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Accounting for Derivatives
 12 Months Ended
Dec. 31, 2013
Accounting for Derivatives  
Accounting for Derivatives

11.  Accounting for Derivatives

 

We are exposed to market risks associated with changes in interest rates and foreign currency exchange rates. We use derivative financial instruments to minimize the risks and/or costs associated with financial activities by managing our exposure to interest rate fluctuations on a portion of our debt obligations. We also use derivative financial instruments to minimize the risks caused by currency fluctuations in certain foreign currencies. We do not use derivative financial instruments for trading or other speculative purposes.

 

Interest Rate Risk

 

At December 31, 2013, the Partnership was a party to interest rate swaps with a notional value of $250.0 million, pursuant to which it makes fixed payments and receives floating payments. The Partnership entered into these swaps to offset changes in expected cash flows due to fluctuations in the associated variable interest rates. These interest rate swaps expire in May 2018. As of December 31, 2013, the weighted average effective fixed interest rate on the interest rate swaps was 1.7%. We have designated these interest rate swaps as cash flow hedging instruments so that any change in their fair values is recognized as a component of comprehensive income (loss) and is included in accumulated other comprehensive income (loss) to the extent the hedge is effective. As the swap terms substantially coincide with the hedged item and are expected to offset changes in expected cash flows due to fluctuations in the variable rate, we currently do not expect a significant amount of ineffectiveness on these hedges. We perform quarterly calculations to determine whether the swap agreements are still effective and to calculate any ineffectiveness. There was no ineffectiveness related to interest rate swaps during the years ended December 31, 2013, 2012 and 2011. We estimate that $3.4 million of deferred pre-tax losses attributable to existing interest rate swaps and included in our accumulated other comprehensive income (loss) at December 31, 2013, will be reclassified into earnings as interest expense at then current values during the next twelve months as the underlying hedged transactions occur. Cash flows from derivatives designated as hedges are classified in our consolidated statements of cash flows under the same category as the cash flows from the underlying assets, liabilities or anticipated transactions, unless the derivative contract contains a significant financing element; in this case, the cash settlements for these derivatives are classified as cash flows from financing activities in our consolidated statement of cash flows.

 

In May 2013, the Partnership amended its interest rate swap agreements with a notional value of $250.0 million to adjust the fixed interest rates and extend the maturity dates to May 2018 consistent with the maturity date of the Partnership Credit Agreement. These amendments effectively created new derivative contracts and terminated the old derivative contracts. As a result, we designated the new hedge relationships under the amended terms and de-designated the original hedge relationships as of the termination date. Upon the designation of the new hedge relationships, we recorded an inception gain of $9.2 million in accumulated other comprehensive income (loss), which is being amortized into interest expense over the terms of the new hedge relationships. During the year ended December 31, 2013, we reclassified $2.2 million of pre-tax inception gains from these new hedge relationships into interest expense. We estimate that $3.4 million of deferred pre-tax inception gains from these new hedge relationships will be amortized into interest expense during the next twelve months. The original hedge relationships qualified for hedge accounting and were included at their fair value in our balance sheet as a liability and accumulated other comprehensive income (loss). The fair value of the interest rate swap agreements immediately prior to the execution of the amendments was a liability of $8.8 million. The associated amount in accumulated other comprehensive income (loss) is being amortized into interest expense over the original terms of the swaps. During the year ended December 31, 2013, we reclassified $2.5 million of pre-tax losses from these terminated interest rate swaps into interest expense. We estimate that $3.7 million of deferred pre-tax losses from these terminated interest rate swaps will be amortized into interest expense during the next twelve months.

 

In the fourth quarter of 2010, the Partnership and we paid $43.0 million to terminate interest rate swap agreements with a total notional value of $585.0 million and a weighted average effective fixed interest rate of 4.6%. These swaps qualified for hedge accounting and were previously included on our balance sheet as a liability and in accumulated other comprehensive income (loss). The liability was paid in connection with the termination, and the associated amount in accumulated other comprehensive income (loss) is being amortized into interest expense over the original terms of the swaps. During the year ended December 31, 2013, we reclassified $1.6 million of pre-tax losses from these terminated interest rate swaps into interest expense. We estimate that $0.9 million of deferred pre-tax losses from these terminated interest rate swaps will be amortized into interest expense during the next twelve months.

 

Foreign Currency Exchange Risk

 

We operate in approximately 30 countries throughout the world, and a fluctuation in the value of the currencies of these countries relative to the U.S. dollar could impact our profits from international operations and the value of the net assets of our international operations when reported in U.S. dollars in our financial statements. From time to time we may enter into foreign currency hedges to reduce our foreign exchange risk associated with cash flows we will receive in a currency other than the functional currency of the local Exterran affiliate that entered into the contract. The impact of foreign currency exchange on our consolidated statements of operations will depend on the amount of our net asset and liability positions exposed to currency fluctuations in future periods.

 

Foreign currency swaps or forward contracts that meet the hedging requirements or that qualify for hedge accounting treatment are accounted for as cash flow hedges and changes in the fair value are recognized as a component of comprehensive income (loss) to the extent the hedge is effective. The amounts recognized as a component of other comprehensive income (loss) will be reclassified into earnings (loss) in the periods in which the underlying foreign currency exchange transaction is recognized and are included under the same category as the income or loss from the underlying assets, liabilities, or anticipated transactions in our consolidated statements of operations. For foreign currency swaps and forward contracts that do not qualify for hedge accounting treatment, changes in fair value and gains and losses on settlement are included under the same category as the income or loss from the underlying assets, liabilities or anticipated transactions in our consolidated statements of operations.

 

The following tables present the effect of derivative instruments on our consolidated financial position and results of operations (in thousands):

 

 

 

December 31, 2013

 

 

 

Balance Sheet Location

 

Fair Value
Asset (Liability)

 

Derivatives designated as hedging instruments:

 

 

 

 

 

Interest rate hedges

 

Intangible and other assets, net

 

$

322

 

Interest rate hedges

 

Accrued liabilities

 

(3,374

)

Total derivatives

 

 

 

$

(3,052

)

 

 

 

December 31, 2012

 

 

 

Balance Sheet Location

 

Fair Value
Asset (Liability)

 

Derivatives designated as hedging instruments:

 

 

 

 

 

Interest rate hedges

 

Accrued liabilities

 

$

(3,873

)

Interest rate hedges

 

Other long-term liabilities

 

(6,043

)

Total derivatives

 

 

 

$

(9,916

)

 

 

 

Year Ended December 31, 2013

 

 

 

 

 

Location of Pre-tax

 

 

 

 

 

 

 

Gain (Loss)

 

Pre-tax Gain (Loss)

 

 

 

Pre-tax Gain (Loss)

 

Reclassified from

 

Reclassified from

 

 

 

Recognized in Other

 

Accumulated Other

 

Accumulated Other

 

 

 

Comprehensive

 

Comprehensive

 

Comprehensive

 

 

 

Income (Loss) on

 

Income (Loss)

 

Income (Loss)

 

 

 

Derivatives

 

into Income (Loss)

 

into Income (Loss)

 

Derivatives designated as cash flow hedges:

 

 

 

 

 

 

 

Interest rate hedges

 

$

3,057

 

Interest expense

 

$

(6,124

)

 

 

 

Year Ended December 31, 2012

 

 

 

 

 

Location of Pre-tax

 

 

 

 

 

 

 

Gain (Loss)

 

Pre-tax Gain (Loss)

 

 

 

Pre-tax Gain (Loss)

 

Reclassified from

 

Reclassified from

 

 

 

Recognized in Other

 

Accumulated Other

 

Accumulated Other

 

 

 

Comprehensive

 

Comprehensive

 

Comprehensive

 

 

 

Income (Loss) on

 

Income (Loss)

 

Income (Loss)

 

 

 

Derivatives

 

into Income (Loss)

 

into Income (Loss)

 

Derivatives designated as cash flow hedges:

 

 

 

 

 

 

 

Interest rate hedges

 

$

(6,066

)

Interest expense

 

$

(26,284

)

 

 

 

Year Ended December 31, 2011

 

 

 

 

 

Location of Pre-tax

 

 

 

 

 

 

 

Gain (Loss)

 

Pre-tax Gain (Loss)

 

 

 

Pre-tax Gain (Loss)

 

Reclassified from

 

Reclassified from

 

 

 

Recognized in Other

 

Accumulated Other

 

Accumulated Other

 

 

 

Comprehensive

 

Comprehensive

 

Comprehensive

 

 

 

Income (Loss) on

 

Income (Loss)

 

Income (Loss)

 

 

 

Derivatives

 

into Income (Loss)

 

into Income (Loss)

 

Derivatives designated as cash flow hedges:

 

 

 

 

 

 

 

Interest rate hedges

 

$

(17,064

)

Interest expense

 

$

(47,729

)

Foreign currency hedge

 

—

 

Fabrication revenue

 

410

 

Total

 

$

(17,064

)

 

 

$

(47,319

)

 

The counterparties to the derivative agreements are major international financial institutions. We monitor the credit quality of these financial institutions and do not expect non-performance by any counterparty, although such non-performance could have a material adverse effect on us. The Partnership has no specific collateral posted for its derivative instruments. The counterparties to the interest rate swaps are also lenders under the Partnership’s senior secured credit facility and, in that capacity, share proportionally in the collateral pledged under the related facility.