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Derivative Instruments
9 Months Ended
Sep. 30, 2021
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Instruments

6. Derivative Instruments

 

In the first quarter of 2019, the Company entered into eight fixed pay/receive variable interest rate swaps. The Company entered into the interest rate swaps in order to reduce its exposure to the risk of increased interest rates.

 

The Company estimates the fair value of derivative instruments using a discounted cash flow technique and uses creditworthiness inputs that corroborate observable market data evaluating the Company’s and counterparties’ risk of non-performance. Valuation of the derivative instruments requires certain assumptions for underlying variables and the use of different assumptions would result in a different valuation. Management believes it has applied assumptions consistently during the period.

 

The Company designated seven of its interest rate swaps as cash flow hedges upon entering into the swaps. Changes in the fair value of the hedged swaps were included in other comprehensive income/(loss), which amounts are reclassified into earnings in the period in which the transaction being hedged affected earnings (i.e., with future settlements of the interest rate swaps). One of the interest rate swaps was not eligible under its terms for hedge treatment and was terminated in 2019 when the associated asset was sold and the related debt was paid off. Changes in fair value of non-hedge derivatives are reflected in earnings in the periods in which they occur.

 

(a) MUFG Swaps

 

The two interest rate swaps entered into by AeroCentury (the “MUFG Swaps”) were intended to protect against the exposure to interest rate increases on $50 million of the Company’s MUFG Credit Facility debt prior to its sale to Drake during the fourth quarter of 2020. The MUFG Swaps had notional amounts totaling $50 million and were to extend through the maturity of the MUFG Credit Facility in February 2023. Under the ISDA agreement for these interest rate swaps, defaults under the MUFG Credit Facility gave the swap counterparty the right to terminate the interest rate swaps with any breakage costs being the liability of the Company.

 

In October 2019, the Company determined that it was no longer probable that forecasted cash flows for its two interest rate swaps with a nominal value of $50 million would occur as scheduled as a result of the Company’s defaults under the MUFG Credit Facility. Therefore, those swaps were no longer subject to hedge accounting and changes in fair market value thereafter were recognized in earnings as they occurred. As a result of the forecasted transaction being not probable to occur, accumulated other comprehensive loss of $34,500 and $1,167,700 related to the MUFG Swaps was recognized as interest expense for the three and nine months ended September 30, 2020. The two swaps related to the MUFG Credit Facility were terminated in March 2020 and the Company incurred a $3.1 million obligation, recorded as interest expense and derivative termination liability, in connection with such termination, payment of which was due no later than the March 31, 2021 maturity of the Drake Indebtedness.

 

The derivative termination liability was included in the liabilities subject to compromise. As part of the Plan of Reorganization, the Bankruptcy Court approved the settlement of claims reported within Liabilities subject to compromise in the Company’s Consolidated balance sheet at their respective allowed claim amounts. See Note 3 – reorganization adjustment (b). Accordingly, the Company did not have derivative termination liability as of September 30, 2021.

 

(b) Nord Swaps

 

With respect to the interest rate swaps entered into by the LLC Borrowers (“the Nord Swaps”), the swaps were deemed necessary so that the anticipated cash flows of such entities, which arise entirely from the lease rents for the aircraft owned by such entities, would be sufficient to make the required Nord Loan principal and interest payments, thereby preventing default so long as the lessees met their lease rent payment obligations.

 

The Nord Swaps were entered into by the LLC Borrowers and provided for reduced notional amounts that mirrored the amortization under the Nord Loans entered into by the LLC Borrowers, effectively converting each of the related Nord Loans from a variable to a fixed interest rate, ranging from 5.38% to 6.30%. Each of Nord Swaps extended for the duration of the corresponding Nord Loan. Two of the swaps had maturities in the fourth quarter of 2020 and were terminated when the associated assets were sold and the related debt was paid off. The other three Nord Swaps had maturities in 2025, but were sold in March 2021 as part of the Company’s sale of its membership interest in ACY E-175.

 

In March 2020, the Company determined that the future hedged interest payments related to its Nord Swaps were no longer probable of occurring, as a result of lease payment defaults for the aircraft owned by ACY 19002 and ACY 19003 and conversations with the lessee for the three aircraft owned by ACY E-175 regarding likely rent concessions, and consequently de-designated all five Nord Swaps as hedges because the lease payments that were used to service the Nord Loans associated with the Nord Swaps were no longer probable to occur. As a result of de-designation, future changes in market value were recognized in ordinary income and AOCI was reclassified to ordinary income as the forecasted transactions occurred. In December 2020, the Company determined that the payments after February 2021 for the three remaining Nord Swaps were probable not to occur as a result of the Company’s agreement to sell its interest in ACY E-175 during the first quarter of 2021. The Company has reflected the following amounts in its net income (loss) and comprehensive income (loss) for the nine months ended September 30, 2021 and 2020:

 

   Successor   Predecessor 
   September 30,
2021
   Period from
January 1, 2021
through
September 29,
2021
   Nine months ended
September 30,
2020
 
Change in value of undesignated interest rate swaps  $
      -
   $(48,700)  $1,980,500 
Reclassification from other comprehensive income to interest expense   
 
    2,600    538,500 
Reclassification from other comprehensive income to interest expense – forecasted transaction probable not to occur   
-
    
-
    1,167,700 
Included in interest expense  $
-
   $46,100   $3,686,700 

 

   Successor   Predecessor 
   September 30,
2021
   Period from
January 1, 2021
through
September 29,
2021
   Nine months ended
September 30,
2020
 
Loss on derivative instruments deferred into other comprehensive income/(loss)  $
       -
   $
-
   $(575,000)
Reclassification from other comprehensive income to interest expense   
 
    2,600    538,500 
Reclassification from other comprehensive income to interest expense – forecasted transaction probable not to occur   
-
    
-
    1,167,700 
Change in accumulated other comprehensive income  $
-
   $2,600   $1,131,200 

 

The Company has reflected the following amounts in its net income (loss) and comprehensive income (loss) for the three months ended September 30, 2021 and 2020:

 

   Successor   Predecessor 
   September 30,
2021
   Period from
January 1, 2021
through
September 29,
2021
   Three months ended
September 30,
2020
 
Change in value of undesignated interest rate swaps  $
        -
   $
        -
   $(10,000)
Reclassification from other comprehensive income to interest expense   
-
    
-
    149,100 
Included in interest expense  $
-
   $
-
   $139,100 

 

   Successor   Predecessor 
   September 30,
2021
   Period from
January 1, 2021
through
September 29,
2021
   Nine months ended
September 30,
2020
 
Reclassification from other comprehensive income to interest expense   
      -
    
           -
    149,000 
Change in accumulated other comprehensive income  $
-
   $
-
   $149,000