Fair Value Option

9 Months Ended

Sep. 30, 2011

Fair Value Option and Fair Value Measurements [Abstract]


8.	*Fair Value Option*

We have elected fair value option (“FVO”) reporting for certain of our fixed rate debt issuances. At September 30, 2011, fixed rate debt accounted for under FVO totaled $16.5 billion, of which $16.0 billion is included as a component of long-term debt and $425 million is included as a component of due to affiliates. At September 30, 2011, we had not elected FVO for $12.3 billion of fixed rate long-term debt carried on our balance sheet. Fixed rate debt accounted for under FVO at September 30, 2011 has an aggregate unpaid principal balance of $16.1 billion which included a foreign currency translation adjustment relating to our foreign denominated FVO debt which increased the debt balance by $455 million.

At December 31, 2010, fixed rate debt accounted for under FVO totaled $21.3 billion, of which $20.8 billion was included as a component of long-term debt and $436 million was included as a component of due to affiliates. At December 31, 2010, we had not elected FVO for $16.8 billion of fixed rate long-term debt carried on our balance sheet. Fixed rate debt accounted for under FVO at December 31, 2010 had an aggregate unpaid principal balance of $20.4 billion which included a foreign currency translation adjustment relating to our foreign denominated FVO debt which increased the debt balance by $404 million.

We determine the fair value of the fixed rate debt accounted for under FVO through the use of a third party pricing service. Such fair value represents the full market price (credit and interest rate impact) based on observable market data for the same or similar debt instruments. See Note 14, “Fair Value Measurements,” for a description of the methods and significant assumptions used to estimate the fair value of our fixed rate debt accounted for under FVO.

The components of gain on debt designated at fair value and related derivatives are as follows:


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2011			2010			2011			2010

	(in millions)

Mark-to-market on debt designated at fair value⁽¹⁾:
Interest rate component	$	(184	)	$	(176	)	$	(52	)	$	(665	)
Credit risk component		679			(190	)		614			200

Total mark-to-market on debt designated at fair value		495			(366	)		562			(465	)
Mark-to-market on the related derivatives⁽¹⁾		146			175			(28	)		460
Net realized gains on the related derivatives		151			190			474			607

Gain on debt designated at fair value and related derivatives	$	792		$	(1	)	$	1,008		$	602

⁽¹⁾

Mark-to-market on debt designated at fair value and related derivatives excludes market value changes due to fluctuations in foreign currency exchange rates. Foreign currency translation gains (losses) recorded in derivative related income (expense) associated with debt designated at fair value was a gain of $241 million and a loss of $51 million during the three and nine months ended September 30, 2011, respectively, compared to a loss of $434 million and a gain of $57 million for the three and nine months ended September 2010, respectively. Offsetting gains (losses) recorded in derivative related income (expense) associated with the related derivatives was a loss of $241 million and a gain of $51 million during the three and nine months ended September 30, 2011, respectively, compared to a gain of $434 million and a loss of $57 million during the three and nine months ended September, 30, 2010, respectively.

The movement in the fair value reflected in gain on debt designated at fair value and related derivatives includes the effect of credit spread changes and interest rate changes, including any economic ineffectiveness in the relationship between the related swaps and our debt and any realized gains or losses on those swaps. With respect to the credit component, as credit spreads narrow accounting losses are booked and the reverse is true if credit spreads widen. Differences arise between the movement in the fair value of our debt and the fair value of the related swap due to the different credit characteristics and differences in the calculation of fair value for debt and derivatives. The size and direction of the accounting consequences of such changes can be volatile from period to period but do not alter the cash flows intended as part of the documented interest rate management strategy. On a cumulative basis, we have recorded fair value option adjustments which increased the value of our debt by $311 million and $873 million at September 30, 2011 and December 31, 2010, respectively.

The change in the fair value of the debt and the change in value of the related derivatives reflect the following:


	•	Interest rate curve – A significant decrease in U.S. interest rates for periods greater than two years during the third quarter of 2011 resulted in a loss in the interest rate component on the mark-to-market of the debt and a gain on the mark-to-market of the related derivative. During the third quarter of 2010 U.S. interest rates decreased resulting in a loss in the interest rate component on the mark-to-market of the debt and a gain on the mark-to-market of the related derivative. While long-term rates were lower during the nine months ended September 30, 2011, changes in market movements on certain debt and related derivatives that mature in the near term resulted in a loss in the interest rate component on the mark-to-market of the debt and a loss on the mark-to-market of the related derivative. As these items near maturity, their values are less sensitive to interest rate movements. A decrease in long term U.S. interest rates for the nine months ending September 30, 2010 resulted in a loss in the interest rate component on the mark-to-market of the debt and a corresponding gain on the mark-to-market of the related derivative. Changes in the value of the interest rate component of the debt as compared to the related derivative are also affected by differences in cash flows and valuation methodologies for the debt and the derivatives. Cash flows on debt are discounted using a single discount rate from the bond yield curve for each bond’s applicable maturity while derivative cash flows are discounted using rates at multiple points along an interest rate yield curve. The impacts of these differences vary as short-term and long-term interest rates shift and time passes. Furthermore, certain derivatives have been called by the counterparty resulting in certain FVO debt having no related derivatives. Approximately 3 percent and 7 percent of our FVO debt does not have a corresponding derivative at September 30, 2011 and December 31, 2010, respectively.


	•	Credit – Our secondary market credit spreads widened substantially during the third quarter of 2011 due to the continuing concerns with the European sovereign debt crisis which has caused spreads to widen throughout the financial services industry as well as the uncertain economic recovery in the United States. During the third quarter of 2010 our secondary spreads tightened as marketplace liquidity improved throughout the quarter. During the first nine months of 2011, the widening of our credit spreads observed during the current quarter offset the overall tightening of our credit spreads recognized during the first half of 2011. During the same period 2010, the tightening of our credit spreads due to improved market place liquidity reversed the widening of our credit spreads during the first half of 2010.

Net income volatility, whether based on changes in the interest rate or credit risk components of the mark-to-market on debt designated at fair value and the related derivatives, impacts the comparability of our reported results between periods. Accordingly, gain on debt designated at fair value and related derivatives for the nine months ended September 30, 2011 should not be considered indicative of the results for any future periods.

- Definition

The entire disclosure for a company's election to apply the fair value option for measurement and reporting of eligible financial assets and liabilities (as defined), as well as certain other eligible items (as defined) included in the statement of financial position, whether such option is elected for a single eligible item or a group of similar eligible items and is in addition to other disclosures concerning fair value which the company may be required to provide. Such disclosure might be expected to include: (1) for items included in the statement of financial position: (a) the reasons for electing a fair value option for each eligible item or group of similar eligible items; (b) if the fair value option is elected for some but not all eligible items within a group of similar eligible items: (i) a description of those similar items and the reasons for partial election and (ii) information of how the group of similar items relates to individual balance sheet line items; (c) for each line item in the statement of financial position that includes an item or items for which the fair value option has been elected: (i) information of how each line item in the statement of financial position relates to major categories of assets and liabilities presented in accordance with other fair value disclosures and (ii) the aggregate carrying amount of ineligible items included in each line item in the balance sheet, if any; (d) the difference between the aggregate fair value and the aggregate unpaid principal balance (assuming contractual principal amounts and fair value option elected) of: (i) loans and long-term receivables (other than securities otherwise reported at fair value) and (ii) long-term debt instruments; (e) for loans held as assets for which the fair value option has been elected: (i) the aggregate fair value of loans that are 90 days or more past due, (ii) if the policy is to recognize interest income separately from other changes in fair value, the aggregate fair value of loans in nonaccrual status, and (iii) the difference between the aggregate fair value and the aggregate unpaid principal balance for loans that are 90 days or more past due, in nonaccrual status, or both; (f) for investments that would have been accounted for under the equity method if the entity had not chosen to apply the fair value option, the information required for such investments, if material either individually or in the aggregate; (2) for items included in the income statement: (a) the amounts of gains and losses from fair value changes included in earnings and in which line in the income statement those gains and losses are reported whether or not combined with gains and losses from items required to be accounted for at fair value; (b) a description of how interest and dividends are measured and where they are reported in the income statement; (c) for loans and other receivables held as assets: (i) the estimated amount of gains or losses included in earnings attributable to changes in instrument-specific credit risk and (ii) how the gains or losses attributable to changes in instrument-specific credit risk were determined; (d) for liabilities with fair values that have been significantly affected during the reporting period by changes in the instrument-specific credit risk: (i) the estimated amount of gains and losses from fair value changes included in earnings that are attributable to changes in the instrument-specific credit risk, (ii) qualitative information about the reasons for those changes, and (iii) how the gains and losses attributable to changes in instrument-specific credit risk were determined; and (3) certain other disclosures as required or determined to be provided.

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