Derivative Instruments

6 Months Ended

Apr. 30, 2012

Derivative Instruments

Derivative Instruments

(9)It is the Company’s policy that derivative transactions are executed only to manage exposures arising in the normal course of business and not for the purpose of creating speculative positions or trading. The Company manages the relationship of the types and amounts of its funding sources to its receivable and lease portfolio in an effort to diminish risk due to interest rate and foreign currency fluctuations, while responding to favorable financing opportunities. The Company also has foreign currency exposures at some of its foreign and domestic operations related to financing in currencies other than the functional currencies.

All derivatives are recorded at fair value on the balance sheet. Each derivative is designated as a cash flow hedge, a fair value hedge, or remains undesignated. All designated hedges are formally documented as to the relationship with the hedged item as well as the risk-management strategy. Both at inception and on an ongoing basis the hedging instrument is assessed as to its effectiveness. If and when a derivative is determined not to be highly effective as a hedge, or the underlying hedged transaction is no longer likely to occur, or the hedge designation is removed, or the derivative is terminated, hedge accounting is discontinued. Any past or future changes in the derivative’s fair value, which will not be effective as an offset to the income effects of the item being hedged, are recognized currently in the income statement.

The Company’s outstanding derivatives have been transacted with both unrelated external counterparties and with John Deere. For derivatives transacted with John Deere, the Company utilizes a centralized hedging center structure in which John Deere enters into a derivative transaction with an unrelated external counterparty and simultaneously enters into a derivative transaction with the Company. Except for collateral provisions, the terms of the transaction between the Company and John Deere are identical to the terms of the transaction between John Deere and its unrelated external counterparty.

Certain of the Company’s derivative agreements executed directly with unrelated external counterparties contain credit support provisions that require the Company to post collateral based on reductions in credit ratings. At April 30, 2012, October 31, 2011 and April 30, 2011, there were no aggregate liability positions for derivatives with credit-risk-related contingent features. The Company, due to its credit rating and amounts of net liability positions, has not posted any collateral. If the credit-risk-related contingent features were triggered, the Company would be required to post full collateral for any liability position, prior to considering applicable netting provisions.

Derivative instruments are subject to significant concentrations of credit risk to the banking sector. The Company manages individual unrelated external counterparty exposure by setting limits that consider the credit rating of the unrelated external counterparty and the size of other financial commitments and exposures between the Company and the unrelated external counterparty banks. All interest rate derivatives are transacted under International Swaps and Derivatives Association (ISDA) documentation. Some of these agreements executed with unrelated external counterparties include credit support provisions. Each master agreement executed with an unrelated external counterparty permits the net settlement of amounts owed in the event of early termination. The maximum amount of loss that the Company would incur on derivatives transacted directly with unrelated external counterparties, if the counterparties to those derivative transactions fail to meet their obligations, not considering collateral received or netting arrangements, was $241 million, $270 million and $308 million as of April 30, 2012, October 31, 2011 and April 30, 2011, respectively. The amount of collateral received from unrelated external counterparties at April 30, 2012, October 31, 2011 and April 30, 2011 to offset this potential maximum loss was $29 million, $25 million and none, respectively. The netting provisions of the agreements would reduce the maximum amount of loss the Company would incur if the unrelated external counterparties to derivative instruments fail to meet their obligations by an additional $66 million, $38 million and $5 million as of April 30, 2012, October 31, 2011 and April 30, 2011, respectively. None of the concentrations of risk with any individual unrelated external counterparty was considered significant in any periods presented.

The Company also has ISDA agreements with John Deere that permit the net settlement of amounts owed between counterparties in the event of early termination. In addition, the Company has agreed to absorb any losses and expenses John Deere incurs if an unrelated external counterparty fails to meet its obligations on a derivative transaction that John Deere entered into to manage exposures of the Company.  The maximum amount of loss that the Company would incur on derivatives transacted with John Deere if the unrelated external counterparty would fail to meet its obligations, considering both the netting arrangements as well as the loss sharing agreement, was $252 million, $151 million and $5 million as of April 30, 2012, October 31, 2011 and April 30, 2011, respectively.

Cash flow hedges

Certain interest rate and cross-currency interest rate contracts (swaps) were designated as hedges of future cash flows from borrowings. The total notional amounts of the receive-variable/pay-fixed interest rate contracts at April 30, 2012, October 31, 2011 and April 30, 2011 were $1,600 million, $1,350 million and $600 million, respectively. The notional amounts of cross-currency interest rate contracts at April 30, 2012, October 31, 2011 and April 30, 2011 were $853 million, $853 million and $956 million, respectively. The effective portions of the fair value gains or losses on these cash flow hedges were recorded in other comprehensive income (OCI) and subsequently reclassified into interest expense or administrative and operating expenses (foreign exchange) in the same periods during which the hedged transactions affected earnings. These amounts offset the effects of interest rate or foreign currency exchange rate changes on the related borrowings. Any ineffective portions of the gains or losses on all interest rate contracts designated as cash flow hedges were recognized currently in interest expense or administrative and operating expenses (foreign exchange) and were not material during any periods presented. The cash flows from these contracts were recorded in operating activities in the statements of consolidated cash flows.

The amount of loss recorded in OCI at April 30, 2012 that is expected to be reclassified to interest expense or administrative and operating expenses in the next twelve months if interest rates or exchange rates remain unchanged is approximately $6 million after-tax. These contracts mature in up to 29 months. There were no gains or losses reclassified from OCI to earnings based on the probability that the original forecasted transaction would not occur.

Fair value hedges

Certain interest rate contracts (swaps) were designated as fair value hedges of borrowings. The total notional amounts of these receive-fixed/pay-variable interest rate contracts at April 30, 2012, October 31, 2011 and April 30, 2011 were $8,546 million, $7,276 million and $5,846 million, respectively. The effective portions of the fair value gains or losses on these contracts were offset by fair value gains or losses on the hedged items (fixed-rate borrowings). Any ineffective portions of the gains or losses were recognized currently in interest expense. The ineffective portions were losses of $5 million and $1 million during the second quarter of 2012 and 2011 and were losses of $8 million and $4 million during the first six months of 2012 and 2011, respectively. The cash flows from these contracts were recorded in operating activities in the statements of consolidated cash flows.

The gains (losses) on these contracts and the underlying borrowings recorded in interest expense were as follows (in millions of dollars):

	Three Months Ended April 30,						Six Months Ended April 30,
	2012			2011			2012			2011
Interest rate contracts *	$	(20.0	)	$	(4.3	)	$	85.3		$	(124.1	)
Borrowings **	15.0			3.8			(93.5		)	120.4

*   Includes changes in fair value of interest rate contracts excluding net accrued interest income of $35.9 million and $38.6 million during the second quarter of 2012 and 2011 and $74.5 million and $81.5 million during the first six months of 2012 and 2011, respectively.

**   Includes adjustments for fair values of hedged borrowings excluding accrued interest expense of $66.0 million and $61.1 million during the second quarter of 2012 and 2011 and $131.8 million and $124.0 million during the first six months of 2012 and 2011, respectively.

Derivatives not designated as hedging instruments

The Company has certain interest rate contracts (swaps and caps), foreign exchange contracts (forwards and swaps) and cross-currency interest rate contracts (swaps), which were not formally designated as hedges. These derivatives were held as economic hedges for underlying interest rate or foreign currency exposures primarily for certain borrowings. The total notional amounts of these interest rate swaps at April 30, 2012, October 31, 2011 and April 30, 2011 were $2,109 million, $2,361 million and $2,137 million, the foreign exchange contracts were $1,362 million, $979 million and $944 million and the cross-currency interest rate contracts were $71 million, $52 million and $54 million, respectively. At April 30, 2012, October 31, 2011 and April 30, 2011 there were also $1,345 million, $1,402 million and $1,160 million, respectively, of interest rate caps purchased and the same amounts sold at the same capped interest rate to facilitate borrowings through securitization of retail notes. The fair value gains or losses from the interest rate contracts were recognized currently in interest expense and the gains or losses from foreign exchange contracts in administrative and operating expenses, generally offsetting over time the expenses on the exposures being hedged. The cash flows from these non-designated contracts were recorded in operating activities in the statements of consolidated cash flows.

Fair values of derivative instruments in the consolidated balance sheets were as follows (in millions of dollars):

	April 30, 2012		October 31,      2011		April 30, 2011
Receivable from John Deere
Designated as hedging instruments:
Interest rate contracts	$	215.8	$	133.1	$	6.3
Cross-currency interest rate contracts	6.0
Total designated	221.8		133.1		6.3
Not designated as hedging instruments:
Interest rate contracts	40.1		35.3
Cross-currency interest rate contracts	.9		.9
Total not designated	41.0		36.2
Other Assets
Designated as hedging instruments:
Interest rate contracts	205.8		237.2		255.0
Cross-currency interest rate contracts					12.7
Total designated	205.8		237.2		267.7
Not designated as hedging instruments:
Interest rate contracts	30.6		31.4		39.0
Foreign exchange contracts	3.3
Cross-currency interest rate contracts	.8		1.6		1.0
Total not designated	34.7		33.0		40.0
Total derivatives	$	503.3	$	439.5	$	314.0
Other Payables to John Deere
Designated as hedging instruments:
Interest rate contracts	$	2.0	$	13.4	$	11.0
Cross-currency interest rate contracts	1.6		1.4		4.1
Total designated	3.6		14.8		15.1
Not designated as hedging instruments:
Interest rate contracts	8.3		6.2		2.9
Cross-currency interest rate contracts	.6				.3
Total not designated	8.9		6.2		3.2
Accounts Payable and Accrued Expenses
Designated as hedging instruments:
Interest rate contracts					4.6
Cross-currency interest rate contracts	40.3		5.5
Total designated	40.3		5.5		4.6
Not designated as hedging instruments:
Interest rate contracts	40.0		37.0		9.2
Foreign exchange contracts	6.6		47.6		34.5
Cross-currency interest rate contracts	.1		.2		3.4
Total not designated	46.7		84.8		47.1
Total derivatives	$	99.5	$	111.3	$	70.0

The classification and gains (losses), including accrued interest expense related to derivative instruments on the statements of consolidated income consisted of the following (in millions of dollars):

	Expense or OCI	Three Months Ended April 30				Six Months Ended April 30
	Classification	2012		2011		2012		2011
Fair Value Hedges:
Interest rate contracts	Interest expense	$	15.9	$	34.3	$	159.8	$	(42.6)
Cash Flow Hedges:
Recognized in OCI
(Effective Portion):
Interest rate contracts	OCI (pretax) *	(2.4)		(1.5)		(8.4)		(2.9)
Foreign exchange contracts	OCI (pretax) *	4.7		72.6		(30.5)		53.7
Reclassified from OCI
(Effective Portion):
Interest rate contracts	Interest expense *	(2.9)		(6.3)		(5.6)		(15.3)
Foreign exchange contracts	Administrative and operating expenses *	.5		70.4		(32.5)		51.3
Recognized Directly in Income
(Ineffective Portion):
Interest rate contracts	Interest expense	**		**		**		**
Foreign exchange contracts	Administrative and operating expenses	**		**		**		**
Not Designated as Hedges:
Interest rate contracts	Interest expense *	$	(2.9)	$	.7	$	(4.3)	$	(4.6)
Foreign exchange contracts	Administrative and operating expenses *	6.2		(83.4)		13.8		(102.6)
Total not designated		$	3.3	$	(82.7)	$	9.5	$	(107.2)

*	Includes interest and foreign exchange gains (losses) from cross-currency interest rate contracts.
**	The amount is not significant.

Included in the above table are interest expense and administrative and operating expense amounts the Company incurred on derivatives transacted with John Deere. The amount of gain the Company recognized on these affiliate party transactions for the three months ended April 30, 2012 and 2011 was $9 million and $10 million, respectively. The amount of gain the Company recognized on these affiliate party transactions for the six months ended April 30, 2012 and 2011 was $134 million and $17 million, respectively. As referenced in the VIE section of Note 1, during the first quarter of 2011 the centralized hedging center VIE that was previously consolidated into the Company’s financial statements was merged into JDFS and thus deconsolidated from the Company. Due to this merger having occurred in January 2011, the affiliate party interest expense amounts referenced above for the six months ended April 30, 2011 relates only to activity that took place between the merger date and April 30, 2011.