Financial Instruments: Derivatives and Hedging

9 Months Ended

Sep. 30, 2012

Financial Instruments: Derivatives and Hedging

Financial Instruments: Derivatives and Hedging

4.     Financial Instruments: Derivatives and Hedging

On September 27, 2012, the Company fixed the interest rate for five-years on the 2012 Term Loan pursuant with an interest rate swap agreement. The variable rate that was fixed under the interest rate swap agreement is described in Note 3.

The interest swap agreement qualifies as a cash flow hedge and has been recognized on the consolidated balance sheet at fair value.  If a derivative qualifies as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in fair value of the hedged asset, liability, or firm commitment through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings.  The ineffective portion of a derivative’s change in fair value will be immediately recognized in earnings, which may increase or decrease reported net income and stockholders’ equity prospectively, depending on future levels of interest rates and other variables affecting the fair values of derivative instruments and hedged items, but will have no effect on cash flows.

The following table summarizes the notional and fair value of our derivative financial instrument at September 30, 2012.  The notional value is an indication of the extent of our involvement in these instruments at that time, but does not represent exposure to credit, interest rate or market risks (in thousands).

	Notional		Strike		Effective	Expiration	Fair
	Value		Rate		Date	Date	Value
Interest Rate Swap	$	400,000	0.75	%	Sep-12	Sep-17	$	(1,671	)

On September 30, 2012, the derivative instrument was reported as an obligation at its fair value of approximately $1.7 million.  This is included in other liabilities: derivative liability on the consolidated balance sheet at September 30, 2012.  Offsetting adjustments are reported as unrealized gains or losses on derivative financial instruments in accumulated other comprehensive income of $1.7 million.

Over time, the unrealized gains and losses held in accumulated other comprehensive income will be reclassified into earnings as a reduction to interest expense in the same periods in which the hedged interest payments affect earnings.  We estimate that approximately $0.3 million of the current balance held in accumulated other comprehensive income will be reclassified into earnings within the next 12 months.

We are hedging the exposure to variability in future cash flows for forecasted transactions in addition to anticipated future interest payments on existing debt.

The fair value of the Company’s derivative instrument is determined using the net discounted cash flows of the expected cash flows of the derivative based on the market based interest rate curve. This financial instrument was classified within Level 2 of the fair value hierarchy and was classified as a liability on the condensed consolidated balance sheet.

Previously the Company’s hedging activity was limited to an interest rate swap.  The purpose of the interest rate swap, which was terminated on February 22, 2011, was to fix the interest rate for the term of the loan and to protect the Company from future interest rate increases on that term loan.

The interest rate swap represented a cash flow hedge and was recorded at fair value and classified as a liability.  Changes in the recorded fair value of the interest rate swap were recorded to other comprehensive income. On February 22, 2011, the Company used approximately $983,000 to terminate the interest rate swap agreement applicable to that term loan.  The payment to terminate the interest rate swap liability was amortized into interest expense through October 15, 2011.

The interest amortization for the Company’s terminated interest rate swap reclassified from accumulated other comprehensive income into interest expense for the nine months ended September 30, 2011 was $921,000 and for the year ended December 31, 2011 was $983,000.  The effective portion of the loss on outstanding derivative recognized in other comprehensive Income for the nine months ended September 30, 2011 was $921,000 and for the year ended December 31, 2011 was $983,000.