Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
General
Market risk is the loss of future earnings, fair values or future cash flows that may result from a change in the price of a financial instrument. The value of a financial instrument may change as a result of changes in the interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market risk sensitive instruments. Market risk is attributable to all market sensitive financial instruments including foreign currency receivables and payables.
Our exposure to market risk is a function of our expenses and revenue generating activities in foreign currencies. The objective of market risk management is to avoid excessive exposure of our earnings and equity to loss. We manage market risk through our treasury operations. Our senior management and our Board of Directors approve our treasury operations’ objectives and policies. The responsibilities of our treasury operations include management of cash resources, implementing hedging strategies for foreign currency exposures, borrowing strategies and ensuring compliance with market risk limits and policies.
Components of Market Risk
Foreign Currency Risk. Our exposure to market risk arises principally from exchange rate risk. Our revenues are primarily denominated in the U.S. dollar representing 88.2% of our total revenues and the U.K. pound sterling representing 8.6% of our total revenues in the year ended December 31, 2021. However, a significant portion of our total expenses are incurred and paid in Indian rupee and the Philippine peso representing 29.4% and 9.5% respectively, of our total expenses in the year ended December 31, 2021. We also incur expenses in the U.S. dollar and currencies of other countries in which we have operations. The exchange rates among the Indian rupee, the Philippine peso and the U.S. dollar have changed substantially in recent years and may fluctuate substantially in the future.
Our exchange rate risk primarily arises from our foreign currency revenues, expenses incurred by our foreign subsidiaries and foreign currency accounts receivable and payable. The average exchange rate of the Indian rupee against the U.S. dollar decreased from 74.07 during the year ended December 31, 2020 to 73.88 during the year ended December 31, 2021, representing an appreciation of 0.3%. The average exchange rate of the Philippine peso against the U.S. dollar decreased from 49.49 during the year ended December 31, 2020 to 49.36 during the year ended December 31, 2021, representing an appreciation of 0.3%. Based upon our level of operations during the year ended December 31, 2021 and excluding any hedging arrangements that we had in place during that period, a 10% appreciation/depreciation in the Indian rupee against the U.S. dollar would have increased/decreased our revenues by approximately $5.6 million and increased/decreased our expenses incurred and paid in Indian rupees by approximately $28.4 million in the year ended December 31, 2021. Similarly, a 10% appreciation/depreciation in the Philippine peso against the U.S. dollar would have increased/decreased our revenues by approximately $0.3 million and increased/decreased our expenses incurred and paid in Philippine peso by approximately $9.2 million in the year ended December 31, 2021.
In order to mitigate our exposure to foreign currency fluctuation risks and minimize the earnings and cash flow volatility associated with forecasted transactions denominated in certain foreign currencies, we enter into foreign currency forward contracts that are designated as cash flow hedges. These contracts must be settled on the day of maturity or may be canceled subject to the receipts or payments of any gains or losses respectively, equal to the difference between the contract exchange rate and the market exchange rate on the date of cancellation. We do not enter into foreign currency forward contracts for speculative or trading purposes. As such, we may not purchase adequate contracts to insulate ourselves from Indian rupee and the Philippine peso foreign exchange currency risks. In addition, any such contracts may not perform adequately as a hedging mechanism. We may, in the future, adopt more active hedging policies, and have done so in the past.
The impact on earnings and/or cash flows related to these foreign currency forward contracts is immaterial as the impact of the maturing cash flow hedges in respective periods are intended to offset the foreign currency impact on the related expenses. Further, a significant number of our client contracts include protection against foreign exchange rate fluctuations which minimizes the impact of volatility in the exchange rates on our operating results.
Cash flow hedges with notional amounts of $514.6 million and $451.9 million were outstanding as at December 31, 2021 and 2020, respectively, with maturity periods of one to forty-two months. The mark-to-market gain, net upon fair valuation of these cash flow hedges as of December 31, 2021 and 2020 was $11.9 million and $16.5 million, respectively, and is included in “Accumulated other comprehensive income/(loss)” on our consolidated balance sheets. During the year ended December 31, 2021, we recognized $10.0 million as a foreign exchange gain from the maturing cash flow hedges, which was largely offset by the foreign exchange loss on the related expenses of $10.1 million. The net impact on earnings for the year ended December 31, 2021 from the maturing cash flow hedges was insignificant, offset by an insignificant foreign currency impact on the related expenses.
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We also enter into foreign currency forward contracts to economically hedge our intercompany balances and other monetary assets and liabilities denominated in currencies other than functional currencies. These derivatives do not qualify as fair value hedges under ASC Topic 815, Derivatives and Hedging . Changes in the fair value of these derivatives are recognized in our consolidated statements of income and are included in “Foreign exchange gain, net.” These derivative instruments mitigate balance sheet risk due to exchange rate movements because gains and losses on the settlement of these derivatives are intended to offset revaluation losses and gains on the foreign currency denominated monetary assets and monetary liabilities being hedged. Forward exchange contracts with notional amounts of USD 134.6 million, GBP 6.8 million, EUR 1.3 million and COP 2,541.9 million were outstanding as of December 31, 2021 compared to USD 143.4 million, GBP 6.8 million, EUR 2.4 million and COP 8,288.0 million outstanding at December 31, 2020. The fair values of these derivative instruments as of December 31, 2021 and 2020 were insignificant in both year and are included in the “Foreign exchange gain, net” in our consolidated statements of income. As of December 31, 2021, the outstanding derivative instruments had maturities of 31 days.
Interest Rate Risk. As described in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” on November 21, 2017 we entered into the Credit Agreement that provides for a $200.0 million revolving credit facility and a letter of credit sub-facility. We have an option to increase the commitments under the Credit Facility by up to an additional $100.0 million. On July 2, 2018, we exercised our option under the Credit Agreement to increase the commitments to $300.0 million. The Credit Facility has a maturity date of November 21, 2022 and is voluntarily pre-payable from time to time without premium or penalty.
Depending on the type of borrowing, loans under the Credit Facility bear interest at a rate equal to the specified prime rate (alternate base rate) or adjusted LIBO rate, plus, in each case, an applicable margin. The applicable margin is tied to the Company’s total net leverage ratio and ranges from 0.00% to 0.75% per annum with respect to loans (“ABR Loans”) pegged to the specified prime rate, and 1.00% to 1.75% per annum on loans (“Eurodollar Loans”) pegged to the adjusted LIBO rate (such applicable margin, the “Applicable Rate”). The revolving credit commitments under the Credit Agreement are subject to a commitment fee. The commitment fee is also tied to the Company’s leverage ratio, and ranges from 0.15% to 0.30% per annum on the average daily amount by which the aggregate revolving commitments exceed the sum of outstanding revolving loans and letter of credit obligations. A 50 basis point increase or decrease in interest rates may impact our interest expense for the year ended December 31, 2021 by approximately $0.5 million.
In October 2018, we issued the Notes with an aggregate principal amount of $150.0 million (see Note 17 - Borrowings to our consolidated financial statements). The Notes bear interest at a fixed rate, so we have no financial statement impact from changes in interest rates. During the year ended December 31, 2021 we prepaid and settled our outstanding obligations under the Notes.
We had cash, cash equivalents and short-term investments totaling $313.9 million and $402.8 million at December 31, 2021 and 2020, respectively. These amounts were invested principally in a short-term investment portfolio primarily comprised of highly-rated debt mutual funds, money market accounts and time deposits. The cash and cash equivalents are held for potential acquisitions of complementary businesses or assets, capital expenditures, working capital requirements and general corporate purposes. We do not enter into these investments for trading or speculative purposes. We believe that we have no material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. The interest income from these funds is subject to fluctuations due to changes in interest rates. Declines in interest rates would reduce our future investment income. A 50 basis point increase or decrease in short term rates would have impacted our interest and dividend income for the year ended December 31, 2021 by approximately $1.0 million.
Credit Risk. As of December 31, 2021 and 2020, we have accounts receivable of $194.2 million and $147.6 million, respectively. We believe that our credit policies reflect normal industry terms and business risk. We do not anticipate non-performance by the counterparties and, accordingly, do not require collateral. Credit losses and write-offs of accounts receivable balances historically have not been material. No single client owed more than 10% of accounts receivable balance as on December 31, 2021 and 2020.
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