Credco’s credit risk, under the terms of the derivative agreements it has with its various counterparties, Credco is not required to either immediately settle any outstanding liability balances or post collateral upon the occurrence of a specified credit risk-related event. Based on the assessment of credit risk of Credco’s derivative counterparties as of June 30, 2016 and December 31, 2015, Credco does not have derivative positions that warrant credit valuation adjustments.

The following table summarizes the total fair value, excluding interest accruals, of derivative assets and liabilities as of June 30, 2016 and December 31, 2015:

		Other Assets				Other Liabilities
		Fair Value				Fair Value
(Millions)		2016		2015		2016		2015
Derivatives designated as hedging instruments:
Interest rate contracts
	Fair value hedges	$	260	$	64	$	―	$	9
Foreign exchange contracts
	Net investment hedges		51		30		56		13
Total derivatives designated as hedging instruments			311		94		56		22
Derivatives not designated as hedging instruments:
	Foreign exchange contracts		303		62		15		33
Total derivatives, gross			614		156		71		55
Less: Cash collateral netting (a)			(260)		(53)		―		―
Derivative asset and derivative liability netting (b)			(28)		(33)		(28)		(33)
Total derivatives, net (c)		$	326	$	70	$	43	$	22

• Represents the offsetting of derivative instruments and the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) arising from derivative instrument(s) executed with the same counterparty under an enforceable master netting arrangement. Additionally, Credco posted $139 million and $128 million as of June 30, 2016 and December 31, 2015, respectively, as initial margin on its centrally cleared interest rate swaps; such amounts are recorded within Other assets on the Consolidated Balance Sheets and are not netted against the derivative balances.
• Represents the amount of netting of derivative assets and derivative liabilities executed with the same counterparty under an enforceable master netting arrangement.
• Credco has no individually significant derivative counterparties and therefore, no significant risk exposure to any single derivative counterparty. The total net derivative assets and derivative liabilities are presented within Other assets and Accrued interest and Other liabilities on the Consolidated Balance Sheets.

A majority of Credco’s derivative assets and liabilities as of June 30, 2016 and December 31, 2015 are subject to master netting agreements with its derivative counterparties. Credco has no derivative amounts subject to enforceable master netting arrangements that are not offset on the Consolidated Balance Sheets.

Fair Value Hedges

Credco is exposed to interest rate risk associated with its fixed-rate long-term debt. Credco uses interest rate swaps to economically convert certain fixed-rate debt obligations to floating-rate obligations at the time of issuance. Credco hedged $17.4 billion and $15.9 billion of its fixed-rate debt to floating-rate debt using interest rate swaps as of June 30, 2016 and December 31, 2015, respectively.

The following table summarizes the impact on the Consolidated Statements of Income and Retained Earnings associated with Credco’s fair value hedgesfor the three and six months ended June 30:

Three Months Ended June 30: (Millions)
	Gains (losses) recognized in income
	Derivative contract					Hedged item					Net hedge
		Amount					Amount				ineffectiveness
Derivative relationship	Income Statement Line Item	2016		2015		Income Statement Line Item	2016		2015		2016		2015
Interest rate contracts	Other expenses	$	63	$	(45)	Other expenses	$	(55)	$	45	$	8	$	―
Six Months Ended June 30: (Millions)
	Gains (losses) recognized in income
	Derivative contract					Hedged item					Net hedge
		Amount					Amount				ineffectiveness
Derivative relationship	Income Statement Line Item	2016		2015		Income Statement Line Item	2016		2015		2016		2015
Interest rate contracts	Other expenses	$	205	$	3	Other expenses	$	(201)	$	1	$	4	$	4

Credco also recognized a net reduction in interest expense on long-term debt of $34 million and $ 44 million for the three months ended June 30, 2016 and 2015, respectively, and $68million and $86million for the six months ended June 30, 2016 and 2015, respectively, primarily related to the net settlements (interest accruals) on Credco’s interest rate derivatives designated as fair value hedges.

Net Investment Hedges

The effective portion of the gain on net investment hedges, net of taxes, recorded in Accumulated Other Comprehensive Loss as part of the cumulative translation adjustment, was $51 million and $22 million for the three months ended June 30, 2016 and 2015, respectively, and $1 million and $85 million for the six months ended June 30, 2016 and 2015, respectively, with any ineffective portion recognized in Other expenses during the period of change. During the three and six months ended June 30, 2016 and 2015, Credco did not reclassify any amounts from Accumulated Other Comprehensive Loss to earnings as a component of Other expenses and no ineffectiveness was recognized in either period.

Derivatives Not Designated as Hedges

The changes in the fair value of derivatives that are not designated as hedges are intended to offset the related foreign exchange gains or losses of the underlying foreign currency exposures. The changes in the fair value of the derivatives and the related underlying foreign currency exposures resulted in a net loss of $ 1 million and a net gain of $15 million for the three months ended June 30, 2016 and 2015, respectively, and a net loss of $ 2 million and a net gain of $29 million for the six months ended June 30, 2016 and 2015, respectively, and are recognized in Other expenses.

Related to its derivatives not designated as hedges, Credco previously disclosed in Note 4 to the Consolidated Financial Statements in its Quarterly Report on Form 10 Q for the period ended June 30, 2015, a loss of $17 million for the three months ended June 30, 2015, and a loss of $31 million for the six months ended June 30, 2015. These amounts should have been disclosed as gains of $21 million and$279 million, respectively, which are the amounts used to calculate the above referenced net gains of $15 million and $29 million. These changes to the previously disclosed amounts have no impact on the Consolidated Statements of Income and Retained Earnings, Balance Sheets or Cash Flows.