Derivatives, Hedging Activities and Interest Expense

3 Months Ended

Sep. 30, 2012

Derivatives, Hedging Activities and Interest Expense [Abstract]

Derivatives, Hedging Activities and Interest Expense

Note 7 – Derivatives, Hedging Activities and Interest Expense

Derivative Instruments

We use derivatives as part of our risk management strategy to hedge against changes in interest rate and foreign currency risks. We manage these risks by entering into derivative transactions with the intent to minimize fluctuations in earnings, cash flows and fair value adjustments of assets and liabilities caused by market volatility. We enter into derivatives for risk management purposes only, and our use of derivatives is limited to the management of interest rate and foreign currency risks.

Our derivative activities are authorized and monitored by our Asset-Liability Committee, which provides a framework for financial controls and governance to manage market risks. We use internal models for analyzing and incorporating data from internal and external sources in developing various hedging strategies. We incorporate the resulting hedging strategies into our overall risk management strategies.

Our approach to asset-liability management involves hedging our risk exposures so that changes in interest rates have a limited effect on our net interest margin and cash flows. Our liabilities consist mainly of fixed and floating rate debt, denominated in various currencies, which we issue in the global capital markets, while our assets consist primarily of U.S. dollar denominated, fixed rate receivables. We enter into interest rate swapsand foreign currency swaps to hedge the interest rate and foreign currency risks that result from the different characteristics of our assets and liabilities. Our resulting asset liability profile is consistent with the overall risk management strategy directed by the Asset-Liability Committee. Gains and losses on these derivatives are recorded in interest expense.

Credit Risk Related Contingent Features

Certain of our derivative contracts are governed by International Swaps and Derivatives Association (“ISDA”) Master Agreements. Substantially all of these ISDA Master Agreements contain reciprocal ratings triggers providing either party with an option to terminate the agreement at market value in the event of a ratings downgrade of the other party below a specified threshold. These agreements require the transfer of collateral on either a monthly or daily basis depending on the counterparty. As of September 30, 2012, we had implemented daily valuation and collateral exchange arrangements with nearly all of our counterparties on a zero threshold, fully-collateralized basis. Our remaining agreements require monthly collateral exchanges in the amount by which a party's net derivatives position exceeds its specified ratings-basedthreshold.

The aggregate fair value of derivative instruments that contain credit risk related contingent features that were in a net liability position at September 30, 2012 was $19 million, excluding embedded derivatives and adjustments made for our own non-performance risk.If our credit ratings declined by one notch, we would not be required to post additional collateral. If our ratings were to decline by two notches or more, we would be required to post an additional $4 million of collateral to the counterparties with which we were in a net liability position at September 30, 2012. In order to settle all derivative instruments that were in a net liability position at September 30, 2012, excluding embedded derivatives and adjustments made for our own non-performance risk, we would be required to pay $19 million.

Note 7 - Derivatives, Hedging Activities and Interest Expense (Continued)
Derivative Activity Impact on Financial Statements
The table below shows the location and amount of derivatives at September 30, 2012 as reported in the
Consolidated Balance Sheet:
		Hedge accounting				Non-hedge				Total
		derivatives				accounting derivatives
		Notional		Fair		Notional		Fair		Notional		Fair
(Dollars in millions)					value				value				value
Other assets
Interest rate swaps		$	465	$	54	$	18,093	$	661	$	18,558	$	715
Foreign currency swaps			1,259		639		8,338		1,289		9,597		1,928
	Total	$	1,724	$	693	$	26,431	$	1,950	$	28,155	$	2,643
Counterparty netting and collateral													(2,594)
	Carrying value of derivative contracts – Other assets											$	49
Other liabilities
Interest rate swaps		$	-	$	-	$	50,535	$	1,018	$	50,535	$	1,018
Interest rate caps			-		-		50		-		50		-
Foreign currency swaps			900		39		231		12		1,131		51
Embedded derivatives			-		-		79		23		79		23
	Total	$	900	$	39	$	50,895	$	1,053	$	51,795	$	1,092
Counterparty netting and collateral													(1,050)
	Carrying value of derivative contracts – Other liabilities											$	42

Collateral represents cash received or deposited under reciprocal arrangements that we have entered into with our derivative counterparties. As of September 30, 2012, we held collateral of $1,640 million which offset derivative assets and posted collateral of $96million which offset derivative liabilities. We also held collateral of $130 million which we did not use to offset derivative assets. 

Note 7 – Derivatives, Hedging Activities and Interest Expense (Continued)
Derivative Activity Impact on Financial Statements
The table below shows the location and amount of derivatives at March 31, 2012 as reported in the
Consolidated Balance Sheet:
		Hedge accounting				Non-hedge				Total
		derivatives				accounting derivatives
		Notional		Fair		Notional		Fair		Notional		Fair
(Dollars in millions)					value				value				value
Other Assets
Interest rate swaps		$	465	$	59	$	15,804	$	380	$	16,269	$	439
Foreign currency swaps			3,291		772		9,866		1,449		13,157		2,221
	Total	$	3,756	$	831	$	25,670	$	1,829	$	29,426	$	2,660
Counterparty netting and collateral held													(2,590)
	Carrying value of derivative contracts – Other assets											$	70
Other liabilities
Interest rate swaps		$	-	$	-	$	51,175	$	1,008	$	51,175	$	1,008
Interest rate caps			-		-		50		-		50		-
Foreign currency swaps			437		29		987		44		1,424		73
Embedded derivatives			-		-		92		24		92		24
	Total	$	437	$	29	$	52,304	$	1,076	$	52,741	$	1,105
Counterparty netting and collateral held													(1,038)
	Carrying value of derivative contracts – Other liabilities											$	67

Collateral represents cash received or deposited under reciprocal arrangements that we have entered into with ourderivative counterparties. As of March 31, 2012, we held collateral of $1,748 million which offset derivative assets and posted collateral of $196million which offset derivative liabilities.

Note 7 – Derivatives, Hedging Activities and Interest Expense (Continued)

The following table summarizes the components of interest expense, including the location and amount of gains or losses on derivative instruments and related hedged items, for the three and six months ended September 30, 2012 and 2011 as reported in our Consolidated Statement of Income:

			Three Months Ended					Six Months Ended
			September 30,				September 30,
(Dollars in millions)				2012		2011		2012		2011
Interest expense on debt			$	347	$	405	$	684	$	886
Interest expense on hedge accounting derivatives				(27)		(54)		(54)		(135)
Interest expense on non-hedge accounting foreign currency
	swaps			(67)		(87)		(134)		(219)
Interest expense on non-hedge accounting interest rate swaps				95		173		198		353
		Interest expense on debt and derivatives		348		437		694		885
Loss (gain) on hedge accounting derivatives:
	Interest rate swaps			2		(7)		5		(14)
	Foreign currency swaps			(8)		306		111		(94)
		(Gain) loss on hedge accounting derivatives		(6)		299		116		(108)
Less hedged item: change in fair value of fixed rate debt				3		(302)		(122)		101
		Ineffectiveness related to hedge accounting derivatives		(3)		(3)		(6)		(7)
Loss (gain) from foreign currency transactions and non-hedge
accounting derivatives:
		Loss (gain) on foreign currency transactions		196		(999)		152		(295)
		(Gain) loss on foreign currency swaps		(206)		780		(238)		(29)
		(Gain) loss on interest rate swaps		(52)		(66)		(261)		52
Total interest expense			$	283	$	149	$	341	$	606

Interest expense on debt and derivatives represents net interest settlements and changes in accruals. Gains and losses from hedge accounting derivatives and foreign currency transactions exclude net interest settlements and changes in accruals.

The following table summarizes the relative fair value allocation of derivative credit valuation adjustments within interest expense.

	Three Months Ended				Six Months Ended
	September 30,				September 30,
(Dollars in millions)		2012		2011		2012		2011
(Gain) loss related to hedge accounting derivatives	$	(2)	$	3	$	(1)	$	5
(Gain) loss on non-hedge accounting foreign currency swaps		(4)		2		-		7
(Gain) loss on non-hedge accounting interest rate swaps		(1)		1		-		2
Total credit valuation adjustment allocated to interest expense	$	(7)	$	6	$	(1)	$	14