Fair Value Measurements and Derivative Instruments

We measure certain financial assets and liabilities at fair value on a recurring basis. Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. An entity is required to classify certain assets and liabilities measured at fair value based on the following fair value hierarchy that prioritizes the inputs used to measure fair value:


Level 1 –	Unadjusted quoted prices in active markets for identical assets and liabilities.


Level 2 –	Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.


Level 3 –	Unobservable inputs that are supported by little or no market activity, may be derived from internally developed methodologies based on management’s best estimate of fair value and that are significant to the fair value of the asset or liability.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect its placement within the fair value hierarchy. The following tables show, by level within the fair value hierarchy, our financial assets and liabilities that are accounted for at fair value on a recurring basis at September 30, 2017 and December 31, 2016.



	September 30, 2017
	Level 1		Level 2			Level 3		Total
Assets:
Investment securities
Money market funds / commercial paper	$	348,659	$	726,283		$	—	$	1,074,942
Equity securities	—		25,242			—		25,242
Commingled fixed income securities	1,571		22,296			—		23,867
Debt securities - U.S. and foreign governments, agencies and municipalities	118,439		18,140			—		136,579
Debt securities - corporate	—		77,761			—		77,761
Mortgage-backed / asset-backed securities	—		161,461			—		161,461
Derivatives
Interest rate swap	—		1,680			—		1,680
Foreign exchange contracts	—		62			—		62
Total assets	$	468,669	$	1,032,925		$	—	$	1,501,594
Liabilities:
Derivatives
Foreign exchange contracts	$	—	$	(389	)	$	—	$	(389	)
Total liabilities	$	—	$	(389	)	$	—	$	(389	)



	December 31, 2016
	Level 1		Level 2			Level 3		Total
Assets:
Investment securities
Money market funds / commercial paper	$	114,471	$	217,175		$	—	$	331,646
Equity securities	—		24,571			—		24,571
Commingled fixed income securities	1,536		22,132			—		23,668
Debt securities - U.S. and foreign governments, agencies and municipalities	116,822		19,358			—		136,180
Debt securities - corporate	—		69,891			—		69,891
Mortgage-backed / asset-backed securities	—		158,996			—		158,996
Derivatives
Interest rate swap	—		1,588			—		1,588
Foreign exchange contracts	—		637			—		637
Total assets	$	232,829	$	514,348		$	—	$	747,177
Liabilities:
Derivatives
Foreign exchange contracts	$	—	$	(3,717	)	$	—	$	(3,717	)
Total liabilities	$	—	$	(3,717	)	$	—	$	(3,717	)

Investment Securities

The valuation of investment securities is based on the market approach using inputs that are observable, or can be corroborated by observable data, in an active marketplace. The following information relates to our classification into the fair value hierarchy:

•

Money Market Funds / Commercial Paper: Money market funds typically invest in government securities, certificates of deposit, commercial paper and other highly liquid, low risk securities. Money market funds are principally used for overnight deposits and are classified as Level 1 when unadjusted quoted prices in active markets are available and as Level 2 when they are not actively traded on an exchange. Direct investments in commercial paper are not listed on an exchange in an active market and are classified as Level 2.


•	Equity Securities: Equity securities are comprised of mutual funds investing in U.S. and foreign common stock. These mutual funds are classified as Level 2 as they are not separately listed on an exchange.

•

Commingled Fixed Income Securities: Mutual funds that invest in a variety of fixed-income securities including securities of the U.S. government and its agencies, corporate debt, mortgage-backed securities and asset-backed securities. The value of the funds is based on the market value of the underlying investments owned by each fund, minus its liabilities, divided by the number of shares outstanding, as reported by the fund manager. These commingled funds are not listed on an exchange in an active market and are classified as Level 2.

•

Debt Securities – U.S. and Foreign Governments, Agencies and Municipalities: Debt securities are classified as Level 1 where active, high volume trades for identical securities exist. Valuation adjustments are not applied to these securities. Debt securities valued using quoted market prices for similar securities or benchmarking model derived prices to quoted market prices and trade data for identical or comparable securities are classified as Level 2.


•	Debt Securities – Corporate: Corporate debt securities are valued using recently executed transactions, market price quotations where observable, or bond spreads. The spread data used are for the same maturity as the security. These securities are classified as Level 2.


•	Mortgage-Backed Securities / Asset-Backed Securities: These securities are valued based on external pricing indices. When external index pricing is not observable, these securities are valued based on external price/spread data. These securities are classified as Level 2.

Investment securities include investments held by The Pitney Bowes Bank (the Bank), whose primary business is to provide financing solutions to clients that rent postage meters and purchase supplies. The Bank's assets and liabilities consist primarily of cash, finance receivables, short and long-term investments and deposit accounts.

Available-For-Sale Securities

Certain investment securities are classified as available-for-sale and recorded at fair value in the Condensed Consolidated Balance Sheets as cash and cash equivalents, short-term investments and other assets depending on the type of investment and maturity. Unrealized holding gains and losses are recorded, net of tax, in accumulated other comprehensive income (AOCI).

Available-for-sale securities at September 30, 2017 and December 31, 2016 consisted of the following:



	September 30, 2017
	Amortized cost		Gross unrealized gains		Gross unrealized losses			Estimated fair value
U.S. and foreign governments, agencies and municipalities	$	134,134	$	2,024	$	(850	)	$	135,308
Corporate notes and bonds	76,105		1,888		(232		)	77,761
Commingled fixed income securities	1,792		—		(22		)	1,770
Mortgage-backed / asset-backed securities	160,948		1,742		(1,229		)	161,461
Total	$	372,979	$	5,654	$	(2,333	)	$	376,300



	December 31, 2016
	Amortized cost		Gross unrealized gains		Gross unrealized losses			Estimated fair value
U.S. and foreign governments, agencies and municipalities	$	136,316	$	1,571	$	(1,707	)	$	136,180
Corporate notes and bonds	69,376		1,180		(665		)	69,891
Commingled fixed income securities	1,568		—		(32		)	1,536
Mortgage-backed / asset-backed securities	159,312		1,566		(1,882		)	158,996
Total	$	366,572	$	4,317	$	(4,286	)	$	366,603

At September 30, 2017, investment securities that were in a loss position for 12 or more continuous months had aggregate unrealized holding losses of $1 million and an estimated fair value of $90 million, and investment securities that were in a loss position for less than 12 continuous months had aggregate unrealized holding losses of $1 million and an estimated fair value of $76 million.

At December 31, 2016, investment securities that were in a loss position for 12 or more continuous months had aggregate unrealized holding losses of less than $1 million and an estimated fair value of $12 million, and investment securities that were in a loss position for less than 12 continuous months had aggregate unrealized holding losses of $4 million and an estimated fair value of $171 million.

We have not recognized an other-than-temporary impairment on any of the investment securities in an unrealized loss position because we have the ability and intent to hold these securities until recovery of the unrealized losses and we expect to receive the contractual principal and interest on these investment securities at maturity.

Scheduled maturities of available-for-sale securities at September 30, 2017 were as follows:



	Amortized cost		Estimated fair value
Within 1 year	$	42,982	$	42,865
After 1 year through 5 years	109,866		110,445
After 5 years through 10 years	61,744		62,673
After 10 years	158,387		160,317
Total	$	372,979	$	376,300

The expected payments on mortgage-backed and asset-backed securities may not coincide with their contractual maturities as borrowers have the right to prepay obligations with or without prepayment penalties.

We have not experienced any significant write-offs in our investment portfolio. The majority of our mortgage-backed securities are either guaranteed or supported by the U.S. Government. We have no investments in inactive markets that would warrant a possible change in our pricing methods or classification within the fair value hierarchy.

Derivative Instruments

In the normal course of business, we are exposed to the impact of changes in foreign currency exchange rates and interest rates. We limit these risks by following established risk management policies and procedures, including the use of derivatives. We use derivative instruments to limit the effects of exchange rate fluctuations on financial results and manage the related cost of debt. We do not use derivatives for trading or speculative purposes. We record derivative instruments at fair value and the accounting for changes in the fair value depends on the intended use of the derivative, the resulting designation and the effectiveness of the instrument in offsetting the risk exposure it is designed to hedge.

Foreign Exchange Contracts

We enter into foreign exchange contracts to mitigate the currency risk associated with the anticipated purchase of inventory between affiliates and from third parties. These contracts are designated as cash flow hedges. The effective portion of the gain or loss on cash flow hedges is included in AOCI in the period that the change in fair value occurs and is reclassified to earnings in the period that the hedged item is recorded in earnings. At September 30, 2017 and December 31, 2016, we had outstanding contracts associated with these anticipated transactions with notional amounts of $12 million and $13 million, respectively.

The valuation of foreign exchange derivatives is based on the market approach using observable market inputs, such as foreign currency spot and forward rates and yield curves. We have not seen a material change in the creditworthiness of those banks acting as derivative counterparties.

Interest Rate Swap

We entered into an interest rate swap with a notional amount of $300 million to mitigate the interest rate risk associated with our $300 million variable-rate term loans. The swap is designated as a cash flow hedge. The effective portion of the gain or loss on the cash flow hedge is included in AOCI in the period that the change in fair value occurs and is reclassified to earnings in the period that the hedged item is recorded in earnings. Under the terms of the swap agreement, we pay fixed-rate interest of 0.8826% and receive variable-rate interest based on 1-month LIBOR. The variable interest rate resets monthly.

The valuation of our interest rate swap is based on the income approach using a model with inputs that are observable or that can be derived from or corroborated by observable market data.

The fair value of derivative instruments at September 30, 2017 and December 31, 2016 was as follows:



Designation of Derivatives	Balance Sheet Location	September 30, 2017			December 31, 2016
Derivatives designated as hedging instruments
Foreign exchange contracts	Other current assets and prepayments	$	3		$	487
	Accounts payable and accrued liabilities	(309		)	(136		)

Interest rate swap	Other assets	1,680			1,588

Derivatives not designated as hedging instruments
Foreign exchange contracts	Other current assets and prepayments	59			150
	Accounts payable and accrued liabilities	(80		)	(3,581		)

	Total derivative assets	$	1,742		$	2,225
	Total derivative liabilities	(389		)	(3,717		)
	Total net derivative asset (liabilities)	$	1,353		$	(1,492	)

The majority of the amounts included in AOCI at September 30, 2017 will be recognized in earnings within the next 12 months. No amount of ineffectiveness was recorded in earnings for these designated cash flow hedges.

The following represents the results of cash flow hedging relationships for the three and nine months ended September 30, 2017 and 2016:



	Three Months Ended September 30,
	Derivative Gain (Loss) Recognized in AOCI (Effective Portion)						Location of Gain (Loss) (Effective Portion)	Gain (Loss) Reclassified from AOCI to Earnings (Effective Portion)
Derivative Instrument	2017			2016			Location of Gain (Loss) (Effective Portion)	2017			2016
Foreign exchange contracts	$	(152	)	$	(158	)	Revenue	$	(139	)	$	(443	)
							Cost of sales	(59		)	301
Interest rate swap	(229		)	(591		)	Interest Expense	—			—
	$	(381	)	$	(749	)		$	(198	)	$	(142	)

	Nine Months Ended September 30,
	Derivative Gain (Loss) Recognized in AOCL (Effective Portion)						Location of Gain (Loss) (Effective Portion)	Gain (Loss) Reclassified from AOCL to Earnings (Effective Portion)
Derivative Instrument	2017			2016			Location of Gain (Loss) (Effective Portion)	2017			2016
Foreign exchange contracts	$	(701	)	$	(114	)	Revenue	$	(133	)	$	290
							Cost of sales	89			(69		)
Interest rate swap	92			(591		)	Interest Expense	—			—
	$	(609	)	$	(705	)		$	(44	)	$	221

We also enter into foreign exchange contracts to minimize the impact of exchange rate fluctuations on short-term intercompany loans and related interest that are denominated in a foreign currency. The revaluation of the intercompany loans and interest and the mark-to-market adjustment on the derivatives are both recorded in earnings. All outstanding contracts at September 30, 2017 mature within 12 months.

The following represents the results of our non-designated derivative instruments for the three and nine months ended September 30, 2017 and 2016:



		Three Months Ended September 30,
		Derivative Gain (Loss) Recognized in Earnings
Derivatives Instrument	Location of Derivative Gain (Loss)	2017			2016
Foreign exchange contracts	Selling, general and administrative expense	$	(655	)	$	1,719

		Nine Months Ended September 30,
		Derivative Gain (Loss) Recognized in Earnings
Derivatives Instrument	Location of Derivative Gain (Loss)	2017			2016
Foreign exchange contracts	Selling, general and administrative expense	$	(1,716	)	$	322

Credit-Risk-Related Contingent Features

Certain derivative instruments contain credit-risk-related contingent features that would require us to post collateral based on a combination of our long-term senior unsecured debt ratings and the net fair value of our derivatives. At September 30, 2017, we did not post any collateral and the maximum amount of collateral that we would be required to post had the credit-risk-related contingent features been triggered was not significant.

Fair Value of Financial Instruments

Our financial instruments include cash and cash equivalents, investment securities, accounts receivable, loan receivables, derivative instruments, accounts payable and debt. The carrying value for cash and cash equivalents, accounts receivable, loans receivable, and accounts payable approximate fair value because of the short maturity of these instruments.

The fair value of our debt is estimated based on recently executed transactions and market price quotations. The inputs used to determine the fair value of our debt were classified as Level 2 in the fair value hierarchy. The carrying value and estimated fair value of our debt at September 30, 2017 and December 31, 2016 were as follows:



	September 30, 2017		December 31, 2016
Carrying value	$	4,182,928	$	3,364,890
Fair value	$	4,185,628	$	3,412,581