NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1.
Summary of Significant Accounting Policies
Organization
Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (“Mastercard International” and together with Mastercard Incorporated, “Mastercard” or the “Company”), is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments and businesses worldwide, enabling them to use electronic forms of payment instead of cash and checks. The Company facilitates the processing of payment transactions including authorization, clearing and settlement, and delivers related products and services. The Company makes payments easier and more efficient by creating a wide range of payment solutions and services through a family of well-known brands, including Mastercard®, Maestro® and Cirrus®. The Company also provides value-added offerings such as loyalty and reward programs, information services and consulting. The Company’s network is designed to ensure safety and security for the global payments system. A typical transaction on the Company’s network involves four participants in addition to the Company: cardholder, merchant, issuer (the cardholder’s financial institution) and acquirer (the merchant’s financial institution). The Company’s customers encompass a vast array of entities, including financial institutions and other entities that act as “issuers” and “acquirers”, as well as merchants, governments, telecommunication companies and other businesses. The Company does not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to cardholders by issuers, or establish the rates charged by acquirers in connection with merchants’ acceptance of the Company’s branded cards.
Consolidation and basis of presentation
The consolidated financial statements include the accounts of Mastercard and its majority-owned and controlled entities, including any variable interest entities (“VIEs”) for which the Company is the primary beneficiary. As of
September 30, 2016
and
December 31, 2015
, there were no significant VIEs which required consolidation. Intercompany transactions and balances have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the 2016 presentation. The Company follows accounting principles generally accepted in the United States of America (“GAAP”).
The balance sheet as of
December 31, 2015
was derived from the audited consolidated financial statements as of
December 31, 2015
. The consolidated financial statements for the
three and nine months ended September 30, 2016
and
2015
and as of
September 30, 2016
are unaudited, and in the opinion of management, include all normal recurring adjustments that are necessary to present fairly the results for interim periods. The results of operations for the
three and nine months ended September 30, 2016
are not necessarily indicative of the results to be expected for the full year.
The accompanying unaudited consolidated financial statements are presented in accordance with the U.S. Securities and Exchange Commission requirements for Quarterly Reports on Form 10-Q. Reference should be made to the Mastercard Incorporated Annual Report on Form 10-K for the year ended
December 31, 2015
for additional disclosures, including a summary of the Company’s significant accounting policies.
Non-controlling interest amounts are included in the consolidated statement of operations within other income (expense). For the
three and nine months ended September 30, 2016
and
2015
, activity from non-controlling interests was insignificant.
Recent accounting pronouncements
Intra-entity asset transfers
- In October 2016, the Financial Accounting Standards Board (“FASB”) issued accounting guidance to simplify the accounting for income tax consequences of intra-entity transfers of assets other than inventory. Under this guidance, companies will be required to recognize the income tax consequences of an intra-entity asset transfer when the transfer occurs. The guidance must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the period of adoption. The Company is in the process of evaluating the impacts this guidance will have on its consolidated financial statements. However, the Company expects that it will recognize a cumulative-effect adjustment to retained earnings upon adoption of the new guidance related to intra-entity asset transfers occurring before adoption. The guidance is effective for periods beginning after December 15, 2017 and early adoption is permitted.
Share-Based Payments
- In March 2016, the FASB
issued accounting guidance related to share-based payments to employees. Under this guidance, companies will be required to recognize the tax effects of exercised or vested awards within the income statement, in the period in which they occur, rather than within additional paid-in-capital. In addition, the guidance changes the
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
limit that companies are allowed to withhold for employees without triggering liability accounting and allows companies to make a policy election to either recognize forfeitures as they occur or estimate them. The guidance is effective for periods beginning after December 15, 2016 and early adoption is permitted. The required transition methods for each aspect of the guidance varies between prospective, retrospective and modified retrospective. The Company will adopt the accounting guidance effective January 1, 2017 and the impact on the tax provision during the period will be dependent upon several factors including, the amount and grant value of equity awards that either vest or are exercised, in addition to, Mastercard’s share price on those dates.
Leases
- In February 2016, the FASB issued accounting guidance that will change how companies account for and present lease arrangements. The guidance requires companies to recognize leased assets and liabilities for both capital and operating leases. The guidance is effective for periods after December 15, 2018 and early adoption is permitted. Companies are required to adopt the guidance using a modified retrospective method. The Company is in the process of evaluating the potential effects this guidance will have on its consolidated financial statements.
Debt Issuance Costs
- In April 2015, the FASB issued accounting guidance that changed the current presentation of debt issuance costs on the balance sheet. This guidance moved debt issuance costs from the assets section of the balance sheet to the liabilities section as a direct deduction from the carrying amount of the debt issued. The Company adopted the accounting guidance effective January 1, 2016. The Company applied the guidance retrospectively and, as such, the
December 31, 2015
balance sheet was adjusted to reflect the effects of the standard. This retrospective adjustment resulted in reductions of prepaid expenses and other current assets, other assets and long-term debt by
$1 million
,
$18 million
and
$19 million
, respectively. As of
September 30, 2016
,
$18 million
of debt issuance costs were classified as an offset to long-term debt.
Revenue Recognition
- In May 2014, the FASB issued accounting guidance that provides a single, comprehensive revenue recognition model for all contracts with customers and supersedes most of the existing revenue recognition requirements. Under this guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued accounting guidance that delayed the effective date of this standard by one year, making the guidance effective for fiscal years beginning after December 15, 2017. The Company will adopt the accounting guidance effective January 1, 2018. The accounting guidance permits either a full retrospective or modified retrospective transition method. The new revenue guidance will impact the timing of recognition for certain of the Company’s customer incentives. Under the new guidance, the Company will recognize certain customer incentives over the life of the contract as revenue is recognized versus as they are earned by the customer. The Company is in the process of evaluating the potential effects this guidance will have on its consolidated financial statements and which method of adoption it will select.
Note 2.
Acquisitions
On July 21, 2016, Mastercard entered into a definitive agreement to acquire a
92.4%
controlling interest in VocaLink Holdings Limited (“VocaLink”) for approximately
£700 million
(approximately
$910 million
as of
September 30, 2016
) after adjusting for cash and certain other estimated liabilities. VocaLink’s existing shareholders have the potential for an earn-out of up to an additional
£169 million
(approximately
$220 million
as of
September 30, 2016
) if certain performance targets are met. Under the agreement, a majority of VocaLink’s shareholders will retain
7.6%
ownership for at least
three years
. VocaLink operates payments clearing systems and ATM switching platforms in the U.K., as well as several other regions. While the Company anticipates completing the transaction by about the middle of 2017, it is subject to regulatory approval and other customary closing conditions.
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Note 3.
Earnings Per Share
The components of basic and diluted earnings per share (“EPS”) for common stock were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
(in millions, except per share data)
|
Numerator:
|
|
|
|
|
|
|
|
Net income
|
$
|
1,184
|
|
|
$
|
977
|
|
|
$
|
3,126
|
|
|
$
|
2,918
|
|
Denominator:
|
|
|
|
|
|
|
|
Basic weighted-average shares outstanding
|
1,096
|
|
|
1,130
|
|
|
1,101
|
|
|
1,136
|
|
Dilutive stock options and stock units
|
3
|
|
|
3
|
|
|
3
|
|
|
3
|
|
Diluted weighted-average shares outstanding
1
|
1,099
|
|
|
1,133
|
|
|
1,104
|
|
|
1,139
|
|
Earnings per Share:
|
|
|
|
|
|
|
|
Basic
|
$
|
1.08
|
|
|
$
|
0.86
|
|
|
$
|
2.84
|
|
|
$
|
2.57
|
|
Diluted
|
$
|
1.08
|
|
|
$
|
0.86
|
|
|
$
|
2.83
|
|
|
$
|
2.56
|
|
1
For the periods presented, the calculation of diluted EPS excluded a minimal amount of anti-dilutive share-based payment awards.
Note 4.
Fair Value and
Investment Securities
Financial Instruments – Recurring Measurements
The Company classifies its fair value measurements of financial instruments into a three-level hierarchy (the “Valuation Hierarchy”). There were
no
transfers made among the three levels in the Valuation Hierarchy during the
three and nine months ended September 30, 2016
.
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
The distribution of the Company’s financial instruments which are measured at fair value on a recurring basis within the Valuation Hierarchy was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
Quoted Prices
in Active
Markets
(Level 1)
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
Fair
Value
|
|
(in millions)
|
Municipal securities
|
$
|
—
|
|
|
$
|
57
|
|
|
$
|
—
|
|
|
$
|
57
|
|
Government and agency securities
1
|
36
|
|
|
125
|
|
|
—
|
|
|
161
|
|
Corporate securities
|
—
|
|
|
905
|
|
|
—
|
|
|
905
|
|
Asset-backed securities
|
—
|
|
|
86
|
|
|
—
|
|
|
86
|
|
Other
|
2
|
|
|
(31
|
)
|
|
—
|
|
|
(29
|
)
|
Total
|
$
|
38
|
|
|
$
|
1,142
|
|
|
$
|
—
|
|
|
$
|
1,180
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
Quoted Prices
in Active
Markets
(Level 1)
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
Fair
Value
|
|
(in millions)
|
Municipal securities
|
$
|
—
|
|
|
$
|
62
|
|
|
$
|
—
|
|
|
$
|
62
|
|
Government and agency securities
1
|
31
|
|
|
64
|
|
|
—
|
|
|
95
|
|
Corporate securities
|
—
|
|
|
645
|
|
|
—
|
|
|
645
|
|
Asset-backed securities
|
—
|
|
|
57
|
|
|
—
|
|
|
57
|
|
Other
|
2
|
|
|
14
|
|
|
—
|
|
|
16
|
|
Total
|
$
|
33
|
|
|
$
|
842
|
|
|
$
|
—
|
|
|
$
|
875
|
|
1
Excludes amounts held in escrow related to the U.S. merchant class litigation settlement of
$543 million
and
$541 million
at
September 30, 2016
and
December 31, 2015
, respectively, which would be included in Level 1 of the Valuation Hierarchy. See
Note 6 (Accrued Expenses and Accrued Litigation)
and
Note 11 (Legal and Regulatory Proceedings)
for further details.
The fair value of the Company’s available-for-sale municipal securities, government and agency securities, corporate securities and asset-backed securities are based on quoted prices for similar assets in active markets and are therefore included in Level 2 of the Valuation Hierarchy. The Company’s foreign currency derivative asset and liability contracts have also been classified within Level 2 in the Other category of the Valuation Hierarchy, as the fair value is based on broker quotes for the same or similar derivative instruments. See
Note 13 (Foreign Exchange Risk Management)
for further details. The Company’s U.S. government securities and marketable equity securities are classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices for identical assets in active markets.
Financial Instruments - Non-Recurring Measurements
Certain financial instruments are carried on the consolidated balance sheet at cost, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, restricted cash, time deposits, accounts receivable, settlement due from customers, restricted security deposits held for customers, accounts payable, settlement due to customers and accrued expenses. In addition, nonmarketable equity investments are measured at fair value on a nonrecurring basis for purposes of initial recognition and impairment testing.
Investments on the consolidated balance sheet include both available-for-sale and short-term held-to-maturity securities. Available-for-sale securities are measured at fair value on a recurring basis and are included in the Valuation Hierarchy table above. Short-term held-to-maturity securities are made up of time deposits with maturities of greater than three months and less than one year and are classified as Level 2 of the Valuation Hierarchy, but are not included in the table above due to their fair values not being measured on a recurring basis. At
September 30, 2016
and
December 31, 2015
, the cost, which approximates fair value, of the Company’s short-term held-to-maturity securities was
$563 million
and
$130 million
, respectively. In addition,
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
at
September 30, 2016
, the Company held
$62 million
of long-term held-to-maturity securities classified in other assets on the consolidated balance sheet, the cost of which approximates fair value.
Debt
The Company estimates the fair value of its long-term debt using the market pricing approach which applies market assumptions for relevant though not directly comparable undertakings. Long-term debt is classified as Level 2 of the Valuation Hierarchy. At
September 30, 2016
, the carrying value and fair value of long-term debt was
$3.3 billion
and
$3.6 billion
, respectively. At
December 31, 2015
, the carrying value and fair value of long-term debt was
$3.3 billion
.
Settlement and Other Guarantee Liabilities
The Company estimates the fair value of its settlement and other guarantees using the market pricing approach which applies market assumptions for relevant though not directly comparable undertakings, as the latter are not observable in the market given the proprietary nature of such guarantees. At
September 30, 2016
and
December 31, 2015
, the carrying value and fair value of settlement and other guarantee liabilities were not material. Settlement and other guarantee liabilities are classified as Level 3 of the Valuation Hierarchy as their valuation requires substantial judgment and estimation of factors that are not currently observable in the market. For additional information regarding the Company’s settlement and other guarantee liabilities, see
Note 12 (Settlement and Other Risk Management)
.
Non-Financial Instruments
Certain assets are measured at fair value on a nonrecurring basis for purposes of initial recognition and impairment testing. The Company’s non-financial assets measured at fair value on a nonrecurring basis include property, plant and equipment, goodwill and other intangible assets. These assets are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment.
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Amortized Costs and Fair Values – Available-for-Sale Investment Securities
The major classes of the Company’s available-for-sale investment securities, for which unrealized gains and losses are recorded as a separate component of other comprehensive income on the consolidated statement of comprehensive income, and their respective amortized cost basis and fair values as of
September 30, 2016
and
December 31, 2015
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
Amortized
Cost
|
|
Gross
Unrealized
Gain
|
|
Gross
Unrealized
Loss
|
|
Fair
Value
|
|
(in millions)
|
Municipal securities
|
$
|
57
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
57
|
|
Government and agency securities
|
160
|
|
|
1
|
|
|
—
|
|
|
161
|
|
Corporate securities
|
901
|
|
|
4
|
|
|
—
|
|
|
905
|
|
Asset-backed securities
|
86
|
|
|
—
|
|
|
—
|
|
|
86
|
|
Other
|
2
|
|
|
—
|
|
|
—
|
|
|
2
|
|
Total
|
$
|
1,206
|
|
|
$
|
5
|
|
|
$
|
—
|
|
|
$
|
1,211
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
Amortized
Cost
|
|
Gross
Unrealized
Gain
|
|
Gross
Unrealized
Loss
|
|
Fair
Value
|
|
(in millions)
|
Municipal securities
|
$
|
62
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
62
|
|
Government and agency securities
|
94
|
|
|
1
|
|
|
—
|
|
|
95
|
|
Corporate securities
|
646
|
|
|
—
|
|
|
(1
|
)
|
|
645
|
|
Asset-backed securities
|
57
|
|
|
—
|
|
|
—
|
|
|
57
|
|
Other
|
2
|
|
|
—
|
|
|
—
|
|
|
2
|
|
Total
|
$
|
861
|
|
|
$
|
1
|
|
|
$
|
(1
|
)
|
|
$
|
861
|
|
The Company’s available-for-sale investment securities held at
September 30, 2016
, primarily carried a credit rating of A-, or better. The municipal securities are primarily comprised of tax-exempt bonds and are diversified across states and sectors. Government and agency securities include U.S. government bonds, U.S. government sponsored agency bonds and foreign government bonds with similar credit quality to that of the U.S. government bonds. Corporate securities are comprised of commercial paper and corporate bonds. The asset-backed securities are investments in bonds which are collateralized primarily by automobile loan receivables.
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Investment Maturities
The maturity distribution based on the contractual terms of the Company’s investment securities at
September 30, 2016
was as follows:
|
|
|
|
|
|
|
|
|
|
Available-For-Sale
|
|
Amortized
Cost
|
|
Fair Value
|
|
(in millions)
|
Due within 1 year
|
$
|
475
|
|
|
$
|
475
|
|
Due after 1 year through 5 years
|
724
|
|
|
728
|
|
Due after 5 years through 10 years
|
1
|
|
|
1
|
|
Due after 10 years
|
5
|
|
|
5
|
|
No contractual maturity
1
|
1
|
|
|
2
|
|
Total
|
$
|
1,206
|
|
|
$
|
1,211
|
|
1
Equity securities have been included in the No contractual maturity category, as these securities do not have stated maturity dates.
Investment Income
Investment income primarily consists of interest income generated from cash, cash equivalents and investments. Gross realized gains and losses are recorded within investment income on the Company’s consolidated statement of operations. The gross realized gains and losses from the sales of available-for-sale securities for the
three and nine months ended September 30, 2016
and
2015
were not significant.
Note 5.
Prepaid Expenses and Other Assets
Prepaid expenses and other current assets consisted of the following:
|
|
|
|
|
|
|
|
|
|
September 30,
2016
|
|
December 31,
2015
|
|
(in millions)
|
Customer and merchant incentives
|
$
|
442
|
|
|
$
|
345
|
|
Prepaid income taxes
|
146
|
|
|
72
|
|
Other
|
234
|
|
|
246
|
|
Total prepaid expenses and other current assets
|
$
|
822
|
|
|
$
|
663
|
|
Other assets consisted of the following:
|
|
|
|
|
|
|
|
|
|
September 30,
2016
|
|
December 31,
2015
|
|
(in millions)
|
Customer and merchant incentives
|
$
|
1,126
|
|
|
$
|
810
|
|
Nonmarketable equity investments
|
149
|
|
|
166
|
|
Prepaid income taxes
|
351
|
|
|
352
|
|
Income taxes receivable
|
172
|
|
|
160
|
|
Other
|
163
|
|
|
92
|
|
Total other assets
|
$
|
1,961
|
|
|
$
|
1,580
|
|
Customer and merchant incentives represent payments made or amounts to be paid to customers and merchants under business agreements. Costs directly related to entering into such an agreement are generally deferred and amortized over the life of the agreement. Amounts to be paid for these incentives and the related liability were included in accrued expenses and other liabilities.
Non-current prepaid income taxes, included in the other asset table above, primarily consists of taxes paid in 2014 relating to the deferred charge on intercompany profits resulting from the reorganization of the Company’s legal entity and tax structure to better align with the business footprint of its non-U.S. operations. This deferred charge is amortized over
25 years
.
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Note 6.
Accrued Expenses and Accrued Litigation
Accrued expenses consisted of the following:
|
|
|
|
|
|
|
|
|
|
September 30,
2016
|
|
December 31,
2015
|
|
(in millions)
|
Customer and merchant incentives
|
$
|
2,326
|
|
|
$
|
1,748
|
|
Personnel costs
|
389
|
|
|
473
|
|
Advertising
|
56
|
|
|
114
|
|
Income and other taxes
|
162
|
|
|
143
|
|
Other
|
281
|
|
|
285
|
|
Total accrued expenses
|
$
|
3,214
|
|
|
$
|
2,763
|
|
As of
September 30, 2016
and
December 31, 2015
, the Company’s provision for litigation was
$716 million
and
$709 million
, respectively. These amounts are not included in the accrued expenses table above and are separately reported as accrued litigation on the consolidated balance sheet. See
Note 11 (Legal and Regulatory Proceedings)
for further discussion of the U.S. merchant class litigation and the U.K. merchant litigation which relate to these accruals.
Note 7.
Stockholders’ Equity
The Company’s Board of Directors has approved share repurchase programs authorizing the Company to repurchase its Class A common stock. The Company typically completes a share repurchase program before a new program becomes effective. The following table summarizes the Company’s share repurchase authorizations of its Class A common stock through
September 30, 2016
, as well as historical purchases:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Authorization Dates
|
|
December 2015
|
|
December
2014
|
|
December
2013
|
|
Total
|
|
(in millions, except average price data)
|
Board authorization
|
$
|
4,000
|
|
|
$
|
3,750
|
|
|
$
|
3,500
|
|
|
$
|
11,250
|
|
Dollar value of shares repurchased during the nine months ended September 30, 2015
|
$
|
—
|
|
|
$
|
2,450
|
|
|
$
|
275
|
|
|
$
|
2,725
|
|
Remaining authorization at December 31, 2015
|
$
|
4,000
|
|
|
$
|
507
|
|
|
$
|
—
|
|
|
$
|
4,507
|
|
Dollar value of shares repurchased during the nine months ended September 30, 2016
|
$
|
1,903
|
|
|
$
|
507
|
|
|
$
|
—
|
|
|
$
|
2,410
|
|
Remaining authorization at September 30, 2016
|
$
|
2,097
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,097
|
|
Shares repurchased during the nine months ended September 30, 2015
|
—
|
|
|
27.0
|
|
|
3.2
|
|
|
30.2
|
|
Average price paid per share during the nine months ended September 30, 2015
|
$
|
—
|
|
|
$
|
90.87
|
|
|
$
|
84.31
|
|
|
$
|
90.16
|
|
Shares repurchased during the nine months ended September 30, 2016
|
20.6
|
|
|
5.7
|
|
|
—
|
|
|
26.3
|
|
Average price paid per share during the nine months ended September 30, 2016
|
$
|
92.35
|
|
|
$
|
89.76
|
|
|
$
|
—
|
|
|
$
|
91.80
|
|
Cumulative shares repurchased through September 30, 2016
|
20.6
|
|
|
40.8
|
|
|
45.8
|
|
|
107.2
|
|
Cumulative average price paid per share
|
$
|
92.35
|
|
|
$
|
92.03
|
|
|
$
|
76.42
|
|
|
$
|
85.42
|
|
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Note 8.
Accumulated Other Comprehensive Income (Loss)
The changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, for the
nine months ended September 30, 2016
and
2015
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign Currency Translation Adjustments
|
|
Translation Adjustments on Net Investment Hedge
|
|
Defined Benefit Pension and Other Postretirement Plans
|
|
Investment Securities Available-for-Sale
|
|
Accumulated Other Comprehensive Income (Loss)
|
|
(in millions)
|
Balance at December 31, 2014
|
$
|
(230
|
)
|
|
$
|
—
|
|
|
$
|
(26
|
)
|
|
$
|
(4
|
)
|
|
$
|
(260
|
)
|
Current period other comprehensive income (loss)
1,2,3
|
(300
|
)
|
|
—
|
|
|
34
|
|
|
(10
|
)
|
|
(276
|
)
|
Balance at September 30, 2015
|
$
|
(530
|
)
|
|
$
|
—
|
|
|
$
|
8
|
|
|
$
|
(14
|
)
|
|
$
|
(536
|
)
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2015
|
$
|
(663
|
)
|
|
$
|
(26
|
)
|
|
$
|
13
|
|
|
$
|
—
|
|
|
$
|
(676
|
)
|
Current period other comprehensive income (loss)
1,3
|
(7
|
)
|
|
(36
|
)
|
|
(1
|
)
|
|
3
|
|
|
(41
|
)
|
Balance at September 30, 2016
|
$
|
(670
|
)
|
|
$
|
(62
|
)
|
|
$
|
12
|
|
|
$
|
3
|
|
|
$
|
(717
|
)
|
|
|
|
|
|
|
|
|
|
|
1
For the
nine months ended September 30, 2016
and
2015
, gains and losses on available-for-sale investment securities, reclassified from accumulated other comprehensive income (loss) to investment income, were not significant.
2
During the
nine months ended September 30, 2015
, the increase in other comprehensive loss related to foreign currency translation adjustments was driven primarily by the euro.
3
During the nine months ended September 30, 2015,
$41 million
of deferred costs (
$26 million
after-tax) related to the Company’s defined benefit pension plan and other post retirement plans were reclassified to general and administrative expenses. These deferred costs were primarily due to the termination of the Company's U.S. defined benefit plan. For the
nine months ended September 30, 2016
, deferred costs related to the Company’s postretirement plans, reclassified from accumulated other comprehensive income (loss) to earnings, were not significant.
Note 9.
Share-Based Payments
During the
nine months ended September 30, 2016
, the Company granted the following awards under the MasterCard Incorporated 2006 Long Term Incentive Plan, as amended and restated (“LTIP”). The LTIP is a shareholder-approved plan that permits the grant of various types of equity awards to employees.
|
|
|
|
|
|
Granted in 2016
|
|
Weighted-Average
Grant-Date
Fair Value
|
|
(in millions)
|
|
|
Non-qualified stock options
|
1.7
|
|
$19
|
Restricted stock units
|
1.4
|
|
$88
|
Performance stock units
|
0.2
|
|
$92
|
Stock options generally vest in
four
equal annual installments beginning
one year
after the date of grant and have a term of
ten years
. The Company used the Black-Scholes option pricing model to estimate the grant date fair value of stock options and calculated the expected term and the expected volatility based on historical Mastercard information. As a result, the expected term of stock options granted in
2016
was
five years
, while the expected volatility was determined to be
23.3%
.
Vesting of the shares underlying the restricted stock units and performance stock units will generally occur
three years
after the date of grant. The fair value of restricted stock units is determined and fixed on the grant date based on the Company’s Class A common stock price, adjusted for the exclusion of dividend equivalents. The Monte Carlo simulation valuation model was used to determine the grant date fair value of performance stock units granted.
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Compensation expense is recorded net of estimated forfeitures over the shorter of the vesting period or the date the individual becomes eligible to retire under the LTIP. The Company uses the straight-line method of attribution over the requisite service period for expensing equity awards.
Note 10.
Income Taxes
The effective income tax rates were
27.5%
and
27.7%
for the
three months ended September 30, 2016
and
2015
, respectively. The effective income tax rates were
27.9%
and
25.8%
for the
nine months ended September 30, 2016
and
2015
, respectively. For the
three months ended September 30, 2016
, the reduction in the effective tax rate versus the comparable period in
2015
was due to various discrete benefits recognized in the period, which were partially offset by a lower repatriation benefit. For the
nine months ended September 30, 2016
, the increase in the effective tax rate versus the comparable period in
2015
was due to the lapping of discrete benefits recognized in 2015 relating to certain foreign taxes becoming eligible to be claimed as credits in the United States and a lower repatriation benefit in the current year, which were partially offset by a more favorable geographic mix of taxable earnings in 2016.
The Company conducts operations in multiple countries and, as a result, is subjected to tax examinations in various jurisdictions, including the United States. Uncertain tax positions are reviewed on an ongoing basis and are adjusted after considering facts and circumstances, including progress of tax audits, developments in case law and closing of statutes of limitations. Within the next twelve months, the Company believes that the resolution of certain federal, foreign and state and local tax examinations are reasonably possible and that a change in estimate may occur. While such a change may be significant, it is not possible to provide a range of the potential change until the examinations progress further or the related statutes of limitation expire. The Company has effectively settled its U.S. federal income tax obligations through 2008, with the exception of transfer pricing issues which are settled through 2011. With limited exception, the Company is no longer subject to state and local or foreign examinations by tax authorities for years before 2009.
Note 11.
Legal and Regulatory Proceedings
Mastercard is a party to legal and regulatory proceedings with respect to a variety of matters in the ordinary course of business. Some of these proceedings are based on complex claims involving substantial uncertainties and unascertainable damages. Accordingly, except as discussed below, it is not possible to determine the probability of loss or estimate damages, and therefore, Mastercard has not established reserves for any of these proceedings. When the Company determines that a loss is both probable and reasonably estimable, Mastercard records a liability and discloses the amount of the liability if it is material. When a material loss contingency is only reasonably possible, Mastercard does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Unless otherwise stated below with respect to these matters, Mastercard cannot provide an estimate of the possible loss or range of loss based on one or more of the following reasons: (1) actual or potential plaintiffs have not claimed an amount of monetary damages or the amounts are unsupportable or exaggerated, (2) the matters are in early stages, (3) there is uncertainty as to the outcome of pending appeals or motions, (4) there are significant factual issues to be resolved, (5) the existence in many such proceedings of multiple defendants or potential defendants whose share of any potential financial responsibility has yet to be determined, and/or (6) there are novel legal issues presented. Furthermore, except as identified with respect to the matters below, Mastercard does not believe that the outcome of any individual existing legal or regulatory proceeding to which it is a party will have a material adverse effect on its results of operations, financial condition or overall business. However, an adverse judgment or other outcome or settlement with respect to any proceedings discussed below could result in fines or payments by Mastercard and/or could require Mastercard to change its business practices. In addition, an adverse outcome in a regulatory proceeding could lead to the filing of civil damage claims and possibly result in significant damage awards. Any of these events could have a material adverse effect on Mastercard’s results of operations, financial condition and overall business.
Interchange Litigation and Regulatory Proceedings
Mastercard’s interchange fees and other practices are subject to regulatory and/or legal review and/or challenges in a number of jurisdictions, including the proceedings described below. When taken as a whole, the resulting decisions, regulations and legislation with respect to interchange fees and acceptance practices may have a material adverse effect on the Company’s prospects for future growth and its overall results of operations, financial position and cash flows.
United States.
In June 2005, the first of a series of complaints were filed on behalf of merchants (the majority of the complaints were styled as class actions, although a few complaints were filed on behalf of individual merchant plaintiffs) against Mastercard
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
International, Visa U.S.A., Inc., Visa International Service Association and a number of financial institutions. Taken together, the claims in the complaints were generally brought under both Sections 1 and 2 of the Sherman Act, which prohibit monopolization and attempts or conspiracies to monopolize a particular industry, and some of these complaints contain unfair competition law claims under state law. The complaints allege, among other things, that Mastercard, Visa, and certain financial institutions conspired to set the price of interchange fees, enacted point of sale acceptance rules (including the no surcharge rule) in violation of antitrust laws and engaged in unlawful tying and bundling of certain products and services. The cases were consolidated for pre-trial proceedings in the U.S. District Court for the Eastern District of New York in MDL No. 1720. The plaintiffs filed a consolidated class action complaint that seeks treble damages.
In July 2006, the group of purported merchant class plaintiffs filed a supplemental complaint alleging that Mastercard’s initial public offering of its Class A Common Stock in May 2006 (the “IPO”) and certain purported agreements entered into between Mastercard and financial institutions in connection with the IPO: (1) violate U.S. antitrust laws and (2) constituted a fraudulent conveyance because the financial institutions allegedly attempted to release, without adequate consideration, Mastercard’s right to assess them for Mastercard’s litigation liabilities. The class plaintiffs sought treble damages and injunctive relief including, but not limited to, an order reversing and unwinding the IPO.
In February 2011, Mastercard and Mastercard International entered into each of: (1) an omnibus judgment sharing and settlement sharing agreement with Visa Inc., Visa U.S.A. Inc. and Visa International Service Association and a number of financial institutions; and (2) a Mastercard settlement and judgment sharing agreement with a number of financial institutions. The agreements provide for the apportionment of certain costs and liabilities which Mastercard, the Visa parties and the financial institutions may incur, jointly and/or severally, in the event of an adverse judgment or settlement of one or all of the cases in the merchant litigations. Among a number of scenarios addressed by the agreements, in the event of a global settlement involving the Visa parties, the financial institutions and Mastercard, Mastercard would pay
12%
of the monetary portion of the settlement. In the event of a settlement involving only Mastercard and the financial institutions with respect to their issuance of Mastercard cards, Mastercard would pay
36%
of the monetary portion of such settlement.
In October 2012, the parties entered into a definitive settlement agreement with respect to the merchant class litigation (including with respect to the claims related to the IPO) and the defendants separately entered into a settlement agreement with the individual merchant plaintiffs. The settlements included cash payments that were apportioned among the defendants pursuant to the omnibus judgment sharing and settlement sharing agreement described above. Mastercard also agreed to provide class members with a short-term reduction in default credit interchange rates and to modify certain of its business practices, including its No Surcharge Rule. Objections to the settlement were filed by both merchants and certain competitors, including Discover. Discover’s objections included a challenge to the settlement on the grounds that certain of the rule changes agreed to in the settlement constitute a restraint of trade in violation of Section 1 of the Sherman Act. The court granted final approval of the settlement in December 2013, and objectors to the settlement appealed that decision to the U.S. Court of Appeals for the Second Circuit. In June 2016, the court of appeals vacated the class action certification, reversed the settlement approval and sent the case back to the district court for further proceedings. The court of appeals’ ruling was based primarily on whether the merchants were adequately represented by counsel in the settlement.
Prior to the reversal of the settlement approval, merchants representing slightly more than
25%
of the Mastercard and Visa purchase volume over the relevant period chose to opt out of the class settlement. Mastercard had anticipated that most of the larger merchants who opted out of the settlement would initiate separate actions seeking to recover damages, and over
30
opt-out complaints have been filed on behalf of numerous merchants in various jurisdictions. Mastercard has executed settlement agreements with a number of opt-out merchants. Mastercard believes these settlement agreements are not impacted by the ruling of the court of appeals. The defendants have consolidated all of these matters (except for one state court action in New Mexico) in front of the same federal district court that approved the merchant class settlement. In July 2014, the district court denied the defendants’ motion to dismiss the opt-out merchant complaints for failure to state a claim. Deposition discovery in these actions and the class action is scheduled to commence in December 2016.
As of
September 30, 2016
, Mastercard had accrued a liability of
$705 million
as a reserve for both the merchant class litigation and the filed and anticipated opt-out merchant cases. As of
September 30, 2016
and
December 31, 2015
, Mastercard had
$543 million
and
$541 million
, respectively, in a qualified cash settlement fund related to the merchant class litigation and classified as restricted cash on its balance sheet. Mastercard believes the reserve for both the merchant class litigation and the filed and anticipated opt-out merchants represents its best estimate of its probable liabilities in these matters at
September 30, 2016
. The portion of the accrued liability relating to both the opt-out merchants and the merchant class litigation settlement does not
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
represent an estimate of a loss, if any, if the matters were litigated to a final outcome. Mastercard cannot estimate the potential liability if that were to occur.
Canada
. In December 2010, a proposed class action complaint was commenced against Mastercard in Quebec on behalf of Canadian merchants. That suit essentially repeated the allegations and arguments of a previously filed application by the Canadian Competition Bureau to the Canadian Competition Tribunal (dismissed in Mastercard’s favor) concerning certain Mastercard rules related to point-of-sale acceptance, including the “honor all cards” and “no surcharge” rules. The Quebec suit sought compensatory and punitive damages in unspecified amounts, as well as injunctive relief. In the first half of 2011, additional purported class action lawsuits were commenced in British Columbia and Ontario against Mastercard, Visa and a number of large Canadian financial institutions. The British Columbia suit seeks compensatory damages in unspecified amounts, and the Ontario suit seeks compensatory damages of
$5 billion
on the basis of alleged conspiracy and various alleged breaches of the Canadian Competition Act. The British Columbia and Ontario suits also seek punitive damages in unspecified amounts, as well as injunctive relief, interest and legal costs. The Quebec suit was later amended to include the same defendants and similar claims as in the British Columbia and Ontario suits. Additional purported class action complaints have been commenced in Saskatchewan and Alberta with claims that largely mirror those in the British Columbia, Ontario and Quebec suits. With respect to the status of the proceedings: (1) several of the merchants’ claims in the British Columbia case have been allowed to proceed on a class basis, and a trial date has been set for September 2018, (2) the class certification hearing in the Quebec suit is scheduled for November 2017 and (3) the Ontario, Saskatchewan and Alberta suits are temporarily suspended while the British Columbia suit proceeds.
Europe.
In July 2015, the European Commission issued a Statement of Objections related to Mastercard’s interregional interchange fees and central acquiring rules within the European Economic Area. The Statement of Objections, which follows an investigation opened in 2013, includes preliminary conclusions concerning the anticompetitive effects of these practices. The European Commission has indicated it intends to seek fines if these conclusions are subsequently confirmed. Although the Statement of Objections does not quantify the level of fines, it is possible that they could be substantial. In April 2016, Mastercard submitted a response to the Statement of Objections disputing the Commission’s preliminary conclusions and participated in a related oral hearing in May 2016.
In the United Kingdom, beginning in May 2012, a number of retailers filed claims or threatened litigation against Mastercard seeking damages for alleged anti-competitive conduct with respect to Mastercard’s cross-border interchange fees and its U.K. and Ireland domestic interchange fees (the “U.K. Merchant claimants”), with claimed purported damages exceeding
$1 billion
. The U.K. Merchant Claimants (including all resolved matters) represent approximately
40%
of Mastercard’s U.K. interchange volume over the relevant damages period. Additional merchants have filed or threatened litigation with respect to interchange rates in Europe (the “Pan-European claimants”) for purported damages exceeding
$1 billion
. In June 2015, Mastercard entered into a settlement with one of the U.K. Merchant claimants for
$61 million
, recorded as a provision for litigation settlement. Mastercard has submitted statements of defense to the remaining retailers’ claims disputing liability and damages. Following the conclusion of a trial for liability and damages for one of the U.K. merchant cases, in July 2016, the tribunal issued a judgment against Mastercard for damages. Mastercard has sought permission from the court to appeal this judgment. Mastercard recorded a litigation provision of
$107 million
in the second quarter of 2016, that includes the amount of the judgment and related legal fees and costs. In October 2016, a liability hearing concluded in a separate action brought on behalf of
11
merchants. If liability is found in this action, the hearing related to damages is not scheduled to start until early 2018.
With respect to the remaining U.K. Merchant claimants’ litigations, Mastercard believes that it is reasonably possible that it could incur a loss and estimates the lower end of a negotiated settlement could result in a loss of approximately
$300 million
. This revised estimate involves significant judgment and may change from time to time due to the varying stages of the U.K. Merchant claimants’ litigations, the filing of claims by additional U.K. merchants, progress in settlement negotiations and the potential uncertainty of numerous unresolved legal issues. As such, subsequent progress in negotiations and/or decisions by courts could increase or decrease this estimate. The above estimate relates only to potential settlements, and Mastercard cannot estimate the potential liability, if any, if the remaining U.K. Merchant claimant litigations are litigated to a final decision. At this time, Mastercard is unable to estimate a probable loss for the matters, if any, and accordingly has not accrued for any loss.
In September 2016, a proposed collective action was filed in the United Kingdom on behalf of U.K. consumers seeking damages for intra-EEA and domestic U.K. interchange fees that were allegedly passed on to consumers by merchants between 1992 and 2008. The complaint, which seeks to leverage the European Commission’s 2007 decision on intra-EEA interchange fees, claims damages in an amount that exceeds
£14 billion
(approximately
$18 billion
). The court has scheduled a case management conference for November 2016.
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
ATM Non-Discrimination Rule Surcharge Complaints
In October 2011, a trade association of independent Automated Teller Machine (“ATM”) operators and
13
independent ATM operators filed a complaint styled as a class action lawsuit in the U.S. District Court for the District of Columbia against both Mastercard and Visa (the “ATM Operators Complaint”). Plaintiffs seek to represent a class of non-bank operators of ATM terminals that operate in the United States with the discretion to determine the price of the ATM access fee for the terminals they operate. Plaintiffs allege that Mastercard and Visa have violated Section 1 of the Sherman Act by imposing rules that require ATM operators to charge non-discriminatory ATM surcharges for transactions processed over Mastercard’s and Visa’s respective networks that are not greater than the surcharge for transactions over other networks accepted at the same ATM. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys’ fees. Plaintiffs have not quantified their damages although they allege that they expect damages to be in the tens of millions of dollars.
Subsequently, multiple related complaints were filed in the U.S. District Court for the District of Columbia alleging both federal antitrust and multiple state unfair competition, consumer protection and common law claims against Mastercard and Visa on behalf of putative classes of users of ATM services (the “ATM Consumer Complaints”). The claims in these actions largely mirror the allegations made in the ATM Operators Complaint, although these complaints seek damages on behalf of consumers of ATM services who pay allegedly inflated ATM fees at both bank and non-bank ATM operators as a result of the defendants’ ATM rules. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys’ fees. Plaintiffs have not quantified their damages although they allege that they expect damages to be in the tens of millions of dollars.
In January 2012, the plaintiffs in the ATM Operators Complaint and the ATM Consumer Complaints filed amended class action complaints that largely mirror their prior complaints. In February 2013, the district court granted Mastercard’s motion to dismiss the complaints for failure to state a claim. On appeal, the Court of Appeals reversed the district court’s order in August 2015 and sent the case back for further proceedings. In March 2016, certain of the plaintiffs in the ATM Operators Complaint filed a motion seeking a preliminary injunction enjoining the enforcement of the nondiscrimination rules pending the outcome of the litigation. In June 2016, the U.S. Supreme Court agreed to hear oral arguments from Mastercard and its co-defendants in both cases, which is scheduled for December 2016.
U.S. Liability Shift Litigation
In March 2016, a proposed U.S. merchant class action complaint was filed in federal court in California alleging that Mastercard, Visa, American Express and Discover (the “Network Defendants”), EMVCo, and a number of issuing banks (the “Bank Defendants”) engaged in a conspiracy to shift fraud liability for card present transactions from issuing banks to merchants not yet in compliance with the standards for EMV chip cards in the United States (the “EMV Liability Shift”), in violation of the Sherman Act and California law. Plaintiffs allege the damages would be the value of all chargebacks for which class members became liable as a result of the EMV Liability Shift on October 1, 2015. The plaintiffs seek treble damages, attorney’s fees and costs and an injunction against future violations of governing law, and the defendants have filed a motion to dismiss. In September 2016, the court denied the Network Defendants’ motion to dismiss the complaint, but granted such a motion for EMVCo and the Bank Defendants. The case against the Network Defendants is now proceeding with a trial currently scheduled for late 2017.
Note 12.
Settlement and Other Risk Management
Mastercard’s rules guarantee the settlement of many of the Mastercard, Cirrus and Maestro branded transactions between its issuers and acquirers (“settlement risk”). Settlement exposure is the outstanding settlement risk to customers under Mastercard’s rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. Gross settlement exposure is estimated using the average daily card volume during the quarter multiplied by the estimated number of days to settle. The Company has global risk management policies and procedures, which include risk standards, to provide a framework for managing the Company’s settlement risk. Customer-reported transaction data and the transaction clearing data underlying the settlement exposure calculation may be revised in subsequent reporting periods.
In the event that Mastercard effects a payment on behalf of a failed customer, Mastercard may seek an assignment of the underlying receivables of the failed customer. Customers may be charged for the amount of any settlement loss incurred during these ordinary course activities of the Company.
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
The Company’s global risk management policies and procedures are aimed at managing the settlement exposure. These risk management procedures include interaction with the bank regulators of countries in which it operates, requiring customers to make adjustments to settlement processes, and requiring collateral from customers. Mastercard requires certain customers that are not in compliance with the Company’s risk standards in effect at the time of review to post collateral, typically in the form of cash, letters of credit, or guarantees. This requirement is based on management’s review of the individual risk circumstances for each customer that is out of compliance. In addition to these amounts, Mastercard holds collateral to cover variability and future growth in customer programs. The Company may also hold collateral to pay merchants in the event of an acquirer failure. Although the Company is not contractually obligated under its rules to effect such payments to merchants, the Company may elect to do so to protect brand integrity. Mastercard monitors its credit risk portfolio on a regular basis and the adequacy of collateral on hand. Additionally, from time to time, the Company reviews its risk management methodology and standards. As such, the amounts of estimated settlement exposure are revised as necessary.
The Company’s estimated settlement exposure from Mastercard, Cirrus and Maestro branded transactions was as follows:
|
|
|
|
|
|
|
|
|
|
September 30,
2016
|
|
December 31,
2015
|
|
(in millions)
|
Gross settlement exposure
|
$
|
43,272
|
|
|
$
|
39,674
|
|
Collateral held for settlement exposure
|
(3,996
|
)
|
|
(3,601
|
)
|
Net uncollateralized settlement exposure
|
$
|
39,276
|
|
|
$
|
36,073
|
|
General economic and political conditions in countries in which Mastercard operates affect the Company’s settlement risk. Many of the Company’s financial institution customers have been directly and adversely impacted by political instability and uncertain economic conditions. These conditions present increased risk that the Company may have to perform under its settlement guarantee. This risk could increase if political, economic and financial market conditions deteriorate further. The Company’s global risk management policies and procedures are revised and enhanced from time to time. Historically, the Company has experienced a low level of losses from financial institution failures.
Mastercard also provides guarantees to customers and certain other counterparties indemnifying them from losses stemming from failures of third parties to perform duties. This includes guarantees of Mastercard-branded travelers cheques issued, but not yet cashed of
$407 million
and
$420 million
at
September 30, 2016
and
December 31, 2015
, respectively, of which
$321 million
and
$332 million
at
September 30, 2016
and
December 31, 2015
, respectively, is mitigated by collateral arrangements. In addition, the Company enters into business agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. Certain indemnifications do not provide a stated maximum exposure. As the extent of the Company’s obligations under these agreements depends entirely upon the occurrence of future events, the Company’s potential future liability under these agreements is not determinable. Historically, payments made by the Company under these types of contractual arrangements have not been material.
Note 13.
Foreign Exchange Risk Management
The Company monitors and manages its exposures as part of its overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results. A principal objective of the Company’s risk management strategies is to reduce significant, unanticipated earnings fluctuations that may arise from volatility in foreign currency exchange rates principally through the use of derivative instruments.
Derivatives
The Company enters into foreign currency derivative contracts to manage risk associated with anticipated receipts and disbursements which are valued based on currencies other than its functional currencies. The Company may also enter into foreign currency derivative contracts to offset possible changes in value due to foreign exchange fluctuations of earnings, assets and liabilities. The objective of these activities is to reduce the Company’s exposure to gains and losses resulting from fluctuations of foreign currencies against its functional currencies.
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
As of
September 30, 2016
, the majority of derivative contracts to hedge foreign currency fluctuations had been entered into with customers of Mastercard. Mastercard’s derivative contracts are summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
December 31, 2015
|
|
Notional
|
|
Estimated Fair
Value
|
|
Notional
|
|
Estimated Fair
Value
|
|
(in millions)
|
Commitments to purchase foreign currency
|
$
|
485
|
|
|
$
|
1
|
|
|
$
|
232
|
|
|
$
|
1
|
|
Commitments to sell foreign currency
|
1,195
|
|
|
(32
|
)
|
|
1,430
|
|
|
12
|
|
Options to sell foreign currency
|
—
|
|
|
—
|
|
|
44
|
|
|
1
|
|
Balance sheet location:
|
|
|
|
|
|
|
|
Accounts receivable
1
|
|
|
$
|
13
|
|
|
|
|
$
|
23
|
|
Other current liabilities
1
|
|
|
(44
|
)
|
|
|
|
(9
|
)
|
1
The fair values of derivative contracts are presented on a gross basis on the balance sheet and are subject to enforceable master netting arrangements, which contain various netting and setoff provisions.
The amount of gain (loss) recognized in income for the contracts to purchase and sell foreign currency is summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
(in millions)
|
Foreign currency derivative contracts
|
|
|
|
|
|
|
|
General and administrative
|
$
|
(6
|
)
|
|
$
|
35
|
|
|
$
|
(42
|
)
|
|
$
|
57
|
|
The fair value of the foreign currency derivative contracts generally reflects the estimated amounts that the Company would receive (or pay), on a pre-tax basis, to terminate the contracts. The terms of the foreign currency derivative contracts are generally less than
18 months
. The Company had
no
deferred gains or losses related to foreign exchange contracts in accumulated other comprehensive income as of
September 30, 2016
and
December 31, 2015
, as these contracts were not accounted for under hedge accounting.
The Company’s derivative financial instruments are subject to both market and counterparty credit risk. Market risk is the risk of loss due to the potential change in an instrument’s value caused by fluctuations in interest rates and other variables related to currency exchange rates. The effect of a hypothetical 10% adverse change in foreign currency forward rates could result in a fair value loss of approximately
$82 million
on the Company’s foreign currency derivative contracts outstanding at
September 30, 2016
related to the hedging program. Counterparty credit risk is the risk of loss due to failure of the counterparty to perform its obligations in accordance with contractual terms. To mitigate counterparty credit risk, the Company enters into derivative contracts with selected financial institutions based upon their credit ratings and other factors. Generally, the Company does not obtain collateral related to derivatives because of the high credit ratings of the counterparties.
Net investment hedge
The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates, with changes in the value of the debt recorded within currency translation adjustment in accumulated other comprehensive income (loss). During the fourth quarter of 2015, the Company designated its
€1.65 billion
euro-denominated debt as a net investment hedge for a portion of its net investment in European foreign operations. As of
September 30, 2016
, the Company had a net foreign currency transaction pre-tax loss of
$96 million
in accumulated other comprehensive income (loss) associated with hedging activity. There was no ineffectiveness in the current period.