American Express 2006 Annual Report Download - page 97

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[ 95 ]
notes to consolidated fi nancial statements
american express company
(loss) income into earnings may be accelerated and all
future market value fluctuations of the derivative will
be reflected in earnings.
Currently, the longest period of time over which the
Company is hedging exposure to variability in future
cash flows is approximately four years, which is related
to long-term debt.
FAIR VALUE HEDGES
A fair value hedge is a derivative designated to hedge
the exposure of future changes in the fair value of an
asset or a liability, or an identified portion thereof that
is attributable to a particular risk. The Company is
exposed to interest rate risk associated with its fixed-rate
long-term debt and fixed-rate corporate debt securities.
The Company uses interest rate swaps to convert certain
fixed-rate long-term debt to floating rate at the time
of issuance. From time to time, the Company enters
into interest rate swaps to hedge its exposure related to
fixed-rate corporate debt securities. Prior to 2006, in
conjunction with its international banking activities,
the Company hedged the fair value changes related to
a portion of its callable term customer deposits using
callable interest rate swaps. The Company no longer
hedges the fair value changes related to callable term
customer deposits because the term certificate of deposit
was modified and hedge accounting is no longer deemed
applicable to prospective transactions.
NET INVESTMENT HEDGES
A net investment hedge in a foreign operation
is a derivative used to hedge future changes in
currency exposure of a net investment in a foreign
operation. The Company designates foreign currency
derivatives, primarily forward agreements, as hedges
of net investments in certain foreign operations. These
derivatives reduce exposure to changes in currency
exchange rates on the Company’s investments in non-
U.S. subsidiaries.
DERIVATIVES NOT DESIGNATED AS HEDGES
The Company has economic hedges that either do
not qualify or are not designated for hedge accounting
treatment. Foreign currency transactions and non-U.S.
dollar cash flow exposures are economically hedged, where
practical, through foreign currency contracts, primarily
forward contracts, foreign currency options, and cross-
currency swaps, and generally mature within one year.
Foreign currency contracts involve the purchase and sale of
a designated currency at an agreed upon rate for settlement
on a specified date. From time to time, the Company
will enter into interest rate swaps to specifically manage
funding costs related to the credit card business. Within
its international banking operations, the Company enters
into derivative contracts to meet the needs of its clients
and, to a limited extent, for trading purposes, including
taking proprietary positions. The international banking
derivative activities also include economic hedging of
various foreign currency and interest rate exposures
related to the Company’s other banking activities. The
following table provides the total fair value, excluding
accruals, of these derivative products assets and liabilities
as of December 31:
(Millions) 2006 2005
Assets Liabilities Assets Liabilities
Foreign currency
transactions $13 $ 3 $13 $13
Interest rate swaps $12 $10 $— $—
International banking
operations(a) $ 330 $ 320 $ 267 $ 226
(a) 2006 and 2005 liabilities include embedded derivatives of $30
million and $25 million, respectively.
EMBEDDED DERIVATIVES
The Company has identified certain derivatives
embedded in other financial instruments that are
required to be accounted for separately from the host
financial instrument. Such items included certain
structured customer deposit products issued by the
international banking operations which have returns
tied to the performance of equity markets, interest rates
or other indices, and financial instruments.
NOTE 11 GUARANTEES AND CERTAIN OFF-
BALANCE SHEET ITEMS
The Company provides cardmember protection plans
that cover losses associated with purchased products,
as well as other guarantees in the ordinary course of
business that are within the scope of FASB Financial
Interpretation No. 45, “Guarantor’s Accounting and
Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others,” (FIN
45). For the Company, FIN 45 guarantees primarily
consist of card and travel protection programs, including
those that (i) cancel and request replacements of lost or
stolen cards, and provide for fraud liability coverage; (ii)
protect eligible purchases made with the card against
accidental damage or theft for up to 90 days from the
date of purchase; (iii) provide account protection in the
event that a cardmember is unable to make payments
on the account due to unforeseen hardship; (iv) protect
cardmembers against billing disputes with the merchant,