Risk Management and Use of Derivative Financial Instruments

In the normal course of our ongoing business operations, we encounter economic risk. There are three main components of economic risk that impact us: interest rate risk, credit risk and market risk. We are primarily subject to interest rate risk on our interest-bearing liabilities, including our Prior Senior Credit Facility and Unsecured Term Loan (Note 12) at December 31, 2013. Credit risk is the risk of default on our operations and our tenants’ inability or unwillingness to make contractually required payments. Market risk includes changes in the value of our properties and related loans, as well as changes in the value of our other securities and the shares we hold in the Managed REITs due to changes in interest rates or other market factors. In addition, we own investments in the European Union and are subject to the risks associated with changing foreign currency exchange rates.

Derivative Financial Instruments

When we use derivative instruments, it is generally to reduce our exposure to fluctuations in interest rates and foreign currency exchange rate movements. We have not entered, and do not plan to enter into, financial instruments for trading or speculative purposes. The primary risks related to our use of derivative instruments include default by a counterparty to a hedging arrangement on its obligation and a downgrade in the credit quality of a counterparty to such an extent that our ability to sell or assign our side of the hedging transaction is impaired. While we seek to mitigate these risks by entering into hedging arrangements with counterparties that are large financial institutions that we deem to be creditworthy, it is possible that our hedging transactions, which are intended to limit losses, could adversely affect our earnings. Furthermore, if we terminate a hedging arrangement, we may be obligated to pay certain costs, such as transaction or breakage fees. We have established policies and procedures for risk assessment and the approval, reporting and monitoring of derivative financial instrument activities.

We measure derivative instruments at fair value and record them as assets or liabilities, depending on our rights or obligations under the applicable derivative contract. Derivatives that are not designated as hedges must be adjusted to fair value through earnings. For a derivative designated and that qualified as a cash flow hedge, the effective portion of the change in fair value of the derivative is recognized in Other comprehensive income (loss) until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value is immediately recognized in earnings.

The following table sets forth certain information regarding our derivative instruments (in thousands):



		Asset Derivatives Fair Value at				Liability Derivatives Fair Value at
Derivatives Designated as Hedging Instruments	Balance Sheet Location	December 31, 2013		December 31, 2012		December 31, 2013			December 31, 2012
Interest rate cap	Other assets, net	$	2	$	25	$	—		$	—
Interest rate swaps	Other assets, net	1,618		—		—			—
Foreign currency forward contracts	Accounts payable, accrued expenses and other liabilities	—		—		(7,083		)	(2,067		)
Interest rate swaps	Accounts payable, accrued expenses and other liabilities	—		—		(2,734		)	(5,825		)
Derivatives Not Designated as Hedging Instruments
Stock warrants ^(a)	Other assets, net	2,160		1,720		—			—
Interest rate swaps ^(b)	Accounts payable, accrued expenses and other liabilities	—		—		(11,995		)	(16,686		)
Total derivatives		$	3,780	$	1,745	$	(21,812	)	$	(24,578	)

__________


(a)	In connection with the CPA^®:15 Merger, we acquired warrants from CPA^®:15, which were granted by Hellweg to CPA^®:15. These warrants give us participation rights to any distributions made by Hellweg 2 and we are entitled to a cash distribution that equals a certain percentage of the liquidity event price of Hellweg 2, should a liquidity event occur.


(b)	These interest rate swaps were acquired from CPA^®:15 in the CPA^®:15 Merger. They do not qualify for hedge accounting; however, they do protect against fluctuations in interest rates related to the variable-rate debt we acquired in the CPA^®:15 Merger.

All derivative transactions with an individual counterparty are governed by a master International Swap and Derivatives Association agreement, which can be considered as a master netting arrangement; however, we report all our derivative instruments on a gross basis on our consolidated balance sheets. At both December 31, 2013 and 2012, no cash collateral had been posted nor received for any of our derivative positions.

The following tables present the impact of derivative instruments on the consolidated financial statements (in thousands):



	Amount of Gain (Loss) Recognized in Other Comprehensive Income (Loss)on Derivatives (Effective Portion) ^(a)
	Years Ended December 31,
Derivatives in Cash Flow Hedging Relationships	2013			2012			2011
Interest rate swaps	$	4,720		$	(1,059	)	$	(3,564	)
Interest rate cap	(15		)	277			—
Foreign currency forward contracts	(5,211		)	(1,480		)	—
Total	$	(506	)	$	(2,262	)	$	(3,564	)



	Amount of Gain (Loss) Reclassified from Other Comprehensive Income (Loss) into Income (Effective Portion) ^(b)
	Years Ended December 31,
Derivatives in Cash Flow Hedging Relationships	2013		2012		2011
Interest rate swaps	$	1,745	$	1,539	$	344
Foreign currency forward contracts	537		239		—
Total	$	2,282	$	1,778	$	344



		Amount of Gain (Loss) Recognized in Income on Derivatives
	Location of Gain (Loss)	Years Ended December 31,
Derivatives Not in Cash Flow Hedging Relationships	Recognized in Income	2013		2012		2011
Interest rate swaps	Interest expense	$	5,249	$	429	$	—
Stock warrants	Other income and (expenses)	440		108		—
Total		$	5,689	$	537	$	—

__________


(a)	Excludes net gains (losses) of $0.5 million, $0.3 million and less than $(0.1) million recognized on unconsolidated jointly-owned investments for the years ended December 31, 2013, 2012 and 2011, respectively.


(b)	Excludes net gains of $0.5 million, $0.4 million and $0.2 million recognized on unconsolidated jointly-owned investments for the years ended December 31, 2013, 2012 and 2011 respectively.

See below for information on our purposes for entering into derivative instruments and for information on derivative instruments owned by unconsolidated investments, which are excluded from the tables above.

Interest Rate Swaps and Caps

We are exposed to the impact of interest rate changes primarily through our borrowing activities. To limit this exposure, we attempt to obtain mortgage financing on a long-term, fixed-rate basis. However, from time to time, we or our investment partners may obtain variable-rate non-recourse mortgage loans and, as a result, may enter into interest rate swap agreements or interest rate cap agreements with counterparties. Interest rate swaps, which effectively convert the variable-rate debt service obligations of the loan to a fixed rate, are agreements in which one party exchanges a stream of interest payments for a counterparty’s stream of cash flow over a specific period. The notional, or face, amount on which the swaps are based is not exchanged. Interest rate caps limit the effective borrowing rate of variable-rate debt obligations while allowing participants to share in downward shifts in interest rates. Our objective in using these derivatives is to limit our exposure to interest rate movements.

The interest rate swaps and cap that we had outstanding on our consolidated subsidiaries at December 31, 2013 are summarized as follows (currency in thousands):



	Number of Instruments	Notional Amount		Fair Value at December 31, 2013 ^(a)
Interest Rate Derivatives	Number of Instruments	Notional Amount		Fair Value at December 31, 2013 ^(a)
Designated as Cash Flow Hedging Instruments
Interest rate swaps	5	$	72,240	$	(24	)
Interest rate swaps	2	€	8,375	(1,092		)
Interest rate cap ^(b)	1	€	64,543	2
Not Designated as Cash Flow Hedging Instruments
Interest rate swaps ^{(c) (d)}	3	€	109,959	(11,995		)
				$	(13,109	)

__________


(a)	Amounts are based on the exchange rate of the euro at December 31, 2013, as applicable.


(b)	The applicable interest rate of the related debt was 1.3%, which was below the strike price of the cap of 2.0% at December 31, 2013.


(c)	These interest rate swaps were acquired from CPA^®:15 in the CPA^®:15 Merger. They do not qualify for hedge accounting; however, they do protect against fluctuations in interest rates related to the variable-rate debt we acquired in the CPA^®:15 Merger.


(d)	Notional and fair value amounts include, on a combined basis, portions attributable to noncontrolling interests totaling $27.5 million and $3.0 million, respectively.

Foreign Currency Contracts

We are exposed to foreign currency exchange rate movements, primarily in the euro and, to a lesser extent, the British pound sterling. We manage foreign currency exchange rate movements by generally placing our debt service obligation on an investment in the same currency as the tenant’s rental obligation to us. This reduces our overall exposure to the net cash flow from that investment. However, we are subject to foreign currency exchange rate movements to the extent of the difference in the timing and amount of the rental obligation and the debt service. Realized and unrealized gains and losses recognized in earnings related to foreign currency transactions are included in Other income and (expenses) in the consolidated financial statements.

In order to hedge certain of our foreign currency cash flow exposures, we enter into foreign currency forward contracts. A foreign currency forward contract is a commitment to deliver a certain amount of currency at a certain price on a specific date in the future. By entering into forward contracts and holding them to maturity, we are locked into a future currency exchange rate for the term of the contract.

The following table presents the foreign currency derivative contracts we had outstanding at December 31, 2013, which were designated as cash flow hedges (currency in thousands):



	Number of Instruments	Notional Amount		Fair Value at December 31, 2013 ^(a)
Foreign Currency Derivatives	Number of Instruments	Notional Amount		Fair Value at December 31, 2013 ^(a)
Foreign currency forward contracts	58	€	100,737	$	(6,357	)
Foreign currency forward contracts	19	£	10,773	(726		)
				$	(7,083	)

__________


(a)	Amounts are based on the applicable exchange rate of the foreign currency at December 31, 2013.

Other

Amounts reported in Other comprehensive (loss) income related to interest rate swaps will be reclassified to Interest expense as interest payments are made on our variable-rate debt. Amounts reported in Other comprehensive (loss) income related to foreign currency derivative contracts will be reclassified to Other income and (expenses) when the hedged foreign currency proceeds from foreign operations are repatriated to the U.S. At December 31, 2013, we estimate that an additional $1.8 million and $1.4 million will be reclassified as interest expense and other income, respectively, during the next 12 months.

We measure our credit exposure on a counterparty basis as the net positive aggregate estimated fair value of our derivatives, net of collateral received, if any. No collateral was received as of December 31, 2013. At December 31, 2013, both our total credit exposure and the maximum exposure to any single counterparty was $1.4 million, inclusive of amounts attributable to noncontrolling interests.

Some of the agreements we have with our derivative counterparties contain certain credit contingent provisions that could result in a declaration of default against us regarding our derivative obligations if we either default or are capable of being declared in default on certain of our indebtedness. At December 31, 2013, we had not been declared in default on any of our derivative obligations. The estimated fair value of our derivatives that were in a net liability position was $22.9 million and $25.7 million at December 31, 2013 and 2012, respectively, which included accrued interest and any adjustment for nonperformance risk. If we had breached any of these provisions at either December 31, 2013 or December 31, 2012, we could have been required to settle our obligations under these agreements at their aggregate termination value of $24.4 million or $27.3 million, respectively.

Portfolio Concentration Risk

Concentrations of credit risk arise when a group of tenants is engaged in similar business activities or is subject to similar economic risks or conditions that could cause them to default on their lease obligations to us. We regularly monitor our portfolio to assess potential concentrations of credit risk. While we believe our portfolio is reasonably well diversified, it does contain concentrations in excess of 10%, based on the percentage of our annualized contractual minimum base rent for the fourth quarter of 2013, in certain areas, as shown in the table below. The percentages in the table below represent our directly-owned real estate properties and do not include our share of equity investments.



	December 31, 2013
Region:
California	10	%
Other U.S.	60	%
Total U.S	70	%
Total Europe	30	%
Total	100	%

Asset Type:
Office	32	%
Industrial	18	%
Warehouse/Distribution	16	%
Retail	13	%
All others	21	%
Total	100	%

Tenant Industry:
Retail	19	%
All other	81	%
Total	100	%

Except for our investment in CPA^®:16 – Global, there were no significant concentrations, individually or in the aggregate, related to our unconsolidated jointly-owned investments. At December 31, 2013, we owned approximately 18.5% of CPA^®:16 – Global, which had total assets at that date of approximately $3.2 billion consisting of a portfolio comprised of full or partial ownership interests in 467 properties, as well as two hotel properties, and has certain concentrations within its portfolio, which are outlined in its consolidated financial statements provided with this Report. The CPA^®:16 Merger was completed on January 31, 2014 (Note 20).