Fair Value of Financial Assets and Liabilities

3 Months Ended

Mar. 31, 2013

Fair Value Disclosures [Abstract]

Fair Value of Financial Assets and Liabilities

5.  Fair Value of Financial Assets and Liabilities

Our fixed income and equity investments are classified as available for sale and recorded at their fair market values. We determine fair value using the following hierarchy:

• Level 1 – Quoted prices in active markets for identical assets or liabilities.

• Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; 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 and that are significant to the fair value of the assets or liabilities.

Most of our fixed income securities are classified as Level 2, with the exception of some of our U.S. government and agency obligations and our investments in publicly traded equity securities, which are classified as Level 1, and all of our auction rate securities, which are classified as Level 3. In addition, our strategic investments held at cost are classified as Level 3. At March 31, 2013, the vast majority of our Level 2 securities were priced by pricing vendors. These pricing vendors utilize the most recent observable market information in pricing these securities or, if specific prices are not available for these securities, use other observable inputs like market transactions involving identical or comparable securities. In the event observable inputs are not available, we assess other factors to determine the security’s market value, including broker quotes or model valuations. Each month, we perform independent price verifications of all of our fixed income holdings. In the event a price fails a pre-established tolerance check, it is researched so that we can assess the cause of the variance to determine what we believe is the appropriate fair market value.

In general, investments with remaining effective maturities of 12 months or less from the balance sheet date are classified as short-term investments. Investments with remaining effective maturities of more than 12 months from the balance sheet date are classified as long-term investments. Our publicly traded equity securities are classified as long-term investments and our strategic investments held at cost are classified as other assets. As a result of the lack of liquidity for auction rate securities, we have classified these as long-term investments as of March 31, 2013 and December 31, 2012. At March 31, 2013 and December 31, 2012, all of our short- and long-term investments, excluding auction rate securities, were recognized at fair value, which was determined based upon observable inputs from our pricing vendors for identical or similar assets. At March 31, 2013 and December 31, 2012, auction rate securities were valued using a discounted cash flow model.

The following tables summarize the composition of our short- and long-term investments at March 31, 2013 and December 31, 2012 (tables in thousands):

	March 31, 2013
	Amortized Cost		Unrealized Gains		Unrealized (Losses)			Aggregate Fair Value
U.S. government and agency obligations	$	2,077,989	$	8,548	$	(1,451	)	$	2,085,086
U.S. corporate debt securities	1,512,318		8,924		(436		)	1,520,806
High yield corporate debt securities	496,222		33,603		(766		)	529,059
Asset-backed securities	3,731		3		(4		)	3,730
Municipal obligations	966,539		4,799		(45		)	971,293
Auction rate securities	72,076		—		(3,829		)	68,247
Foreign debt securities	1,408,091		8,092		(720		)	1,415,463
Total fixed income securities	6,536,966		63,969		(7,251		)	6,593,684
Publicly traded equity securities	70,374		40,313		(616		)	110,071
Total	$	6,607,340	$	104,282	$	(7,867	)	$	6,703,755

We held approximately $1.4 billion in foreign debt securities at March 31, 2013. These securities have an average credit rating of A+, and approximately 5% of these securities are deemed sovereign debt with an average credit rating of AA+. None of the securities deemed sovereign debt are from Greece, Italy, Ireland, Portugal, Spain or Cyprus. Additionally, we have an immaterial amount of exposure to French agencies and financial institutions.

	December 31, 2012
	Amortized Cost		Unrealized Gains		Unrealized (Losses)			Aggregate Fair Value
U.S. government and agency obligations	$	2,190,957	$	10,225	$	(967	)	$	2,200,215
U.S. corporate debt securities	1,480,026		10,189		(509		)	1,489,706
High yield corporate debt securities	485,799		34,223		(800		)	519,222
Asset-backed securities	2,115		3		—			2,118
Municipal obligations	1,032,320		3,007		(540		)	1,034,787
Auction rate securities	73,545		—		(3,365		)	70,180
Foreign debt securities	1,270,035		9,082		(255		)	1,278,862
Total fixed income securities	6,534,797		66,729		(6,436		)	6,595,090
Publicly traded equity securities	46,665		40,548		(731		)	86,482
Total	$	6,581,462	$	107,277	$	(7,167	)	$	6,681,572

The following tables represent our fair value hierarchy for our financial assets and liabilities measured at fair value as of March 31, 2013 and December 31, 2012 (in thousands):

	March 31, 2013
	Level 1		Level 2			Level 3		Total
Cash	$	1,622,174	$	—		$	—	$	1,622,174
Cash equivalents	3,225,860		456,271			—		3,682,131
U.S. government and agency obligations	1,137,609		947,477			—		2,085,086
U.S. corporate debt securities	—		1,520,806			—		1,520,806
High yield corporate debt securities	—		529,059			—		529,059
Asset-backed securities	—		3,730			—		3,730
Municipal obligations	—		971,293			—		971,293
Auction rate securities	—		—			68,247		68,247
Foreign debt securities	—		1,415,463			—		1,415,463
Publicly traded equity securities	110,071		—			—		110,071
Total cash and investments	$	6,095,714	$	5,844,099		$	68,247	$	12,008,060
Other items:
Strategic investments held at cost	$	—	$	—		$	325,437	$	325,437
Investment in joint venture	—		—			33,226		33,226
Convertible debt	—		(2,534,038		)	—		(2,534,038		)
Foreign exchange derivative assets	—		22,261			—		22,261
Foreign exchange derivative liabilities	—		(40,403		)	—		(40,403		)
Commodity derivative assets	—		75			—		75

	December 31, 2012
	Level 1		Level 2			Level 3		Total
Cash	$	1,493,843	$	—		$	—	$	1,493,843
Cash equivalents	2,898,183		362,034			—		3,260,217
U.S. government and agency obligations	1,324,919		871,290			—		2,196,209
U.S. corporate debt securities	—		1,480,450			—		1,480,450
High yield corporate debt securities	—		510,412			—		510,412
Asset-backed securities	—		2,117			—		2,117
Municipal obligations	—		1,022,889			—		1,022,889
Auction rate securities	—		—			70,086		70,086
Foreign debt securities	—		1,273,023			—		1,273,023
Publicly traded equity securities	86,482		—			—		86,482
Total cash and investments	$	5,803,427	$	5,522,215		$	70,086	$	11,395,728
Other items:
Strategic investments held at cost	$	—	$	—		$	351,855	$	351,855
Investment in joint venture	—		—			32,745		32,745
Convertible debt	—		(2,665,690		)	—		(2,665,690		)
Foreign exchange derivative assets	—		30,189			—		30,189
Foreign exchange derivative liabilities	—		(34,590		)	—		(34,590		)
Commodity derivative assets	—		(588		)	—		(588		)

Our auction rate securities are predominantly rated investment grade and are primarily collateralized by student loans. The underlying loans of all but two of our auction rate securities, with a market value of $16.0 million, have partial guarantees by the U.S. government as part of the Federal Family Education Loan Program (“FFELP”) through the U.S. Department of Education. FFELP guarantees at least 95% of the loans which collateralize the auction rate securities. We believe the quality of the collateral underlying most of our auction rate securities will enable us to recover our principal balance.

To determine the estimated fair value of our investment in auction rate securities, we used a discounted cash flow model using a five year time horizon. As of March 31, 2013, the coupon rates used ranged from 0% to 5% and the discount rate was 1%, which rate represents the rate at which similar FFELP backed securities with a five year time horizon outside of the auction rate securities market were trading at March 31, 2013. The assumptions used in preparing the discounted cash flow model include an incremental discount rate for the lack of liquidity in the market (“liquidity discount margin”) for an estimated period of time. The discount rate we selected was based on AA-rated banks as the majority of our portfolio is invested in student loans where EMC acts as a financier to these lenders. The liquidity discount margin represents an estimate of the additional return an investor would require for the lack of liquidity of these securities over an estimated five year holding period. The rate used for the discount margin was 1% at March 31, 2013 and December 31, 2012 due to the narrowing of credit spreads on AA-rated banks during 2012.

The following table provides a summary of changes in fair value of our Level 3 auction rate securities for the three months ended March 31, 2013 and 2012 (table in thousands):

	For the Three Months Ended
	March 31, 2013			March 31, 2012
Balance, beginning of the period	$	70,180		$	74,687
Calls at par value	(580		)	(219		)
Other-than-temporary impairment loss	(889		)	—
(Increase) decrease in previously recognized unrealized losses included in other comprehensive income	(464		)	4,026
Balance, end of the period	$	68,247		$	78,494

Significant changes in the unobservable inputs discussed above could result in a significantly lower or higher fair value measurement. Generally, an increase in the discount rate, liquidity discount margin or coupon rate results in a decrease in our fair value measurement and a decrease in the discount rate, liquidity discount margin or coupon rate results in an increase in our fair value measurement.

We account for our joint venture LenovoEMC using the fair value method of accounting. To determine the estimated fair value of our investment, we use a discounted cash flow model using a three year time horizon. The discount rate used was 6%, which represents the incremental borrowing rate for a market participant. The assumptions used in preparing the discounted cash flow model include an analysis of estimated Lenovo NAS revenue against a prescribed target as well as consideration of the purchase price put and call features included in the joint venture agreement. The put and call features create a floor and a cap on the fair value of the investment. As such, there is a limit to the impact on the fair value that would result from significant changes in the unobservable inputs.

The following table provides a summary of changes in fair value of our LenovoEMC joint venture for the three months ended March 31, 2013 and 2012 (table in thousands):

	For the Three Months Ended
	March 31, 2013		March 31, 2012
Balance, beginning of the period	$	32,745	$	—
Realized gain included in other income (expense)	481		—
Balance, end of period	$	33,226	$	—

We perform a fair value calculation of our strategic investments held at cost on a quarterly basis using the most currently available information as part of our impairment reviews. To determine the estimated fair value of private strategic investments held at cost we use a combination of several valuation techniques including discounted cash flow models, acquisition comparables and trading comparables. In addition, we evaluate the impact of pre- and post-money valuations of recent financing events and the impact of those on our fully diluted ownership percentages, and we consider any available information regarding the issuer’s historical and forecasted performance as well as market comparables and conditions. The fair value of these investments is considered in our review for impairment if any events and changes in circumstances occur that might have a significant adverse effect on their value.

Investment Losses

Unrealized losses on investments at March 31, 2013 by investment category and length of time the investment has been in a continuous unrealized loss position are as follows (table in thousands):

	Less Than 12 Months					12 Months or Greater					Total
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
U.S. government and agency obligations	$	254,486	$	(1,235	)	$	9,295	$	(216	)	$	263,781	$	(1,451	)
U.S. corporate debt securities	273,100		(436		)	—		—			273,100		(436		)
High yield corporate debt securities	43,943		(673		)	164		(93		)	44,107		(766		)
Asset-backed securities	2,666		(4		)	6		—			2,672		(4		)
Municipal obligations	24,624		(33		)	9,587		(12		)	34,211		(45		)
Auction rate securities	—		—			68,247		(3,829		)	68,247		(3,829		)
Foreign debt securities	298,632		(720		)	—		—			298,632		(720		)
Publicly traded equity securities	1,315		(616		)	—		—			1,315		(616		)
Total	$	898,766	$	(3,717	)	$	87,299	$	(4,150	)	$	986,065	$	(7,867	)

For all of our securities for which the amortized cost basis was greater than the fair value at March 31, 2013, we have concluded that currently we neither plan to sell the security nor is it more likely than not that we would be required to sell the security before its anticipated recovery. In making the determination as to whether the unrealized loss is other-than-temporary, we considered the length of time and extent the investment has been in an unrealized loss position, the financial condition and near-term prospects of the issuers, the issuers’ credit rating, third party guarantees and the time to maturity.

Contractual Maturities

The contractual maturities of fixed income securities held at March 31, 2013 are as follows (table in thousands):

	March 31, 2013
	Amortized Cost Basis		Aggregate Fair Value
Due within one year	$	1,220,229	$	1,223,463
Due after 1 year through 5 years	4,423,210		4,450,632
Due after 5 years through 10 years	484,206		511,333
Due after 10 years	409,321		408,256
Total	$	6,536,966	$	6,593,684