CORNING INC /NY | 2013 | FY | 3

15.      Hedging Activities

Corning is exposed to interest rate and foreign currency risks due to the movement of these rates.

The areas in which exchange rate fluctuations affect us include:

·  
Financial instruments and transactions denominated in foreign currencies, which impact earnings; and

·  
The translation of net assets in foreign subsidiaries for which the functional currency is not the U.S. dollar, which impacts our net equity.

Our most significant foreign currency exposures relate to the Japanese yen, South Korean won, New Taiwan dollar, Chinese Renminbi, and the Euro.  We seek to mitigate the impact of exchange rate movements in our income statement by using over-the-counter (OTC) derivative instruments including foreign exchange forward and option contracts typically with durations of 36 months or less.  In general, these hedges expire coincident with the timing of the underlying foreign currency commitments and transactions.

We are exposed to potential losses in the event of non-performance by our counterparties to these derivative contracts.  However, we minimize this risk by limiting the counterparties to a diverse group of highly-rated major international financial institutions with which we have other financial relationships.  We do not expect to record any losses as a result of such counterparty default.  Neither we nor our counterparties are required to post collateral for these financial instruments.  In July 2013, the Finance Committee of the Board of Directors approved the Company’s qualification for and election of the end-user exception to the mandatory swap clearing requirement of the Dodd-Frank Act.

Cash Flow Hedges

Our cash flow hedging activities utilize OTC foreign exchange forward contracts to reduce the risk that movements in exchange rates will adversely affect the net cash flows resulting from the sale of products to foreign customers and purchases from foreign suppliers.  Our cash flow hedging activity also uses interest rate swaps to reduce the risk of increases in benchmark interest rates on the probable issuance of debt and associated interest payments.  Corning uses a regression analysis to monitor the effectiveness of its cash flow hedges both prospectively and retrospectively.  Through December 31, 2013, the hedge ineffectiveness related to these instruments is not material.  Corning defers net gains and losses related to effective portion of cash flow hedges into accumulated other comprehensive (loss) income on the consolidated balance sheet until such time as the hedged item impacts earnings.  At December 31, 2013, the amount of net gain expected to be reclassified into earnings within the next 12 months is $5 million.

Fair Value Hedges

In October of 2012, we entered into two interest rate swaps that are designated as fair value hedges and economically exchange a notional amount of $550 million of previously issued fixed rate long-term debt to floating rate debt.  Under the terms of the swap agreements, we pay the counterparty a floating rate that is indexed to the one-month LIBOR rate.

Corning utilizes the long haul method for effectiveness analysis, both retrospectively and prospectively.  The analysis excludes the impact of credit risk from the assessment of hedge effectiveness.  The amount recorded in current period earnings in the other income, net component, relative to ineffectiveness, is nominal for the year ended December 31, 2013.  There were no outstanding fair value hedges in 2012 or 2011.

Net gains and losses from fair value hedges and the effects of the corresponding hedged item are recorded on the same line item of the consolidated statement of operations.

Undesignated Hedges

Corning also uses OTC foreign exchange forward and option contracts that are not designated as hedging instruments for accounting purposes.  The undesignated hedges limit exposures to foreign functional currency fluctuations related to certain subsidiaries’ monetary assets, monetary liabilities and net earnings in foreign currencies.

A significant portion of the Company’s non-U.S. revenues are denominated in Japanese yen.  When these revenues are translated back to U.S. dollars, the Company is exposed to foreign exchange rate movements in the Japanese yen.  To protect translated earnings against movements in the Japanese yen, the Company has entered into a series of purchased collars and average rate forwards.

The Company also uses these types of contracts to reduce the potential for unfavorable changes in foreign exchange rates to decrease the U.S. dollar value of translated earnings.  With a purchased collar structure, the Company writes a local currency call option and purchases a local currency put option.  The purchased collars offset the impact of translated earnings above the put price and below the call strike price and that offset is reported in other income, net.  The Company entered into a series of purchased collars, settling quarterly, to hedge the effect of translation impact for each respective quarter, and span up to the fourth quarter of 2014.  Due to the nature of the instruments, only either the put option or the call option can be exercised at maturity.  As of December 31, 2013, the U.S. dollar net notional value of the purchased collars is $3 billion.  The Company entered into a series of average rate forwards with no associated premium, which will partially hedge the impact of Japanese yen translation on the Company’s projected 2015 net income.  These forwards have a notional value of $0.9 billion and will settle net without obligation to deliver Japanese yen.

The Company benefits from the increase in the U.S. dollar equivalent value of its foreign currency earnings in translation.  The purchased collar, within other income, would cap the benefit at the strike price of the written call or offset the decline from translation above the strike price of the purchased put.

The fair value of these derivative contracts are recorded as either assets (gain position) or liabilities (loss position) on the Consolidated Balance Sheet.  Changes in the fair value of the derivative contracts are recorded currently in earnings in the other income line of the Consolidated Statement of Operations.

The following table summarizes the notional amounts and respective fair values of Corning’s derivative financial instruments on a gross basis for December 31, 2013 and December 31, 2012 (in millions):

     
Asset derivatives
 
Liability derivatives
 
Notional amount
 
Balance sheet location
 
Fair value
 
Balance sheet location
 
Fair value
 
2013
 
2012
   
2013
 
2012
   
2013
 
2012
                               
Derivatives designated as hedging instruments
                                         
                                           
Foreign exchange contracts
$
433
 
$
719
 
Other current assets
 
$
8
 
$
57
 
Other accrued liabilities
 
$
(3)
 
$
(3)
Interest rate contracts
$
550
 
$
550
                 
Other liabilities
 
$
(28)
     
Derivatives not designated as hedging instruments
                                         
                                           
Foreign exchange contracts
$
804
 
$
1,939
 
Other current assets
 
$
20
 
$
109
 
Other accrued liabilities
 
$
(3)
 
$
(10)
Translated earnings contracts
$
6,826
       
Other current assets
 
$
344
       
Other accrued liabilities
 
$
(3)
     
             
Other assets
 
$
90
       
Other liabilities
           
                                           
Total derivatives
$
8,613
 
$
3,208
     
$
462
 
$
166
     
$
(37)
 
$
(13)

The following tables summarize the effect on the consolidated financial statements relating to Corning’s derivative financial instruments (in millions):

 
Effect of derivative instruments on the consolidated financial statements for the years ended December 31 
Derivatives
in hedging
relationships
Gain/(loss) recognized in other
comprehensive income (OCI) (2)
 
Location of gain/(loss) reclassified from
accumulated OCI into income
effective/ineffective
 
Gain/(loss) reclassified from
accumulated OCI into income
ineffective/effective (1)
2013
 
2012
 
2011
   
2013
 
2012
 
2011
                                       
Cash flow hedges
                                     
                   
Net sales
       
$
1
     
Interest rate hedge
$
33
 
$
15
 
$
(33)
 
Cost of sales
 
$
38
 
$
16
 
$
(12)
Foreign exchange contracts
$
56
 
$
85
 
$
(28)
 
Other income, net
 
$
91
 
$
11
 
$
(42)
                                       
Total cash flow hedges
$
89
 
$
100
 
$
(61)
     
$
129
 
$
28
 
$
(54)

     
Gain (loss) recognized in income (2)
 
Undesignated
derivatives
Location
 
2013
 
2012
 
2011
 
                       
Foreign exchange contracts – balance sheet
Other income, net
 
$
100
 
$
82
 
$
137
 
Foreign exchange contracts – loans
Other income, net
 
$
87
 
$
141
 
$
(252)
 
Translated earnings contracts
Other income, net
 
$
435
             
                       
Total undesignated
   
$
622
 
$
223
 
$
(115)
 

(1)  
The amount of hedge ineffectiveness for the year ended December 31, 2013 was $24 million related to interest rate swaps settled in the fourth quarter.  The amount of ineffectiveness for 2012 and 2011 was insignificant.

(2)  
Certain amounts for prior periods were reclassified to conform to the current presentation.  The gain (loss) on foreign exchange contracts is now disclosed in two categories, Foreign exchange contracts – balance sheet, and Foreign exchange contracts – loans.

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