American Express 2010 Annual Report Download - page 96

and $15.1 billion, respectively, of its fixed-rate debt to floating-
rate debt using interest rate swaps.
To the extent the fair value hedge is effective, the gain or loss
on the hedging instrument offsets the loss or gain on the hedged
item attributable to the hedged risk. Any difference between the
changes in the fair value of the derivative and the hedged item is
referred to as hedge ineffectiveness and is reflected in earnings
as a component of other, net expenses. Hedge ineffectiveness
may be caused by differences between the debt’s interest coupon
and the benchmark rate, which are primarily due to credit
spreads at inception of the hedging relationship that are not
reflected in the valuation of the interest rate swap. Furthermore,
hedge ineffectiveness may be caused by changes in the
relationship between 3-month LIBOR and 1-month LIBOR
rates, as these so-called basis spreads may impact the
valuation of the interest rate swap without causing an
offsetting impact in the value of the hedged debt. If a fair
value hedge is de-designated or no longer considered to be
effective, changes in fair value of the derivative continue to be
recorded through earnings but the hedged asset or liability is no
longer adjusted for changes in fair value due to changes in
interest rates. The existing basis adjustment of the hedged
asset or liability is then amortized or accreted as an
adjustment to yield over the remaining life of that asset
or liability.
The following table summarizes the impact on the Consolidated Statements of Income associated with the Company’s hedges of fixed-
rate long-term debt described above:
Derivative relationship Location 2010 2009 2008 Location 2010 2009 2008 2010 2009 2008
Amount Amount
Net hedge
ineffectiveness
Derivative contract Hedged item
(Millions) Gains (losses) recognized in income
For the Years Ended December 31:
Interest rate contracts Other, net expenses $ 246 $ (446) $ 967 Other, net expenses $ (233) $ 437 $ (898) $13 $ (9) $ 69
The Company also recognized a net reduction in interest
expense on long-term debt and other of $522 million,
$464 million and $122 million for the three years ended
December 31, 2010, 2009 and 2008, respectively, primarily
related to the net settlements (interest accruals) on the
Company’s interest rate derivatives designated as fair
value hedges.
CASH FLOW HEDGES
A cash flow hedge involves a derivative designated to hedge the
Company’s exposure to variable future cash flows attributable to
a particular risk. Such exposures may relate to either an existing
recognized asset or liability or a forecasted transaction. The
Company hedges existing long-term variable-rate debt, the
rollover of short-term borrowings and the anticipated
forecasted issuance of additional funding through the use of
derivatives, primarily interest rate swaps. These derivative
instruments effectively convert floating-rate debt to fixed-rate
debt for the duration of the instrument. As of December 31, 2010
and 2009, the Company hedged $1.3 billion and $1.6 billion,
respectively, of its floating debt using interest rate swaps.
For derivatives designated as cash flow hedges, the effective
portion of the gain or loss on the derivatives is recorded in AOCI
and reclassified into earnings when the hedged cash flows are
recognized in earnings. The amount that is reclassified into
earnings is presented in the Consolidated Statements of
Income in the same line item in which the hedged instrument
or transaction is recognized, primarily in interest expense. Any
ineffective portion of the gain or loss on the derivatives is
reported as a component of other, net expenses. If a cash
flow hedge is de-designated or terminated prior to maturity,
the amount previously recorded in AOCI is recognized into
earnings over the period that the hedged item impacts
earnings. If a hedge relationship is discontinued because it is
probable that the forecasted transaction will not occur according
to the original strategy, any related amounts previously recorded
in AOCI are recognized into earnings immediately.
In the normal course of business, as the hedged cash flows are
recognized into earnings, the Company expects to reclassify
$11 million of net pretax losses on derivatives from AOCI into
earnings during the next 12 months.
NET INVESTMENT HEDGES
A net investment hedge is used to hedge future changes in
currency exposure of a net investment in a foreign operation.
The Company primarily designates foreign currency derivatives,
typically foreign exchange forwards, and on occasion foreign
currency denominated debt, as hedges of net investments in
certain foreign operations. These instruments reduce exposure
to changes in currency exchange rates on the Company’s
investments in non-U.S. subsidiaries. The effective portion of
the gain or loss on net investment hedges is recorded in AOCI as
part of the cumulative translation adjustment. Any ineffective
portion of the gain or loss on net investment hedges is
recognized in other, net expenses during the period of change.
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AMERICAN EXPRESS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS