Interest Rate Contracts

3 Months Ended

Mar. 31, 2014

Interest Rate Contracts

8. Interest Rate Contracts

Risk Management Objective of Using Derivatives

We are exposed to certain risk arising from both our business operations and economic conditions.  We principally manage our exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of our debt funding and the use of derivative financial instruments.  Specifically, we enter into derivative financial instruments to manage exposures that arise from business activities that result in the payment of future known and uncertain cash amounts, the value of which are determined by interest rates.  Our derivative financial instruments are used to manage differences in the amount, timing, and duration of our known or expected cash payments principally related to our borrowings.  

Derivative Instruments

Our objectives in using interest rate derivatives are to add stability to interest expense and to manage exposure to interest rate movements. To accomplish this objective, we primarily use interest rate swaps as part of our interest rate risk management strategy.  Interest rate swaps involve the receipt of variable amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. We do not use derivatives for trading or speculative purposes.  

The accounting for changes in fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship.  Derivatives that are not designated as hedges must be adjusted to fair value through earnings. For a derivative that is designated and that qualifies as a cash flow hedge, the effective portion of the change in fair value of the derivative is initially recorded in accumulated other comprehensive income (“AOCI”).  Amounts recorded in AOCI are subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings.  The ineffective portion of a derivative’s change in fair value is immediately recognized in earnings.

On February 4, 2014, we executed two forward interest rate swaps to hedge the variable cash flows associated with our existing $60.0 million variable-rate term loan. Each of the two swaps has a notional value of $30.0 million, which will be in effect beginning in 2015. The first forward swap will effectively fix $30.0 million of debt at 3.726% annually from the period from January 15, 2015 to February 15, 2019. The second forward swap will effectively fix the other $30.0 million of debt at 3.91% annually from the period from July 15, 2015 to February 15, 2019.

Prior to our IPO, our predecessor was party to an interest rate swap that was not designated as a hedge, and as such, the changes in its fair value were recognized in earnings.  This interest rate swap reached its natural termination on March 15, 2013.  As of March 31, 2014 and December 31, 2013, we do not have any derivatives that are not designated as hedges.

The following table is a summary of our derivative instruments and their fair value, which is included in the line item “Other assets” on the accompanying consolidated balance sheets.  

						Fair Value(1)				Notional Amount in Effect as of
Derivative Instrument	Effective Date	Maturity Date	Interest Strike Rate			March 31, 2014		December 31, 2013		March 31, 2014		December 31, 2013
Designated as hedging instruments:
Interest Rate Swap	1/15/2015	2/15/2019		1.826	%		146,000		-		-		-
Interest Rate Swap	7/15/2015	2/15/2019		2.010	%		154,000		-		-		-
							300,000		-		-		-

(1) We record all derivative instruments on a gross basis in the consolidated balance sheets, and accordingly, there are no offsetting amounts that net assets against liabilities. All of our derivatives were in an asset position as end of the period noted above.

The following table presents the impact of our derivative instruments on our consolidated and combined statement of operations for the periods presented:

	For the Three Months Ended March  31,
	2014		2013
Interest Rate Swaps in Cash Flow Hedging Relationships:
Amount of gain recognized in AOCI on derivatives (effective portion)		300,000		-
Amount of gain (loss) reclassified from AOCI into earnings under "Interest expense" (effective portion)		-		-
Amount of gain (loss) recognized in earnings under "Interest expense" (ineffective portion and amount excluded from effectiveness testing)		-		-
Interest Rate Swaps Not in Cash Flow Hedging Relationships:
Amount of realized and unrealized gain recognized in earnings under "Gain on mark-to-market of interest rate swaps"		-		49,000

Amounts reported in AOCI related to derivatives will be reclassified to interest expense as interest payments and accruals are made on our variable-rate debt. During the next twelve months, we estimate that an additional $98,000 will be reclassified as an increase to interest expense.

Credit-risk-related Contingent Features

We have agreements with each of our derivative counterparties that contain a provision where if we default on any of our indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender within a specified time period, then we could also be declared in default on its derivative obligations.

 Certain of our agreements with our derivative counterparties contain provisions where if a merger or acquisition occurs that materially changes our creditworthiness in an adverse manner, we may be required to fully collateralize our obligations under the derivative instrument.

As of March 31, 2014, we did not have any derivatives that were in a net liability position, and therefore the provisions described above do not apply.