DERIVATIVE INSTRUMENTS

3 Months Ended

Jan. 31, 2013

DERIVATIVE INSTRUMENTS

DERIVATIVE INSTRUMENTS

(16) 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’s financial services operations manage the relationship of the types and amounts of their funding sources to their 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 buying, selling and 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.

Certain of the Company’s derivative agreements contain credit support provisions that may require the Company to post collateral based on reductions in credit ratings.  The aggregate fair value of all derivatives with credit-risk-related contingent features that were in a net liability position at January 31, 2013, October 31, 2012 and January 31, 2012, was $36 million, $32 million and $13 million, respectively.  The Company, due to its credit rating and amounts of net liability position, has not posted any collateral.  If the credit-risk-related contingent features were triggered, the Company would be required to post full collateral for this 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 counterparty exposure by setting limits that consider the credit rating of the counterparty and the size of other financial commitments and exposures between the Company and the counterparty banks.  All interest rate derivatives are transacted under International Swaps and Derivatives Association (ISDA) documentation.  Some of these agreements include credit support provisions.  Each master agreement permits the net settlement of amounts owed in the event of default.  The maximum amount of loss that the Company would incur if counterparties to derivative instruments fail to meet their obligations, not considering collateral received or netting arrangements, was $600 million, $637 million and $584 million as of January 31, 2013, October 31, 2012 and January 31, 2012, respectively.  The amount of collateral received at January 31, 2013, October 31, 2012 and January 31, 2012 to offset this potential maximum loss was $95 million, $102 million and $38 million, respectively.  The netting provisions of the agreements would reduce the maximum amount of loss the Company would incur if the counterparties to derivative instruments fail to meet their obligations by an additional $91 million, $92 million and $81 million as of January 31, 2013, October 31, 2012 and January 31, 2012, respectively.  None of the concentrations of risk with any individual counterparty was considered significant in any periods presented.

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 January 31, 2013, October 31, 2012 and January 31, 2012 were $3,100 million, $2,850 million and $1,600 million, respectively.  The notional amounts of cross-currency interest rate contracts at January 31, 2013, October 31, 2012 and January 31, 2012 were $923 million, $923 million and $853 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 other operating expenses (foreign exchange) in the same periods during which the hedged transactions affect earnings.  These amounts offset the effects of interest rate or foreign currency changes on the related borrowings.  Any ineffective portions of the gains or losses on all cash flow interest rate contracts designated as hedges were recognized currently in interest expense or other 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 consolidated statement of cash flows.

The amount of loss recorded in OCI at January 31, 2013 that is expected to be reclassified to interest expense or other operating expenses in the next twelve months if interest rates or exchange rates remain unchanged is approximately $9 million after-tax.  These contracts mature in up to 68 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 January 31, 2013, October 31, 2012 and January 31, 2012 were $9,025 million, $9,266 million and $7,892 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.  During the first three months of 2013 and 2012, the ineffective portions were a gain of $2 million and a loss of $3 million, respectively.  The cash flows from these contracts were recorded in operating activities in the consolidated statement of cash flows.

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

	Three Months Ended January 31
	2013		2012
Interest rate contracts *	$	(73)	$	107
Borrowings **	75		(110)

* Includes changes in fair values of interest rate contracts excluding net accrued interest income of $38 million and $41 million during the first three months of 2013 and 2012, respectively.

** Includes adjustment for fair values of hedged borrowings excluding accrued interest expense of $67 million and $71 million during the first three months of 2013 and 2012, 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 and purchases or sales of inventory.  The total notional amounts of these interest rate swaps at January 31, 2013, October 31, 2012 and January 31, 2012 were $4,624 million, $4,400 million and $2,693 million, the foreign exchange contracts were $4,698 million, $3,999 million and $3,253 million and the cross-currency interest rate contracts were $82 million, $78 million and $61 million, respectively.  At January 31, 2013, October 31, 2012 and January 31, 2012, there were also $1,263 million, $1,445 million and $1,505 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 cost of sales or other 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 statement of consolidated cash flows.

Fair values of derivative instruments in the condensed consolidated balance sheet in millions of dollars follow:

Other Assets	January 31 2013		October 31 2012		January 31 2012
Designated as hedging instruments:
Interest rate contracts	$	493	$	536	$	494
Cross-currency interest rate contracts	7		10		5
Total designated	500		546		499
Not designated as hedging instruments:
Interest rate contracts	64		73		75
Foreign exchange contracts	35		17		8
Cross-currency interest rate contracts	1		1		2
Total not designated	100		91		85
Total derivatives	$	600	$	637	$	584
Accounts Payable and Accrued Expenses
Designated as hedging instruments:
Interest rate contracts	$	18	$	12	$	3
Cross-currency interest rate contracts	31		58		44
Total designated	49		70		47
Not designated as hedging instruments:
Interest rate contracts	57		60		55
Foreign exchange contracts	35		18		86
Cross-currency interest rate contracts	2		1		1
Total not designated	94		79		142
Total derivatives	$	143	$	149	$	189

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

	Expense or	Three Months Ended
	OCI	January 31
	Classification	2013				2012
Fair Value Hedges:
Interest rate contracts	Interest		$	(35	)	$	148
Cash Flow Hedges:
Recognized in OCI
(Effective Portion):
Interest rate contracts	OCI (pretax) *		(2		)	(6		)
Foreign exchange contracts	OCI (pretax) *		22			(35		)
Reclassified from OCI
(Effective Portion):
Interest rate contracts	Interest *		(5		)	(3		)
Foreign exchange contracts	Other *		19			(33		)
Recognized Directly in Income
(Ineffective Portion)			**			**
Not Designated as Hedges:
Interest rate contracts	Interest *		$	1		$	(2	)
Foreign exchange contracts	Cost of sales					2
Foreign exchange contracts	Other *		(51		)	10
Total not designated			$	(50	)	$	10

*        Includes interest and foreign exchange gains (losses) from cross-currency interest rate contracts.

**      The amount is not significant.