Derivatives and Hedging Activities

12 Months Ended

Dec. 31, 2020

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivatives and Hedging ActivitiesCredco uses derivative financial instruments to manage exposures to various market risks. These instruments derive their value from an underlying variable or multiple variables, including interest rates and foreign exchange rates, and are carried at fair value on the Consolidated Balance Sheets. These instruments enable end users to increase, reduce or alter exposure to various market risks and, for that reason, are an integral component of Credco’s market risk management. Credco does not transact in derivatives for trading purposes.

Market risk is the risk to earnings or asset and liability values resulting from movements in market prices. Credco’s market risk exposures include:

•Interest rate risk in its funding activities; and

•Foreign exchange risk arising from earnings, funding, transactions and investments in currencies other than the U.S. dollar.

American Express centrally monitors market risks using market risk limits and escalation triggers as defined in its Asset/Liability Management Policy.

Interest rate risk primarily arises through the funding of Card Member receivables and fixed-rate loans with variable-rate borrowings, as well as through the risk to net interest margin from changes in the relationship between benchmark rates such as Prime, London interbank offered rate (LIBOR) and the overnight indexed swap rate. Interest rate exposure within charge card and fixed-rate lending products is managed by varying the proportion of total funding provided by short-term and variable-rate debt compared to fixed-rate debt. In addition, interest rate swaps are used from time to time to economically convert fixed-rate debt obligations to variable-rate obligations or to convert variable-rate debt obligations to fixed-rate obligations. Credco may change the mix between variable-rate and fixed-rate funding based on changes in business volumes and mix, among other factors.

Foreign exchange risk is generated by funding foreign currency Card Member receivables and loans with U.S. dollars, foreign currency balance sheet exposures, foreign subsidiary equity and foreign currency earnings in entities outside the United States. Credco’s foreign exchange risk is managed primarily by entering into agreements to buy and sell currencies on a spot basis or by hedging this market exposure to the extent it is economical, through various means, including the use of derivatives such as foreign exchange forwards. Exposures from foreign subsidiary equity in Credco’s entities outside the United States are hedged through the use of foreign exchange forwards executed either by Credco or TRS.

Derivatives may give rise to counterparty credit risk, which is the risk that a derivative counterparty will default on, or otherwise be unable to perform pursuant to an uncollateralized derivative exposure. This risk is managed by considering the current exposure, which is the replacement cost of contracts on the measurement date, as well as estimating the maximum potential future exposure of the contracts over the next 12 months, considering such factors as the volatility of the underlying or reference index. To mitigate derivative credit risk, counterparties are required to be pre-approved by American Express and rated as investment grade, and counterparty risk exposures are centrally monitored.

A majority of Credco’s derivative assets and liabilities as of December 31, 2020, and 2019 are subject to master netting agreements with its derivative counterparties. Accordingly, where appropriate, Credco has elected to present derivative assets and liabilities with the same counterparty on a net basis in the Consolidated Balance Sheets. To further mitigate counterparty credit risk, Credco’s interest rate swaps are cleared through a central clearinghouse and are collateralized to the full amount of the fair value of the contracts.

In relation to Credco’s credit risk, certain of Credco’s bilateral derivative agreements include provisions that allow Credco’s counterparties to terminate the agreement in the event of a downgrade of Credco’s debt credit rating below investment grade and settle the outstanding net liability position. As of December 31, 2020, these derivatives were not in a material net liability position and Credco had no material risk exposure to any individual derivative counterparty. Based on Credco’s assessment of the credit risk of its derivative counterparties and its own credit risk as of December 31, 2020, and 2019, no credit risk adjustment to the derivative portfolio was required.

Credco’s derivatives are carried at fair value on the Consolidated Balance Sheets. The accounting for changes in fair value depends on the instruments’ intended use and the resulting hedge designation, if any, as discussed below. Refer to Note 7 for a description of Credco’s methodology for determining the fair value of derivatives.

The following table summarizes the total fair value, excluding interest accruals, of derivative assets and liabilities as of December 31:


	Other Assets Fair Value				Other Liabilities Fair Value
(Millions)	2020		2019		2020		2019
Derivatives designated as hedging instruments:
Fair value hedges - Interest rate contracts(a)(b)	$	—	$	—	$	—	$	—
Net investment hedges - Foreign exchange contracts	1		12		195		44
Total derivatives designated as hedging instruments	1		12		195		44
Derivatives not designated as hedging instruments:
Foreign exchange contracts	48		31		89		182
Total derivatives, gross	49		43		284		226
Derivative asset and derivative liability netting(c)	(15)		(27)		(15)		(27)
Total derivatives, net	$	34	$	16	$	269	$	199

(a)For Credco’s centrally cleared derivatives, variation margin payments are legally characterized as settlement payments as opposed to collateral.

(b)Credco posted $12 million and $20 million as of December 31, 2020, and 2019, respectively, as initial margin on its centrally cleared interest rate swaps; such amounts are recorded within Other assets on Credco’s Consolidated Balance Sheets and are not netted against the derivative balances.

(c)Represents the amount of netting of derivative assets and derivative liabilities executed with the same counterparties under an enforceable master netting arrangement.

Derivative Financial Instruments that Qualify for Hedge Accounting

Derivatives executed for hedge accounting purposes are documented and designated as such when Credco enters into the contracts. In accordance with its risk management policies, Credco structures its hedges with terms similar to those of the item being hedged. Credco formally assesses, at inception of the hedge accounting relationship and on a quarterly basis, whether derivatives designated as hedges are highly effective in offsetting the fair value or cash flows of the hedged items. These assessments usually are made through the application of a regression analysis method. If it is determined that a derivative is not highly effective as a hedge, Credco will discontinue the application of hedge accounting.

Fair Value Hedges

A fair value hedge involves a derivative designated to hedge Credco’s exposure to future changes in the fair value of an asset or a liability, or an identified portion thereof that is attributable to a particular risk.

Interest Rate Contracts

Credco is exposed to interest rate risk associated with its fixed-rate debt obligations. At the time of issuance, certain fixed-rate long-term debt obligations are designated in fair value hedging relationships using interest rate swaps to economically convert the fixed interest rate to a floating interest rate. Credco has $3.5 billion and $8.8 billion of its fixed-rate debt obligations designated in fair value hedging relationships as of December 31, 2020, and 2019, respectively.

Gains or losses on the fair value hedging instrument principally offset the losses or gains on the hedged item attributable to the hedged risk. The changes in the fair value of the derivative and the changes in the hedged item may not fully offset due to differences between a debt obligation’s interest rate and the benchmark rate, primarily due to credit spreads at inception of the hedging relationship that are not reflected in the fair value of the interest rate swap. Furthermore, the difference may be caused by changes in 1-month LIBOR, 3-month LIBOR and the overnight indexed swap rate, as spreads between these rates impact the fair value of the interest rate swap without an exact offsetting impact to the fair value of the hedged debt.

The following table presents the gains and losses recognized in Interest Expense on the Consolidated Statements of Income associated with the fair value hedges of Credco’s fixed-rate long-term debt for the years ended December 31:


	Gains (losses)
(Millions)	2020		2019		2018
Fixed-rate long-term debt	$	(42)	$	(181)	$	29
Derivatives designated as hedging instruments	45		184		(13)
Total	$	3	$	3	$	16

The carrying values of the hedged liabilities, recorded within Long-term debt on the Consolidated Balance Sheets, were $3.5 billion and $8.7 billion as of December 31, 2020, and 2019, respectively, including the cumulative amount of fair value hedging adjustments of $40 million and $(2) million for the respective periods.

Credco recognized a net decrease of $39 million for the year ended December 31, 2020, and net increases of $90 million and $75 million in Interest expense on Long-term debt for the years ended December 31, 2019 and 2018, respectively, primarily related to the net settlements including interest accruals on Credco’s interest rate derivatives designated as fair value hedges.

Net Investment Hedges

A net investment hedge is used to hedge future changes in currency exposure of a net investment in a foreign operation. Credco 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 Credco’s investments in non-U.S. subsidiaries. Credco had notional amounts of approximately $2.9 billion and $3.0 billion of foreign currency derivatives designated as net investment hedges as of December 31, 2020, and 2019, respectively. The gain or loss on net investment hedges, net of taxes, recorded in AOCI as part of the cumulative translation adjustment were losses of $131 million and $44 million for the years ended December 31, 2020, and 2019, respectively, and a gain of $127 million for the year ended December 31, 2018.

Derivatives Not Designated as Hedges

Credco has derivatives that act as economic hedges, but are not designated as such for hedge accounting purposes. Foreign currency transactions from time to time may be partially or fully economically hedged through foreign currency contracts, primarily foreign exchange forwards. These hedges generally mature within one year. Foreign currency contracts involve the purchase and sale of designated currencies at an agreed-upon rate for settlement on a specified date.

The changes in the fair value of derivatives that are not designated as hedges are intended to offset the related foreign exchange gains or losses of the underlying foreign currency exposures. The changes in the fair value of the derivatives and the related underlying foreign currency exposures resulted in a net gains of $15 million, $87 million and $59 million for the years ended December 31, 2020, 2019 and 2018, respectively, which are recognized in Other, net expenses in the Consolidated Statements of Income.

AMERICAN EXPRESS CREDIT CORP 10-K