America Online 2015 Annual Report Download - page 33

Guarantees
We guarantee the debentures and first mortgage bonds of our
operating telephone company subsidiaries as well as the debt obli-
gations of GTE Corporation that were issued and outstanding prior to
July1, 2003 (see Note7 to the consolidated financial statements).
In connection with the execution of agreements for the sale of busi-
nesses and investments, Verizon ordinarily provides representations
and warranties to the purchasers pertaining to a variety of nonfinancial
matters, such as ownership of the securities being sold, as well as
financial losses (see Note16 to the consolidated financial statements).
As of December31, 2015, letters of credit totaling approximately
$0.1billion, which were executed in the normal course of business
and support several financing arrangements and payment obligations
to third parties, were outstanding (see Note16 to the consolidated
financial statements).
Market Risk
We are exposed to various types of market risk in the normal course
of business, including the impact of interest rate changes, foreign
currency exchange rate fluctuations, changes in investment, equity
and commodity prices and changes in corporate tax rates. We employ
risk management strategies, which may include the use of a variety
of derivatives including cross currency swaps, foreign currency
and prepaid forwards and collars, interest rate swap agreements,
commodity swap and forward agreements and interest rate locks. We
do not hold derivatives for trading purposes.
It is our general policy to enter into interest rate, foreign currency and
other derivative transactions only to the extent necessary to achieve
our desired objectives in optimizing exposure to various market risks.
Our objectives include maintaining a mix of fixed and variable rate
debt to lower borrowing costs within reasonable risk parameters
and to protect against earnings and cash flow volatility resulting
from changes in market conditions. We do not hedge our market risk
exposure in a manner that would completely eliminate the effect of
changes in interest rates and foreign exchange rates on our earnings.
At December31, 2015 and 2014, we posted collateral of approximately
$0.1billion and $0.6billion, respectively, related to derivative contracts
under collateral exchange arrangements. During the first and second
quarter of 2015, we paid an immaterial amount of cash to enter into
amendments to certain collateral exchange arrangements. These
amendments suspend cash collateral posting for a specified period of
time by both counterparties. While we may be exposed to credit losses
due to the nonperformance of our counterparties, we consider the
risk remote. As such, we do not expect that our results of operations
or financial condition will be materially affected by these risk manage-
ment strategies.
Interest Rate Risk
We are exposed to changes in interest rates, primarily on our short-
term debt and the portion of long-term debt that carries floating
interest rates. As of December31, 2015, approximately 81% of the
aggregate principal amount of our total debt portfolio consisted of
fixed rate indebtedness, including the effect of interest rate swap
agreements designated as hedges. The impact of a 100 basis point
change in interest rates affecting our floating rate debt would result
in a change in annual interest expense, including our interest rate
swap agreements that are designated as hedges, of approximately
$0.2billion. The interest rates on substantially all of our existing
long-term debt obligations are unaffected by changes to our
credit ratings.
The table that follows summarizes the fair values of our long-term
debt, including current maturities, and interest rate swap derivatives as
of December31, 2015 and 2014. The table also provides a sensitivity
analysis of the estimated fair values of these financial instruments
assuming 100-basis-point upward and downward shifts in the yield
curve. Our sensitivity analysis does not include the fair values of our
commercial paper and bank loans, if any, because they are not signifi-
cantly affected by changes in market interest rates.
(dollars in millions)
Long-term debt and
related derivatives Fair Value
Fair Value
assuming
+ 100 basis
point shift
Fair Value
assuming
− 100 basis
point shift
At December31, 2015 $ 117,943 $ 108,992 $ 128,641
At December31, 2014 126,139 115,695 138,420
Interest Rate Swaps
We enter into domestic interest rate swaps to achieve a targeted mix of
fixed and variable rate debt. We principally receive fixed rates and pay
variable rates based on LIBOR, resulting in a net increase or decrease
to Interest expense. These swaps are designated as fair value hedges
and hedge against changes in the fair value of our debt portfolio. We
record the interest rate swaps at fair value on our consolidated balance
sheets as assets and liabilities.
During the third quarter of 2015, we entered into interest rate swaps
with a total notional value of $3.2billion. During the fourth quarter of
2015, we entered into interest rate swaps with a total notional value of
$2.6billion. At December31, 2015 and 2014, the total notional amount
of the interest rate swaps was $7.6billion and $1.8billion, respectively.
The fair value of these contracts was $0.1billion at December31, 2015
and was not material at December31, 2014. The ineffective portion
of these interest rate swaps was not material at December31, 2015
and 2014.
Forward Interest Rate Swaps
In order to manage our exposure to future interest rate changes, we
have entered into forward interest rate swaps. We designated these
contracts as cash flow hedges. At December31, 2014, these swaps
had a notional value of $2.0billion. The fair value of these contracts
was $0.2billion at December31, 2014, which was included within
Other liabilities on our consolidated balance sheet. During the third
quarter of 2015, we settled these forward interest rate swaps and the
pre-tax loss was not material. During the third quarter of 2015, we
entered into forward interest rate swaps with a total notional value
of $0.8billion. The fair value of these contracts was not material at
December31, 2015.
Foreign Currency Translation
The functional currency for our foreign operations is primarily the local
currency. The translation of income statement and balance sheet
amounts of our foreign operations into U.S. dollars is recorded as
cumulative translation adjustments, which are included in Accumulated
other comprehensive income in our consolidated balance sheets.
Gains and losses on foreign currency transactions are recorded in the
consolidated statements of income in Other income and (expense),
net. At December31, 2015, our primary translation exposure was to the
British Pound Sterling, Euro and Australian Dollar.
31Verizon Communications Inc. and Subsidiaries
Management’s Discussion and Analysis ofFinancialCondition and Results of Operations continued