(5) Derivative Financial Instruments

The fair value of outstanding derivatives recorded in the accompanying Condensed Consolidated Balance Sheets were as follows:



Asset Derivatives	Classification	December 31, 2016		September 30, 2016
Derivatives designated as hedging instruments:
Foreign exchange contracts	Receivables, net	$	10.1	$	5.5
Commodity swaps	Receivables, net	3.3		2.9
Foreign exchange contracts	Other assets	0.1		0.1
Total asset derivatives designated as hedging instruments		13.5		8.5
Derivatives not designated as hedging instruments:
Call option receivable from FGL	Funds withheld receivables	12.2		11.3
Call options	Other assets	8.3		5.9
Foreign exchange contracts	Receivables, net	0.1		0.2
Total asset derivatives		$	34.1	$	25.9



Liability Derivatives	Classification	December 31, 2016		September 30, 2016
Derivatives designated as hedging instruments:
Interest rate swaps	Accounts payable and other current liabilities	$	0.3	$	0.7
Interest rate swaps	Other liabilities	0.4		0.4
Commodity swaps	Accounts payable and other current liabilities	0.2		0.1
Foreign exchange contracts	Accounts payable and other current liabilities	0.1		1.7
Foreign exchange contracts	Other liabilities	0.1		0.1
Total liability derivatives designated as hedging instruments		1.1		3.0
Derivatives not designated as hedging instruments:
Embedded derivatives in Front Street's assumed FIA business	Insurance reserves	121.2		131.2
Foreign exchange contracts	Accounts payable and other current liabilities	0.3		0.2
Total liability derivatives		$	122.6	$	134.4

For derivative instruments that are used to economically hedge the fair value of Spectrum Brands’ third party and intercompany foreign currency payments, commodity purchases and interest rate payments, the gain (loss) associated with the derivative contract is recognized in earnings in the period of change. The Company recognizes all derivative instruments as assets or liabilities in the accompanying Condensed Consolidated Balance Sheets at fair value.

The following tables summarize the impact of the effective portion of designated hedges and the gain recognized in the accompanying Condensed Consolidated Statements of Operations for the three months ended December 31, 2016 and 2015:



Three months ended December 31, 2016	Classification	Effective portion
		Gain in AOCI		Gain (Loss) reclassified to Earnings
Interest rate swaps	Interest expense	$	0.1	$	(0.3	)
Commodity swaps	Cost of consumer products and other goods sold	0.1		0.8
Net investment hedge	Other income (expense), net	32.5		—
Foreign exchange contracts	Net consumer and other product sales	0.2		—
Foreign exchange contracts	Cost of consumer products and other goods sold	10.3		4.3
		$	43.2	$	4.8



Three months ended December 31, 2015	Classification	Effective portion
		Gain (Loss) in AOCI			Gain (Loss) reclassified to Earnings
Interest rate swaps	Interest expense	$	0.3		$	(0.5	)
Commodity swaps	Cost of consumer products and other goods sold	(1.0		)	(1.4		)
Foreign exchange contracts	Net consumer and other product sales	(0.1		)	—
Foreign exchange contracts	Cost of consumer products and other goods sold	5.4			2.1
		$	4.6		$	0.2

During the three months ended December 31, 2016 and 2015, the Company recognized the following gains and losses on its derivatives:



		Three months ended December 31,
Classification	Derivatives Not Designated as Hedging Instruments	2016			2015
Revenues:
Net investment losses	Call options	$	3.1		$	1.9
Operating costs and expenses:
Cost of consumer products and other goods sold	Commodity swaps	$	0.1		$	—
Benefits and other changes in policy reserves	Embedded derivatives in Front Street's assumed FIA business	(10.0		)	(2.4		)
Other income (expense), net	Foreign exchange contracts	0.7			(2.1		)

Additional Disclosures

Call options. Derivative financial instruments included within the funds withheld receivables at fair value in the accompanying Condensed Consolidated Balance Sheets are in the form of call options receivable by Front Street. Front Street hedges exposure to product related equity market risk by entering into derivative transactions. These options hedge Front Street’s share of the FIA index credit. The change in fair value is recognized within “Net investment losses” in the accompanying Condensed Consolidated Statements of Operations.

Call option receivable from FGL. Under the terms of the modified coinsurance arrangement between Front Street and FGL, FGL is required to pay Front Street a portion of the net cost of equity option purchases and the proceeds from expirations related to the equity options which hedge the index credit feature of the reinsured FIA contracts. Accordingly, the receivable from FGL is reflected in “Funds withheld receivables” as of the balance sheet date with changes in fair value recognized within “Net investment losses” in the accompanying Condensed Consolidated Statements of Operations.

Embedded derivatives in Front Street’s assumed FIA business from FGL. Front Street has assumed FIA contracts that permit the holder to elect an interest rate return or an equity index linked component, where interest credited to the contracts is linked to the performance of various equity indices, primarily the Standard & Poor’s Ratings Services (“S&P”) 500 Index. This feature represents an embedded derivative under U.S. GAAP. The FIA embedded derivative is valued at fair value and included in the “Insurance reserves” in the accompanying Condensed Consolidated Balance Sheets with changes in fair value included as a component of “Benefits and other changes in policy reserves” in the accompanying Condensed Consolidated Statements of Operations.

Interest Rate Swaps. Spectrum Brands uses interest rate swaps to manage its interest rate risk. The swaps are designated as cash flow hedges with the changes in fair value recorded in Accumulated other comprehensive (loss) income (“AOCI”) and as a derivative hedge asset or liability, as applicable. The swaps settle periodically in arrears with the related amounts for the current settlement period payable to, or receivable from, the counterparties included in accrued liabilities or receivables, respectively, and recognized in earnings as an adjustment to interest expense from the underlying debt to which the swap is designated. As of December 31, 2016 and September 30, 2016, Spectrum Brands had a series of U.S. dollar denominated interest rate swaps outstanding which effectively fix the interest on floating rate debt, exclusive of lender spreads, at 1.36% for a notional principal amount of $300.0 through April 2017. The derivative net gain estimated to be reclassified from AOCI into earnings over the next 12 months is $0.2, net of tax. Spectrum Brands’ interest rate swap derivative financial instruments at December 31, 2016 and September 30, 2016 were as follows:



	December 31, 2016			September 30, 2016
	Notional		Remaining Years	Notional		Remaining Years
Interest rate swaps - fixed	$	300.0	0.3	$	300.0	0.5

Foreign exchange contracts - cash flow hedges. Spectrum Brands periodically enters into forward foreign exchange contracts to hedge a portion of the risk from forecasted foreign currency denominated third party and intercompany sales or payments. These obligations generally require Spectrum Brands to exchange foreign currencies for U.S. Dollars, Euros, Pounds Sterling, Australian Dollars, Canadian Dollars (“CAD”) or Japanese Yen. These foreign exchange contracts are cash flow hedges of fluctuating foreign exchange related to sales of product or raw material purchases. Until the sale or purchase is recognized, the fair value of the related hedge is recorded in AOCI and as a derivative hedge asset or liability, as applicable. At the time the sale or purchase is recognized, the fair value of the related hedge is reclassified as an adjustment to “Net consumer and other product sales” or “Cost of consumer products and other goods sold”, respectively, in the accompanying Condensed Consolidated Statements of Operations. At December 31, 2016, Spectrum Brands had a series of foreign exchange derivative contracts outstanding through December 2017. The derivative net gains estimated to be reclassified from AOCI into earnings over the next 12 months is $4.4, net of tax. At December 31, 2016 and September 30, 2016, Spectrum Brands had foreign exchange derivative contracts designated as cash flow hedges with a notional value of $259.9 and $224.8, respectively.

Commodity swaps - cash flow hedges. Spectrum Brands is exposed to risk from fluctuating prices for raw materials, specifically zinc and brass used in its manufacturing processes. Spectrum Brands hedges a portion of the risk associated with the purchase of these materials through the use of commodity swaps. The hedge contracts are designated as cash flow hedges with the fair value changes recorded in AOCI and as a hedge asset or liability, as applicable. The unrecognized changes in fair value of the hedge contracts are reclassified from AOCI into earnings when the hedged purchase of raw materials also affects earnings. The swaps effectively fix the floating price on a specified quantity of raw materials through a specified date. At December 31, 2016, Spectrum Brands had a series of zinc and brass swap contracts outstanding through December 2017. The derivative net gains estimated to be reclassified from AOCI into earnings over the next 12 months is $1.3, net of tax. Spectrum Brands had the following commodity swap contracts outstanding as of December 31, 2016 and September 30, 2016:



	December 31, 2016			September 30, 2016
	Notional	Contract Value		Notional	Contract Value
Zinc swap contracts (tons)	5.1	$	9.8	6.7	$	12.8
Brass swap contracts (tons)	1.0	3.8		1.0	4.0

Net Investment Hedge. On September 20, 2016, Spectrum Brands, Inc., a subsidiary of Spectrum Brands, issued €425.0 aggregate principal amount of 4.00% Notes at par value, due October 1, 2026 (“4.00% Notes”). Spectrum Brands’ 4.00% Notes are denominated in Euros and have been designated as a net investment hedge of the translation of Spectrum Brands’ net investments in Euro denominated subsidiaries at the time of issuance. As a result, the translation of the Euro denominated debt is recognized in AOCI with any ineffective portion recognized as foreign currency translation gains or losses in the accompanying Condensed Consolidated Statements of Operations when the aggregate principal exceeds the net investment in its Euro denominated subsidiaries. Net gains or losses from the net investment hedge are reclassified from AOCI into earnings upon a liquidation event or deconsolidation of Euro denominated subsidiaries. As of December 31, 2016, the hedge was fully effective and no ineffective portion was recognized in earnings.

Commodity Swaps - not designated as hedges for accounting purposes. Spectrum Brands periodically enters into commodity swap contracts to economically hedge the risk from fluctuating prices for raw materials, specifically the pass-through of market prices for silver used in manufacturing purchased watch batteries. Spectrum Brands hedges a portion of the risk associated with these materials through the use of commodity swaps. The commodity swap contracts are designated as economic hedges with the unrealized gain or loss recorded in earnings and as an asset or liability at each period end. The unrecognized changes in the fair value of the commodity swap contracts are adjusted through earnings when the realized gains or losses affect earnings upon settlement of the commodity swap contracts. The commodity swap contracts effectively fix the floating price on a specified quantity of silver through a specified date. At December 31, 2016, Spectrum Brands had a series of commodity swaps outstanding through September 2017. Spectrum Brands had the following commodity swaps outstanding as of December 31, 2016 and September 30, 2016:



	December 31, 2016			September 30, 2016
	Notional	Contract Value		Notional	Contract Value
Silver (troy oz.)	20.0	$	0.4	31.0	$	0.6

Foreign exchange contracts - not designated as hedges for accounting purposes- Spectrum Brands. Spectrum Brands periodically enters into forward and swap foreign exchange contracts to economically hedge a portion of the risk from third party and intercompany payments resulting from existing obligations. These obligations generally require Spectrum Brands to exchange foreign currencies for U.S. Dollars, CAD, Euros, Pounds Sterling, Taiwanese Dollars, Hong Kong Dollars or Australian Dollars. These foreign exchange contracts are fair value hedges of a related liability or asset recorded in the accompanying Condensed Consolidated Balance Sheets. The gain or loss on the derivative hedge contracts is recorded in earnings as an offset to the change in value of the related liability or asset at each period end. At December 31, 2016, Spectrum Brands had a series of forward exchange contracts outstanding through December 2017. At December 31, 2016 and September 30, 2016, Spectrum Brands had $206.3 and $131.4, respectively, of notional value for such foreign exchange derivative contracts outstanding.

Credit Risk

Spectrum Brands is exposed to the risk of default by the counterparties with which Spectrum Brands transacts and generally does not require collateral or other security to support financial instruments subject to credit risk. Spectrum Brands monitors counterparty credit risk on an individual basis by periodically assessing each counterparty’s credit rating exposure. The maximum loss due to credit risk equals the fair value of the gross asset derivatives that are concentrated with certain domestic and foreign financial institution counterparties. Spectrum Brands considers these exposures when measuring its credit reserve on its derivative assets, which was insignificant as of December 31, 2016 and September 30, 2016.

Spectrum Brands’ standard contracts do not contain credit risk related contingent features whereby Spectrum Brands would be required to post additional cash collateral as a result of a credit event. However, Spectrum Brands is typically required to post collateral in the normal course of business to offset its liability positions. As of December 31, 2016 and September 30, 2016, there was no cash collateral outstanding. In addition, as of December 31, 2016 and September 30, 2016, Spectrum Brands had no posted standby letters of credit related to such liability positions. The cash collateral is included in “Receivables, net” within the accompanying Condensed Consolidated Balance Sheets.

Front Street is exposed to credit risk in the event of non-performance by its counterparties on call options. Front Street seeks to reduce the risk associated with such agreements by purchasing such options from large, well-established financial institutions, but there can be no assurance that Front Street will not suffer losses in the event of counterparty non-performance. No collateral was posted by its counterparties; accordingly, at December 31, 2016, the maximum amount of loss due to credit risk that Front Street would incur if parties to the call options failed completely to perform according to the terms of the contracts was $8.3.

Earnings from FIA reinsurance are primarily generated from the excess of net investment income earned over the sum of interest credited to policyholders and the cost of hedging the risk on FIA policies, known as the net investment spread. With respect to FIAs, the cost of hedging the risk includes the expenses incurred to fund the annual index credits. Proceeds received upon expiration or early termination of call options purchased to fund annual index credits are recorded as part of the fair value changes associated with reinsurance contracts in the accompanying Condensed Consolidated Statements of Operations, and are largely offset by an expense for index credits earned on annuity contractholder fund balances.