Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures About 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, forward starting interest rate swaps, interest rate swaps, interest rate caps, treasury rate locks and foreign exchange forwards. 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 optimizing 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
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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.
Counterparties to our derivative contracts are major financial institutions with whom we have negotiated derivatives agreements (ISDA master agreements) and credit support annex (CSA) agreements which provide rules for collateral exchange. The CSA agreements contain fixed cap amounts or rating based thresholds such that we or our counterparties may be required to hold or post collateral based upon changes in outstanding positions as compared to established thresholds or caps and changes in credit ratings. We do not offset fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral arising from derivative instruments recognized at fair value. At both December 31, 2023 and 2022, we did not hold any collateral. At December 31, 2023 and 2022, we posted $1.4 billion and $2.3 billion, respectively, of collateral related to derivative contracts under collateral exchange agreements, which were recorded as Prepaid expenses and other in our consolidated balance sheets. While we may be exposed to credit losses due to the nonperformance of our counterparties, we consider the risk remote and do not expect that any such nonperformance would result in a significant effect on our results of operations or financial condition due to our diversified pool of counterparties. See Note 9 to the consolidated financial statements for additional information regarding the derivative portfolio.
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, 2023, approximately 76% of the 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 $379 million. The interest rates on our existing long-term debt obligations are unaffected by changes to our credit ratings.
U.S. dollar London Inter-Bank Offered Rate (LIBOR) rates ceased publication on June 30, 2023. Outstanding debt and derivative transactions that were benchmarked to LIBOR were repaid or transitioned to interest rates that are linked to the Secured Overnight Financing Rate as the benchmark rate by June 30, 2023. There was not a significant impact to our financial position given our current mix of variable and fixed-rate debt and taking into account the impact of our interest rate hedging.
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, 2023 and 2022. The table also provides a sensitivity analysis of the estimated fair values of these financial instruments assuming 100-basis-point upward and downward shifts in the yield curve. Our sensitivity 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)
Long-term debt and related derivatives Fair Value Fair Value assuming
+ 100 basis point shift Fair Value assuming
- 100 basis point shift
At December 31, 2023 $ 150,058 $ 142,551 $ 158,912
At December 31, 2022 143,648 136,199 152,427
Interest Rate Swaps
We enter into interest rate swaps to achieve a targeted mix of fixed and variable rate debt. We principally receive fixed rates and pay variable rates, resulting in a net increase or decrease to Interest expense. These swaps are designated as fair value hedges and hedge against interest rate risk exposure of designated debt issuances. At December 31, 2023, the fair value of the liability of these contracts was $4.5 billion. At December 31, 2022, the fair value of the liability of these contracts was $4.6 billion. At both December 31, 2023 and 2022, the total notional amount of the interest rate swaps was $26.1 billion.
Foreign Currency Risk
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 is recorded as cumulative 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 statements of income. At December 31, 2023, our primary translation exposure was to the British Pound Sterling, Euro, Australian Dollar and Swedish Krona.
Cross Currency Swaps
We have entered into cross currency swaps to exchange our British Pound Sterling, Euro, Swiss Franc, Canadian Dollar and Australian Dollar-denominated cash flows into U.S. dollars and to fix our cash payments in U.S. dollars, as well as to mitigate the impact of foreign currency transaction gains or losses. On March 31, 2022, we voluntarily elected to de-designate our cross currency swaps previously designated as cash flow hedges and re-designated the swaps as fair value hedges. Subsequently
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executed cross currency swaps are also designated as fair value hedges. The fair value of the asset of these contracts was $762 million and $305 million at December 31, 2023 and 2022, respectively. At December 31, 2023 and 2022, the fair value of the liability of these contracts was $2.1 billion and $3.6 billion, respectively. At December 31, 2023 and 2022, the total notional amount of the cross currency swaps was $33.5 billion and $35.0 billion, respectively.
Foreign Exchange Forwards
We also have foreign exchange forwards which we use as an economic hedge but for which we have elected not to apply hedge accounting. We enter into British Pound Sterling and Euro foreign exchange forwards to mitigate our foreign exchange rate risk related to non-functional currency denominated monetary assets and liabilities of international subsidiaries.
At both December 31, 2023 and 2022, the fair value of the asset and liability of these contracts was insignificant. At December 31, 2023 and 2022, the total notional amount of the foreign exchange forwards was $1.1 billion and $920 million, respectively.
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