Risk Management and Use of Derivative Financial Instruments | 9 Months Ended |
Sep. 30, 2013 |
Risk Management and Use of Deriviative Financial Instruments | ' |
Derivative Instruments And Hedging Activities Disclosure | ' |
Note 9. Risk Management and Use of Derivative Financial Instruments |
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Risk Management |
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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 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. |
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Use of Derivative Financial Instruments |
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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. |
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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 income (loss) until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value is immediately 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 income (loss) as part of the cumulative foreign currency translation adjustment. The ineffective portion of the change in fair value of the derivative is recognized directly in earnings. Amounts are reclassified out of Other comprehensive income (loss) into earnings when the hedged investment is either sold or substantially liquidated. |
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The following table sets forth certain information regarding our derivative instruments (in thousands): |
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| | | | Asset Derivatives Fair Value at | | Liability Derivatives Fair Value at | | |
| | Balance Sheet Location | | September 30, 2013 | | 31-Dec-12 | | September 30, 2013 | | 31-Dec-12 | | |
Derivatives Designated | | | | | | | | | | | | | | | | |
as Hedging Instruments | | | | | | | | | | | | | | | | |
Foreign currency forwards | | Other assets, net | | $ | 1,524 | | $ | 4,229 | | $ | - | | $ | - | | |
Foreign currency collars | | Other assets, net | | | 1,041 | | | 2,743 | | | - | | | - | | |
Interest rate cap | | Other assets, net | | | - | | | 1 | | | - | | | - | | |
Interest rate swap | | Other assets, net | | | 962 | | | - | | | - | | | - | | |
Foreign currency forwards | | Accounts payable, | | | | | | | | | | | | | | |
| | accrued expenses and | | | | | | | | | | | | | | |
| | other liabilities | | | - | | | - | | | -6,977 | | | -2,533 | | |
Interest rate swaps | | Accounts payable, | | | | | | | | | | | | | | |
| | accrued expenses and | | | | | | | | | | | | | | |
| | other liabilities | | | - | | | - | | | -14,288 | | | -20,142 | | |
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Derivatives Not Designated | | | | | | | | | | | | | | | | |
as Hedging Instruments | | | | | | | | | | | | | | | | |
Embedded derivatives (a) | | Accounts payable, | | | | | | | | | | | | | | |
| | accrued expenses and | | | | | | | | | | | | | | |
| | other liabilities | | | - | | | - | | | -1,629 | | | -1,141 | | |
Stock warrants (b) | | Other assets, net | | | 1,716 | | | 1,485 | | | - | | | - | | |
Foreign currency forward | | Other assets, net | | | 1,076 | | | - | | | - | | | - | | |
Swaption (c) | | Other assets, net | | | 1,015 | | | - | | | - | | | - | | |
Put options | | Accounts payable, | | | | | | | | | | | | | | |
| | accrued expenses and | | | | | | | | | | | | | | |
Total derivatives | | | | $ | 7,334 | | $ | 8,458 | | $ | -22,894 | | $ | -23,816 | | |
__________ |
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In connection with an ADC Arrangement with IDL Wheel Tenant, LLC, we agreed to fund a portion of the loan in euros and we locked the euro to U.S. dollar exchange rate at $1.278 with the developer at the time of the transaction (Note 6). This component of the loan is deemed to be an embedded derivative. |
As part of our purchase of an interest in Hellweg Die Profi-Baumärkte GmbH & Co. KG (“Hellweg 2”) from Corporate Property Associates 14 Incorporated (“CPA®:14”), an affiliate at that time, 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 such a liquidity event occur. |
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. |
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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 the balance sheet. At September 30, 2013, no cash collateral had been posted nor received for any of our derivative positions. |
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The following tables present the impact of our derivative instruments on the consolidated financial statements (in thousands): |
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| | Amount of Gain (Loss) Recognized in | | | | |
| | Other Comprehensive Income (Loss) on Derivatives (Effective Portion) | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, | | | | |
Derivatives in Cash Flow Hedging Relationships | | 2013 | | 2012 | | 2013 | | 2012 | | | | |
Interest rate swaps | | $ | -744 | | $ | -3,780 | | $ | 7,712 | | $ | -10,109 | | | | |
Foreign currency forward contracts | | | -7,449 | | | -1,777 | | | -4,012 | | | -268 | | | | |
Interest rate cap (a) | | | 315 | | | 242 | | | 880 | | | 576 | | | | |
Foreign currency collars | | | -1,410 | | | -1,119 | | | -1,471 | | | -1,326 | | | | |
Put options | | | - | | | - | | | - | | | 192 | | | | |
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Derivatives in Net Investment Hedging Relationships (b) | | | | | | | | | | | | | | | | |
Foreign currency forward contracts | | | -934 | | | -769 | | | 82 | | | 816 | | | | |
Total | | $ | -10,222 | | $ | -7,203 | | $ | 3,191 | | $ | -10,119 | | | | |
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| | Amount of Gain (Loss) Reclassified from | | | | |
| | Other Comprehensive Income (Loss) into Income (Effective Portion) | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, | | | | |
Derivatives in Cash Flow Hedging Relationships | | 2013 | | 2012 | | 2013 | | 2012 | | | | |
Foreign currency collars(c) | | $ | -188 | | $ | -273 | | $ | -1,129 | | $ | -1,719 | | | | |
Foreign currency forward contracts(c) | | | -353 | | | -228 | | | -724 | | | -366 | | | | |
Interest rate cap | | | 316 | | | 247 | | | 881 | | | 653 | | | | |
Interest rate swaps | | | 1,595 | | | 1,164 | | | 4,501 | | | 2,532 | | | | |
Total | | $ | 1,370 | | $ | 910 | | $ | 3,529 | | $ | 1,100 | | | | |
__________ |
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Includes gains attributable to noncontrolling interests of $0.1 million for both the three months ended September 30, 2013 and 2012 and $0.4 million and $0.3 million for the nine months ended September 30, 2013 and 2012, respectively. |
The effective portion of the change in fair value and the settlement of these contracts is reported in the foreign currency translation adjustment section of Other comprehensive income (loss) until the underlying investment is sold, at which time we reclassify the gain or loss to earnings. |
Gains (losses) reclassified from Other comprehensive income (loss) into income (loss) for contracts and collars that have matured are included in Other income and (expenses). |
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| | | | Amount of Gain (Loss) Recognized in Income on Derivatives | | |
Derivatives Not in Cash Flow | | Location of Gain (Loss) | | Three Months Ended September 30, | | Nine Months Ended September 30, | | |
Hedging Relationships | | Recognized in Income | | 2013 | | 2012 | | 2013 | | 2012 | | |
Foreign currency forward contracts | | Other income and (expenses) | | $ | 59 | | $ | - | | $ | 822 | | $ | - | | |
Swaption | | Other income and (expenses) | | | 58 | | | - | | | 237 | | | - | | |
Interest rate swaps (a) | | Interest expense | | | -50 | | | -18 | | | 154 | | | 5 | | |
Put options | | Other income and (expenses) | | | - | | | - | | | - | | | -2 | | |
Stock warrants | | Other income and (expenses) | | | 66 | | | -66 | | | 231 | | | -66 | | |
Embedded derivatives | | Other income and (expenses) | | | -1,093 | | | - | | | -540 | | | - | | |
Total | | | | $ | -960 | | $ | -84 | | $ | 904 | | $ | -63 | | |
___________ |
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Relates to the ineffective portion of the hedging relationship. |
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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. |
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Interest Rate Swaps, Cap, and Swaption |
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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 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. |
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The interest rate swaps, cap, and swaption that we had outstanding on our consolidated subsidiaries at September 30, 2013 are summarized as follows (currency in thousands): |
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| | | | Notional | | Contractual | | Effective | | Expiration | | Fair Value at | | |
Description | | Type | | Amount | | Interest Rate | | Date | | Date | | September 30, 2013 (a) | | |
Designated as Cash Flow Hedging Instruments | | | | | | | | | | | | | | |
6-Month Euro Interbank Offered Rate (“Euribor”) | | “Pay-fixed” swap | | € | 164,250 | | 4.20% | | Sep-11 | | Sep-16 | | $ | -8,289 | | |
3-Month Euribor | | “Pay-fixed” swap | | € | 9,828 | | 4.40% | | Feb-13 | | Feb-18 | | | -134 | | |
3-Month Euribor | | “Pay-fixed” swap | | € | 5,753 | | 5.80% | | Jul-10 | | Nov-17 | | | -503 | | |
3-Month Euribor | | “Pay-fixed” swap | | € | 3,803 | | 6.50% | | Jun-12 | | May-17 | | | -120 | | |
3-Month Euribor | | “Pay-fixed” swap | | € | 2,922 | | 4.20% | | Apr-13 | | Apr-18 | | | -5 | | |
3-Month LIBOR (b) | | Interest rate cap | | $ | 116,581 | | N/A | | Aug-09 | | Aug-14 | | | - | | |
1-Month LIBOR | | “Pay-fixed” swap | | $ | 92,400 | | 3.90% | | Feb-12 | | Feb-17 | | | -1,532 | | |
3-Month LIBOR | | “Pay-fixed” swap | | $ | 25,482 | | 5.70% | | Jan-10 | | Dec-19 | | | -2,567 | | |
1-Month LIBOR | | “Pay-fixed” swap | | $ | 22,841 | | 5.70% | | Dec-19 | | Jan-24 | | | -29 | | |
1-Month LIBOR | | “Pay-fixed” swap | | $ | 19,673 | | 4.80% | | Dec-12 | | Dec-22 | | | 688 | | |
1-Month LIBOR | | “Pay-fixed” swap | | $ | 14,880 | | 4.30% | | Apr-13 | | Apr-18 | | | -510 | | |
1-Month LIBOR | | “Pay-fixed” swap | | $ | 12,374 | | 4.80% | | Jul-13 | | Jan-24 | | | -265 | | |
1-Month LIBOR | | “Pay-fixed” swap | | $ | 8,886 | | 5.00% | | Mar-12 | | Mar-22 | | | 31 | | |
1-Month LIBOR | | “Pay-fixed” swap | | $ | 4,368 | | 4.60% | | Jun-12 | | Jul-22 | | | 114 | | |
1-Month LIBOR | | “Pay-fixed” swap | | $ | 4,225 | | 4.80% | | Oct-12 | | Nov-22 | | | 129 | | |
1-Month LIBOR | | “Pay-fixed” swap | | $ | 4,049 | | 6.00% | | Jan-11 | | Jan-21 | | | -333 | | |
1-Month LIBOR | | “Pay-fixed” swap | | $ | 1,572 | | 4.80% | | Dec-11 | | Dec-21 | | | -1 | | |
Not Designated as a Hedging Instrument | | | | | | | | | | | | | | | | |
1-Month LIBOR | | Swaption | | $ | 13,230 | | N/A | | Apr-18 | | Apr-23 | | | 1,015 | | |
| | | | | | | | | | | | | $ | -12,311 | | |
__________ |
(a) Amounts are based on the exchange rate of the euro at September 30, 2013, as applicable. |
(b) The applicable interest rate of the related debt was 2.8%, which was below the strike price of the cap of 4.0% at September 30, 2013. The notional amount and fair value of $52.5 million and less than $0.1 million, respectively, attributable to noncontrolling interests is included in this swap. |
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The interest rate swap that one of our unconsolidated jointly-owned investments had outstanding at September 30, 2013 and was designated as cash flow hedge is summarized as follows (currency in thousands): |
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| | Ownership | | | | | | | | | | | | | | |
| | Interest in Investee | | | | Notional | | Contractual | | Effective | | Expiration | | Fair Value at |
Description | | at September 30, 2013 | | Type | | Amount | | Interest Rate | | Date | | Date | | September 30, 2013 |
3-Month Euribor (a) | | 85.00% | | “Pay-fixed” swap | | € | 14,648 | | 1.20% | | Mar-13 | | Mar-20 | | $ | 16 |
__________ |
(a) Amounts are based on the exchange rate of the euro at September 30, 2013, as applicable. |
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Foreign Currency Contracts |
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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. |
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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. |
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The following table presents the foreign currency derivative contracts we had outstanding and their designations at September 30, 2013 (currency in thousands, except strike price): |
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| | Notional | | Strike | | Effective | | Expiration | | Fair Value at | | | |
Type | | Amount | | Price | | Date | | Date | | September 30, 2013 | | | |
Designated as Cash Flow Hedging Instruments | | | | | | | | | | | | | | | | |
Collars | | € | 20,444 | | $ | 1.40 - 1.42 | | Sep-11 | | 12/2013 - 9/2014 | | $ | 1,041 | | | |
Forward contracts | | € | 56,700 | | | 1.28 - 1.29 | | May-12 | | 12/2014 - 6/2017 | | | -3,967 | | | |
Forward contracts | | € | 18,500 | | | 1.34 - 1.35 | | Sep-11 | | 3/2014 - 3/2015 | | | -210 | | | |
Forward contracts | | € | 17,100 | | | 1.34 | | Dec-12 | | 9/2017 - 3/2018 | | | -610 | | | |
Forward contracts | | € | 12,000 | | | 1.38 | | Aug-13 | | 12/2018 - 3/2019 | | | -231 | | | |
Forward contracts | | € | 11,800 | | | 1.41 | | Sep-13 | | 6/2019 - 9/2019 | | | -51 | | | |
Forward contracts | | € | 11,400 | | | 1.35 | | Jun-13 | | 6/2018 - 9/2018 | | | -423 | | | |
Forward contracts | | € | 11,342 | | | 1.34 | | Jan-13 | | 9/2015 - 3/2016 | | | -184 | | | |
Forward contracts | | ¥ | 776,666 | | | .0122 - .0128 | | Dec-12 | | 12/2013 - 12/2017 | | | 1,524 | | | |
Designated as Net Investment Hedging Instruments | | | | | | | | | | | | | | | | |
Forward contracts | | € | 45,000 | | | 1.33 | | Jul-13 | | Jul-15 | | | -1,301 | | | |
Not Designated as a Hedging Instrument | | | | | | | | | | | | | | | | |
Forward contracts | | ¥ | 610,129 | | | 0.0128 | | Dec-12 | | Dec-17 | | | 1,076 | | | |
| | | | | | | | | | | | $ | -3,336 | | | |
Other |
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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 September 30, 2013, we estimate that an additional $7.1 million, inclusive of amounts attributable to noncontrolling interests of $0.6 million, and $1.1 million will be reclassified as interest expense and other income, respectively, during the next 12 months. |
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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 September 30, 2013. At September 30, 2013, our total credit exposure was $2.7 million, inclusive of noncontrolling interest, and the maximum exposure to any single counterparty was $1.9 million. |
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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 September 30, 2013, 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 $22.5 million and $23.0 million at September 30, 2013 and December 31, 2012, respectively, which included accrued interest and any adjustment for nonperformance risk. If we had breached any of these provisions at either September 30, 2013 or December 31, 2012, we could have been required to settle our obligations under these agreements at their aggregate termination value of $24.1 million or $25.1 million, respectively. |
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Portfolio Concentration Risk |
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Concentrations of credit risk arise when a group of tenants is engaged in similar business activities or is subject to 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 annualized contractual minimum base rent for the third quarter of 2013, in certain areas. There were no significant changes to our portfolio concentrations at September 30, 2013 as compared to December 31, 2012. |
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