Quarterly report pursuant to Section 13 or 15(d)

Interest Rate Hedge Swaps

v2.4.0.8
Interest Rate Hedge Swaps
 9 Months Ended
Sep. 30, 2013
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
INTEREST RATE HEDGE SWAPS
INTEREST RATE HEDGE SWAPS
Derivative financial instruments
Currently, the Company uses interest rate swaps to manage its interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including forward interest rate curves. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts.  The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate forward curves.
To comply with the provisions of ASC 820, the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty's nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees. In conjunction with the FASB's fair value measurement guidance in ASC 820, the Company made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.
Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of September 30, 2013, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
The table below presents the Company's assets and liabilities measured at fair value on a recurring basis as well as their classification on the Consolidated Balance Sheets as of September 30, 2013, aggregated by the level in the fair value hierarchy within which those measurements fall. Hedges that are valued as receivable by the Company are considered Asset Derivatives and those that are valued as payable by the Company are considered Liability Derivatives. There were no outstanding derivative financial instruments as of November 30, 2012.
Derivative Financial Instruments Measured At Fair Value on a Recurring Basis
 
 
Balance Sheet
Classification
 
 
Fair Value Hierarchy
Balance Sheet Line Item
 
 
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
September 30, 2013
Hedged derivative asset
 
Assets
 
 
$
—

 
$
516,305

 
$
—

Hedged derivative liability
 
Liabilities
 
 
$
—

 
$
—

 
$
—

Level 1 – quoted prices in active markets for identical investments
Level 2 – other significant observable inputs (including quoted prices for similar investments, market corroborated inputs, etc.)
Level 3 – significant unobservable inputs (including the Company’s own assumptions in determining the fair value of investments)
Risk Management Objective of Using Derivatives
The Company is exposed to certain risk arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its debt funding and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company's derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company's known or expected cash receipts and its known or expected cash payments principally related to the Company's investments and borrowings.
Cash Flow Hedges of Interest Rate Risk
The Company's objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps and caps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. Interest rate caps designated as cash flow hedges involve the receipt of variable amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an upfront premium.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in Accumulated Other Comprehensive Income (“AOCI”) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The Company elected to designate its interest rate swaps as cash flow hedges in April 2013. During the three and nine months ended September 30, 2013, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three and nine months ended September 30, 2013 there was ineffectiveness of approximately $1,000 (loss) and $6,000 (gain), respectively, recorded in earnings resulting from interest rate swaps that did not have a fair value of zero at inception of the hedging relationship. The Company did not have any derivatives designated as Cash Flow Hedges during the three and nine months ended August 31, 2012.

Amounts reported in AOCI related to derivatives will be reclassified to interest expense as interest payments are made on the Company's variable-rate debt. Over the next 12 months, the Company estimates that an additional $265 thousand will be reclassified as an increase to interest expense.

As of September 30, 2013, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk:
Outstanding Derivatives Designated as Cash Flow Hedges of Interest Rate Risk
Interest Rate Derivative
 
Number of Instruments
 
Notional Amount Outstanding
 
 
 
 
 
Floating Rate Received
 
Fixed Rate Paid
 
 
 
Effective Date
 
Termination Date
 
 
Interest Rate Swap
 
2
 
$52,500,000
 
February 5, 2013
 
December 5, 2017
 
1-month US Dollar LIBOR
 
0.865%

Non-Designated Hedges

Derivatives not designated as hedges are not speculative and are used to manage the Company's exposure to interest rate movements and other identified risks. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in earnings and were equal to a net loss of approximately zero and $75 thousand for the three and nine months ended September 30, 2013, respectively. The Company did not have any derivatives during the three and nine months ended August 31, 2012.

As the Company elected to designate its interest rate swaps in cash flow hedging relationships in April 2013 (see Cash Flow Hedges of Interest Rate Risk above), the Company did not have any non-designated hedges as of September 30, 2013.

Tabular Disclosure of the Effect of Derivative Instruments on the Income Statement
The tables below present the effect of the Company's derivative financial instruments on the Income Statement for the three and nine months ended September 30, 2013 and August 31, 2012.
Effect of Derivative Financial Instruments on Income Statement
Derivatives in Cash Flow Hedging Relationships
 
Amount of Gain (Loss) Recognized in AOCI
on Derivative
(Effective Portion)
 
Location of
Gain (Loss) Reclassified from AOCI into Net Income (Effective Portion)
 
Amount of Gain (Loss) Reclassified from AOCI on Derivatives (Effective Portion) Recognized in Net Income *
 
Location of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
 
Amount of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion, Amounts Excluded from Effectiveness Testing)
 
 
 
 
 
For the three months ended:
 
September 30, 2013
 
August 31, 2012
 
 
September 30, 2013
 
August 31, 2012
 
 
September 30, 2013
 
August 31, 2012
Interest Rate Products
 
$
(397,214
)
 
$
—

 
Interest Expense
 
$
(72,757
)
 
$
—

 
Interest Expense
 
$
(1,062
)
 
$
—

For the nine months ended:
 
September 30, 2013
 
August 31, 2012
 
 
 
September 30, 2013
 
August 31, 2012
 
 
 
September 30, 2013
 
August 31, 2012
Interest Rate Products
 
$
669,674

 
$
—

 
Interest Expense
 
$
(142,750
)
 
$
—

 
Interest Expense
 
$
6,098

 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedging Instruments
 
Location of
Gain (Loss) Recognized in Income on Derivative
 
Amount of Gain (Loss) Recognized in Income on Derivative *
 
 
 
 
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
 
 
September 30, 2013
 
August 31, 2012
 
September 30, 2013
 
August 31,
2012
 
 
 
 
Interest rate contracts
 
Interest Expense
 
$
—

 
$
—

 
$
(75,200
)
 
$
—

 
 
 
 
* The gain or (loss) recognized in income on derivatives includes changes in fair value of the derivatives as
    well as the periodic cash settlements and interest accruals for derivatives not designated as hedging
    instruments

Tabular Disclosure of Offsetting Derivatives
The table below presents a gross presentation, the effects of offsetting, and a net presentation of the Company's derivatives as of September 30, 2013. The net amounts of derivative assets or liabilities can be reconciled to the tabular disclosure of fair value. The tabular disclosure of fair value provides the location that derivative assets and liabilities are presented on the Balance Sheet.
Offsetting Derivatives
 
 
Gross Amounts of Recognized Assets
 
Gross Amounts Offset in the Statement of Financial Position
 
Net Amounts of Assets presented in the Statement of Financial Position
 
Gross Amounts Not
Offset in the Statement
of Financial Position
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial Instruments
 
Cash Collateral Received
 
Net Amount
Offsetting Derivative Assets as of September 30, 2013
 
$
516,305

 
$
—

 
$
516,305

 
$
—

 
$
—

 
$
516,305

 
 
 
 
 
 
 
 
 
 
 
 
 
Offsetting Derivative Liabilities as of September 30, 2013
 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—


Credit-Risk Related Contingent Features
The Company has agreements with some of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the company could also be declared in default on its derivative obligations.
As of September 30, 2013, the Company did not have any derivatives that were in a net liability position. Therefore, the credit risk-related contingent features discussed above would not apply as of September 30, 2013.