Derivative Instruments

12 Months Ended

Dec. 31, 2019

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments

The Company was not party to any derivative instruments in 2018.

In the first quarter of 2019, the Company entered into eight fixed pay/receive variable interest rate swaps.

Six of the interest rate swaps were entered into by the LLC Borrowers, one of which terminated in the fourth quarter of 2019 in connection with the sale of the related aircraft, and provided for reduced notional amounts that mirror the amortization under the Nord Term Loans entered into by the LLC Borrowers, effectively converting each of the six Nord Term Loans from a variable to a fixed interest rate, ranging from 5.38% to 6.30%. Each of these six interest rate swaps extended for the duration of the corresponding Term Loan, with maturities from 2020 through 2025.

The other two interest rate swaps, the MUFG Swaps related to the Company’s MUFG Credit Facility, were entered into by AeroCentury and 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 give the swap counterparty the right to terminate the interest rate swaps with any breakage costs being the liability of the Company. The counterparty agreed under the Forbearance Agreement and subsequent amendments to refrain from exercising any termination or other remedies as a result of the Company’s defaults under the MUFG Credit Facility during the forbearance period under the Forbearance Agreement. In March 2020, the Company was notified that the counterparties had terminated the MUFG Swaps.

The Company entered into the interest rate swaps in order to reduce its exposure to the risk of increased interest rates. With respect to the six interest rate swaps entered into by the LLC Borrowers, 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 Term Loan principal and interest payments, thereby preventing default so long as the lessees met their lease rent payment obligations. The two interest rate swaps entered into by AeroCentury were intended to protect against the exposure to interest rate increases on $50 million of the Company’s MUFG Credit Facility debt.

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. Changes in the fair value of the hedged swaps are included in other comprehensive income/(loss), which amounts are reclassified into earnings in the period in which the transaction being hedged affects 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.

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 discussed in Note 15, the MUFG Swaps were terminated in the first quarter of 2020 and the amount of accumulated other comprehensive income/(loss) related to such cash flows will be recognized as an expense at such time in the first quarter of 2020.

The Company has reflected the following amounts in its net loss:

	For the Years Ended December 31,
	2019			2018
Change in value of interest rate swaps	$	255,200		$	-
Other items		147,400			-
Included in interest expense	$	402,600		$	-
The following amount was included in other comprehensive income/(loss), before tax
Unrealized loss on derivative instruments	$	(1,932,100	)	$	-
Other items		186,400			-
Change in value of hedged interest rate swaps	$	(1,745,700	)	$	-

Before the termination of the MUFG Swaps discussed in Note 15, approximately $575,000 of the current balance of accumulated other comprehensive income/(loss) was expected to be reclassified in the next twelve months, although certain additional amounts may be recognized in the event the Company determines that some of the forecasted cash flows that are intended to be hedged under the interest rate swaps related to its MUFG Credit Facility are probable of not occurring.

At December 31, 2019, the fair value of the Company’s interest rate swaps was as follows:

Designated interest rate hedges fair value	$	(570,900	)
Other interest rate swaps		(1,253,600	)
Total derivative (liability)	$	(1,824,500	)

The Company evaluates the creditworthiness of the counterparties under its hedging agreements. The swap counterparties for the Company’s interest rate swaps are large financial institutions in the United States that possess an investment grade credit rating. Based on this rating, the Company believes that the counterparties are creditworthy and that their continuing performance under the hedging agreements is probable.