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 foreign currency exchange rates, certain commodity prices, and interest rates. To manage these risks, we enter into various derivatives contracts:
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• | Foreign currency exchange contracts, including forwards and options, that are used to manage foreign exchange exposure; |
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• | Commodity contracts, including forwards and options, that are used to manage commodity price risk; |
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• | Interest rate contracts including swaps, caps, and floors that are used to manage the effects of interest rate fluctuations; and |
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• | Cross-currency interest rate swap contracts that are used to manage foreign currency and interest rate exposures on foreign-denominated debt. |
Our derivatives are over-the-counter customized derivative transactions and are not exchange-traded. We review our hedging program, derivative positions, and overall risk management strategy on a regular basis.
Derivative Financial Instruments and Hedge Accounting. Derivatives are recorded on the balance sheet at fair value and presented on a gross basis.
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. Regardless, we only enter into transactions that we believe will be highly effective at offsetting the underlying economic risk.
Cash Flow Hedges. Our Automotive sector has designated certain forward contracts as cash flow hedges of forecasted transactions with exposure to foreign currency exchange risk.
NOTE 16. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)
The effective portion of changes in the fair value of cash flow hedges is deferred in Accumulated other comprehensive income/(loss) and is recognized in Automotive cost of sales when the hedged item affects earnings. The ineffective portion is reported in Automotive cost of sales in the period of measurement. Our policy is to de-designate cash flow hedges prior to the time forecasted transactions are recognized as assets or liabilities on the balance sheet and report subsequent changes in fair value through Automotive cost of sales. If it becomes probable that the originally-forecasted transaction will not occur, the related amount included in Accumulated other comprehensive income/(loss) is reclassified and recognized in earnings. The majority of our cash flow hedges mature in two years or less.
Fair Value Hedges. Our Financial Services sector uses derivatives to reduce the risk of changes in the fair value of debt. We have designated certain receive-fixed, pay-float 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. If the hedge relationship is deemed to be highly effective, we record the changes in the fair value of the hedged debt related to the risk being hedged in Financial Services debt with the offset in Financial Services other income/(loss), net. The change in fair value of the related derivative (excluding accrued interest) also is recorded in Financial Services other income/(loss), net. Net interest settlements and accruals on fair value hedges are excluded from the assessment of hedge effectiveness and 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 statement of cash flows.
Hedge ineffectiveness is the difference between the change in fair value of the derivative instrument and the change in fair value of the hedged item attributable to changes in the benchmark interest rate. Ineffectiveness is recorded directly to income.
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 amortized over its remaining life.
Derivatives Not Designated as Hedging Instruments. Our Automotive sector reports changes in the fair value of derivatives not designated as hedging instruments through Automotive cost of sales. 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.
Our Financial Services sector reports net interest settlements and accruals and changes in the fair value of interest rate swaps not designated as hedging instruments in Financial Services other income/(loss) 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 Financial Services other income/(loss) 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.
Normal Purchases and Normal Sales Classification. We have elected to apply the normal purchases and normal sales classification for physical supply contracts that are entered into for the purpose of procuring commodities to be used in production over a reasonable period in the normal course of our business.
NOTE 16. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)
Income Effect of Derivative Financial Instruments
The following table summarizes by hedge designation the pre-tax gains/(losses) recorded in Other comprehensive income/(loss) (“OCI”), reclassified from Accumulated other comprehensive income/(loss) (“AOCI”) to income and/or recognized directly in income for the years ended December 31 (in millions):
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| 2013 | | 2012 | | 2011 |
| Gains/(Losses) Recorded in OCI | | Gains/(Losses) Reclassified from AOCI to Income | | Gains/(Losses) Recognized in Income | | Gains/(Losses) Recorded in OCI | | Gains/(Losses) Reclassified from AOCI to Income | | Gains/(Losses) Recognized in Income | | Gains/(Losses) Recorded in OCI | | Gains/(Losses) Reclassified from AOCI to Income | | Gains/(Losses) Recognized in Income |
Automotive Sector | | | | | | | | | | | | | | | | | |
Cash flow hedges | | | | | | | | | | | | | | | | | |
Foreign currency exchange contracts | $ | 317 |
| | $ | (80 | ) | | $ | (3 | ) | | $ | (371 | ) | | $ | (377 | ) | | $ | 1 |
| | $ | (100 | ) | | $ | 119 |
| | $ | (3 | ) |
Derivatives not designated as hedging instruments | |
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Foreign currency exchange contracts | |
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| | $ | (26 | ) | | |
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| | $ | (138 | ) | | | | | | $ | 20 |
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Commodity contracts | |
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| | (84 | ) | | |
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| | (65 | ) | | | | | | (423 | ) |
Other – warrants | |
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| | — |
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| | (4 | ) | | | | | | (1 | ) |
Total | |
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| | $ | (110 | ) | | |
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| | $ | (207 | ) | | | | | | $ | (404 | ) |
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Financial Services Sector | |
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Fair value hedges | |
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Interest rate contracts | |
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Net interest settlements and accruals excluded from the assessment of hedge effectiveness | |
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| | $ | 254 |
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| | $ | 177 |
| | | | | | $ | 217 |
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Ineffectiveness (a) | |
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| | (44 | ) | | |
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| | 16 |
| | | | | | (30 | ) |
Total | |
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| | $ | 210 |
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| | $ | 193 |
| | | | | | $ | 187 |
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Derivatives not designated as hedging instruments | |
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Interest rate contracts | |
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| | $ | (33 | ) | | |
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| | $ | (14 | ) | | | | | | $ | (5 | ) |
Foreign currency exchange contracts | |
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| | 21 |
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| | (70 | ) | | | | | | (48 | ) |
Cross-currency interest rate swap contracts | |
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| | (88 | ) | | |
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| | (150 | ) | | | | | | (3 | ) |
Other (b) | |
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| | — |
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| | (81 | ) | | | | | | 65 |
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Total | |
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| | $ | (100 | ) | | |
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| | $ | (315 | ) | | | | | | $ | 9 |
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__________
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(a) | For 2013, 2012, and 2011, hedge ineffectiveness reflects change in fair value on derivatives of $658 million loss, $228 million gain, and $433 million gain, respectively, and change in value on hedged debt attributable to the change in benchmark interest rate of $614 million gain, $212 million loss, and $463 million loss, respectively. |
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(b) | Reflects gains/(losses) for derivative features included in the FUEL Notes (see Note 4). |
NOTE 16. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)
Balance Sheet Effect of Derivative Financial Instruments
The following table summarizes the notional amount and estimated fair value of our derivative financial instruments (in millions):
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| December 31, 2013 | | December 31, 2012 |
| Notional | | Fair Value of Assets | | Fair Value of Liabilities | | Notional | | Fair Value of Assets | | Fair Value of Liabilities |
Automotive Sector | | | | | | | | | | | |
Cash flow hedges | | | | | | | | | | | |
Foreign currency exchange contracts | $ | 16,238 |
| | $ | 413 |
| | $ | 189 |
| | $ | 17,663 |
| | $ | 150 |
| | $ | 357 |
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Derivatives not designated as hedging instruments | | | | | | | | | | | |
Foreign currency exchange contracts | 11,599 |
| | 144 |
| | 210 |
| | 9,225 |
| | 68 |
| | 129 |
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Commodity contracts | 3,006 |
| | 23 |
| | 19 |
| | 1,854 |
| | 23 |
| | 124 |
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Total derivatives not designated as hedging instruments | 14,605 |
| | 167 |
| | 229 |
| | 11,079 |
| | 91 |
| | 253 |
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Total Automotive sector derivative financial instruments | $ | 30,843 |
| | $ | 580 |
| | $ | 418 |
| | $ | 28,742 |
| | $ | 241 |
| | $ | 610 |
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Financial Services Sector | |
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Fair value hedges | |
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Interest rate contracts | $ | 18,778 |
| | $ | 360 |
| | $ | 179 |
| | $ | 16,754 |
| | $ | 787 |
| | $ | 8 |
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Derivatives not designated as hedging instruments | | | | | | | | | | | |
Interest rate contracts | 69,863 |
| | 224 |
| | 126 |
| | 68,919 |
| | 504 |
| | 248 |
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Foreign currency exchange contracts | 2,410 |
| | 1 |
| | 25 |
| | 2,378 |
| | 9 |
| | 8 |
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Cross-currency interest rate swap contracts | 2,620 |
| | — |
| | 176 |
| | 3,006 |
| | — |
| | 117 |
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Total derivatives not designated as hedging instruments | 74,893 |
| | 225 |
| | 327 |
| | 74,303 |
| | 513 |
| | 373 |
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Total Financial Services sector derivative financial instruments | $ | 93,671 |
| | $ | 585 |
| | $ | 506 |
| | $ | 91,057 |
| | $ | 1,300 |
| | $ | 381 |
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Notional amounts are presented on a gross basis. The notional amounts of the derivative financial instruments do not represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates, or commodity volumes and prices.
On our consolidated balance sheet, derivative assets are reported in Other assets for Automotive and Financial Services sectors, and derivative liabilities are reported in Payables for our Automotive sector and in Other liabilities and deferred revenue for our Financial Services sector.
NOTE 16. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)
Counterparty Risk and Collateral
The use of derivatives exposes us to the risk that a counterparty may default on a derivative contract. We establish exposure limits for each counterparty to minimize this risk and provide counterparty diversification. Substantially all of our derivative exposures are with counterparties that have an investment grade rating. The aggregate fair value of our derivative instruments in asset positions on December 31, 2013 was $1.2 billion, representing the maximum loss that we would recognize at that date if all counterparties failed to perform as contracted. We enter into master agreements with counterparties that may allow for netting of exposures in the event of default or termination of the counterparty agreement due to breach of contract.
The gross and net amounts of derivative assets and liabilities were as follows (in millions):
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| December 31, 2013 | | December 31, 2012 |
| Fair Value of Assets | | Fair Value of Liabilities | | Fair Value of Assets | | Fair Value of Liabilities |
Automotive Sector | | | | | | | |
Gross derivative amounts recognized in balance sheet | $ | 580 |
| | $ | 418 |
| | $ | 241 |
| | $ | 610 |
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Gross derivative amounts not offset in the balance sheet that are eligible for offsetting | (359 | ) | | (359 | ) | | (218 | ) | | (218 | ) |
Net amount | $ | 221 |
| | $ | 59 |
| | $ | 23 |
| | $ | 392 |
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Financial Services Sector | | | | | | | |
Gross derivative amounts recognized in balance sheet | $ | 585 |
| | $ | 506 |
| | $ | 1,300 |
| | $ | 381 |
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Gross derivative amounts not offset in the balance sheet that are eligible for offsetting | (296 | ) | | (296 | ) | | (222 | ) | | (222 | ) |
Net amount | $ | 289 |
| | $ | 210 |
| | $ | 1,078 |
| | $ | 159 |
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We may receive or pledge cash collateral with certain counterparties based on our net position with regard to foreign currency and commodity derivative contracts, which is reported in Other Assets or Payables on our consolidated balance sheet. As of December 31, 2013 and 2012, we did not receive or pledge any cash collateral.
We include an adjustment for non-performance risk in the measurement of fair value of derivative instruments. Our adjustment for non-performance risk is relative to a measure based on an unadjusted inter-bank deposit rate (e.g., LIBOR). For our Automotive sector, at December 31, 2013 and 2012, our adjustment decreased derivative assets by $1 million and $1 million, respectively, and decreased derivative liabilities by $1 million and $1 million, respectively. For our Financial Services sector, at December 31, 2013 and 2012, our adjustment increased derivative assets by $2 million and decreased derivative assets by $14 million, respectively, and decreased derivative liabilities by $25 million and $5 million, respectively. See Note 4 for more detail on valuation methodologies.
