Note 8 – Derivative Instruments and Hedging Activity

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 risk, including interest rate, liquidity and credit risk primarily by managing the amount, sources and duration of its debt funding and, to a limited extent, the use of derivative instruments. For additional information regarding the leveling of our derivatives, (refer to Note 10 – Fair Value Measurements.)

The Company’s objective in using interest rate derivatives is to manage its exposure to interest rate movements and add stability to interest expense. To accomplish this objective, the Company uses interest rate swaps 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 agreement without exchange of the underlying notional amount.

In April 2012, the Company entered into an amortizing forward-starting interest rate swap agreement to hedge against changes in future cash flows resulting from changes in interest rates on $22.3 million in variable-rate borrowings. Under the terms of the interest rate swap agreement, the Company receives from the counterparty interest on the notional amount based on 1 month LIBOR and pays to the counterparty a fixed rate of 1.92%. The notional amount as of December 31, 2018 is $18.5 million. This swap effectively converts $22.3 million of variable-rate borrowings to fixed-rate borrowings from July 1, 2013 to May 1, 2019. As of December 31, 2018, this interest rate swap was valued as an asset of approximately $0.0 million.

In September 2013, the Company entered into an interest rate swap agreement to hedge against changes in future cash flows resulting from changes in interest rates on $35.0 million in variable-rate borrowings. Under the terms of the interest rate swap agreement, the Company receives from the counterparty interest on the notional amount based on 1 month LIBOR and pays to the counterparty a fixed rate of 2.20%. This swap effectively converts $35.0 million of variable-rate borrowings to fixed-rate borrowings from October 3, 2013 to September 29, 2020. As of December 31, 2018, this interest rate swap was valued as an asset of approximately $0.2 million.

In July 2014, the Company entered into interest rate swap agreements to hedge against changes in future cash flows resulting from changes in interest rates on $65.0 million in variable-rate borrowings. Under the terms of the interest rate swap agreement, the Company receives from the counterparty interest on the notional amount based on 1 month LIBOR and pays to the counterparty a fixed rate of 2.09%. This swap effectively converts $65.0 million of variable-rate borrowings to fixed-rate borrowings from July 21, 2014 to July 21, 2021. As of December 31, 2018, this interest rate swap was valued as an asset of approximately $0.6 million.

In September 2016, the Company entered into an interest rate swap agreement to hedge against changes in future cash flows resulting from changes in interest rates on $40.0 million in variable-rate borrowings. Under the terms of the interest rate swap agreement, the Company receives from the counterparty interest on the notional amount based on 1 month LIBOR and pays to the counterparty a fixed rate of 1.40%. This swap effectively converts $40.0 million of variable-rate borrowings to fixed-rate borrowings from August 1, 2016 to July 1, 2023. As of December 31, 2018, this interest rate swap was valued as an asset of approximately $1.8 million.

In December 2018, the Company entered into interest rate swap agreements to hedge against changes in future cash flows resulting from changes in interest rates on $100.0 million in variable-rate borrowings. Under the terms of the interest rate swap agreements, the Company receives from the counterparty interest on the notional amount based on 1 month LIBOR and pays to the counterparty a fixed rate of 2.66%. This swap effectively converts $100.0 million of variable-rate borrowings to fixed-rate borrowings from December 27, 2018 to January 15, 2026. As of December 31, 2018, this interest rate swap was valued as a liability of approximately $1.1 million.

Companies are required to recognize all derivative instruments as either assets or liabilities at fair value on the balance sheet. The Company has designated these derivative instruments as cash flow hedges. As such, the effective portion of changes in the fair value of the derivatives designated, and that qualify as cash flow hedges, is recorded as a component of Other Comprehensive Income (Loss). The ineffective portion of the change in fair value of the derivative instrument is recognized directly in interest expense. For the years ended December 31, 2018 and 2017, the Company has not recorded any hedge ineffectiveness in earnings. Amounts in Accumulated Other Comprehensive Income (Loss) related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. During the next twelve months, the Company estimates that an additional $0.8 million will be reclassified as a reduction to interest expense.

The Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk (in thousands, except number of instruments):


	Number of Instruments		Notional
	December 31,	December 31,	December 31,		December 31,
Interest Rate Derivatives	2018	2017	2018		2017
Interest Rate Swap	10	11	$	258,543	$	184,304

The table below presents the estimated fair value of the Company’s derivative financial instruments as well as their classification in the consolidated balance sheets (in thousands).

The table below presents the effect of the Company’s derivative financial instruments in the consolidated statements of operations and other comprehensive loss for the years ended December 31, 2018 and 2017 (in thousands).


						Location of
						Income/(Loss)
Derivatives in						Reclassified from
Cash Flow						Accumulated OCI	Amount of Income/(Loss) Reclassified
Hedging		Amount of Income/(Loss) Recognized				into Income	from Accumulated OCI into Expense
Relationships		in OCI on Derivative (Effective Portion)				(Effective Portion)	(Effective Portion)

Twelve months ended December 31,		2018		2017			2018		2017

	Interest rate swaps	$	193	$	622	Interest Expense	$	(139)	$	1,313

The Company does not use derivative instruments for trading or other speculative purposes and did not have any other derivative instruments or hedging activities as of December 31, 2018.

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.

As of December 31, 2018, the fair value of derivatives in a net liability position related to these agreements, excluding any adjustment for nonperformance risk, was $0.6 million. As of December 31, 2018, the Company has not posted any collateral related to these net liability positions. If the Company had breached any of these provisions as of December 31, 2018, it could have been required to settle its obligations under the agreements at their termination value of $0.6 million.

Although the derivative contracts are subject to master netting arrangements, which serve as credit mitigants to both us and our counterparties under certain situations, we do not net our derivative fair values or any existing rights or obligations to cash collateral on the Consolidated Balance Sheets.

The table below presents a gross presentation of the effects of offsetting and a net presentation of the Company’s derivatives as of December 31, 2018 and December 31, 2017. The gross amounts of derivative assets or liabilities can be reconciled to the Tabular Disclosure of Fair Values of Derivative Instruments above, which also provides the location that derivative assets and liabilities are presented on the Consolidated Balance Sheets (in thousands):

Offsetting of Derivative Assets

As of December 31, 2018

Gross Amounts

Net Amounts of

Offset in the

Assets presented

Gross Amounts Not Offset in the

Gross Amounts

Statement of

in the statement

Statement of Financial Position

of Recognized

Financial

of Financial

Financial

Cash Collateral

Assets

Position

Instruments

Received

Net Amount

Derivatives

2,539

—

2,539

(575)

—

1,964

Offsetting of Derivative Liabilities

As of December 31, 2018

Net Amounts of

Gross Amounts

Liabilities

Offset in the

presented in the

Gross Amounts Not Offset in the

Gross Amounts

Statement of

statement of

Statement of Financial Position

of Recognized

Financial

Cash Collateral

Liabilities

Position

Instruments

Received

Net Amount

Derivatives

1,135

—

1,135

(575)

—

560

Offsetting of Derivative Assets

As of December 31, 2017

Gross Amounts

Net Amounts of

Offset in the

Assets presented

Gross Amounts Not Offset in the

Gross Amounts

Statement of

in the statement

Statement of Financial Position

of Recognized

Financial

of Financial

Financial

Cash Collateral

Assets

Position

Instruments

Received

Net Amount

Derivatives

1,592

—

1,592

(42)

—

1,550

Offsetting of Derivative Liabilities

As of December 31, 2017

Net Amounts of

Gross Amounts

Liabilities

Offset in the

presented in the

Gross Amounts Not Offset in the

Gross Amounts

Statement of

statement of

Statement of Financial Position

of Recognized

Financial

Cash Collateral

Liabilities

Position

Instruments

Received

Net Amount

Derivatives

242

—

242

(42)

—

200

Asset Derivatives

December 31, 2018

December 31, 2017

Fair Value

Fair Value

Derivatives designated as cash flow hedges:

Interest Rate Swaps