Derivative Financial Instruments

12 Months Ended

Dec. 31, 2011

Derivative Financial Instruments

Derivative Financial Instruments

Note 10—Derivative Financial Instruments

        The Company recognizes all derivatives as either assets or liabilities in the Consolidated Balance Sheets and measures those instruments at fair value. Additionally, the fair value adjustments will affect either accumulated other comprehensive loss until the hedged item is recognized in earnings, or net income (loss) attributable to Arbor Realty Trust, Inc., depending on whether the derivative instrument qualifies as a hedge for accounting purposes and, if so, the nature of the hedging activity. The ineffective portion of a derivative's change in fair value is recognized immediately in earnings.

        In connection with the Company's interest rate risk management, the Company periodically hedges a portion of its interest rate risk by entering into derivative financial instrument contracts. Specifically, the Company's derivative financial instruments are used to manage differences in the amount, timing, and duration of its expected cash receipts and its expected cash payments principally related to its investments and borrowings. The Company's objectives in using interest rate derivatives are to add stability to interest income and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. The Company has entered into various interest rate swap agreements to hedge its exposure to interest rate risk on (i) variable rate borrowings as it relates to fixed rate loans; (ii) the difference between the CDO investor return being based on the three-month LIBOR index while the supporting assets of the CDO are based on the one-month LIBOR index; and (iii) use of LIBOR rate caps in loan agreements.

        Derivative financial instruments must be effective in reducing the Company's interest rate risk exposure in order to qualify for hedge accounting. When the terms of an underlying transaction are modified, or when the underlying hedged item ceases to exist, all changes in the fair value of the instrument are marked-to-market with changes in value included in net income for each period until the derivative instrument matures or is settled. In cases where a derivative financial instrument is terminated early, any gain or loss is generally amortized over the remaining life of the hedged item. Any derivative instrument used for risk management that does not meet the hedging criteria is marked-to-market with the changes in value included in net income. The Company does not use derivatives for trading or speculative purposes.

        The following is a summary of the derivative financial instruments held by the Company as of December 31, 2011 and 2010 (dollars in thousands):

		Notional Value										Fair Value
Designation\Cash Flow	Derivative	Count		December 31, 2011		Count		December 31, 2010		Expiration Date	Balance Sheet Location	December 31, 2011			December 31, 2010
Non-Qualifying	Basis Swaps		9	$	854,079		9	$	1,056,851	2012 - 2015	Other Assets	$	1,563		$	1,306
Non-Qualifying	LIBOR Caps		2	$	13,000		1	$	7,000	2012 - 2013	Other Assets	$	1		$	12
Qualifying	LIBOR Cap		1	$	73,301		—	$	—	2013	Other Assets	$	1		$	—
Qualifying	Interest Rate Swaps		24	$	515,327		30	$	639,696	2012 - 2017	Other Liabilities	$	(45,890	)	$	(50,803	)

        The fair value of Non-Qualifying Basis Swap Hedges was $1.6 million and $1.3 million as of December 31, 2011 and 2010, respectively, and was recorded in other assets in the Consolidated Balance Sheets. These basis swaps are used to manage the Company's exposure to interest rate movements and other identified risks but do not meet hedge accounting requirements. The Company is exposed to changes in the fair value of certain of its fixed rate obligations due to changes in benchmark interest rates and uses interest rate swaps to manage its exposure to changes in fair value on these instruments attributable to changes in the benchmark interest rate. These interest rate swaps designated as fair value hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without the exchange of the underlying notional amount. The fair value of the Non-Qualifying LIBOR Cap Hedges was less than $0.1 million at December 31, 2011 and 2010, and was recorded in other assets in the Consolidated Balance Sheets. The Company entered into these hedges in the fourth quarter of 2010 and the first quarter of 2011 due to loan agreements which required LIBOR Caps of 1% to 2%. In addition, during the year ended December 31, 2011, the notional value on four basis swaps decreased by approximately $202.8 million pursuant to the contractual terms of the respective swap agreements. During the year ended December 31, 2010, the notional value of one basis swap decreased by approximately $4.9 million pursuant to the contractual terms of the swap agreement. For the years ended December 31, 2011, 2010 and 2009, the change in fair value of the Non-Qualifying Swaps was $0.2 million, $(0.7) million and $(5.2) million, respectively, and was recorded in interest expense on the Consolidated Statements of Operations.

        The fair value of Qualifying Interest Rate Swap Cash Flow Hedges as of December 31, 2011 and 2010 was $(45.9) million and $(50.8) million, respectively, and was recorded in other liabilities in the Consolidated Balance Sheets. The change in the fair value of Qualifying Interest Rate Swap Cash Flow Hedges was recorded in accumulated other comprehensive loss in the Consolidated Balance Sheets. These interest rate swaps are used to hedge the variable cash flows associated with existing variable-rate debt, and amounts reported in accumulated other comprehensive loss related to derivatives will be reclassified to interest expense as interest payments are made on the Company's variable-rate debt. During the year ended December 31, 2011, the Company entered into a LIBOR Cap with a notional value of approximately $73.3 million that qualifies as a cash flow hedge. The fair value of the Qualifying LIBOR Cap Hedge was less than $0.1 million at December 31, 2011 and was recorded in other assets in the Consolidated Balance Sheet. The Company entered into this hedge in the first quarter of 2011 due to a loan agreement which required a LIBOR Cap of 2%. In addition, during the year ended December 31, 2011, the notional values on two interest rate swaps decreased by approximately $14.2 million pursuant to the contractual terms of the respective swap agreements and six interest rate swaps matured with a combined notional value of approximately $111.3 million. During the year ended December 31, 2010, the Company entered into two new interest rate swaps that qualify as cash flow hedges with a combined notional value of approximately $7.5 million, the notional value on two interest rate swaps decreased by approximately $43.2 million pursuant to the contractual terms of the respective swap agreements, and six interest rate swaps matured with a combined notional value of approximately $34.9 million. As of December 31, 2011, the Company expects to reclassify approximately $(15.8) million of other comprehensive loss from Qualifying Cash Flow Hedges to interest expense over the next twelve months assuming interest rates on that date are held constant.

        Gains and losses on terminated swaps are being deferred and recognized in earnings over the original life of the hedged item. These swap agreements must be effective in reducing the variability of cash flows of the hedged items in order to qualify for the aforementioned hedge accounting treatment. As of December 31, 2011 and 2010, the Company has a net deferred loss of $2.9 million and $4.5 million, respectively, in accumulated other comprehensive loss. The Company recorded $1.8 million, $1.7 million and $1.1 million as additional interest expense related to the amortization of the loss for the years ended December 31, 2011, 2010 and 2009, respectively, and $0.2 million, $0.2 million and $0.3 million as a reduction to interest expense related to the accretion of the net gains for the years ended December 31, 2011, 2010 and 2009, respectively. The Company expects to record approximately $0.7 million of net deferred loss to interest expense over the next twelve months. The Company also recorded a loss of $8.7 million on the termination of the interest rate swaps related to the restructured trust preferred securities directly to loss on terminated swaps in 2009 as the interest rate swaps were determined to no longer be effective or necessary due to the modified interest payment structure of the newly issued unsecured junior subordinated notes.

        The following table presents the effect of the Company's derivative financial instruments on the Statements of Operations as of December 31, 2011, 2010 and 2009 (dollars in thousands):

		Amount of Gain or (Loss) Recognized in Other Comprehensive Loss (Effective Portion) For the Year Ended December 31,							Amount of Loss Reclassified from Accumulated Other Comprehensive Loss into Interest Expense (Effective Portion) For the Year Ended December 31,									Amount of Loss Reclassified from Accumulated Other Comprehensive Loss into Loss on Terminated Swaps (Ineffective Portion) For the Year Ended December 31,							Amount of Gain or (Loss) Recognized in Interest Expense (Ineffective Portion) For the Year Ended December 31,
Designation\Cash Flow	Derivative	2011		2010			2009		2011			2010			2009			2011		2010		2009			2011		2010			2009
Non-Qualifying	Basis Swaps / Caps	$	—	$	—		$	—	$	—		$	—		$	—		$	—	$	—	$	—		$	827	$	(94	)	$	2,538
Qualifying	Interest Rate Swaps / Cap	$	6,465	$	(1,956	)	$	43,276	$	(27,163	)	$	(30,949	)	$	(29,616	)	$	—	$	—	$	(8,730	)	$	—	$	—		$	—

        The cumulative amount of other comprehensive loss related to net unrealized losses on derivatives designated as Cash Flow Hedges as of December 31, 2011 and 2010 of approximately $(48.8) million and $(55.3) million, respectively, is a combination of the fair value of qualifying cash flow hedges of $(45.9) million and $(50.8) million, respectively, deferred losses on terminated interest swaps of $(3.7) million and $(5.5) million as of December 31, 2011 and 2010, respectively, and deferred net gains on termination of interest swaps of $0.8 million and $1.0 million as of December 31, 2011 and 2010, respectively.

        The Company has agreements with certain of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations. As of December 31, 2011 and 2010, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements, was $(22.0) million and $(21.1) million, respectively. As of December 31, 2011 and 2010, the Company had minimum collateral posting thresholds with certain of its derivative counterparties and had posted collateral of $21.9 million and $21.3 million, respectively, which is recorded in other assets in the Company's Consolidated Balance Sheets.