Cleveland-Cliffs Inc. Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

FAIR VALUE OF FINANCIAL INSTRUMENTS

FAIR VALUE OF FINANCIAL INSTRUMENTS

9 Months Ended

Sep. 30, 2015

NOTE 6 - FAIR VALUE MEASUREMENTS

The following represents the assets and liabilities of the Company measured at fair value at September 30, 2015 and December 31, 2014:



	(In Millions)
	September 30, 2015
Description	Quoted Prices in Active Markets for Identical Assets/Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Assets:
Cash equivalents	$	80.0	$	—	$	—	$	80.0
Derivative assets	—		—		10.4		10.4
Total	$	80.0	$	—	$	10.4	$	90.4
Liabilities:
Derivative liabilities	$	—	$	—	$	0.8	$	0.8
Total	$	—	$	—	$	0.8	$	0.8



	(In Millions)
	December 31, 2014
Description	Quoted Prices in Active Markets for Identical Assets/Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Assets:
Derivative assets	$	—	$	—	$	63.2	$	63.2
Available-for-sale marketable securities	4.3		—		—		4.3
Total	$	4.3	$	—	$	63.2	$	67.5
Liabilities:
Derivative liabilities	$	—	$	—	$	9.5	$	9.5
Foreign exchange contracts	—		31.5		—		31.5
Total	$	—	$	31.5	$	9.5	$	41.0

Financial assets classified in Level 1 at September 30, 2015 includes money market funds. Financial assets classified in Level 1 at December 31, 2014 include available-for-sale marketable securities. The valuation of these instruments is based upon unadjusted quoted prices for identical assets in active markets.

The valuation of financial assets and liabilities classified in Level 2 is determined using a market approach based upon quoted prices for similar assets and liabilities in active markets, or other inputs that are observable. Level 2 securities primarily include derivative financial instruments valued using financial models that use as their basis readily observable market parameters. At December 31, 2014, such derivative financial instruments included our existing foreign currency exchange contracts. The fair value of the foreign currency exchange contracts is based on forward market prices and represents the estimated amount we would receive or pay to terminate these agreements at the reporting date, taking into account creditworthiness, nonperformance risk and liquidity risks associated with current market conditions.

The derivative financial assets classified within Level 3 at September 30, 2015 and December 31, 2014 primarily relate to a freestanding derivative instrument related to certain supply agreements with one of our U.S. Iron Ore customers. The agreements include provisions for supplemental revenue or refunds based on the customer’s annual steel pricing at the time the product is consumed in the customer’s blast furnaces. We account for this provision as a derivative instrument at the time of sale and adjust this provision to fair value as an adjustment to Product revenues each reporting period until the product is consumed and the amounts are settled. The fair value of the instrument is determined using a market approach based on an estimate of the annual realized price of hot-rolled steel at the steelmaker’s facilities, and takes into consideration current market conditions and nonperformance risk.

The Level 3 derivative assets and liabilities also consisted of derivatives related to certain provisional pricing arrangements with our U.S. Iron Ore and Asia Pacific Iron Ore customers at September 30, 2015 and December 31, 2014. These provisional pricing arrangements specify provisional price calculations, where the pricing mechanisms generally are based on market pricing, with the final revenue rate to be based on market inputs at a specified point in time in the future, per the terms of the supply agreements. The difference between the estimated final revenue at the date of sale and the estimated final revenue rate is characterized as a derivative and is required to be accounted for separately once the revenue has been recognized. The derivative instrument is adjusted to fair value through Product revenues each reporting period based upon current market data and forward-looking estimates provided by management until the final revenue rate is determined.

The following table illustrates information about quantitative inputs and assumptions for the derivative assets and derivative liabilities categorized in Level 3 of the fair value hierarchy:

Qualitative/Quantitative Information About Level 3 Fair Value Measurements

(In Millions)

Fair Value at September 30, 2015

Balance Sheet Location

Valuation Technique

Unobservable Input

Range or Point Estimate per ton

(Weighted Average)

Provisional Pricing Arrangements

0.6

Other current assets

Market Approach

Management's

Estimate of 62% Fe

$56

0.8

Other current liabilities

Customer Supply Agreement

9.8

Other current assets

Market Approach

Hot-Rolled Steel Estimate

$470 - $515 ($489)

The significant unobservable input used in the fair value measurement of the reporting entity’s provisional pricing arrangements is management’s estimate of 62 percent Fe fines spot price based upon current market data, including historical seasonality and forward-looking estimates determined by management. Significant increases or decreases in this input would result in a significantly higher or lower fair value measurement, respectively.

The significant unobservable input used in the fair value measurement of the reporting entity’s customer supply agreement is the future hot-rolled steel price that is estimated based on projections provided by the customer, current market data, analysts' projections and forward-looking estimates determined by management. Significant increases or decreases in this input would result in a significantly higher or lower fair value measurement, respectively.

We recognize any transfers between levels as of the beginning of the reporting period. There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the three and nine months ended September 30, 2015 or 2014. The following tables represent a reconciliation of the changes in fair value of financial instruments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2015 and 2014.



	(In Millions)
	Derivative Assets (Level 3)
	Three Months Ended September 30,						Nine Months Ended September 30,
	2015			2014			2015			2014
Beginning balance	$	7.7		$	33.0		$	63.2		$	57.7
Total gains (losses)
Included in earnings	15.0			62.6			28.1			124.6
Settlements	(12.3		)	(41.1		)	(80.9		)	(127.8		)
Transfers into Level 3	—			—			—			—
Transfers out of Level 3	—			—			—			—
Ending balance - September 30	$	10.4		$	54.5		$	10.4		$	54.5
Total gains for the period included in earnings attributable to the change in unrealized gains on assets still held at the reporting date	$	12.2		$	62.6		$	22.7		$	124.6



	(In Millions)
	Derivative Liabilities (Level 3)
	Three Months Ended September 30,						Nine Months Ended September 30,
	2015			2014			2015			2014
Beginning balance	$	(8.0	)	$	(20.2	)	$	(9.5	)	$	(1.0	)
Total gains (losses)
Included in earnings	(13.7		)	2.3			(45.4		)	(17.9		)
Settlements	20.9			—			54.1			1.0
Transfers into Level 3	—			—			—			—
Transfers out of Level 3	—			—			—			—
Ending balance - September 30	$	(0.8	)	$	(17.9	)	$	(0.8	)	$	(17.9	)
Total gains (losses) for the period included in earnings attributable to the change in unrealized losses on liabilities still held at the reporting date	$	(0.5	)	$	2.3		$	(0.8	)	$	(17.9	)

Gains and losses included in earnings are reported in Product revenues in the Statements of Unaudited Condensed Consolidated Operations for the three and nine months ended September 30, 2015 and 2014.

The carrying amount for certain financial instruments (e.g., Accounts receivable, net, Accounts payable and Accrued expenses) approximates fair value and, therefore, has been excluded from the table below. A summary of the carrying amount and fair value of other financial instruments at September 30, 2015 and December 31, 2014 were as follows:



		(In Millions)
		September 30, 2015				December 31, 2014
	Classification	Carrying Value		Fair Value		Carrying Value		Fair Value
Long-term debt:
Senior Notes—$700 million	Level 1	$	412.3	$	115.4	$	689.5	$	367.3
Senior Notes—$1.3 billion	Level 1	793.3		242.4		1,279.9		704.0
Senior Notes—$400 million	Level 1	289.9		99.6		393.7		228.1
Senior Notes—$500 million	Level 1	309.9		162.6		477.4		312.0
Senior First Lien Notes —$540 million	Level 1	506.4		477.9		—		—
Senior Second Lien Notes —$544.2 million	Level 1	407.4		217.7		—		—
ABL Facility	Level 2	—		—		—		—
Fair value adjustment to interest rate hedge	Level 2	2.4		2.4		2.8		2.8
Total long-term debt		$	2,721.6	$	1,318.0	$	2,843.3	$	1,614.2

The fair value of long-term debt was determined using quoted market prices based upon current borrowing rates. The asset based revolving credit facility is variable rate interest and approximates fair value. See NOTE 5 - DEBT AND CREDIT FACILITIES for further information.

Items Measured at Fair Value on a Non-Recurring Basis

The following tables present information about the financial and non-financial assets and liabilities that were measured on a fair value basis at March 31, 2015 and December 31, 2014. There were no financial and non-financial assets and liabilities that were measured on a non-recurring fair value basis at September 30, 2015. The tables also indicate the fair value hierarchy of the valuation techniques used to determine such fair value.



	(In Millions)
	March 31, 2015
Description	Quoted Prices in Active Markets for Identical Assets/ Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total		Total Gains
Liabilities:
$544.2 Million 7.75% 2020 Second Lien Notes	$	—	$	397.2	$	—	$	397.2	$	269.5
	$	—	$	397.2	$	—	$	397.2	$	269.5

The $544.2 million 7.75 percent Second Lien Notes issued in the exchange offers were recorded as an extinguishment of debt as the change in debt terms was considered substantial. As such, the newly issued Second Lien Senior Notes were recorded at fair value at the issuance date. In order to determine the fair value of the Second Lien Senior Notes on the date of the exchange, we utilized the median bid ask spread obtained from various investment banks for the exchange date. The bid ask spread is indicative of the fair value of the notes on the exchange date. The 27.0 percent discount equated to a discount of $147.0 million on the issue value of $544.2 million, or an estimated fair value of $397.2 million.



	(In Millions)
	December 31, 2014
Description	Quoted Prices in Active Markets for Identical Assets/ Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total		Total Losses
Assets:
Goodwill impairment - Asia Pacific Iron Ore reporting unit	$	—	$	—	$	—	$	—	$	73.5
Other long-lived assets - Property, plant and equipment and Mineral rights:
Asia Pacific Iron Ore reporting unit	—		—		72.4		72.4		526.5
Other reporting units	—		—		—		—		11.3
Other long-lived assets - Intangibles and other long-term assets:
Asia Pacific Iron Ore reporting unit	—		—		7.0		7.0		24.2
Investment in ventures impairment - Global Exploration	—		—		—		—		9.2
	$	—	$	—	$	79.4	$	79.4	$	644.7

Financial Assets

During the third quarter of 2014, an impairment charge of $9.2 million to investment in ventures was recorded within our Global Exploration operating segment as a decision was made to abandon the investment during the period.

Non-Financial Assets

During the third and fourth quarter of 2014, we identified factors that indicated the carrying values of the asset groups in the chart above may not be recoverable primarily due to long-term price forecasts as part of management’s long-range planning process. Updated estimates of long-term prices for all products, specifically the Platts 62 percent Fe fines spot price were lower than prior estimates. This especially affects the Asia Pacific Iron Ore business segment because their contracts correlate heavily to world market spot pricing, which were updated based upon current market conditions, macro-economic factors influencing the balance of supply and demand for our products and expectations for future cost and capital expenditure requirements. Additionally, our CEO, Lourenco Goncalves, was appointed by the Board of Directors in early August 2014 and was subsequently identified as the CODM in accordance with ASC 280, Segment Reporting. Our CODM views Asia Pacific Iron Ore as a non-core asset and has communicated plans to evaluate the business unit for a change in strategy including possible divestiture. These factors, among other considerations utilized in the individual impairment assessments, indicate that the carrying value of the respective asset groups in the chart above and Asia Pacific Iron Ore goodwill may not be recoverable.

During the third quarter of 2014, a goodwill impairment charge of $73.5 million was recorded for our Asia Pacific Iron Ore reporting units within our Asia Pacific Iron Ore operating segment. Based on our review of the fair value hierarchy, the inputs used in these fair value measurements were considered Level 3 inputs.

We also recorded impairment charges to property, plant and equipment, mineral rights, intangible assets and other long-term assets during the second half of 2014 related to our Asia Pacific Iron Ore operating segment, along with impairments charged to reporting units within our Other reportable segments. A detailed break out of the impairment charges is shown in the chart above. The recorded impairment charges reduce the related assets to their estimated fair value as we determined that the future cash flows associated with these operations were not sufficient to support the recoverability of the carrying value of these assets. Fair value was determined based on management's best estimate within a range of fair values, which is considered a Level 3 input, and resulted in an asset impairment charge of $562.0 million. The Level 3 inputs used to determine fair value included models developed and market inputs obtained by management which provided a range of fair value estimates of property, plant and equipment. Management’s models include internally developed long-term future cash flow estimates, capital expenditure and cost estimates, market inputs to determine long-term pricing assumptions, discount rates, and foreign exchange rates.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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