DERIVATIVE FINANCIAL INSTRUMENTS AND FINANCIAL GUARANTEES
We primarily use derivatives as a risk management tool to decrease our exposure to fluctuations in the foreign currency market, and do not use derivative financial instruments for trading or speculative purposes. We are exposed to fluctuations in foreign currency exchange rates as a result of our net investment in Sears Canada. Further, Sears Canada is exposed to fluctuations in foreign currency exchange rates due to inventory purchase contracts denominated in U.S. dollars. The recorded amounts and corresponding gains on the hedging activity were not material as of February 1, 2014 and February 2, 2013 or for fiscal years 2013, 2012 and 2011.
Hedges of Net Investment in Sears Canada
During the fourth quarter of 2013, we entered into a foreign currency forward contract with a total Canadian notional value of $43 million, and with a remaining life of 0.1 years at February 1, 2014. This contract was designated and qualified as a hedge of the foreign currency exposure of our net investment in Sears Canada.
For derivatives that are designated as hedges of our net investment in Sears Canada, we assess effectiveness based on changes in forward currency exchange rates. Changes in forward rates on the derivatives are recorded in the currency translation adjustments line in accumulated other comprehensive loss and will remain there until we substantially liquidate or sell our holdings in Sears Canada.
We settled foreign currency forward contracts during 2013 and 2012 and received net amounts of $9 million and $6 million, respectively, relative to these contract settlements. As hedge accounting was applied to these contracts, an offsetting amount was recorded as a component of other comprehensive loss.
Sears Canada Hedges of Merchandise Purchases
At February 1, 2014, Sears Canada had $90 million notional amount of foreign exchange forward contracts. Sears Canada had no outstanding foreign currency forward contracts at February 2, 2013. These forward contracts are used to reduce the foreign exchange risk with respect to U.S. dollar denominated assets and liabilities and purchases of goods or services.
Sears Canada has merchandise purchase contracts denominated in U.S. currency. The merchandise purchase contracts are considered embedded derivatives under relevant accounting rules.
We record mark-to-market adjustments for the fair value of forward contracts and embedded derivatives at the end of each period. Changes in the fair value of any derivatives that are not designated as hedges are recorded in earnings each period. Sears Canada mitigates the risk of foreign currency exchange rates by entering into foreign exchange forward contracts. Since the Company's functional currency is the U.S. dollar, we are not directly exposed to the risk of exchange rate changes due to Sears Canada's contracts, and therefore we do not account for these instruments as a hedge of our foreign currency exposure risk.
Counterparty Credit Risk
We actively manage the risk of nonpayment by our derivative counterparties by limiting our exposure to individual counterparties based on credit ratings, value at risk and maturities. The counterparties to these instruments are major financial institutions with investment grade credit ratings or better at February 1, 2014 and February 2, 2013.
Financial Guarantees
We issue various types of guarantees in the normal course of business. We had the following guarantees outstanding at February 1, 2014:
|
| | | | | | | | | | | | | | | | |
millions | | Bank
Issued | | SRAC
Issued | | Other | | Total |
Standby letters of credit | | $ | 683 |
| | $ | 16 |
| | $ | — |
| | $ | 699 |
|
Commercial letters of credit | | 13 |
| | 105 |
| | — |
| | 118 |
|
Secondary lease obligations | | — |
| | — |
| | 55 |
| | 55 |
|
The secondary lease obligations related to certain store leases of previously divested Sears businesses. We remain secondarily liable if the primary obligor defaults.
