Use of Derivative Financial Instruments

3 Months Ended

Mar. 31, 2013

Use of Derivative Financial Instruments

Use of Derivative Financial Instruments

6. Use of Derivative Financial Instruments

Risk Management Objective of Using Derivatives

The Company’s use of derivative instruments is limited to the utilization of interest rate swaps to manage interest rate risk exposures and not for speculative purposes. The principal objective of such arrangements is to minimize the risks and/or costs associated with the Company’s operating and financial structure, as well as to hedge specific transactions.

On March 1, 2013, the Company entered into an interest rate swap agreement for notional amount of $25.0 million with an effective date of March 1, 2013 that converts the one-month LIBOR rate on the $25.0 million outstanding balance of the $150.0 million Wells Fargo Unsecured Term Loan from a variable rate of one-month LIBOR plus a spread of 2.15% to 2.70% based on the Company’s consolidated leverage ratio to a fixed rate of 1.33% plus a spread of 2.15% to 2.70% based on the Company’s consolidated leverage ratio. This swap was designated as a cash flow hedge of interest rate risk.  The following table details the Company’s outstanding interest rate swaps as of March 31, 2013 (collectively, the “Unsecured Term Loan Swaps”) (in thousands).

Interest Rate Derivative	Trade Date	Notional Amount		Fixed Interest Rate		Variable Interest Rate	Maturity Date
Interest rate swap	Sept-14-2012	$	10,000	0.7945	%	One-month LIBOR	September 10, 2017
Interest rate swap	Sept-14-2012	$	10,000	0.7945	%	One-month LIBOR	September 10, 2017
Interest rate swap	Sept-14-2012	$	10,000	0.7945	%	One-month LIBOR	September 10, 2017
Interest rate swap	Sept-14-2012	$	10,000	0.7945	%	One-month LIBOR	September 10, 2017
Interest rate swap	Sept-14-2012	$	10,000	0.7975	%	One-month LIBOR	September 10, 2017
Interest rate swap	Sept-20-2012	$	25,000	0.7525	%	One-month LIBOR	September 10, 2017
Interest rate swap	Sept-24-2012	$	25,000	0.727	%	One-month LIBOR	September 10, 2017
Interest rate swap	March-1-2013	$	25,000	1.33	%	One-month LIBOR	February 14, 2020

The fair value of the interest rate swaps outstanding as of March 31, 2013 and December 31, 2012 was as follows (in thousands):

	Balance Sheet Location	Notional AmountMarch 31, 2013		Fair Value March 31, 2013			Notional Amount December 31, 2012		Fair Value December 31, 2012
Unsecured Term Loan Swaps	Interest Rate Swaps	$	125,000	$	(469	)	$	100,000	$	(480	)

Cash Flow Hedges of Interest Rate Risk

The Company’s objectives in using interest rate swaps are to add stability to interest expense and to manage its exposure to interest rate movements.  Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

The effective portion of changes in the fair value of derivatives designated and qualifies as cash flow hedges is recorded in accumulated other comprehensive loss and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. On September 14, 2012, the Company commenced a program of utilizing such designated derivatives to hedge the variable cash flows associated with certain variable-rate debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three months ended March 31, 2013, the Company did not record any hedge ineffectiveness related to the hedged derivatives.

Amounts reported in accumulated other comprehensive loss related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. The Company estimates that an additional $0.8 million will be reclassified from accumulated other comprehensive loss as an increase to interest expense over the next twelve months.

The table below details the location in the financial statements of the gain or loss recognized on interest rate swaps designated as cash flow hedges for the three months ended March 31, 2013 and March 31, 2012, respectively:

	Three months ended March 31, 2013		Three months ended March 31, 2012
Amount of loss recognized in accumulated other comprehensive loss on interest rate swaps (effective portion)	$	154	$	—
Amount of loss reclassified from accumulated other comprehensive loss into income (loss) as interest expense (effective portion)	$	165	$	—
Amount of loss recognized in income on swaps (ineffective portion and amount excluded from effectiveness testing)	$	—	$	—

The Company is exposed to credit risk in the event of non-performance by the counterparties to the interest rate swaps.  The Company minimizes this risk exposure by limiting counterparties to major banks and investment brokers who meet established credit and capital guidelines.

Credit-risk-related Contingent Features

As of March 31, 2013, the fair value of the interest rate swaps are in a net liability position of $0.4 million, which includes accrued interest, but excludes any adjustment for nonperformance risk related to these agreements. As of March 31, 2013, the Company has not posted any collateral related to these agreements.  The adjustment for nonperformance risk included in the fair value of the Company’s net liability position was $0.1 million as of March 31, 2013.  If the Company had breached any of its provisions at March 31, 2013, it could have been required to settle its obligations under the agreements at its termination value of $0.4 million.

Fair Value of Interest Rate Swaps

The valuation of the interest rate swaps is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market- based inputs including interest rate curves. The fair values of interest rate swaps are determined by using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. As of March 31, 2013 and December 31, 2012, the Company applied the provisions of this standard to the valuation of its interest rate swaps.

The following sets forth the Company’s financial instruments that are accounted for at fair value on a recurring basis as of March 31, 2013 and December 31, 2012 (in thousands):

				Fair Market Measurements as of March 31, 2013 Using:
	March 31, 2013			Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Unobservable Inputs (Level 3)
Liabilities:
Interest Rate Swaps	$	(469	)	$	—	$	(469	)	$	—

				Fair Market Measurements as of December 31, 2012 Using:
	December 31, 2012			Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Unobservable Inputs (Level 3)
Liabilities:
Interest Rate Swaps	$	(480	)	$	—	$	(480	)	$	—