American Express 2010 Annual Report Download - page 95

justified through various means, including the use of derivatives
such as foreign exchange forward, and cross-currency swap
contracts, which can help “lock in” the value of the
Company’s exposure to specific currencies.
Derivatives may give rise to counterparty credit risk. The
Company manages this risk by considering the current
exposure, which is the replacement cost of contracts on the
measurement date, as well as estimating the maximum potential
value of the contracts over the next 12 months, considering such
factors as the volatility of the underlying or reference index. To
mitigate derivative credit risk, counterparties are required to be
pre-approved and rated as investment grade. Counterparty risk
exposures are monitored by the Company’s Institutional Risk
Management Committee (IRMC). The IRMC formally reviews
large institutional exposures to ensure compliance with the
Company’s ERMC guidelines and procedures and determines
the risk mitigation actions, when necessary. Additionally, in
order to mitigate the bilateral counterparty credit risk
associated with derivatives, the Company has, in certain
limited instances, entered into agreements with its derivative
counterparties including master netting agreements, which may
provide a right of offset for certain exposures between
the parties.
In relation to the Company’s credit risk, under the terms of the
derivative agreements it has with its various counterparties, the
Company is not required to either immediately settle any
outstanding liability balances or post collateral upon the
occurrence of a specified credit risk-related event. In relation
to counterparty credit risk, as of December 31, 2010 and 2009,
such risk associated with the Company’s derivatives was not
significant. The Company’s derivatives are carried at fair value
on the Consolidated Balance Sheets. The accounting for changes
in fair value depends on the instruments’ intended use and the
resulting hedge designation, if any, as discussed below. Refer to
Note 3 for a description of the Company’s methodology for
determining the fair value of its derivatives.
The following table summarizes the total gross fair value, excluding interest accruals, of derivative assets and liabilities as of
December 31:
(Millions) 2010 2009 2010 2009
Other Assets
Fair Value
Other Liabilities
Fair Value
Derivatives designated as hedging instruments:
Interest rate contracts
Fair value hedges $ 909 $ 632 $38$6
Cash flow hedges 2113 44
Foreign exchange contracts
Net investment hedges 66 132 272 130
Total derivatives designated as hedging instruments $ 977 $ 765 $ 323 $ 180
Derivatives not designated as hedging instruments:
Interest rate contracts $3$11$3$5
Foreign exchange contracts, including certain embedded derivatives
(a)
109 57 91 95
Equity-linked embedded derivative
(b)
——23
Total derivatives not designated as hedging instruments 112 68 96 103
Total derivatives
(c)
$ 1,089 $ 833 $ 419 $ 283
(a) Includes foreign currency derivatives embedded in certain operating agreements.
(b) Represents an equity-linked derivative embedded in one of the Company’s investment securities.
(c) GAAP permits the netting of derivative assets and derivative liabilities when a legally enforceable master netting agreement exists between the Company and its
derivative counterparty. As of December 31, 2010 and 2009, $18 million and $33 million, respectively, of derivative assets and liabilities have been offset and presented
net on the Consolidated Balance Sheets.
DERIVATIVE FINANCIAL INSTRUMENTS THAT
QUALIFY FOR HEDGE ACCOUNTING
Derivatives executed for hedge accounting purposes are
documented and designated as such when the Company
enters into the contracts. In accordance with its risk
management policies, the Company structures its hedges with
very similar terms to the hedged items. The Company formally
assesses, at inception of the hedge accounting relationship and
on a quarterly basis, whether derivatives designated as hedges
are highly effective in offsetting the fair value or cash flows of the
hedged items. These assessments usually are made through the
application of the regression analysis method. If it is determined
that a derivative is not highly effective as a hedge, the Company
will discontinue the application of hedge accounting.
FAIR VALUE HEDGES
A fair value hedge involves a derivative designated to hedge the
Company’s exposure to 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.
The Company uses interest rate swaps to convert certain fixed-
rate long-term debt to floating-rate at the time of issuance. As of
December 31, 2010 and 2009, the Company hedged $15.9 billion
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AMERICAN EXPRESS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS