Verizon Wireless 2009 Annual Report Download - page 34

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against changes in the fair value of our debt portfolio. We record the
interest rate swaps at fair value on our balance sheet as assets and lia-
bilities. Changes in the fair value of the interest rate swaps are recorded
to Interest expense, which are offset by changes in the fair value of the
debt due to changes in interest rates. The fair value of these contracts
was $171 million and $415 million at December 31, 2009 and 2008,
respectively, and are included in Other assets and Long-term debt. As
of December 31, 2009, the total notional amount of these interest rate
swaps was $6.0 billion.
Alltel Interest Rate Swaps
As a result of the Alltel acquisition, Verizon Wireless acquired seven interest
rate swap agreements with a notional value of $9.5 billion that paid fixed
and received variable rates based on three-month and one-month LIBOR
with maturities ranging from 2009 to 2013. During the second quarter
of 2009, we settled all of these agreements using cash generated from
operations for a gain that was not significant. Changes in the fair value of
these swaps were recorded in earnings through settlement.
Equity Price Risk
Prepaid Forward Agreement
During the first quarter of 2009, we entered into a privately negotiated
prepaid forward agreement for 14 million shares of Verizon common
stock at a cost of approximately $390 million. During the fourth quarter
of 2009, we terminated the prepaid forward agreement with respect to
5 million shares of Verizon common stock, which resulted in the delivery
of those shares to Verizon. The remaining balance of the prepaid forward
agreement for 9 million shares of Verizon common stock at December 31,
2009 of $252 million is included in Other assets. Changes in the fair value
of the agreement, which were not significant during 2009, were included
in Selling, general and administrative expense and Cost of services
and sales.
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 are recorded as cumu-
lative translation adjustments, which are included in Accumulated other
comprehensive loss in our consolidated balance sheets. Gains and losses
on foreign currency transactions are recorded in the consolidated state-
ments of income in Other income and (expense), net. At December 31,
2009, our primary translation exposure was to the British Pounds Sterling,
the Euro and the Australian Dollar.
Cross Currency Swaps
During the fourth quarter of 2008, Verizon Wireless entered into cross cur-
rency swaps designated as cash flow hedges to exchange approximately
$2.4 billion of the net proceeds from the December 2008 Verizon Wireless
co-issued debt offering of British Pounds Sterling and Euro denominated
debt into U.S. dollars and to fix our future interest and principal payments
in U.S. dollars, as well as mitigate the impact of foreign currency transac-
tion gains or losses. The fair value of these swaps included in Other assets
at December 31, 2009 was approximately $315 million and, at December
31, 2008, was insignificant. During 2009, a pretax gain of $310 million
was recognized in Other comprehensive income, of which $135 million
was reclassified from Accumulated other comprehensive loss to Other
income and (expense), net to offset the related pretax foreign currency
transaction loss on the underlying debt obligation.
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 and commodity swap 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 limiting our 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. We do not expect that our net
income, liquidity and cash flows will be materially affected by these risk
management 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, 2009, more than two-thirds in 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 $0.1 billion. The interest rates on our existing
long-term debt obligations, with the exception of a three-year term loan,
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, 2009 and 2008. The table also provides a sensitivity anal-
ysis of the estimated fair values of these financial instruments assuming
100-basis-point upward and downward shifts in the yield curve. Our sen-
sitivity analysis does not include the fair values of our commercial paper
and bank loans, if any, because they are not significantly affected by
changes in market interest rates.
(dollars in millions)
At December 31, 2009 Fair Values
Fair Value
assuming
+ 100 basis
point shift
Fair Value
assuming
- 100 basis
point shift
Long-term debt and related
derivatives $ 66,042 $ 62,788 $ 69,801
At December 31, 2008
Long-term debt and related
derivatives $ 51,258 $ 48,465 $ 54,444
Interest Rate Swaps
We have entered into domestic interest rate swaps to achieve a targeted
mix of fixed and variable rate debt, where we principally receive fixed
rates and pay variable rates based on London Interbank Offered Rate
(LIBOR). These swaps are designated as fair value hedges and hedge
Management’s Discussion and Analysis
of Financial Condition and Results of Operations continued