Risk Management and Use of Derivative Financial Instruments

Risk Management

In the normal course of our ongoing business operations, we encounter economic risk. There are four main components of economic risk that impact us: interest rate risk, credit risk, market risk, and foreign currency risk. We are primarily subject to interest rate risk on our interest-bearing liabilities, including the Senior Unsecured Credit Facility (Note 11), at September 30, 2014. 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. We own investments in the European Union and in Asia 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 (loss) income 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):



Derivatives Designated as Hedging Instruments	Balance Sheet Location	Asset Derivatives Fair Value at				Liability Derivatives Fair Value at
Derivatives Designated as Hedging Instruments	Balance Sheet Location	September 30, 2014		December 31, 2013		September 30, 2014			December 31, 2013
Interest rate caps	Other assets, net	$	6	$	2	$	—		$	—
Interest rate swaps	Other assets, net	987		1,618		—			—
Foreign currency forward contracts	Other assets, net	3,629		—		—			—
Foreign currency forward contracts ^(a)	Accounts payable, accrued expenses and other liabilities	—		—		(451		)	(7,083		)
Interest rate swaps ^(a)	Accounts payable, accrued expenses and other liabilities	—		—		(5,097		)	(2,734		)
Derivatives Not Designated as Hedging Instruments
Stock warrants ^(b)	Other assets, net	3,753		2,160		—			—
Interest rate swaps ^(c)	Accounts payable, accrued expenses and other liabilities	—		—		(9,033		)	(11,995		)
Total derivatives		$	8,375	$	3,780	$	(14,581	)	$	(21,812	)

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(a)	In connection with the CPA^®:16 Merger, we acquired interest rate swaps and a cap, which were in a net liability position, and foreign currency forward contracts, which were in a net asset position, that had fair values of $2.0 million and $1.2 million, respectively, at September 30, 2014.

(b)

In connection with the CPA^®:16 Merger, we acquired warrants from CPA^®:16 – Global, which had previously been granted by Hellweg 2 to CPA^®:16 – Global, that had a fair value of $1.3 million at September 30, 2014. These warrants give us participation rights to any distributions made by Hellweg 2 and entitle us to a cash distribution that equals a certain percentage of the liquidity event price of Hellweg 2, should a liquidity event occur.


(c)	These interest rate swaps do not qualify for hedge accounting; however, they do protect against fluctuations in interest rates related to the underlying variable-rate debt.

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 financial statements. At both September 30, 2014 and December 31, 2013, no cash collateral had been posted nor received for any of our derivative positions.

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



	Amount of Gain (Loss) Recognized in Other Comprehensive (Loss) Income on Derivatives (Effective Portion) ^(a)
	Three Months Ended September 30,					Nine Months Ended September 30,
Derivatives in Cash Flow Hedging Relationships	2014		2013			2014			2013
Interest rate swaps	$	689	$	16		$	(928	)	$	3,669
Interest rate caps	14		(23		)	(7		)	(13		)
Foreign currency forward contracts	15,372		(4,058		)	12,256			(2,885		)
Total	$	16,075	$	(4,065	)	$	11,321		$	771

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(a)	Excludes net gains recognized on unconsolidated jointly-owned investments, which are included in Net income from equity investments in real estate and the Managed REITs in the consolidated financial statements, of $0.1 million for each of the three months ended September 30, 2014 and 2013, and $0.3 million and $0.5 million for the nine months ended September 30, 2014 and 2013, respectively.



		Amount of (Loss) Gain Reclassified from Other Comprehensive (Loss) Income on Derivatives (Effective Portion) ^(a)
Derivatives in Cash Flow Hedging Relationships	Location of Gain (Loss) Recognized in Income	Three Months Ended September 30,						Nine Months Ended September 30,
Derivatives in Cash Flow Hedging Relationships	Location of Gain (Loss) Recognized in Income	2014			2013 ^(b)			2014			2013 ^(b)
Interest rate swaps and caps	Interest expense	$	(661	)	$	(436	)	$	(2,024	)	$	(1,311	)
Foreign currency forward contracts	Other income and (expenses)	337			(206		)	(487		)	(182		)
Total		$	(324	)	$	(642	)	$	(2,511	)	$	(1,493	)

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(a)	Excludes net losses recognized on unconsolidated jointly-owned investments of $0.1 million and $0.1 million for the three months ended September 30, 2014 and 2013, respectively, and $0.4 million and $0.5 million for the nine months ended September 30, 2014 and 2013, respectively.


(b)	The amounts included in this column for the periods presented herein have been revised to reverse the signs that were incorrectly presented when originally filed. In addition, the corresponding amounts for the years ended December 31, 2013 and 2012 will be similarly revised in the Form 10-K for the year ended December 31, 2014 when filed.

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 contracts are settled. At September 30, 2014, we estimate that an additional $2.4 million and $1.5 million will be reclassified as interest expense and other expenses, respectively, during the next 12 months.



		Amount of Gain Recognized in Income on Derivatives
Derivatives Not in Cash Flow Hedging Relationships	Location of Gain (Loss) Recognized in Income	Three Months Ended September 30,				Nine Months Ended September 30,
Derivatives Not in Cash Flow Hedging Relationships	Location of Gain (Loss) Recognized in Income	2014		2013		2014		2013
Interest rate swaps	Interest expense	$	1,007	$	801	$	1,992	$	4,211
Stock warrants	Other income and (expenses)	268		80		134		360
Total		$	1,275	$	881	$	2,126	$	4,571

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 caps that we had outstanding on our consolidated subsidiaries at September 30, 2014 are summarized as follows (currency in thousands):



	Number of Instruments	Face Amount		Fair Value at September 30, 2014 ^(a)
Interest Rate Derivatives	Number of Instruments	Face Amount		Fair Value at September 30, 2014 ^(a)
Designated as Cash Flow Hedging Instruments
Interest rate swaps	14	$	130,298	$	(2,957	)
Interest rate swaps	2	€	8,225	(1,153		)
Interest rate caps ^(b)	2	€	107,554	6
Not Designated as Cash Flow Hedging Instruments
Interest rate swaps ^(c)	3	€	108,048	(9,033		)
				$	(13,137	)

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(a)	Fair value amounts are based on the exchange rate of the euro at September 30, 2014, as applicable.


(b)	The applicable interest rates of the related debt were 1.2% and 1.1%, which were below the strike prices of the caps of 3.0% and 2.0%, respectively, at September 30, 2014.


(c)	These interest rate swaps do not qualify for hedge accounting; however, they do protect against fluctuations in interest rates related to the underlying variable-rate debt.

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 and certain other currencies. 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 September 30, 2014, which were designated as cash flow hedges (currency in thousands):



	Number of Instruments	Face Amount		Fair Value at September 30, 2014 ^(a)
Foreign Currency Derivatives	Number of Instruments	Face Amount		Fair Value at September 30, 2014 ^(a)
Foreign currency forward contracts	72	€	163,500	$	3,589
Foreign currency forward contracts	17	£	9,100	(411		)
				$	3,178

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(a)	Fair value amounts are based on the applicable exchange rate of the foreign currency at September 30, 2014.

Credit Risk-Related Contingent Features

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 September 30, 2014. At September 30, 2014, our total credit exposure was $3.7 million and the maximum exposure to any single counterparty was $1.8 million.

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 September 30, 2014, 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 $15.7 million at September 30, 2014, which included accrued interest and any adjustment for nonperformance risk. If we had breached any of these provisions at September 30, 2014, we could have been required to settle our obligations under these agreements at their aggregate termination value of $16.1 million.

Net Investment Hedge

During the nine months ended September 30, 2014, we borrowed an aggregate of €178.5 million under the Revolver to prepay several non-recourse mortgage loans denominated in euro (Note 11). This borrowing is designated as and effective as an economic hedge of our net investments in these euro-denominated entities. Variability in the exchange rate of the euro with respect to the U.S. dollar impacts our financial results as the financial results of our euro-denominated subsidiaries are translated to U.S. dollars each period, with the effect of changes in the euro to U.S. dollar exchange rate being recorded in Other comprehensive (loss) income as part of the cumulative foreign currency translation adjustment. As a result, the borrowing in euro under the Revolver is recorded at cost in the consolidated financial statements and all changes in the value related to changes in the spot rate will be reported in the same manner as a translation adjustment, which is recorded in Other comprehensive (loss) income as part of the cumulative foreign currency translation adjustment.