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31. Financial instruments

The relationship between classes and categories as well as the reconciliation to the statement of financial position line items is shown in the following table:

The derivative financial instruments embedded in the Mandatory Exchangeable Bonds (MEB) were included in the statement of financial position item short-term accrued expenses and other short-term liabilities until the maturity of the MEB (for details relating to the MEB, please see note 24, Mandatory Exchangeable Bonds). Due to their special character and the difference in valuation, the embedded derivatives were classified separately. Also because of their special character and different valuation, the Contingent Value Rights (CVR) were classified separately from their statement of financial position item.

Valuation of financial instruments

The carrying amounts of financial instruments at December 31, classified into categories, were as follows:

€ in millions 2012 2011
1 There are no financial instruments designated as at fair value through profit or loss upon initial recognition.
Loans and receivables 3,668 3,428
Financial liabilities measured at amortized cost 11,897 10,574
Assets measured at fair value in the consolidated statement of income1 37 44
Liabilities measured at fair value in the consolidated statement of income1 32 77
Available for sale financial assets 182 26
Relating to no category 330 68

€ in millions 2012 2011
1 There are no financial instruments designated as at fair value through profit or loss upon initial recognition.
Loans and receivables 3,668 3,428
Financial liabilities measured at amortized cost 11,897 10,574
Assets measured at fair value in the consolidated statement of income1 37 44
Liabilities measured at fair value in the consolidated statement of income1 32 77
Available for sale financial assets 182 26
Relating to no category 330 68

The following table presents the carrying amounts and fair values as well as the fair value hierarchy levels of Fresenius Group’s financial instruments as of December 31, classified into classes:

    2012 2011
€ in millions Fair value hierarchy level Carrying amount Fair value Carrying amount Fair value
Cash and cash equivalents 1 885 885 635 635
Assets recognized at carrying amount 3 3,668 3,668 3,428 3,427
Assets recognized at fair value 1 182 182 26 26
Liabilities recognized at carrying amount 2 11,991 12,593 10,627 10,874
Liabilities recognized at fair value 2 23 23 18 18
Noncontrolling interest subject to put provisions recognized at fair value 3 398 398 317 317
Derivatives for hedging purposes 2 -35 -35 -212 -212

    2012 2011
€ in millions Fair value hierarchy level Carrying amount Fair value Carrying amount Fair value
Cash and cash equivalents 1 885 885 635 635
Assets recognized at carrying amount 3 3,668 3,668 3,428 3,427
Assets recognized at fair value 1 182 182 26 26
Liabilities recognized at carrying amount 2 11,991 12,593 10,627 10,874
Liabilities recognized at fair value 2 23 23 18 18
Noncontrolling interest subject to put provisions recognized at fair value 3 398 398 317 317
Derivatives for hedging purposes 2 -35 -35 -212 -212

The significant methods and assumptions used to estimate the fair values of financial instruments as well as classification of fair value measurements according to the three-tier fair value hierarchy are as follows:

Cash and cash equivalents are stated at nominal value, which equals the fair value.

The nominal value of short-term financial instruments such as accounts receivable and payable and short-term debt represents its carrying amount, which is a reasonable estimate of the fair value due to the relatively short period to maturity for these instruments.

The fair values of major long-term financial instruments are calculated on the basis of market information. Financial instruments for which market quotes are available are measured with the market quotes at the reporting date. The fair values of the other long-term financial liabilities are calculated at the present value of respective future cash flows. To determine these present values, the prevailing interest rates and credit spreads for the Fresenius Group as of the date of the statement of financial position are used.

The fair value of Fresenius Medical Care’s loan to Renal Advantage Partners, LLC was based on significant unobservable inputs of comparable instruments and thus the class assets recognized at carrying amount consisting of trade accounts receivable and this loan is classified as fair value hierarchy Level 3.

The class assets recognized at fair value comprises German government securities and shares. The fair values of these assets are calculated on the basis of market information. Therefore, this class is classified as Level 1.

The class liabilities recognized at carrying amount is classified as hierarchy Level 2.

The class liabilities recognized at fair value is classified as hierarchy Level 2. Until the maturity of the MEB and the delisting of the CVR, this class consisted of the derivatives embedded in the MEB and the CVR.

The carrying amounts of derivatives embedded in the MEB and the CVR corresponded with their fair values. The MEB matured on August 14, 2011. The embedded derivatives were measured at fair value, which was estimated based on a Black-Scholes model which uses significant other observable inputs. Therefore, they were classified as Level 2.

The CVR were traded on the stock exchange in the United States and were therefore valued with the current stock exchange price until December 31, 2010. Consequently, they were classified as Level 1. In the first quarter of 2011, the CVR were deregistered and delisted from the NASDAQ due to the expiration of the underlying agreement and became valueless.

The valuation of the class noncontrolling interest subject to put provisions recognized at fair value is determined using significant unobservable inputs. It is therefore classified as Level 3.

Derivatives, mainly consisting of interest rate swaps and foreign exchange forward contracts, are valued as follows: The fair value of interest rate swaps is calculated by discounting the future cash flows on the basis of the market interest rates applicable for the remaining term of the contract as of the date of the statement of financial position. To determine the fair value of foreign exchange forward contracts, the contracted forward rate is compared to the current forward rate for the remaining term of the contract as of the date of the statement of financial position. The result is then discounted on the basis of the market interest rates prevailing at the date of the statement of financial position for the respective currency.

Fresenius Group’s own credit risk is incorporated in the fair value estimation of derivatives that are liabilities. Counterparty credit-risk adjustments are factored into the valuation of derivatives that are assets.

For the fair value measurement of the class derivatives for hedging purposes, significant other observable inputs are used. Therefore, they are classified as Level 2 in accordance with the defined fair value hierarchy levels.

Currently, there is no indication that a decrease in the value of Fresenius Group’s financing receivables is probable. Therefore, the allowances on credit losses of financing receivables are immaterial.

Fair values of derivative financial instruments


  Dec. 31, 2012 Dec. 31, 2011
€ in millions Assets Liabilities Assets Liabilities
1 Derivatives designated as hedging instruments and foreign exchange contracts not designated as hedging instruments are classified as derivatives for hedging purposes.
Interest rate contracts (current) 0 50 0 103
Interest rate contracts (non-current) 0 18 0 60
Foreign exchange contracts (current) 15 11 9 39
Foreign exchange contracts (non-current) 1 - 1 5
Derivatives designated as hedging instruments1 16 79 10 207
         
Interest rate contracts (current) 0 6 0 0
Interest rate contracts (non-current) 0 2 0 3
Foreign exchange contracts (current)1 37 9 43 58
Foreign exchange contracts (non-current)1 - - 1 1
Derivatives not designated as hedging instruments 37 17 44 62

  Dec. 31, 2012 Dec. 31, 2011
€ in millions Assets Liabilities Assets Liabilities
1 Derivatives designated as hedging instruments and foreign exchange contracts not designated as hedging instruments are classified as derivatives for hedging purposes.
Interest rate contracts (current) 0 50 0 103
Interest rate contracts (non-current) 0 18 0 60
Foreign exchange contracts (current) 15 11 9 39
Foreign exchange contracts (non-current) 1 - 1 5
Derivatives designated as hedging instruments1 16 79 10 207
         
Interest rate contracts (current) 0 6 0 0
Interest rate contracts (non-current) 0 2 0 3
Foreign exchange contracts (current)1 37 9 43 58
Foreign exchange contracts (non-current)1 - - 1 1
Derivatives not designated as hedging instruments 37 17 44 62

Derivative financial instruments are marked to market each reporting period, resulting in carrying amounts equal to fair values at the reporting date.

Derivatives not designated as hedging instruments, which are derivatives that do not qualify for hedge accounting, are also solely entered into to hedge economic business transactions and not for speculative purposes.

Derivatives for hedging purposes were recognized at gross value within other assets in an amount of €53 million and other liabilities in an amount of €88 million.

The current portion of interest rate contracts and foreign exchange contracts indicated as assets in the previous table is recognized within other current assets in the consolidated statement of financial position, while the current portion of those indicated as liabilities is included in short-term accrued expenses and other short-term liabilities. The non-current portions indicated as assets or liabilities are recognized in other non-current assets or in long-term accrued expenses and other long-term liabilities, respectively. The derivatives embedded in the MEB were recognized within other short-term liabilities until the maturity of the MEB.

Effects of financial instruments recorded in the consolidated statement of income

The net gains and losses from financial instruments consisted of allowances for doubtful accounts in an amount of €251 million and foreign currency transactions of -€22 million. Interest income of €54 million resulted mainly from trade accounts receivable and loans to related parties. Interest expense of €720 million resulted mainly from financial liabilities, which are not recognized at fair value in the consolidated statement of income.

Effect of derivatives designated as hedging instruments on the Consolidated Statement of comprehensive income


  2012
€ in millions Gain or loss recognized in other comprehensive income (loss) (effective portion) Gain or loss reclassified from accumulated other comprehensive income (loss) (effective portion) Gain or loss recognized in the consolidated statement of income
1 The amount of gain or loss recognized in the consolidated statement of income solely relates to the ineffective portion.
Interest rate contracts -20 29 2
Foreign exchange contracts 39 -7 0
Derivatives in cash flow hedging relationships1 19 22 2
Foreign exchange contracts     4
Derivatives in fair value hedging relationships     4
Derivatives designated as hedging instruments 19 22 6

  2012
€ in millions Gain or loss recognized in other comprehensive income (loss) (effective portion) Gain or loss reclassified from accumulated other comprehensive income (loss) (effective portion) Gain or loss recognized in the consolidated statement of income
1 The amount of gain or loss recognized in the consolidated statement of income solely relates to the ineffective portion.
Interest rate contracts -20 29 2
Foreign exchange contracts 39 -7 0
Derivatives in cash flow hedging relationships1 19 22 2
Foreign exchange contracts     4
Derivatives in fair value hedging relationships     4
Derivatives designated as hedging instruments 19 22 6

  2011
€ in millions Gain or loss recognized in other comprehensive income (loss) (effective portion) Gain or loss reclassified from accumulated other comprehensive income (loss) (effective portion) Gain or loss recognized in the consolidated statement of income
1 The amount of gain or loss recognized in the consolidated statement of income solely relates to the ineffective portion.
Interest rate contracts -60 14 -7
Foreign exchange contracts -31 -4 -
Derivatives in cash flow hedging relationships1 -91 10 -7
Foreign exchange contracts     -7
Derivatives in fair value hedging relationships     -7
Derivatives designated as hedging instruments -91 10 -14

  2011
€ in millions Gain or loss recognized in other comprehensive income (loss) (effective portion) Gain or loss reclassified from accumulated other comprehensive income (loss) (effective portion) Gain or loss recognized in the consolidated statement of income
1 The amount of gain or loss recognized in the consolidated statement of income solely relates to the ineffective portion.
Interest rate contracts -60 14 -7
Foreign exchange contracts -31 -4 -
Derivatives in cash flow hedging relationships1 -91 10 -7
Foreign exchange contracts     -7
Derivatives in fair value hedging relationships     -7
Derivatives designated as hedging instruments -91 10 -14

In 2012, losses of €9 million (2011: €8 million) for available for sale financial assets were recognized in other comprehensive income (loss).

Effect of derivatives not designated as hedging instruments on the consolidated Statement of comprehensive income


  Gain or loss recognized in the consolidated statement of income
€ in millions 2012 2011
Interest rate contracts - 3
Foreign exchange contracts -23 43
Derivatives embedded in the MEB 0 -100
Derivatives not designated as hedging instruments -23 -54

  Gain or loss recognized in the consolidated statement of income
€ in millions 2012 2011
Interest rate contracts - 3
Foreign exchange contracts -23 43
Derivatives embedded in the MEB 0 -100
Derivatives not designated as hedging instruments -23 -54

Losses from derivatives in fair value hedging relationships and from foreign exchange contracts not designated as hedging instruments recognized in the consolidated statement of income are faced by gains from the underlying transactions in the corresponding amount.

The Fresenius Group expects to recognize a net amount of €2 million of the existing gains for foreign exchange contracts deferred in accumulated other comprehensive income (loss) in the consolidated statement of income within the next 12 months. For interest rate contracts, the Fresenius Group expects to recognize €48 million of losses in the course of normal business during the next 12 months in interest expense.

Gains and losses from foreign exchange contracts and the corresponding underlying transactions are accounted for as cost of sales, selling, general and administrative expenses and net interest. Gains and losses resulting from interest rate contracts are recognized as net interest in the consolidated statement of income. Until 2011, the position other financial result in the consolidated statement of income included gains and losses from the valuation of the derivatives embedded in the MEB, which was made until August 14, 2011 (see note 11, Other financial result).

Market risk

General

The Fresenius Group is exposed to effects related to foreign exchange fluctuations in connection with its international business activities that are denominated in various currencies. In order to finance its business operations, the Fresenius Group issues senior notes and commercial papers and enters into mainly long-term credit agreements and euro notes (Schuldscheindarlehen) with banks. Due to these financing activities, the Fresenius Group is exposed to interest risk caused by changes in variable interest rates and the risk of changes in the fair value of statement of financial position items bearing fixed interest rates.

In order to manage the risk of interest rate and foreign exchange rate fluctuations, the Fresenius Group enters into certain hedging transactions with highly rated financial institutions as authorized by the Management Board. Derivative financial instruments are not entered into for trading purposes.

In general, the Fresenius Group conducts its derivative financial instrument activities under the control of a single centralized department. The Fresenius Group has established guidelines derived from best practice standards in the banking industry for risk assessment procedures and supervision concerning the use of financial derivatives. These guidelines require amongst other things a clear segregation of duties in the areas of execution, administration, accounting and controlling. Risk limits are continuously monitored and, where appropriate, the use of hedging instruments is adjusted to that extent.

The Fresenius Group defines benchmarks for individual exposures in order to quantify interest and foreign exchange risks. The benchmarks are derived from achievable and sustainable market rates. Depending on the individual benchmarks, hedging strategies are determined and generally implemented by means of micro hedges.

Earnings of the Fresenius Group were not materially affected by hedge ineffectiveness in the reporting period since the critical terms of the interest and foreign exchange derivatives mainly matched the critical terms of the underlying exposures.

Securities, which are predominantly held as German government securities and shares, are generally subject to the risk of changing stock exchange prices. Therefore, the stock exchange prices of these securities are continuously monitored to identify possible price risks on time.

Derivative financial instruments

Foreign exchange risk management

The Fresenius Group has determined the euro as its financial reporting currency. Therefore, foreign exchange translation risks resulting from the fluctuation of exchange rates between the euro and the local currencies, in which the financial statements of the foreign subsidiaries are prepared, have an impact on results of operations and financial positions reported in the consolidated financial statements.

Besides translation risks, foreign exchange transaction risks exist, which mainly relate to transactions such as purchases and sales as well as engineering and services provided by the Fresenius Group which are denominated in foreign currencies. A major part of transaction risks arise from products manufactured in Fresenius Group’s worldwide production sites which are usually denominated in the local currency of the respective manufacturer and are delivered worldwide to various Fresenius Group entities. These intragroup sales are mainly denominated in euros, U.S. dollars and yens. Therefore, Group companies are exposed to changes of the foreign exchange rates between the invoicing currencies and the local currencies in which they conduct their businesses. Solely for the purpose of hedging existing and foreseeable foreign exchange transaction exposures, the Fresenius Group enters into foreign exchange forward contracts and, on a small scale, foreign exchange options. To ensure that no foreign exchange risks result from loans in foreign currencies, the Fresenius Group enters into foreign exchange swap contracts.

As of December 31, 2012, the notional amounts of foreign exchange contracts totaled €2,950 million. These foreign exchange contracts have been entered into to hedge risks from operational business and in connection with loans in foreign currency. The predominant part of the foreign exchange forward contracts to hedge risks from operational business was recognized as cash flow hedge, while foreign exchange contracts in connection with loans in foreign currencies are partly recognized as fair value hedges. The fair values of cash flow hedges and fair value hedges were €5 million and -€4 thousand, respectively.

The hedge-effective portion of changes in the fair value of foreign exchange forward contracts that are designated and qualified as cash flow hedges of forecasted product purchases and sales is reported in accumulated other comprehensive income (loss). These amounts are subsequently reclassified into earnings as a component of cost of sales or as selling, general and administrative expenses in the same period in which the hedged transaction affects earnings.

As of December 31, 2012, the Fresenius Group was party to foreign exchange contracts with a maximum maturity of 35 months.

The Fresenius Group uses a Cash-Flow-at-Risk (CFaR) model in order to estimate and quantify such transaction risks from foreign currencies. The basis for the analysis of the currency risks are the foreign currency cash flows that are reasonably expected to arise within the following 12 months, less any hedges. Under the CFaR approach, the potential currency fluctuations of these net exposures are shown as probability distributions based on historical volatilities and correlations of the preceding 250 business days. The calculation is made assuming a confidence level of 95% and a holding period of up to one year. The aggregation of currency risks has risk-mitigating effects due to correlations between the transactions concerned, i. e. the overall portfolio’s risk exposure is generally less than the sum total of the underlying individual risks. As of December 31, 2012, the Fresenius Group’s cash flow at risk amounts to €43 million, this means, with a probability of 95%, a potential loss in relation to the forecasted foreign exchange cash flows of the next 12 months will be not higher than €43 million.

Interest rate risk management

Fresenius Group’s interest rate risks mainly arise from money market and capital market transactions of the Group for financing its business activities.

The Fresenius Group enters into interest rate swaps and, on a small scale, into interest rate options in order to protect against the risk of rising interest rates. These interest rate derivatives are mainly designated as cash flow hedges and have been entered into in order to convert payments based on variable interest rates into payments at a fixed interest rate and in anticipation of future debt issuances. The U.S. dollar interest rate swaps with a notional volume of US$1,200 million (€909 million) and a fair value of -US$29 million (-€22 million) expire at various dates in the years 2013 and 2014. The euro interest rate swaps with a notional volume of €676 million and a fair value of -€54 million expire in the years 2013 to 2022. The U.S. dollar interest rate swaps bear an average interest rate of 3.25% and the euro interest rate swaps bear an average interest rate of 2.95%.

Interest payables and interest receivables in connection with the swap agreements are accrued and recorded as an adjustment to the interest expense at each reporting date. Concerning interest rate contracts, unscheduled repayments or the renegotiation of hedged items may in some cases lead to the de-designation of the hedging instrument, which existed up to that point. From that date, the respective hedging transactions are recognized in the consolidated statement of income.

For purposes of analyzing the impact of changes in the relevant reference interest rates on Fresenius Group’s results of operations, the Group calculates the portion of financial debt which bears variable interest rates and which has not been hedged by means of interest rate swaps or options against rising interest rates. For this particular part of its liabilities, the Fresenius Group assumes an increase in the reference rates of 0.5% compared to the actual rates as of the date of the statement of financial position. The corresponding additional annual interest expense is then compared to the net income attributable to shareholders of Fresenius SE & Co. KGaA. This analysis shows that an increase of 0.5% in the relevant reference rates would have an effect of less than 1% on the consolidated net income attributable to shareholders of Fresenius SE & Co. KGaA and Fresenius SE & Co. KGaA shareholders’ equity.

Stock price risk management

Price risks arise from changing stock prices of available for sale financial assets. Gains and losses arising from available for sale financial assets are recognized directly in the consolidated statement of equity until the asset is disposed of or if it is considered to be impaired. A decline of 10% in prices of the recognized assets would have an effect of less than 0.2% on Fresenius SE & Co. KGaA shareholders’ equity.

Credit risk

The Fresenius Group is exposed to potential losses regarding financial instruments in the event of non-performance by counterparties. With respect to derivative financial instruments, it is not expected that any counterparty fails to meet its obligations as the counterparties are highly rated financial institutions. The maximum credit exposure of derivatives is represented by the fair value of those contracts with a positive fair value amounting to €53 million for foreign exchange derivatives at December 31, 2012. No credit exposure existed from interest rate derivatives. The maximum credit risk resulting from the use of non-derivative financial instruments is defined as the total amount of all receivables. In order to control this credit risk, the Management of the Fresenius Group performs an ageing analysis of trade accounts receivable. For details on the ageing analysis and on the allowance for doubtful accounts, please see note 15, Trade accounts receivable.

Liquidity risk

The liquidity risk is defined as the risk that a company is potentially unable to meet its financial obligations. The Management of the Fresenius Group manages the liquidity of the Group by means of effective working capital and cash management as well as an anticipatory evaluation of refinancing alternatives. The Management of the Fresenius Group believes that existing credit facilities as well as the cash generated by operating activities and additional short-term borrowings are sufficient to meet the Company’s foreseeable demand for liquidity (see note 22, Debt and capital lease obligations).

The following table shows the future undiscounted contractual cash flows (including interests) resulting from recognized financial liabilities as well as the fair value of noncontrolling interest subject to put provisions and the fair value of derivative financial instruments:

€ in millions up to 1 year 1 to 3 years 3 to 5 years more than 5 years
1 Future interest payments for financial liabilities with variable interest rates were calculated using the latest interest rates fixed prior to December 31, 2012.
Long-term debt and capital lease obligations (including accounts receivable securitization program)1 640 2,029 2,263 413
Short-term debt 217 0 0 0
Senior Notes 325 1,413 1,356 4,781
Trade accounts payable 961 0 0 0
Noncontrolling interest subject to put provisions 168 55 84 91
Derivative financial instruments 76 13 6 1
Total 2,387 3,510 3,709 5,286

€ in millions up to 1 year 1 to 3 years 3 to 5 years more than 5 years
1 Future interest payments for financial liabilities with variable interest rates were calculated using the latest interest rates fixed prior to December 31, 2012.
Long-term debt and capital lease obligations (including accounts receivable securitization program)1 640 2,029 2,263 413
Short-term debt 217 0 0 0
Senior Notes 325 1,413 1,356 4,781
Trade accounts payable 961 0 0 0
Noncontrolling interest subject to put provisions 168 55 84 91
Derivative financial instruments 76 13 6 1
Total 2,387 3,510 3,709 5,286

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