Notes to Consolidated Financial Statements

NOTE 10

FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS

The following table presents the balances of assets measured at fair value on a recurring basis as of December 31, 2009:

(dollars in millions)

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Assets:

                       

Short-term investments

$

274

 

$

216

 

$

 

$

490

 

Investments in unconsolidated businesses

 

417

 

 

 

 

 

 

417

 

Other assets

 

 

 

1,365

 

 

 

 

1,365

 

Short-term investments and Investments in unconsolidated businesses include equity securities, mutual funds and U.S. Treasuries, which are generally measured using quoted prices in active markets and are classified as Level 1.

Other assets and the short-term investments classified as Level 2 are comprised of domestic and foreign corporate and government bonds. While quoted prices in active markets for certain of these debt securities are available, for some they are not. We use alternative matrix pricing as a practical expedient resulting in our debt securities being classified as Level 2. Our derivative contracts included in Other assets are primarily comprised of cross currency and interest rate swaps. Derivative contracts are valued using models based on readily observable market parameters for all substantial terms of our derivative contracts and thus are classified within Level 2. We use mid-market pricing for fair value measurements of our derivative instruments.

Gross unrealized gains and losses on marketable securities and other investments were not significant during 2009 and 2008.

Upon closing of the Alltel acquisition (see Note 2), the $4.8 billion investment in Alltel debt, which was classified as Level 3 at December 31, 2008, became an intercompany loan and is eliminated in consolidation.

Investment Impairment Charge

During 2008, we recorded a pretax charge of $48 million ($31 million after-tax) related to an other-than-temporary decline in the fair value of our investments in certain marketable securities.

Fair Value of Short-term and Long-term Debt

The fair value of our short-term and long-term debt, excluding capital leases, is determined based on market quotes for similar terms and maturities or future cash flows discounted at current rates. The fair value and carrying value of our long-term and short-term debt, excluding capital leases, were as follows:

(dollars in millions)

At December 31,

2009

 

2008

 

 

Carrying
Amount

 

Fair
Value

 

Carrying
Amount

 

Fair
Value

 

Short- and long-term debt

$

61,859

 

$

67,359

 

$

51,562

 

$

53,174

 

Derivatives

Interest Rate Swaps

We have entered into domestic interest rate swaps to achieve a targeted mix of fixed and variable rate debt, where we principally receive fixed rates and pay variable rates based on London Interbank Offered Rate (LIBOR). These swaps are designated as fair value hedges and hedge against changes in the fair value of our debt portfolio. We record the interest rate swaps at fair value on our balance sheet as assets and liabilities. Changes in the fair value of the interest rate swaps are recorded to interest expense, which are offset by changes in the fair value of the debt due to changes in interest rates. The fair value of these contracts was $171 million and $415 million at December 31, 2009 and December 31, 2008, respectively, and is included in Other assets and Long-term debt. As of December 31, 2009, the total notional amount of these interest rate swaps was $6.0 billion.

Cross Currency Swaps

During the fourth quarter of 2008, Verizon Wireless entered into cross currency swaps designated as cash flow hedges to exchange approximately $2.4 billion of the net proceeds from the December 2008 Verizon Wireless co-issued debt offering of British Pounds Sterling and Euro denominated debt into U.S. dollars and to fix our future interest and principal payments in U.S. dollars, as well as mitigate the impact of foreign currency transaction gains or losses. The fair value of these swaps included in Other assets at December 31, 2009 was approximately $315 million and at December 31, 2008 was insignificant. During 2009, a pretax gain of $310 million was recognized in Other comprehensive income, of which $135 million was reclassified from Accumulated other comprehensive loss to Other income and (expense), net to offset the related pretax foreign currency transaction loss on the underlying debt obligation.

Alltel Interest Rate Swaps

As a result of the Alltel acquisition, Verizon Wireless acquired seven interest rate swap agreements with a notional value of $9.5 billion that paid fixed and received variable rates based on three-month and one-month LIBOR with maturities ranging from 2009 to 2013. During the second quarter of 2009, we settled all of these agreements using cash generated from operations for a gain that was not significant. Changes in the fair value of these swaps were recorded in earnings through settlement.

Prepaid Forward Agreement

During the first quarter of 2009, we entered into a privately negotiated prepaid forward agreement for 14 million shares of Verizon common stock at a cost of approximately $390 million. During the fourth quarter of 2009, we terminated the prepaid forward agreement with respect to 5 million shares of Verizon common stock, which resulted in the delivery of those shares to Verizon. The remaining balance of the prepaid forward agreement for 9 million shares of Verizon common stock at December 31, 2009 of $252 million is included in Other assets. Changes in the fair value of the agreement, which were not significant during 2009, were included in Selling, general and administrative expense and Cost of services and sales.

Concentrations of Credit Risk

Financial instruments that subject us to concentrations of credit risk consist primarily of temporary cash investments, short-term and long-term investments, trade receivables, certain notes receivable, including lease receivables, and derivative contracts. Our policy is to deposit our temporary cash investments with major financial institutions. Counterparties to our derivative contracts are also major financial institutions. The financial institutions have all been accorded high ratings by primary rating agencies. We limit the dollar amount of contracts entered into with any one financial institution and monitor our counterparties’ credit ratings. We generally do not give or receive collateral on swap agreements due to our credit rating and those of our counterparties. While we may be exposed to credit losses due to the nonperformance of our counterparties, we consider the risk remote and do not expect the settlement of these transactions to have a material effect on our results of operations or financial condition.