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Risk Management and Use of Derivative Financial Instruments
 6 Months Ended
Jun. 30, 2014
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Risk Management and Use of Derivative Financial Instruments
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 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 assets and liabilities. 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 investments due to changes in interest rates or other market factors. In addition, we own investments in Europe 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. In addition to derivative instruments that we entered into on our own behalf, we may also be a party to derivative instruments that are embedded in other contracts, and we may own common stock warrants, granted to us by lessees when structuring lease transactions, which are considered to be derivative instruments. 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. For a derivative designated and that qualified as a net investment hedge, the effective portion of the change in the fair value and/or the net settlement of the derivative are reported in Other comprehensive loss as part of the cumulative foreign currency translation adjustment. Amounts are reclassified out of Other comprehensive (loss) income into earnings when the hedged investment is either sold or substantially liquidated. The ineffective portion of the change in fair value of any derivative is recognized directly in earnings.
 
The following table sets forth certain information regarding our derivative instruments for the years presented (in thousands):
Derivatives Designated
as Hedging Instruments
 
 
 
Asset Derivatives Fair Value at 
 
Liability Derivatives Fair Value at
 
Balance Sheet Location
 
June 30, 2014
 
December 31, 2013
 
June 30, 2014
 
December 31, 2013
Foreign currency forward contracts
 
Other assets, net
 
$
1,801

 
$
2,002

 
$
—

 
$
—

Interest rate swaps
 
Other assets, net
 
549

 
1,895

 
—

 
—

Foreign currency collars
 
Other assets, net
 
145

 
429

 
—

 
—

Foreign currency forward contracts
 
Accounts payable, accrued expenses and other liabilities
 
—

 
—

 
(11,818
)
 
(11,928
)
Interest rate swaps
 
Accounts payable, accrued expenses and other liabilities
 
—

 
—

 
(15,287
)
 
(12,911
)
Derivatives Not Designated
as Hedging Instruments
 
 
 


 


 


 


Embedded derivatives (a)
 
Accounts payable, accrued expenses and other liabilities
 
—

 
—

 
(599
)
 
(2,164
)
Embedded derivatives (b)
 
Other assets, net
 
2,295

 
2,314

 
—

 
—

Stock warrants (c)
 
Other assets, net
 
1,716

 
1,782

 
—

 
—

Foreign currency forward contract (d)
 
Other assets, net
 
1,402

 
1,521

 
—

 
—

Swaption (e)
 
Other assets, net
 
775

 
1,205

 
—

 
—

Total derivatives
 
 
 
$
8,683

 
$
11,148

 
$
(27,704
)
 
$
(27,003
)
 
___________
(a)
In connection with the ADC Arrangement with IDL Wheel Tenant, LLC, we agreed to fund a portion of the loan in the euro and we locked the euro to U.S. dollar exchange rate at $1.278 to the developer at the time of the transaction (Note 6). This component of the loan is deemed to be an embedded derivative that requires separate measurement.
(b)
In December 2013, there was an amendment to the loan commitment for the refinancing of Agrokor d.d., referred to as the Agrokor 4 portfolio, which provided for an effective net settlement provision.
(c)
As part of the purchase of an interest in Hellweg Die Profi-Baumärkte GmbH & Co. KG, or Hellweg 2, from our then affiliate, Corporate Property Associates 14 Incorporated, or CPA®:14, in May 2011, we acquired warrants from CPA®:14, which were granted by Hellweg 2 to CPA®:14. 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.
(d)
In connection with one of our investments located in Japan, we entered into a foreign currency forward contract that protects against fluctuations in foreign currency rates related to the Japanese yen, but it did not qualify for hedge accounting.
(e)
In connection with the non-recourse debt financing related to our Cuisine Solutions, Inc. investment, we executed a swap and purchased a swaption, which grants us the right to enter into a new swap with a predetermined fixed rate should there be an extension of the loan maturity date.

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 June 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 on the consolidated financial statements (in thousands):
 
 
Amount of Gain (Loss) Recognized in
Other Comprehensive Loss on Derivatives (Effective Portion)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Derivatives in Cash Flow Hedging Relationships 
 
2014
 
2013
 
2014
 
2013
Interest rate cap (a)
 
$
355

 
$
298

 
$
687

 
$
565

Interest rate swaps
 
(2,502
)
 
6,490

 
(4,421
)
 
8,457

Foreign currency collars
 
(83
)
 
(1,077
)
 
(199
)
 
(61
)
Foreign currency forward contracts
 
400

 
(1,770
)
 
(409
)
 
3,435

 
 
 
 
 
 
 
 
 
Derivatives in Net Investment Hedging Relationships (b)
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
257

 
(847
)
 
318

 
1,016

Total
 
$
(1,573
)
 
$
3,094

 
$
(4,024
)
 
$
13,412

 
 
 
Amount of Gain (Loss) Reclassified from
Other Comprehensive Loss into Income (Effective Portion)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Derivatives in Cash Flow Hedging Relationships 
 
2014
 
2013
 
2014
 
2013
Interest rate cap
 
$
(355
)
 
$
(298
)
 
$
(687
)
 
$
(565
)
Interest rate swaps
 
(2,217
)
 
(1,748
)
 
(3,932
)
 
(3,382
)
Foreign currency collars (c)
 
118

 
523

 
194

 
941

Foreign currency forward contracts (c)
 
89

 
83

 
(100
)
 
372

Total
 
$
(2,365
)
 
$
(1,440
)
 
$
(4,525
)
 
$
(2,634
)
 ___________
(a)
Includes gains attributable to noncontrolling interests of $0.2 million and $0.1 million for the three months ended June 30, 2014 and 2013, respectively, and $0.3 million for both the six months ended June 30, 2014 and 2013, respectively.
(b)
The effective portion of the change in fair value and the settlement of these contracts are reported in the foreign currency translation adjustment section of Other comprehensive (loss) income until the underlying investment is sold, at which time we reclassify the gain or loss to earnings.
(c)
Gains (losses) reclassified from Other comprehensive (loss) income into income (loss) for contracts and collars that have matured are included in Other income and (expenses) in the consolidated financial statements.

 
 
 
 
Amount of Gain (Loss) Recognized in
Income on Derivatives
Derivatives Not in Cash Flow 
Hedging Relationships
 
Location of Gain (Loss) Recognized in Income
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Embedded credit derivatives
 
Other income and (expenses)
 
$
163

 
$
(394
)
 
$
281

 
$
554

Foreign currency forward contracts
 
Other income and (expenses)
 
(56
)
 
199

 
(118
)
 
762

Stock warrants
 
Other income and (expenses)
 
(66
)
 
—

 
(66
)
 
165

Swaption
 
Other income and (expenses)
 
(172
)
 
179

 
(430
)
 
179

Interest rate swaps (a)
 
Interest expense
 
53

 
76

 
124

 
179

Total
 
 
 
$
(78
)
 
$
60

 
$
(209
)
 
$
1,839

___________
(a)
Relates to the ineffective portion of the hedging relationship.
 
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 Cap
 
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. An interest rate cap limits the effective borrowing rate of variable-rate debt obligations while allowing participants to share in downward shifts in interest rates. A swaption gives us the right but not the obligation to enter into an interest rate swap, of which the terms and conditions are set on the trade date, on a specified date in the future. Our objective in using these derivatives is to limit our exposure to interest rate movements.
 
The interest rate swaps, cap, and swaption that we had outstanding on our consolidated subsidiaries at June 30, 2014 are summarized as follows (currency in thousands):
Interest Rate Derivatives
 
Number of Instruments
 
Notional
Amount
 
Fair Value at
June 30, 2014 (a)
Interest rate cap (b)
 
1
 
$
113,842

 
$
—

Interest rate swaps
 
6
 
€
186,099

 
(9,575
)
Interest rate swaps
 
12
 
$
209,154

 
(5,163
)
Swaption
 
1
 
$
13,230

 
775

 
 
 
 
 

 
$
(13,963
)
____________
(a)
Fair value amount is based on the exchange rate of the euro at June 30, 2014, as applicable.
(b)
The applicable interest rate of the related debt was 2.7%, which was below the interest rate of the cap of 4.0% at June 30, 2014. The notional amount of $51.2 million attributable to the noncontrolling interest is included in this cap and there is no fair value.

The interest rate swap that one of our unconsolidated jointly-owned investments had outstanding at June 30, 2014 and was designated as cash flow hedge is summarized as follows (currency in thousands):
Interest Rate Derivative
 
 Ownership Interest in Investee at
June 30, 2014
 
Number of Instruments
 
Notional
Amount
 
Fair Value at
June 30, 2014 (a)
Interest rate swap
 
85%
 
1
 
€
12,001

 
$
(500
)
____________
(a)
Fair value amount is based on the exchange rate of the euro at June 30, 2014.

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 the Japanese yen. 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 and collars. 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. A foreign currency collar consists of a written call option and a purchased put option to sell the foreign currency. These instruments lock the range in which the foreign currency exchange rate may fluctuate.

The following table presents the foreign currency derivative contracts we had outstanding and their designations at June 30, 2014 (currency in thousands):
Foreign Currency Derivatives
 
Number of Instruments
 
Notional
Amount
 
Fair Value at
June 30, 2014 (a)
Designated as Cash Flow Hedging Instruments
 
 
 
 
 
 
Foreign currency collars
 
1
 
€
4,468

 
$
145

Foreign currency forward contracts
 
105
 
€
209,723

 
(9,573
)
Foreign currency forward contracts
 
14
 
¥
650,343

 
1,556

Designated as Net Investment Hedging Instruments
 
 
 
 
 
 
Foreign currency forward contracts
 
1
 
€
45,000

 
(2,000
)
Not Designated as Hedging Instruments
 
 
 
 
 
 
Foreign currency forward contracts
 
1
 
¥
610,129

 
1,402

 
 
 
 
 
 
$
(8,470
)
___________
(a)
Fair value amounts are based on the applicable exchange rate of the euro or the Japanese yen at June 30, 2014.
 
Other

Amounts reported in Other comprehensive income (loss) 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 income (loss) 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 June 30, 2014, we estimate that an additional $7.5 million, inclusive of amounts attributable to noncontrolling interests of $0.1 million, and $1.3 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 June 30, 2014. At June 30, 2014, our total credit exposure was $1.8 million, inclusive of noncontrolling interest, and the maximum exposure to any single counterparty was $1.3 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 June 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 $27.9 million and $25.1 million at June 30, 2014 and December 31, 2013, respectively, which included accrued interest and any adjustment for nonperformance risk. If we had breached any of these provisions at either June 30, 2014 or December 31, 2013, we could have been required to settle our obligations under these agreements at their aggregate termination value of $29.7 million and $27.1 million, respectively.
 
Portfolio Concentration Risk
 
Concentrations of credit risk arise when a number of tenants are engaged in similar business activities or have 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 contractual minimum annualized base rent for the second quarter of 2014, in certain areas. There were no significant changes to our portfolio concentrations at June 30, 2014 as compared to December 31, 2013.

Information about Geographic Areas

Our portfolio is comprised of domestic and international investments. At the end of the reporting period, our international investments were comprised of investments primarily in Europe and, to a lesser extent, Asia. With the exception of Italy, no other country comprised more than 10% of our total lease revenues or total long-lived assets at June 30, 2014. Foreign currency exposure and risk management are discussed above. The following tables present information about our investments on a geographic basis (in thousands):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Domestic
 
 
 
 
 
 
 
 
Revenues
$
68,920

 
$
63,988

 
$
139,978

 
$
125,851

 
Income from continuing operations before income taxes and after gain on sale of real estate, net of tax
34,241

 
11,862

 
42,842

 
23,721

 
Net income attributable to noncontrolling interests
(7,443
)
 
(7,695
)
 
(14,966
)
 
(14,818
)
 
Net income attributable to CPA®:17 – Global
26,296

 
2,594

 
26,588

 
7,389

Italy
 
 
 
 
 
 
 
 
Revenues
$
7,859

 
$
7,859

 
$
15,950

 
$
15,275

 
Income from continuing operations before income taxes and after gain on sale of real estate, net of tax
1,922

 
1,922

 
3,885

 
3,859

 
Net income attributable to noncontrolling interests
—

 
—

 
—

 
—

 
Net income attributable to CPA®:17 – Global
1,922

 
1,922

 
3,823

 
3,858

Other International
 
 
 
 
 
 
 
 
Revenues
$
22,007

 
$
17,144

 
$
44,008

 
$
34,591

 
Income from continuing operations before income taxes and after gain on sale of real estate, net of tax
10,462

 
7,442

 
16,898

 
16,344

 
Net income attributable to noncontrolling interests
(197
)
 
(237
)
 
(351
)
 
(401
)
 
Net income attributable to CPA®:17 – Global
8,103

 
8,287

 
14,536

 
16,380

Total
 
 
 
 
 
 
 
 
Revenues
$
98,786

 
$
88,991

 
$
199,936

 
$
175,717

 
Income from continuing operations before income taxes and after gain on sale of real estate, net of tax
46,625

 
21,226

 
63,625

 
43,924

 
Net income attributable to noncontrolling interests
(7,640
)
 
(7,932
)
 
(15,317
)
 
(15,219
)
 
Net income attributable to CPA®:17 – Global
36,321

 
12,803

 
44,947

 
27,627

 
 
June 30, 2014
 
December 31, 2013
Domestic
 
 
 
 
Long-lived assets (a)
$
2,405,834

 
$
2,195,465

 
Non-recourse debt
1,331,765

 
1,319,094

Italy
 
 
 
 
Long-lived assets (a)
$
337,303

 
$
343,876

 
Non-recourse debt
220,942

 
223,937

Other International
 
 
 
 
Long-lived assets (a)
$
897,886

 
$
1,022,754

 
Non-recourse debt
388,141

 
372,570

Total
 
 
 
 
Long-lived assets (a)
$
3,641,023

 
$
3,562,095

 
Non-recourse debt
1,940,848

 
1,915,601

___________
(a)
Consists of Net investments in real estate. 

For the six months ended June 30, 2014, the following tenants represent 5% or more of total lease revenues:
•
Metro Cash & Carry Italia S.p.A;
•
The New York Times Company; and
•
General Parts Inc., Golden State Supply LLC, Straus-Frank Enterprises LLC, General Parts Distribution LLC and Worldpac Inc.