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, 2013

NOTE 8 - FAIR VALUE OF FINANCIAL INSTRUMENTS

The following represents the assets and liabilities of the Company measured at fair value at September 30, 2013 and December 31, 2012:



	(In Millions)
	September 30, 2013
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	$	192.0	$	—	$	—	$	192.0
Derivative assets	—		1.7		66.7		68.4
Marketable securities	26.7		—		—		26.7
Foreign exchange contracts	—		4.3		—		4.3
Total	$	218.7	$	6.0	$	66.7	$	291.4
Liabilities:
Derivative liabilities	$	—	$	2.7	$	11.4	$	14.1
Foreign exchange contracts	—		22.0		—		22.0
Total	$	—	$	24.7	$	11.4	$	36.1



	(In Millions)
	December 31, 2012
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	$	100.0	$	—	$	—	$	100.0
Derivative assets	—		—		62.4		62.4
Marketable securities	27.0		—		—		27.0
Foreign exchange contracts	—		16.2		—		16.2
Total	$	127.0	$	16.2	$	62.4	$	205.6
Liabilities:
Derivative liabilities	$	—	$	—	$	11.3	$	11.3
Foreign exchange contracts	—		1.9		—		1.9
Total	$	—	$	1.9	$	11.3	$	13.2

Financial assets classified in Level 1 at September 30, 2013 and December 31, 2012 include money market funds and 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 September 30, 2013, such derivative financial instruments included our existing foreign currency exchange contracts, commodity contracts, and interest rate swaps. At December 31, 2012, 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, 2013 and December 31, 2012 included 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 at September 30, 2013 and December 31, 2012, also consisted of derivatives related to certain provisional pricing arrangements with our U.S. Iron Ore, Eastern Canadian Iron Ore and Asia Pacific Iron Ore customers at September 30, 2013 and our U.S. Iron Ore and Eastern Canadian Iron Ore customers at December 31, 2012. 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 provisionally agreed-upon price 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

Balance Sheet Location

Valuation Technique

Unobservable Input

Range or Point Estimate

(Weighted Average)

9/30/2013

Provisional Pricing Arrangements

4.6

Derivative assets

Market Approach

Management's

Estimate of 62% Fe

$131

11.4

Derivative liabilities

Customer Supply Agreement

62.1

Derivative assets

Market Approach

Hot-Rolled Steel Estimate

$590 - $660 ($630)

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 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 agreements is the future hot-rolled steel price that is estimated based on current market data, analysts' projections, projections provided by the customer 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.

Substantially all of the financial assets and liabilities are carried at fair value or contracted amounts that approximate fair value.

We recognize any transfers between levels as of the beginning of the reporting period, including both transfers into and out of levels. There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the nine months of 2013 or 2012. 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, 2013 and 2012.



	(In Millions)
	Derivative Assets (Level 3)
	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Beginning balance	$	45.1		$	83.9		$	62.4		$	157.9
Total gains
Included in earnings	57.6			24.9			118.0			129.6
Settlements	(36.0		)	(52.9		)	(113.7		)	(231.6		)
Transfers into Level 3	—			—			—			—
Transfers out of Level 3	—			—			—			—
Ending balance - September 30	$	66.7		$	55.9		$	66.7		$	55.9
Total gains for the period included in earnings attributable to the change in unrealized gains on assets still held at the reporting date	$	57.6		$	24.9		$	118.0		$	129.6



	(In Millions)
	Derivative Liabilities (Level 3)
	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Beginning balance	$	(32.0	)	$	(15.8	)	$	(11.3	)	$	(19.5	)
Total gains
Included in earnings	20.6			4.1			(11.4		)	(11.7		)
Settlements	—			—			11.3			19.5
Transfers into Level 3	—			—			—			—
Transfers out of Level 3	—			—			—			—
Ending balance - September 30	$	(11.4	)	$	(11.7	)	$	(11.4	)	$	(11.7	)
Total gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) on liabilities still held at the reporting date	$	20.6		$	4.1		$	(11.4	)	$	(11.7	)

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, 2013 and 2012.

The carrying amount for certain financial instruments (e.g. Accounts receivable, net, Accounts payable and Accrued expenses) approximate fair value and, therefore, have been excluded from the table below. A summary of the carrying amount and fair value of other financial instruments at September 30, 2013 and December 31, 2012 were as follows:



		(In Millions)
		September 30, 2013				December 31, 2012
	Classification	Carrying Value		Fair Value		Carrying Value		Fair Value
Other receivables:
Customer supplemental payments	Level 2	$	—	$	—	$	22.3	$	21.3
ArcelorMittal USA—Receivable	Level 2	13.4		14.3		19.3		21.3
Other	Level 2	10.1		10.1		10.9		10.9
Total receivables		$	23.5	$	24.4	$	52.5	$	53.5
Long-term debt:
Term loan—$1.25 billion	Level 2	$	—	$	—	$	753.0	$	753.0
Senior notes—$700 million	Level 2	699.4		719.2		699.4		759.4
Senior notes—$1.3 billion	Level 2	1,289.6		1,442.2		1,289.4		1,524.7
Senior notes—$400 million	Level 2	398.4		439.7		398.2		464.3
Senior notes—$500 million	Level 2	496.3		528.4		495.7		528.4
Revolving loan	Level 2	380.0		380.0		325.0		325.0
Equipment Loan Facilities	Level 2	54.2		54.2		—		—
Fair Value Adjustment to Interest Rate Hedge	Level 2	1.7		1.7		—		—
Total long-term debt		$	3,319.6	$	3,565.4	$	3,960.7	$	4,354.8

The fair value of the receivables and debt are based on the fair market yield curves for the remainder of the term expected to be outstanding.

The terms of one of our U.S. Iron Ore pellet supply agreements required supplemental payments to be paid by the customer during the period 2009 through 2012, with the option to defer a portion of the 2009 monthly amount up to $22.3 million in exchange for interest payments until the deferred amount was repaid in 2013. Interest was payable by the customer quarterly and began in September 2009 at the higher of 9 percent or the prime rate plus 350 basis points. During the first half of 2013, payments totaling $22.3 million on the outstanding amount due were made by the customer and the receivable was fully repaid by the end of June 2013. As of December 31, 2012, the receivable of $22.3 million was classified as current and recorded in Other current assets in the Statements of Unaudited Condensed Consolidated Financial Position as all supplemental payments to be paid by the customer were due by the end of 2013. The fair value of the receivable of $21.3 million at December 31, 2012 is based on a discount rate of 2.81 percent, which represented the estimated credit-adjusted risk-free interest rate for the period the receivable was outstanding.

In 2002, we entered into an agreement with Ispat that restructured the ownership of the Empire mine and increased our ownership from 46.7 percent to 79.0 percent in exchange for the assumption of all mine liabilities. Under the terms of the agreement, we indemnified Ispat from obligations of Empire in exchange for certain future payments to Empire and to us by Ispat of $120.0 million, recorded at a present value of $13.4 million and $19.3 million at September 30, 2013 and December 31, 2012, respectively, of which $10.0 million was recorded in Other current assets at September 30, 2013 and December 31, 2012. The fair value of the receivable of $14.3 million and $21.3 million at September 30, 2013 and December 31, 2012, respectively, is based on a discount rate of 1.98 percent and 2.85 percent, respectively, which represents the estimated credit-adjusted risk-free interest rate for the period the receivable is outstanding.

The fair value of long-term debt was determined using quoted market prices or discounted cash flows based upon current borrowing rates. The term loan and revolving loan are variable rate interest and approximate fair value. See NOTE 9 - DEBT AND CREDIT FACILITIES for further information.

Items Measured at Fair Value on a Non-Recurring Basis

The following tables present information about the impairment charges on both financial and nonfinancial assets that were measured on a fair value basis at September 30, 2013 and December 31, 2012. The table also indicates the fair value hierarchy of the valuation techniques used to determine such fair value.



	(In Millions)
	September 30, 2013
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:
Investment in ventures impairment - Amapá	—	—	—	$	—	$	67.6

In light of the March 28, 2013 collapse of the Santana port shiploader and subsequent evaluation of the effect that this event had on the carrying value of our investment in Amapá as of June 30, 2013, we recorded an impairment charge of $67.6 million in the second quarter of 2013.



	(In Millions)
	December 31, 2012
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:
Investment in ventures impairment - Amapá	$	—	$	—	$	72.5	$	72.5

On December 27, 2012, the board of directors approved the sale of our 30 percent investment in Amapá, which is recorded as an equity method investment in the Statements of Unaudited Condensed Consolidated Operations. The carrying value of the investment was reduced to fair value of $72.5 million as of December 31, 2012, resulting in an impairment charge of $365.4 million, which was recorded in the fourth quarter of 2012. We believe the sum of the sale proceeds approximates fair value. The fair value of the proceeds (and therefore the portion of the equity method investment measured at fair value) was determined using a probability-weighted cash flow approach.

- 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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