Accounting for Derivatives

12 Months Ended

Dec. 31, 2012

Accounting for Derivatives

Accounting for Derivatives

11.  Accounting for Derivatives

We are exposed to market risks primarily associated with changes in interest rates and foreign currency exchange rates. We use derivative financial instruments to minimize the risks and/or costs associated with financial activities by managing our exposure to interest rate fluctuations on a portion of our debt obligations. We also use derivative financial instruments to minimize the risks caused by currency fluctuations in certain foreign currencies. We do not use derivative financial instruments for trading or other speculative purposes.

Interest Rate Risk

At December 31, 2012, we were a party to interest rate swaps pursuant to which we make fixed payments and receive floating payments on a notional value of $250.0 million. We entered into these swaps to offset changes in expected cash flows due to fluctuations in the associated variable interest rates. Our interest rate swaps expire in November 2015. As of December 31, 2012, the weighted average effective fixed interest rate on our interest rate swaps was 1.8%. We have designated these interest rate swaps as cash flow hedging instruments so that any change in their fair values is recognized as a component of comprehensive income (loss) and is included in accumulated other comprehensive income (loss) to the extent the hedge is effective. The swap terms substantially coincide with the hedged item and are expected to offset changes in expected cash flows due to fluctuations in the variable rate, and therefore we currently do not expect a significant amount of ineffectiveness on these hedges. We perform quarterly calculations to determine whether the swap agreements are still effective and to calculate any ineffectiveness. For the years ended December 31, 2012 and 2011 there was no ineffectiveness related to interest rate swaps. We recorded approximately $0.2 million of interest expense for the year ended December 31, 2010, due to the ineffectiveness related to interest rate swaps. We estimate that $3.9 million of deferred pre-tax losses attributable to existing interest rate swaps and included in our accumulated other comprehensive income (loss) at December 31, 2012, will be reclassified into earnings as interest expense at then-current values during the next twelve months as the underlying hedged transactions occur. Cash flows from derivatives designated as hedges are classified in our consolidated statements of cash flows under the same category as the cash flows from the underlying assets, liabilities or anticipated transactions.

In the fourth quarter of 2010, we paid $43.0 million to terminate interest rate swap agreements with a total notional value of $585.0 million and a weighted average effective fixed interest rate of 4.6%. These swaps qualified for hedge accounting and were previously included on our balance sheet as a liability and in accumulated other comprehensive income (loss). The liability was paid in connection with the termination, and the associated amount in accumulated other comprehensive income (loss) is being amortized into interest expense over the original terms of the swaps. We estimate that $1.6 million of deferred pre-tax losses from these terminated interest rate swaps will be amortized into interest expense during the next twelve months.

Foreign Currency Exchange Risk

We operate in approximately 30 countries throughout the world, and a fluctuation in the value of the currencies of these countries relative to the U.S. dollar could impact our profits from international operations and the value of the net assets of our international operations when reported in U.S. dollars in our financial statements. From time to time we may enter into foreign currency hedges to reduce our foreign exchange risk associated with cash flows we will receive in a currency other than the functional currency of the local Exterran affiliate that entered into the contract. The impact of foreign currency exchange on our consolidated statements of operations will depend on the amount of our net asset and liability positions exposed to currency fluctuations in future periods.

Foreign currency swaps or forward contracts that meet the hedging requirements or that qualify for hedge accounting treatment are accounted for as cash flow hedges and changes in the fair value are recognized as a component of comprehensive income (loss) to the extent the hedge is effective. The amounts recognized as a component of other comprehensive income (loss) will be reclassified into earnings (loss) in the periods in which the underlying foreign currency exchange transaction is recognized and are included under the same category as the income or loss from the underlying assets, liabilities, or anticipated transactions in our consolidated statements of operations. For foreign currency swaps and forward contracts that do not qualify for hedge accounting treatment, changes in fair value and gains and losses on settlement are included under the same category as the income or loss from the underlying assets, liabilities or anticipated transactions in our consolidated statements of operations.

The following tables present the effect of derivative instruments on our consolidated financial position and results of operations (in thousands). The impacts to other comprehensive income (loss) and accumulated other comprehensive (income) loss on derivatives disclosed below are presented net of tax:

	December 31, 2012
	Balance Sheet Location	Fair ValueAsset (Liability)
Derivatives designated as hedging instruments:
Interest rate hedges	Accrued liabilities	$	(3,873	)
Interest rate hedges	Other long-term liabilities	(6,043		)
Total derivatives		$	(9,916	)

	December 31, 2011
	Balance Sheet Location	Fair ValueAsset (Liability)
Derivatives designated as hedging instruments:
Interest rate hedges	Accrued liabilities	$	(14,250	)
Interest rate hedges	Other long-term liabilities	(5,196		)
Total derivatives		$	(19,446	)

	Year Ended December 31, 2012
				Location of Gain (Loss)	Gain (Loss)
	Gain (Loss)			Reclassified from	Reclassified from
	Recognized in Other			Accumulated Other	Accumulated Other
	Comprehensive			Comprehensive	Comprehensive
	Income (Loss) on			Income (loss)	Income (loss)
	Derivatives			into Income (Loss)	into Income (Loss)
Derivatives designated as cash flow hedges:
Interest rate hedges	$	(13,458	)	Interest expense	$	(26,284	)

	Year Ended December 31, 2011
				Location of Gain (Loss)	Gain (Loss)
	Gain (Loss)			Reclassified from	Reclassified from
	Recognized in Other			Accumulated Other	Accumulated Other
	Comprehensive			Comprehensive	Comprehensive
	Income (Loss) on			Income (loss)	Income (loss)
	Derivatives			into Income (Loss)	into Income (Loss)
Derivatives designated as cash flow hedges:
Interest rate hedges	$	(29,178	)	Interest expense	$	(47,729	)
Foreign currency hedge	—			Fabrication revenue	410
Total	$	(29,178	)		$	(47,319	)

	Year Ended December 31, 2010
				Location of Gain (Loss)	Gain (Loss)
	Gain (Loss)			Reclassified from	Reclassified from
	Recognized in Other			Accumulated Other	Accumulated Other
	Comprehensive			Comprehensive	Comprehensive
	Income (Loss) on			Income (loss)	Income (loss)
	Derivatives			into Income (Loss)	into Income (Loss)
Derivatives designated as cash flow hedges:
Interest rate hedges	$	(44,558	)	Interest expense	$	(55,771	)
Foreign currency hedge	(3,880		)	Fabrication revenue	(3,470		)
Total	$	(48,438	)		$	(59,241	)

The counterparties to our derivative agreements are major international financial institutions. We monitor the credit quality of these financial institutions and do not expect non-performance by any counterparty, although such non-performance could have a material adverse effect on us. We have no specific collateral posted for our derivative instruments. The counterparties to our interest rate swaps are also lenders under our credit facilities and, in that capacity, share proportionally in the collateral pledged under the related facility.