12.

Financial Instruments and Fair Value Measurements

Derivative Financial Instruments

In the normal course of business, our operations are exposed to global market risks, including the effect of changes in foreign currency exchange rates and interest rates. To manage these risks, we may enter into various derivative contracts. Foreign currency contracts, including forwards and options, may be used to manage foreign currency exposure. We may use interest rate swaps to manage the effect of interest rate fluctuations. We do not use derivative financial instruments for trading or speculative purposes. The majority of our derivative financial instruments are customized derivative transactions and are not exchange-traded. Management reviews our hedging program, derivative positions, and overall risk management strategy on a regular basis. We only enter into transactions that we believe will be highly effective at offsetting the underlying risk.

Our use of derivatives does involve the risk that counterparties may default on a derivative contract. We establish exposure limits for each counterparty to minimize this risk and provide counterparty diversification. Substantially all of our derivative exposures are with counterparties that have long-term credit ratings of single-A or better. We enter into master agreements with counterparties that generally allow for netting of certain exposures; thereby significantly reducing the actual loss that would be incurred should a counterparty fail to perform its contractual obligations. To mitigate pre-settlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal.

All derivatives are recognized at fair value in the Consolidated Balance Sheets within the line items Other Assets or Accounts Payable and Accrued Expenses, as applicable. We do not net our derivative position by counterparty for purposes of balance sheet presentation and disclosure. Derivatives can be designated as fair value hedges, cash flow hedges or hedges of net investments in foreign operations. The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives are designated as, and qualify as, hedging instruments.

For derivatives that will be accounted for as hedging instruments in accordance with the accounting standards, at inception of the transaction, we formally designate and document: the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, we formally assess both at inception and at least quarterly thereafter, whether the derivatives used in hedging transactions are effective at offsetting changes in either the fair values or cash flows of the related underlying exposures. The ineffective portion of a derivative financial instrument’s change in fair value, if any, is immediately recognized in earnings. Derivatives not designated as hedges are not speculative and are used to manage our exposure to foreign currency fluctuations but do not meet the strict hedge accounting requirements.

Changes in the fair value of derivatives that are designated and qualify as cash flow hedges and hedges of net investments in foreign operations are recorded in Accumulated Other Comprehensive Loss in the Consolidated Balance Sheets. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures hedged, fluctuations in the value of the derivative instruments will generally be offset by changes in the fair values or cash flows of the underlying exposures being hedged. The changes in fair values of derivatives that were not designated and/or did not qualify as hedging instruments are immediately recognized in earnings. For cash flow hedges, we reclassify changes in the fair value of derivatives into the applicable line item in the Consolidated Statements of Operations in which the hedged items are recorded in the same period that the underlying hedged items affect earnings.

Our co-investment ventures may also enter into derivative contracts. As we act as the manager of these ventures, our ventures use the same risk mitigation and exposure limits related to counterparties. In addition, these ventures primarily follow the same hedging strategy as Prologis. For our consolidated co-investment ventures, the accounting treatment is as described in this footnote. For our unconsolidated co-investment ventures, we record our proportionate share of any earnings impact in Earnings from Unconsolidated Entities, Net in the Consolidated Statements of Operations. In addition, for derivatives in our unconsolidated ventures that have been designated and qualify as hedging instruments, we record our proportionate share of the effective gain or loss as a component of Accumulated Other Comprehensive Loss in the Consolidated Balance Sheets. In both circumstances, we record the offsetting amount as Investments in and Advances to Unconsolidated Entities in the Consolidated Balance Sheets.

Foreign currency hedges

We hedge the net assets of certain international subsidiaries (net investment hedges) using foreign currency derivative contracts to offset the translation and economic exposures related to our investments in these subsidiaries by locking in a forward exchange rate at the inception of the hedge. We measure the effectiveness of our net investment hedges by using the changes in forward exchange rates because this method reflects our risk management strategies, the economics of those strategies in our financial statements and better manages interest rate differentials between different countries. Under this method, all changes in fair value of the forward currency derivative contracts designated as net investment hedges are reported in equity in the foreign currency translation component of Accumulated Other Comprehensive Loss and offsets translation adjustments on the underlying net assets of foreign subsidiaries and affiliates, which are also recorded in Accumulated Other Comprehensive Loss. Ineffectiveness, if any, is recognized in earnings.

In 2013, we entered into seven foreign currency contracts that expire in June 2017 and June 2018 with an aggregate notional amount of €599.9 million ($800.0 million using the weighted average forward rate of 1.33) to hedge a portion of our investment in Europe at a fixed euro rate in U.S. dollars. We also entered into three foreign currency contracts that expire in June 2018 with an aggregate notional amount of ¥24.1 billion ($250.0 million using the weighted average forward rate of 96.54) to hedge a portion of our investment in Japan at a fixed yen rate in U.S. dollars. Pursuant to these contracts, we will sell either euro or yen and buy U.S. dollars at the forward rate upon maturity. In addition, we will receive quarterly payments in U.S. dollars at a predetermined rate with no corresponding payments by us. These derivatives were designated and qualify as hedging instruments and, therefore, the changes in fair value of these derivatives were recorded in the foreign currency translation component of Accumulated Other Comprehensive Loss in the Consolidated Balance Sheets.

In the fourth quarter of 2012, we entered into foreign currency contracts that expired in April and May 2013. These contracts were designated and qualified as hedging instruments. During 2013, we settled these contracts with a combined notional amount of $1.3 billion. As a result of these settlements, we have realized a gain of $4.3 million, in Other Comprehensive Income (Loss) in the Consolidated Statements of Comprehensive Income for the nine months ended September 30, 2013, respectively.

We had $4.3 million recorded in Other Assets at September 30, 2013, and $15.6 million and $17.5 million recorded in Accounts Payable and Accrued Expenses at September 30, 2013 and December 31, 2012, respectively, in the Consolidated Balance Sheets relating to the fair value of our net investment hedges. Amounts included in Accumulated Other Comprehensive Loss in the Consolidated Balance Sheets at September 30, 2013 and December 31, 2012, were losses of $2.3 million and $17.5 million, respectively. None of our net investment hedges were ineffective during the three and nine months ended September 30, 2013, therefore, there was no impact on earnings. For the three and nine months ended September, 30, 2013, we recorded losses of $21.7 million and gains of $12.6 million, respectively, in Other Comprehensive Income (Loss) in the Consolidated Statements of Comprehensive Income due to the change in fair value of our net investment hedges.

Interest rate hedges

Our interest rate risk management strategy is to limit the impact of future interest rate changes on earnings and cash flows as well as to stabilize interest expense and manage our exposure to interest rate movements. To achieve this objective, we may enter into interest rate swap agreements, which allow us to borrow on a fixed rate basis for longer-term debt issuances, or interest rate cap agreements, which allow us to minimize the impact of increases in interest rates. We typically designate our interest rate swap and interest rate cap agreements as cash flow hedges as these derivative instruments may be used to manage the interest rate risk on potential future debt issuances or to fix the interest rate on variable rate debt issuances. The maximum length of time that we hedge our exposure to future cash flows is typically less than 10 years. We use cash flow hedges to minimize the variability in cash flows of assets, liabilities or forecasted transactions caused by fluctuations in interest rates.

We have entered into interest rate swap agreements that allow us to receive variable-rate amounts from a counterparty in exchange for us making fixed-rate payments over the life of our agreements without the exchange of the underlying notional amount. We had two interest rate swap contracts, including one contract denominated in euro and one contract denominated in U.S. dollar, outstanding at September 30, 2013. We had $6.2 million and $28.0 million accrued in Accounts Payable and Accrued Expenses in the Consolidated Balance Sheets relating to our unsettled derivative contracts at September 30, 2013 and December 31, 2012, respectively.

The effective portion of the gain or loss on the derivative is reported as a component of Accumulated Other Comprehensive Loss in the Consolidated Balance Sheets, and reclassified to Interest Expense in the Consolidated Statements of Operations over the corresponding period of the hedged item. The amounts reclassified to interest expense for the three and nine months ended September 30, 2013 were not considered significant. The amounts reclassified to interest expense for the three and nine months ended September 30, 2012 were $3.6 million and $9.4 million, respectively. For the next twelve months from September 30, 2013, we estimate that an additional expense of $1.2 million will be reclassified into interest expense. Amounts included in Accumulated Other Comprehensive Loss in the Consolidated Balance Sheets at September 30, 2013 and December 31, 2012, were a losses of $14.8 million and $33.8 million, respectively. For the three and nine months ended September 30, 2013, we recorded gains of $2.6 million and $14.1 million, respectively, and for the three and nine months ended September 30, 2012, we recorded losses of $8.7 million and $9.8 million, respectively, in Other Comprehensive Income (Loss) in the Consolidated Statements of Comprehensive Income due to the change in fair value of these derivatives. To the extent the hedged debt is paid off early, the amounts in Accumulated Other Comprehensive Loss are recognized as Gains (Losses) on Early Extinguishment of Debt, Net in the Consolidated Statements of Operations.

Losses on a derivative representing hedge ineffectiveness are recognized in Interest Expense at the time the ineffectiveness occurred. Losses due to hedge ineffectiveness were not considered material during the three and nine months ended September 30, 2013. We recorded losses of $0.6 million and $3.1 million during the three and nine months ended September 30, 2012, respectively.

The following table summarizes the activity in our derivative instruments (in millions) for the nine months ended September 30, 2013:


	2013								2012
	Foreign Currency Contracts			Interest Rate Swaps (1)			Interest Rate Caps		Foreign Currency Forwards		Interest Rate Swaps			Interest Rate Caps
Notional amounts at January 1	$	1,303.8		$	1,314.8		$	—	$	—	$	1,496.5		$	—
New contracts		1,050.0			—			—		—		444.2			—
Acquired contracts (2)		—			—			—		—		71.0			—
Matured or expired contracts		(1,303.8	)		(1,230.2	)		—		—		(460.0	)		—

Notional amounts at September 30	$	1,050.0		$	84.6		$	—	$	—	$	1,551.7		$	—

(1)

During the nine months ended September 30, 2013, we settled 12 contracts with a notional value of $319.9 million, and contributed 13 contracts with a notional value of $383.9 million related to the transfer of assets to the newly formed PELP co-investment venture. We also settled five contracts in Japan with a notional value of $526.4 million in connection with the contributions of properties to NPR.

(2)	During the nine months ended September 30, 2012, we acquired one interest rate swap contract with a notional amount of $71.0 million in connection with the acquisition of our interest in NAIF II.

In connection with the contributions to NPR, we reclassified a loss related to interest rate swaps of $7.8 million during the first quarter of 2013 from Accumulated Other Comprehensive Loss in the Consolidated Balance Sheets to Gains (Losses) on Early Extinguishment of Debt, Net in the Consolidated Statements of Operations.

Fair Value Measurements

We have estimated the fair value of our financial instruments using available market information and valuation methodologies we believe to be appropriate for these purposes. Considerable judgment and a high degree of subjectivity are involved in developing these estimates and, accordingly, they are not necessarily indicative of amounts that we would realize upon disposition.

Fair Value Measurements on a Recurring and Non-Recurring Basis

At September 30, 2013, other than the derivatives discussed above and in Note 6, we do not have any significant financial assets or financial liabilities that are measured at fair value on a recurring basis in the Consolidated Financial Statements.

Assets measured at fair value on a non-recurring basis in the Consolidated Financial Statements consist of real estate assets and investments in and advances to unconsolidated entities that were subject to impairment charges. There were no assets that met this criteria at September 30, 2013.

Fair Value of Financial Instruments

At September 30, 2013 and December 31, 2012, our carrying amounts of certain financial instruments, including cash and cash equivalents, restricted cash, accounts and notes receivable, accounts payable, and accrued expenses were representative of their fair values due to the short-term nature of these instruments.

At September 30, 2013 and December 31, 2012, the fair value of our derivative instruments were determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves, foreign exchange rates, and implied volatilities. The fair values of our interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts or payments and the discounted expected variable cash payments. The variable cash payments are based on an expectation of future interest rates, or forward curves, derived from observable market interest rate curves. The fair values of our net investment hedges are based upon the change in the spot rate at the end of the period as compared to the strike price at inception.

We incorporate credit valuation adjustments to appropriately reflect both our nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

We have determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy. Although the credit valuation adjustments associated with our derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by us and our counterparties, we assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives.

At September 30, 2013 and December 31, 2012, the fair value of our senior notes and exchangeable senior notes has been estimated based upon quoted market prices for the same (Level 1) or similar (Level 2) issues when current quoted market prices are available, the fair value of our Credit Facilities has been estimated by discounting the future cash flows using rates and borrowing spreads currently available to us (Level 3), and the fair value of our secured mortgage debt and assessment bonds that do not have current quoted market prices available has been estimated by discounting the future cash flows using rates currently available to us for debt with similar terms and maturities (Level 3). The differences in the fair value of our debt from the carrying value in the table below are the result of differences in interest rates and/or borrowing spreads that were available to us at September 30, 2013 and December 31, 2012, as compared with those in effect when the debt was issued or acquired. The senior notes and many of the issues of secured mortgage debt contain pre-payment penalties or yield maintenance provisions that could make the cost of refinancing the debt at lower rates exceed the benefit that would be derived from doing so.

The following table reflects the carrying amounts and estimated fair values of our debt (in thousands):


	September 30, 2013				December 31, 2012
	Carrying Value		Fair Value		Carrying Value		Fair Value
Debt:
Credit Facilities	$	992,776	$	993,310	$	888,966	$	893,577
Senior notes		4,980,625		5,415,442		5,223,136		5,867,124
Exchangeable senior notes		397,481		525,958		876,884		1,007,236
Secured mortgage debt		1,772,342		1,922,436		3,625,908		3,765,556
Secured mortgage debt of consolidated entities		296,783		304,063		450,923		455,880
Other debt of consolidated entities		4,345		4,345		67,749		68,751
Other debt		674,965		685,293		657,228		660,951

Total debt	$	9,119,317	$	9,850,847	$	11,790,794	$	12,719,075