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Interest Rate Contracts
9 Months Ended
Sep. 30, 2012
Interest Rate Contracts [Abstract]  
Interest Rate Contracts
Interest Rate Contracts

Cash Flow Hedges of Interest Rate Risk

We manage our interest rate risk associated with floating-rate borrowings by obtaining interest rate swap and interest rate cap contracts. Our objective in using derivatives is to add stability to interest expense and to manage our exposure to interest rate movements or other identified risks. To accomplish this objective, we primarily use interest rate swaps as part of our cash flow hedging strategy to convert our floating-rate debt to a fixed-rate basis, thus reducing the impact of interest rate changes on future interest expense and cash flows. These agreements involve the receipt of floating-rate amounts in exchange for fixed-rate interest payments over the life of the agreements without an exchange of the underlying principal amount. In limited instances, we use interest rate caps to limit our exposure to interest rate increases on an underlying floating-rate debt instrument. We may enter into derivative contracts that are intended to hedge certain economic risks, even though hedge accounting does not apply, or for which we elect to not apply hedge accounting. We do not use any other derivative instruments.

As of September 30, 2012, the totals of our existing swaps that qualified as highly effective cash flow hedges were as follows:

Interest Rate Derivative
 
Number of Instruments
 
Notional (in thousands)
Interest Rate Swaps
 
9
 
$2,168,080
Interest Rate Caps
 
2
 
$111,920


Non-designated Hedges

Derivatives not designated as hedges are not speculative. As of September 30, 2012, we had the following outstanding interest rate derivatives that were not designated for accounting purposes as hedging instruments, but were used to hedge our economic exposure to interest rate risk:

Interest Rate Derivative
 
Number of Instruments
 
Notional (in thousands)
Purchased Caps
 
4
 
$100,000
 
 
 
 
 


Credit-risk-related Contingent Features

We have agreements with each of our derivative counterparties that contain a provision under which we could also be declared in default on our derivative obligations if we default on any of our indebtedness, including any default where repayment of the indebtedness has not been accelerated by the lender.  We have agreements with certain of our derivative counterparties that contain a provision under which, if we fail to maintain a minimum cash and cash equivalents balance of $1.0 million, then the derivative counterparty would have the right to terminate the derivative.  There have been no events of default on any of our derivatives.

As of September 30, 2012, the fair value of derivatives in a net liability position, when aggregated by counterparty, was $118.4 million, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements.

Accounting for Interest Rate Contracts

Hedge accounting generally provides for the timing of gain or loss recognition on the hedging instrument to match the earnings effect of the hedged forecasted transactions in a cash flow hedge. All other changes in fair value, with the exception of hedge ineffectiveness, are recorded in accumulated other comprehensive income (loss) (AOCI), which is a component of equity outside of earnings. Amounts reported in AOCI related to derivatives designated as accounting hedges will be reclassified to interest expense as interest payments are made on our hedged variable-rate debt. The ineffective portion of changes in the fair value of the derivative is recognized directly in earnings as interest expense. We assess the effectiveness of each hedging relationship by comparing the changes in fair value or cash flows of the derivative hedging instrument with the changes in fair value or cash flows of the designated hedged item or transaction. For derivatives not designated as hedges, changes in fair value are recognized directly in earnings as interest expense.

For derivatives designated as cash flow hedges, we estimate an additional $38.0 million will be reclassified within the next 12 months from AOCI to interest expense as an increase to interest expense.

The following table represents the effect of derivative instruments on our consolidated statements of operations (in thousands) for the nine months ended September 30:

 
2012
 
2011
Derivatives Designated as Cash Flow Hedges:
 
 
 
Amount of gain (loss) recognized in other comprehensive income (OCI) on derivatives (effective portion)
$
(44,271
)
 
$
(107,568
)
Amount of gain (loss) reclassified from AOCI into earnings under "interest expense" (effective portion) (1) 
$
(44,066
)
 
$
(64,370
)
Amount of gain (loss) on derivatives recognized in earnings under "interest expense" (ineffective portion and amount excluded from effectiveness testing)
$
(38
)
 
$
50

Derivatives Not Designated as Cash Flow Hedges:
 

 
 

Amount of realized and unrealized gain (loss) on derivatives recognized in earnings under "interest expense"
$
(37
)
 
$
(253
)

(1)
The nine months ended September 30, 2012 and 2011 includes a non-cash expense of $8.8 million and $10.4 million, respectively, related to the amortization of accumulated other comprehensive income balances on previously terminated swaps.

Fair Value Measurement

We record all derivatives on the balance sheet at fair value, using the framework for measuring fair value established by the FASB.  The fair value of these hedges is obtained through independent third-party valuation sources that use conventional valuation algorithms.  The following table represents the fair values of derivative instruments (in thousands) as of:
 
 
September 30, 2012
 
December 31, 2011
Derivative assets disclosed as "Interest Rate Contracts":
 
 
 
Derivatives designated as accounting hedges
$

 
$
55

Derivatives not designated as accounting hedges
9

 
644

Total derivative assets
$
9

 
$
699

Derivative liabilities disclosed as "Interest Rate Contracts":
 

 
 

Derivatives designated as accounting hedges
$
110,994

 
$
97,774

Derivatives not designated as accounting hedges

 
643

Total derivative liabilities
$
110,994

 
$
98,417



The FASB fair value framework includes a hierarchy that distinguishes between assumptions based on market data obtained from sources independent of the reporting entity and the reporting entity’s own assumptions about market-based inputs.  Level 1 inputs utilize unadjusted quoted prices in active markets for identical assets or liabilities.  Level 2 inputs are observable either directly or indirectly for similar assets and liabilities in active markets.  Level 3 inputs are unobservable assumptions generated by the reporting entity.

The valuation of our interest rate swaps and caps is 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 and implied volatilities.  We incorporate credit valuation adjustments to appropriately reflect both our own 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 considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts and guarantees.  We have determined that our derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.  We did not have any fair value measurements using significant unobservable inputs (Level 3) as of September 30, 2012.

The table below presents the derivative assets and liabilities presented in our financial statements at their estimated fair value on a gross basis as of September 30, 2012 without reflecting any net settlement positions with the same counterparty (in thousands):
 
September 30, 2012
 
Assets
 
Liabilities
Quoted Prices in Active Markets for Identical Assets and Liabilities (Level 1)
$

 
$

Significant Other Observable Inputs (Level 2)
9

 
110,994

Significant Unobservable Inputs (Level 3)

 

Fair Value of Interest Rate Contracts
$
9

 
$
110,994