Derivative Instruments and Hedging Activities

6 Months Ended

Mar. 31, 2020

Derivative Instruments and Hedging Activities

Derivative Instruments and Hedging Activities

Note 8. Derivative instruments and hedging activities

Derivative instruments not designated or qualifying as hedging instruments

In May 2018, Woodward entered into cross-currency interest rate swap agreements that synthetically convert $167,420 of floating-rate debt under Woodward’s then existing revolving credit agreement to Euro denominated floating-rate debt in conjunction with the L’Orange acquisition (the “Floating-Rate Cross-Currency Swap”). Also in May 2018, Woodward entered into cross-currency interest rate swap agreements that synthetically convert an aggregate principal amount of $400,000 of fixed-rate debt associated with the 2018 Note Purchase Agreement (as defined in Note 15, Credit facilities short-term borrowings and long-term debt) to Euro denominated fixed-rate debt (the “Fixed-Rate Cross-Currency Swaps”). The cross-currency interest rate swaps, which effectively reduce the interest rate on the underlying fixed and floating-rate debt under the 2018 Notes (as defined in Note 15, Credit facilities short-term borrowings and long-term debt) and Woodward’s then existing revolving credit agreement, respectively, is recorded as a reduction to “Interest expense” in Woodward’s Condensed Consolidated Statements of Earnings.

Derivatives instruments in fair value hedging relationships

Concurrent with the entry into the Floating-Rate Cross-Currency Swap, a corresponding Euro denominated intercompany loan receivable with identical terms and notional amount as the underlying Euro denominated floating-rate debt, with a reciprocal cross-currency interest rate swap, was entered into by Woodward Barbados Financing SRL (“Barbados”), a wholly owned subsidiary of Woodward, and is designated as a fair value hedge under the criteria prescribed in ASC Topic 815, “Derivatives and Hedging” (“ASC 815”). The objective of the derivative instrument is to hedge against the foreign currency exchange risk attributable to the spot remeasurement of the Euro denominated intercompany loan.

Only the change in the fair value related to the cross-currency basis spread, or excluded component, of the derivative instrument is recognized in accumulated other comprehensive (losses) earnings (“accumulated OCI”). The remaining change in the fair value of the derivative instrument is recognized in foreign currency transaction gain or loss included in “Selling, general and administrative costs” in Woodward’s Condensed Consolidated Statements of Earnings. The change in the fair value of the derivative instrument in foreign currency transaction gain or loss offsets the change in the spot remeasurement of the intercompany Euro denominated loan. Hedge effectiveness is assessed based on the fair value changes of the derivative instrument, after excluding any fair value changes related to the cross-currency basis spread. The initial cost of the cross-currency basis spread is recorded in earnings each period through the swap accrual process. There are no credit-risk-related contingent features associated with the floating-rate cross-currency interest rate swap.

Derivative instruments in cash flow hedging relationships

In conjunction with the entry into the Fixed-Rate Cross-Currency Swaps, five corresponding intercompany loans receivable, with identical terms and amounts of each tranche of the underlying aggregate principal amount of $400,000 of fixed-rate debt, and reciprocal cross-currency interest rate swaps were entered into by Barbados, which are designated as cash flow hedges under the criteria prescribed in ASC 815. The objective of these derivative instruments is to hedge the risk of variability in cash flows attributable to the foreign currency exchange risk of cash flows for future principal and interest payments associated with the Euro denominated intercompany loans over a fifteen-year period.

Changes in the fair values of the derivative instruments are recognized in accumulated OCI and reclassified to foreign currency transaction gain or loss included in “Selling, general and administrative costs” in Woodward’s Condensed Consolidated Statements of Earnings. Reclassifications out of accumulated OCI of the change in fair value occur each reporting period based upon changes in the spot rate remeasurement of the Euro denominated intercompany loans, including associated interest. Hedge effectiveness is assessed based on the fair value changes of the derivative instruments and deemed to be highly effective in offsetting exposure to variability in foreign exchange rates. There are no credit-risk-related contingent features associated with these fixed-rate cross-currency interest rate swaps.

Derivatives instruments in net investment hedging relationships

On September 23, 2016, Woodward and Woodward International Holding B.V., a wholly owned subsidiary of Woodward organized under the laws of The Netherlands (the “BV Subsidiary”), each entered into a note purchase agreement (the “2016 Note Purchase Agreement”) relating to the sale by Woodward and the BV Subsidiary of an aggregate principal amount of €160,000 of senior unsecured notes in a series of private placement transactions. Woodward issued €40,000 aggregate principal amount of Woodward’s Series M Senior Notes due September 23, 2026 (the “Series M Notes”). Woodward designated the Series M Notes as a hedge of a foreign currency exposure of Woodward’s net investment in its Euro denominated functional currency subsidiaries. Related to the Series M Notes, included in foreign currency translation adjustments within total comprehensive (losses) earnings are net foreign exchange gains of $650 for the three-months and foreign exchange losses of $395 for the six-months ended March 31, 2020, compared to net foreign exchange gains of $925 for the three-months and $1,574 for the six-months ended March 31, 2019.

Impact of derivative instruments designated as qualifying hedging instruments

The following table discloses the impact of derivative instruments designated as qualifying hedging instruments on Woodward’s Condensed Consolidated Statements of Earnings:

		Three-Months Ended
		March 31, 2020
Derivatives in:	Location	Amount of (Income) Expense Recognized in Earnings on Derivative		Amount of (Gain) Loss Recognized in Accumulated OCI on Derivative		Amount of (Gain) Loss Reclassified from Accumulated OCI into Earnings
Cross currency interest rate swap agreement designated as fair value hedges	Selling, general and administrative expenses	$	(2,043)	$	(1,523)	$	(1,646)
Cross currency interest rate swap agreements designated as cash flow hedges	Selling, general and administrative expenses		(5,598)		(43,775)		(5,598)
Treasury lock agreement designated as cash flow hedge	Interest expense		(18)		-		(18)
		$	(7,659)	$	(45,298)	$	(7,262)
		Three-Months Ended
		March 31, 2019
Derivatives in:	Location	Amount of (Income) Expense Recognized in Earnings on Derivative		Amount of (Gain) Loss Recognized in Accumulated OCI on Derivative		Amount of (Gain) Loss Reclassified from Accumulated OCI into Earnings
Cross currency interest rate swap agreement designated as fair value hedges	Selling, general and administrative expenses	$	(3,033)	$	(3,030)	$	(2,883)
Cross currency interest rate swap agreements designated as cash flow hedges	Selling, general and administrative expenses		(7,994)		(6,579)		(7,994)
Treasury lock agreement designated as cash flow hedge	Interest expense		(18)		-		(18)
		$	(11,045)	$	(9,609)	$	(10,895)

‎

		Six-Months Ended
		March 31, 2020
Derivatives in:	Location	Amount of (Income) Expense Recognized in Earnings on Derivative		Amount of (Gain) Loss Recognized in Accumulated OCI on Derivative		Amount of (Gain) Loss Reclassified from Accumulated OCI into Earnings
Cross-currency interest rate swap agreement designated as fair value hedges	Selling, general and administrative expenses	$	233	$	2,075	$	1,037
Cross-currency interest rate swap agreements designated as cash flow hedges	Selling, general and administrative expenses		3,393		(36,079)		3,393
Treasury lock agreement designated as cash flow hedge	Interest expense		(36)		-		(36)
		$	3,590	$	(34,004)	$	4,394
		Six-Months Ended
		March 31, 2019
Derivatives in:	Location	Amount of (Income) Expense Recognized in Earnings on Derivative		Amount of (Gain) Loss Recognized in Accumulated OCI on Derivative		Amount of (Gain) Loss Reclassified from Accumulated OCI into Earnings
Cross-currency interest rate swap agreement designated as fair value hedges	Selling, general and administrative expenses	$	(5,422)	$	(5,535)	$	(5,135)
Cross-currency interest rate swap agreements designated as cash flow hedges	Selling, general and administrative expenses		(13,550)		(22,637)		(13,550)
Treasury lock agreement designated as cash flow hedge	Interest expense		(36)		-		(36)
		$	(19,008)	$	(28,172)	$	(18,721)

The remaining unrecognized gains and losses in Woodward’s Condensed Consolidated Balance Sheets associated with derivative instruments that were previously entered into by Woodward, which are classified in accumulated OCI, were net gains of $33,394 as of March 31, 2020 and net losses of $5,004 as of September 30, 2019.