DERIVATIVES AND HEDGING ACTIVITY (UNITED DOMINION REALTY, L.P.)

12 Months Ended

Dec. 31, 2018

13. DERIVATIVES AND HEDGING ACTIVITY

Risk Management Objective of Using Derivatives

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

Cash Flow Hedges of Interest Rate Risk

The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps and caps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate 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. Interest rate caps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium.

The changes in the fair value of derivatives designated and that qualify as cash flow hedges are recorded in Accumulated other comprehensive income/(loss), net on the Consolidated Balance Sheets and subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the years ended December 31, 2018, 2017, and 2016, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt.

During the year ended December 31, 2017, the Company recognized a loss of $0.1 million, reclassified from Accumulated other comprehensive income/(loss), net to Interest expense due to the de-designation of a cash flow hedge. No amounts were de-designated during the years ended December 31, 2018 and 2016.

Amounts reported in Accumulated other comprehensive income/(loss), net on the Consolidated Balance Sheets related to derivatives that will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. Through December 31, 2019, the Company estimates that an additional $3.9 million will be reclassified as a decrease to Interest expense.

As of December 31, 2018, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk (dollars in thousands):


	Number of
Product	Instruments	Notional
Interest rate swaps (a)	4	$	315,000
Interest rate caps	1	$	65,197

(a)

In addition to the interest rate swaps summarized above, the Company entered into an additional interest rate swap during the year ended December 31, 2018 with a notional value of $50.0 million that will become effective in December 2019.

The Company also entered into two additional interest rate swaps during the year ended December 31, 2018 with a notional value totaling $150.0 million that were terminated and settled in conjunction with the October 2018 issuance of $300.0 million of senior unsecured medium-term notes as disclosed in Note 6, Secured and Unsecured Debt, Net. The Company received $3.1 million to settle the swaps. The entire $3.1 million was initially deferred as a component of Accumulated other comprehensive income (loss), net and will be recognized as a decrease to Interest expense over the ten-year term of the notes.

Derivatives not designated as hedges are not speculative and are used to manage the Company’s exposure to interest rate movements and other identified risks but do not meet the strict hedge accounting requirements of GAAP. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in earnings and resulted in no gain or loss for year ended December 31, 2018 and a loss of less than $0.1 million for the years ended December 31, 2017, and 2016.

As of December 31, 2018, the Company had the following outstanding derivatives that were not designated as hedges in qualifying hedging relationships (dollars in thousands):


	Number of
Product	Instruments	Notional
Interest rate caps	1	$	19,880

Tabular Disclosure of Fair Values of Derivative Instruments on the Consolidated Balance Sheet

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Consolidated Balance Sheets as of December 31, 2018 and 2017 (dollars in thousands):


	Asset Derivatives				Liability Derivatives
	(included in Other assets)				(included in Other liabilities)
	Fair Value at:				Fair Value at:
	December 31,		December 31,		December 31,		December 31,
	2018		2017		2018		2017
Derivatives designated as hedging instruments:
Interest rate products	$	4,757	$	5,743	$	356	$	—

Tabular Disclosure of the Effect of Derivative Instruments on the Consolidated Statements of Operations

The tables below present the effect of the Company’s derivative financial instruments on the Consolidated Statements of Operations for the years ended December 31, 2018, 2017, and 2016 (dollars in thousands):


													Gain/(Loss) Recognized in
							Gain/(Loss) Reclassified						Interest expense
	Unrealized holding gain/(loss)						from Accumulated OCI into						(Amount Excluded from
	Recognized in OCI						Interest expense						Effectiveness Testing)
	Year Ended December 31,						Year Ended December 31,						Year Ended December 31,
Derivatives in Cash Flow Hedging Relationships	2018		2017		2016		2018		2017		2016		2018		2017		2016
Interest rate products	$	4,806	$	1,802	$	3,514	$	1,948	$	(1,271)	$	(3,657)	$	—	$	(136)	$	—


	Year Ended
	December 31,
	2018		2017		2018
Total amount of Interest expense presented on the Consolidated Statements of Operations	$	134,168	$	128,711	$	123,031


	Gain/(Loss) Recognized in
	Interest income and other income/(expense), net
	Year Ended December 31,
Derivatives Not Designated as Hedging Instruments	2018		2017		2016
Interest rate products	$	—	$	(1)	(3)

Credit-risk-related Contingent Features

The Company has agreements with its derivative counterparties that contain a provision where the Company could be declared in default on its derivative obligations if repayment of the underlying indebtedness is accelerated by the lender due to the Company’s default on the indebtedness.

The Company has certain agreements with some of its derivative counterparties that contain a provision where, in the event of default by the Company or the counterparty, the right of setoff may be exercised. Any amount payable to one party by the other party may be reduced by its setoff against any amounts payable by the other party. Events that give rise to default by either party may include, but are not limited to, the failure to pay or deliver payment under the derivative agreement, the failure to comply with or perform under the derivative agreement, bankruptcy, a merger without assumption of the derivative agreement, or in a merger, a surviving entity’s creditworthiness is materially weaker than the original party to the derivative agreement.

As of December 31, 2018, the fair value of derivatives was in a net asset position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements, of $4.7 million.

Tabular Disclosure of Offsetting Derivatives

The Company has elected not to offset derivative positions on the consolidated financial statements. The tables below present the effect on its financial position had the Company made the election to offset its derivative positions as of December 31, 2018 and 2017 (dollars in thousands):


			Gross		Net Amounts of		Gross Amounts Not Offset
			Amounts		Assets		in the Consolidated
	Gross		Offset in the		Presented in the		Balance Sheet
	Amounts of		Consolidated		Consolidated				Cash
	Recognized		Balance		Balance Sheets		Financial		Collateral
Offsetting of Derivative Assets	Assets		Sheets		(a)		Instruments		Received		Net Amount
December 31, 2018	$	4,757	$	—	$	4,757	$	—	$	—	$	4,757

December 31, 2017	$	5,743	$	—	$	5,743	$	—	$	—	$	5,743

(a)

Amounts reconcile to the aggregate fair value of derivative assets in the “Tabular Disclosure of Fair Values of Derivative Instruments on the Consolidated Balance Sheets” located in this footnote.


			Gross		Net Amounts of		Gross Amounts Not Offset
			Amounts		Liabilities		in the Consolidated
	Gross		Offset in the		Presented in the		Balance Sheet
	Amounts of		Consolidated		Consolidated				Cash
	Recognized		Balance		Balance Sheets		Financial		Collateral
Offsetting of Derivative Liabilities	Liabilities		Sheets		(a)		Instruments		Posted		Net Amount
December 31, 2018	$	356	$	—	$	356	$	—	$	—	$	356

December 31, 2017	$	—	$	—	$	—	$	—	$	—	$	—

(a)

Amounts reconcile to the aggregate fair value of derivative liabilities in the “Tabular Disclosure of Fair Values of Derivative Instruments on the Consolidated Balance Sheets” located in this footnote.

United Dominion Reality L.P.

Entity information

DERIVATIVES AND HEDGING ACTIVITY

8. DERIVATIVES AND HEDGING ACTIVITY

Risk Management Objective of Using Derivatives

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

Cash Flow Hedges of Interest Rate Risk

The General Partner’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the General Partner primarily uses interest rate swaps and caps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the General Partner making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. Interest rate caps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium.

A portion of the General Partner’s interest rate derivatives are owed by the Operating Partnership based on the General Partner’s underlying debt instruments owed by the Operating Partnership. (See Note 5, Debt, Net.)

The changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in Accumulated other comprehensive income/(loss), net on the Consolidated Balance Sheets and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the years ended December 31, 2017 and 2016, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt. As of and during the year ended December 31, 2018, no derivatives designated as cash flow hedges were held by the Operating Partnership.

During the year ended December 31, 2017, the Operating Partnership recognized a loss of $0.1 million reclassified from Accumulated other comprehensive income/(loss), net to Interest expense due to the de-designation of a cash flow hedge. No amounts were de-designated during the years ended December 31, 2018 and 2016.

Amounts reported in Accumulated other comprehensive income/(loss), net related to derivatives will be reclassified to interest expense as interest payments are made on the General Partner’s variable-rate debt that is owed by the Operating Partnership. As of December 31, 2018, no derivatives designated as cash flow hedges were held by the Operating Partnership and, as a result, no amounts are anticipated to be reclassified as an increase to interest expense through December 31, 2019.

Derivatives not designated as hedges are not speculative and are used to manage the Operating Partnership’s exposure to interest rate movements and other identified risks but do not meet the strict hedge accounting requirements of GAAP. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in earnings and resulted no gain or loss for the year ended December 31, 2018 and a loss of less than $0.1 million for each of the years ended December 31, 2017 and 2016.

As of December 31, 2018, we had the following outstanding derivatives that were not designated as hedges in qualifying hedging relationships (dollars in thousands):


	Number of
Product	Instruments	Notional
Interest rate caps	1	$	19,880

Tabular Disclosure of Fair Values of Derivative Instruments on the Consolidated Balance Sheets

As of December 31, 2018 and December 31, 2017, the fair value of the Operating Partnership’s derivative financial instruments was zero.

Tabular Disclosure of the Effect of Derivative Instruments on the Consolidated Statements of Operations

The tables below present the effect of the derivative financial instruments on the Consolidated Statements of Operations for the years ended December 31, 2018, 2017, and 2016 (dollars in thousands):


													Gain/(Loss) Recognized in
							Gain/(Loss) Reclassified						Interest expense
	Unrealized holding gain/(loss)						from Accumulated OCI into						(Amount Excluded from
	Recognized in OCI						Interest expense						Effectiveness Testing)
Derivatives in Cash Flow Hedging Relationships	2018		2017		2016		2018		2017		2016		2018		2017		2016
Interest rate products	$	—	$	—	$	(4)	$	—	$	—	$	(12)	$	—	$	(106)	$	—


	Year Ended
	December 31,
	2018		2017		2016
Total amount of Interest expense presented on the Consolidated Statements of Operations	$	8,733	$	18,156		17,855


	Gain/(Loss) Recognized in
	Interest income and other
	income/(expense), net
Derivatives Not Designated as Hedging Instruments	2018		2017		2016
Interest rate products	$	—	$	(1)	$	(3)

Credit-risk-related Contingent Features

The General Partner has agreements with its derivative counterparties that contain a provision where the General Partner could be declared in default on its derivative obligations if repayment of the underlying indebtedness is accelerated by the lender due to the General Partner’s default on the indebtedness.

The General Partner has certain agreements with some of its derivative counterparties that contain a provision where, in the event of default by the General Partner or the counterparty, the right of setoff may be exercised. Any amount payable to one party by the other party may be reduced by its setoff against any amounts payable by the other party. Events that give rise to default by either party may include, but are not limited to, the failure to pay or deliver payment under the derivative agreement, the failure to comply with or perform under the derivative agreement, bankruptcy, a merger without assumption of the derivative agreement, or in a merger, a surviving entity’s creditworthiness is materially weaker than the original party to the derivative agreement.