NOTE 12 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The Company is exposed to interest rate risk relating to its ongoing business operations. To manage interest rate exposure, the Company enters into hedge transactions (interest rate swaps) using derivative financial instruments. The objective of entering into interest rate swaps is to eliminate the variability of cash flows in the LIBOR interest payments associated with variable-rate loans over the life of the loans. As changes in interest rates impact the future cash flow of interest payments, the hedges provide a synthetic offset to interest rate movements.

In addition, the Company is exposed to foreign currency and interest rate cash flow exposure related to a non-functional currency long-term debt held by various of its wholly owned subsidiaries. To manage this foreign currency and interest rate cash flow exposures, the Company’s subsidiaries enter into cross-currency interest rate swaps that convert its U.S. dollar denominated floating interest payments to functional currency fixed interest payments during the life of the hedging instrument. As changes in foreign exchange and interest rates impact the future cash flow of interest payments, the hedge is intended to offset changes in cash flows attributable to interest rate and foreign exchange movements.

These derivative instruments (cash flow hedging instruments) are designated and qualify as cash flow hedges, with the entire gain or loss on the derivative reported as a component of other comprehensive income (loss). Amounts are deferred in other comprehensive income (loss) and reclassified into earnings in the same income statement line item that is used to present earnings effect of the hedged item when the hedged item affects earnings.

The Company is exposed to foreign-currency exchange-rate fluctuations in the normal course of business, including foreign-currency exchange-rate fluctuations on U.S. dollar denominated liabilities within its international subsidiaries whose functional currency is other than the U.S. dollar. The Company manages these fluctuations, in part, through the use of non-deliverable forward foreign-exchange contracts that are intended to offset changes in cash flow attributable to currency exchange movements. These contracts are intended primarily to economically address exposure to U.S. dollar merchandise inventory expenditures made by the Company’s international subsidiaries whose functional currency is other than the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. The Company seeks to mitigate foreign-currency exchange-rate risk with the use of these contracts and does not intend to engage in speculative transactions. These contracts do not contain any credit-risk-related contingent features.

Cash Flow Hedges

As of August 31, 2018, all of the Company’s interest rate swap and cross-currency interest rate swap derivative financial instruments are designated and qualify as cash flow hedges. The Company formally documents the hedging relationships for its derivative instruments that qualify for hedge accounting.

The following table summarizes agreements for which the Company has recorded cash flow hedge accounting transactions during the twelve months ended August 31, 2018:

Subsidiary

Date
Entered
into

Derivative
Financial
Counter-
party

Derivative
Financial
Instruments

Initial
US$
Notional
Amount

Bank
US$
loan
Held
with

Floating Leg
(swap
counter-party)

Fixed Rate
for PSMT
Subsidiary

Settlement
Dates

Effective
Period of swap

PriceSmart, Inc

7-Nov-16

MUFG Union Bank, N.A. ("Union Bank")

Interest rate swap

35,700,000

Union Bank

Variable rate 1-month Libor plus 1.7%

3.65

1st day of each month beginning on April 1, 2017

March 1, 2017 - March 1, 2027

Costa Rica

28-Aug-15

Citibank, N.A. ("Citi")

Cross currency interest rate swap

7,500,000

Citibank, N.A.

Variable rate 3-month Libor plus 2.50%

7.65

28th day of August, November, February, and May beginning on November 30, 2015

August 28, 2015 -
August 28, 2020

Honduras(1)

24-Mar-15

Citibank, N.A. ("Citi")

Cross currency interest rate swap

8,500,000

Citibank, N.A.

Variable rate 3-month Libor plus 3.25%

10.75

24th day of March, June, September, and December beginning on June 24, 2015

Refinanced on February 26, 2018

Honduras(1)

26-Feb-18

Citibank, N.A. ("Citi")

Cross currency interest rate swap

13,500,000

Citibank, N.A.

Variable rate 3-month Libor plus 3.00%

9.75

29th day of May, August, November and February beginning May 29, 2018

February 26, 2018 -
February 24, 2024

El Salvador

16-Dec-14

Bank of Nova Scotia ("Scotiabank")

Interest rate swap

4,000,000

Bank of Nova Scotia

Variable rate 30-day Libor plus 3.5%

4.78

29th day of each month beginning on December 29, 2014

December 1, 2014 -
August 29, 2019

Colombia

10-Dec-14

Citibank, N.A. ("Citi")

Cross currency interest rate swap

15,000,000

Citibank, N.A.

Variable rate 3-month Libor plus 2.8%

8.25

4th day of March, June, Sept, Dec. beginning on March 4, 2015

December 4, 2014 -
December 3, 2019

Panama

9-Dec-14

Bank of Nova Scotia ("Scotiabank")

Interest rate swap

10,000,000

Bank of Nova Scotia

Variable rate 30-day Libor plus 3.5%

5.16

28th day of each month beginning December 29, 2014

November 28, 2014 -
November 29, 2019

Honduras

23-Oct-14

Citibank, N.A. ("Citi")

Cross currency interest rate swap

5,000,000

Citibank, N.A.

Variable rate 3-month Libor plus 3.5%

11.6

22nd day of January, April, July, and October beginning on January 22, 2015

Settled on

October 22, 2017

Panama

1-Aug-14

Bank of Nova Scotia ("Scotiabank")

Interest rate swap

5,000,000

Bank of Nova Scotia

Variable rate 30-day Libor plus 3.5%

4.89

21st day of each month beginning on September 22, 2014

August 21, 2014 -
August 21, 2019

Panama

22-May-14

Bank of Nova Scotia ("Scotiabank")

Interest rate swap

3,970,000

Bank of Nova Scotia

Variable rate 30-day Libor plus 3.5%

4.98

4th day of each month beginning on June 4, 2014

May 5, 2014 -
April 4, 2019

Panama

25-Jun-18

Bank of Nova Scotia ("Scotiabank")

Interest rate swap

14,625,000

Bank of Nova Scotia

Variable rate 3-month Libor plus 3.0%

5.99

23rd day of each month beginning on July 23, 2018

June 25, 2018 -

March 23, 2023

⁽¹⁾

In February 2018, the Company’s Honduras subsidiary refinanced its portfolio of loans entered into with Citibank. The original notional amount of this portfolio of loans was $13.5 million, which the Company drew down in fiscal year 2015. There was approximately $7.9 million of remaining principal at the time of refinancing. Under the refinancing agreement, the portfolio of loans was combined into one loan and the notional amount of the loan increased back to the original $13.5 million, with the interest rate set at the 90 day LIBOR rate plus 3.0%. In conjunction with the refinancing of these loans, the Company’s Honduras subsidiary drew down the additional $5.6 million notional amount during February 2018. As part of the terms, the existing cash flow hedge related to the original loan, was de-designated and incorporated into a new hedging relationship where the Company’s Honduras subsidiary has entered into a cross-currency interest rate swap with Citibank. Under this new hedge agreement, the Company’s Honduras subsidiary will pay Honduras Lempiras, at a fixed interest rate of 9.75%.

For the twelve-month periods ended August 31, 2018, 2017 and 2016 the Company included the gain or loss on the hedged items (that is, variable-rate borrowings) in the same line item—interest expense—as the offsetting gain or loss on the related interest rate swaps as follows (in thousands):




Income Statement Classification	Interest expense on borrowings(1)		Cost of swaps (2)		Total
Interest expense for the year ended August 31, 2018	$	4,100	$	981	$	5,081
Interest expense for the year ended August 31, 2017	$	3,605	$	1,588	$	5,193
Interest expense for the year ended August 31, 2016	$	3,087	$	1,982	$	5,069

⁽¹⁾

This amount is representative of the interest expense recognized on the underlying hedged transactions.

⁽²⁾

This amount is representative of the interest expense recognized on the interest rate swaps designated as cash flow hedging instruments.

The total notional balance of the Company’s pay-fixed/receive-variable interest rate swaps and cross-currency interest rate swaps was as follows (in thousands):



	Notional Amount as of
	August 31,		August 31,
Floating Rate Payer (Swap Counterparty)	2018		2017
Union Bank	$	35,700	$	35,700
Citibank N.A.		27,825		26,088
Scotiabank		25,149		13,724
Total	$	88,674	$	75,512

The following table summarizes the fair value of interest rate swap and cross-currency interest rate swap derivative instruments that qualify for derivative hedge accounting (in thousands, except footnote data):



		August 31, 2018						August 31, 2017
Derivatives designated as cash flow hedging instruments	Balance Sheet Location	Fair Value		Net Tax Effect		Net OCI		Fair Value		Net Tax Effect		Net OCI
Cross-currency interest rate swaps	Other non-current assets	$	2,405		(819)		1,586	$	2,547		(950)		1,597
Interest rate swaps	Other non-current assets		1,959		(434)		1,525		—		—		—
Interest rate swaps	Other long-term liabilities		(8)		2		(6)		(231)		80		(151)
Cross-currency interest rate swaps	Other long-term liabilities		(494)		148		(346)		(451)		135		(316)
Net fair value of derivatives designated as hedging instruments		$	3,862	$	(1,103)	$	2,759	$	1,865	$	(735)	$	1,130

Fair Value Instruments

From time to time the Company enters into non-deliverable forward foreign-exchange contracts. These contracts are treated for accounting purposes as fair value contracts and do not qualify for derivative hedge accounting. The use of non-deliverable forward foreign-exchange contracts is intended to offset changes in cash flow attributable to currency exchange movements. These contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by the Company’s international subsidiaries whose functional currency is other than the U.S. dollar.

As of August 31, 2018 the Company did not have any open non-deliverable forward foreign-exchange contracts.

For the twelve-month periods ended August 31, 2018, 2017 and 2016, the Company included in its consolidated statements of income the forward derivative (gain) or loss on the non-deliverable forward foreign-exchange contracts as follows (in thousands):



	Years Ended August 31
Income Statement Classification	2018		2017		2016
Other income (expense), net	$	143	$	(387)	$	(166)

For derivatives that do not qualify for hedge accounting, there were no significant related assets or liabilities recorded on the consolidated balance sheet at August 31, 2018 or 2017.