Quarterly report pursuant to Section 13 or 15(d)

FAIR VALUE OF FINANCIAL INSTRUMENTS

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FAIR VALUE OF FINANCIAL INSTRUMENTS
9 Months Ended
Sep. 30, 2012
FAIR VALUE OF FINANCIAL INSTRUMENTS  
FAIR VALUE OF FINANCIAL INSTRUMENTS

NOTE 8.  FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The majority of the assets and liabilities we carry at fair value are available-for-sale (AFS) securities and derivatives.  AFS securities are derived from level 1 or level 2 inputs.  Derivative assets and liabilities are derived from level 2 inputs.  The predominance of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services.  When material, we adjust the values of our derivative contracts for counter-party or our credit risk.  There were no transfers into or out of levels 2 or 3 in the first nine months of 2012.

 

The following table summarizes our financial instruments recorded at fair value in our Condensed Consolidated Balance Sheets at September 30, 2012:

 

 

 

Fair Value Measurements Using

 

 

 

Quoted prices in
active markets for
identical assets

 

Significant other
observable inputs

 

Significant
unobservable inputs

 

 

 

In millions

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

 

Available-for-sale debt securities

 

 

 

 

 

 

 

 

 

Debt mutual funds

 

$

78

 

$

65

 

$

 

$

143

 

Bank debentures

 

 

50

 

 

50

 

Certificates of deposit

 

 

32

 

 

32

 

Government debt securities-non-U.S.

 

 

3

 

 

3

 

Corporate debt securities

 

 

2

 

 

2

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale equity securities

 

 

 

 

 

 

 

 

 

Financial services industry

 

9

 

 

 

9

 

 

 

 

 

 

 

 

 

 

 

Derivative assets

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

 

88

 

 

88

 

Commodity swap contracts

 

 

6

 

 

6

 

Foreign currency forward contracts

 

 

5

 

 

5

 

Commodity call option contracts

 

 

1

 

 

1

 

Total assets

 

$

87

 

$

252

 

$

 

$

339

 

 

 

 

 

 

 

 

 

 

 

Derivative liabilities

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts

 

 

1

 

 

1

 

Total liabilities

 

$

 

$

1

 

$

 

$

1

 

 

The following table summarizes our financial instruments recorded at fair value in our Condensed Consolidated Balance Sheets at December 31, 2011:

 

 

 

Fair Value Measurements Using

 

 

 

Quoted prices in
active markets for
identical assets

 

Significant other
observable inputs

 

Significant
unobservable inputs

 

 

 

In millions

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

 

Available-for-sale debt securities

 

 

 

 

 

 

 

 

 

Debt mutual funds

 

$

53

 

$

64

 

$

 

$

117

 

Bank debentures

 

 

82

 

 

82

 

Certificates of deposit

 

 

66

 

 

66

 

Government debt securities-non-U.S.

 

 

3

 

 

3

 

Corporate debt securities

 

 

2

 

 

2

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale equity securities

 

 

 

 

 

 

 

 

 

Financial services industry

 

7

 

 

 

7

 

 

 

 

 

 

 

 

 

 

 

Derivative assets

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

 

82

 

 

82

 

Total assets

 

$

60

 

$

299

 

$

 

$

359

 

 

 

 

 

 

 

 

 

 

 

Derivative liabilities

 

 

 

 

 

 

 

 

 

Commodity swap contracts

 

 

22

 

 

22

 

Foreign currency forward contracts

 

 

8

 

 

8

 

Total liabilities

 

$

 

$

30

 

$

 

$

30

 

 

The substantial majority of our assets were valued utilizing a market approach.  A description of the valuation techniques and inputs used for our level 2 fair value measures are as follows:

 

Debt mutual funds — Assets in level 2 consist of exchange traded mutual funds that lack sufficient trading volume to be classified at level 1.  The fair value measure for these investments is the daily net asset value published on a regulated governmental website.  Daily quoted prices are available from the issuing brokerage and are used on a test basis to corroborate this level 2 input.

 

Bank debentures and Certificates of deposit — These investments provide us with a fixed rate of return and generally range in maturity from six months to three years.  The counter-parties to these investments are reputable financial institutions with investment grade credit ratings.  Since these instruments are not tradable and must be settled directly by Cummins with the respective financial institution, our fair value measure is the financial institutions’ month-end statement.

 

Government debt securities-non-U.S. and Corporate debt securities — The fair value measure for these securities are broker quotes received from reputable firms.  These securities are infrequently traded on a national stock exchange and these values are used on a test basis to corroborate our level 2 input measure.

 

Foreign currency forward contracts — The fair value measure for these contracts are determined based on forward foreign exchange rates received from third-party pricing services.  These rates are based upon market transactions and are periodically corroborated by comparing to third-party broker quotes.

 

Commodity swap contracts — The fair value measure for these contracts are current spot market data adjusted for the appropriate current forward curves provided by external financial institutions.  The current spot price is the most significant component of this valuation and is based upon market transactions.  We use third-party pricing services for the spot price component of this valuation which is periodically corroborated by market data from broker quotes.

 

Commodity call and put option contracts — We utilize the month-end statement from the issuing financial institution as our fair value measure for this investment.  We corroborate this valuation through the use of a third-party pricing service for similar assets and liabilities.

 

Interest rate contracts — We currently have only one interest rate contract.  We utilize the month-end statement from the issuing financial institution as our fair value measure for this investment.  We corroborate this valuation through the use of a third-party pricing service for similar assets and liabilities.

 

Fair Value of Other Financial Instruments

 

Based on borrowing rates currently available to us for bank loans with similar terms and average maturities, considering our risk premium, the fair value and carrying value of total debt, including current maturities, at September 30, 2012 and December 31, 2011, are set forth in the table below.  The carrying values of all other receivables and liabilities approximated fair values (derived from level 2 inputs).

 

 

 

September 30,

 

December 31,

 

In millions

 

2012

 

2011

 

Fair value of total debt

 

$

957

 

$

901

 

Carrying value of total debt

 

801

 

783