Derivative Financial Instruments

6 Months Ended

Jun. 30, 2011

Derivative Financial Instruments

Derivative Financial Instruments

Note 8 — Derivative Financial Instruments

Interest Rate Swap Agreements

In the fourth quarter 2010, we entered into an agreement to swap $98 million of a floating rate obligation for a fixed rate obligation at an average of 1.03% against LIBOR in U.S. dollars.  The swap is scheduled to mature on March 31, 2014, and was accounted for as a cash flow hedge of our floating rate bank loan. To ensure the swap was highly effective, all the principal terms of the swap matched the terms of the bank loan.  The fair value of the interest rate swap was a liability of $0.2 million at June 30, 2011 and an asset of $0.7 million at December 31, 2010.

Cross — Currency Interest Rate Swap Agreement

In September 2006, we entered into a cross-currency interest rate swap agreement to hedge a portion of our net Euro investment in Hexcel SASU (France).  This agreement is accounted for as a hedge of the foreign currency exposure of a net investment in a foreign operation and to the extent it is effective, gains and losses are recorded as an offset in the cumulative translation account (“CTA”), the same account in which translation gains and losses on the investment in Hexcel SASU are recorded.  All other changes, including any difference in current interest, are excluded from the assessment of effectiveness and are included in operating income as a component of interest expense.  The agreement has a notional value of $63.4 million, a term of five years, and is scheduled to mature on September 20, 2011.  We receive interest in U.S. dollars quarterly and pay interest in Euros on the same day.  U.S. interest is based on the three month LIBOR.  Euro interest is based on the three month EURIBOR.  The fair value of the swap at June 30, 2011 and December 31, 2010 was a liability of $8.5 million and $3.0 million, respectively.  Net credits to interest expense of $0.2 million related to the excluded portion of the derivative were recorded in the second quarter of 2011.  A net credit to interest expense of $0.2 million and a net charge to interest expense of $0.3 million related to the excluded portion of the derivative were recorded in the first six months of 2011 and 2010, respectively.  Net charges to interest expense of $0.2 million and $0.1 million related to the interest coupons were recorded during the second quarters of 2011 and 2010, respectively.  Net charges to interest expense of $0.3 million and $0.2 million related to the interest coupons were recorded during the first six months of 2011 and 2010, respectively.  The net amount of losses included in the CTA adjustment during the second quarter and six-month period of 2011 was $1.5 million and $6.8 million, respectively.  The net amount of gains included in the CTA adjustment during the second quarter and six-month period of 2010 were $6.2 million and $10.6 million, respectively.  The impact of applying prescribed credit risk adjustments was immaterial.

Foreign Currency Forward Exchange Contracts

A number of our European subsidiaries are exposed to the impact of exchange rate volatility between the U.S. dollar and the subsidiaries’ functional currencies, being either the Euro or the British Pound Sterling.  We entered into contracts to exchange U.S. dollars for Euros and British Pound Sterling through December 2013.  The aggregate notional amount of these contracts was $122.0 million and $124.2 million at June 30, 2011 and December 31, 2010, respectively.  The purpose of these contracts is to hedge a portion of the forecasted transactions of European subsidiaries under long-term sales contracts with certain customers.  These contracts are expected to provide us with a more balanced matching of future cash receipts by currency, thereby reducing our exposure to fluctuations in currency exchange rates.  These forward contracts are designated as cash flow hedges of forecasted revenues.  The effective portion of the hedges, gains of $2.7 million and $7.5 million, were recorded in other comprehensive income (“OCI”) for the three months and six months ended June 30, 2011, respectively, and losses of $5.2 million and $10.9 million for the three- and six-month periods ended June 30, 2010, respectively.  We excluded the forward points from the effectiveness assessment and recorded them as a reduction to interest expense of $0.3 million for the quarter and an increase to interest expense of $0.2 million for the six months ended June 30, 2011, and a reduction to interest expense of $0.3 million for the six months ended June 30, 2010. The carrying amount of these contracts was $5.9 million classified as other assets and $0.2 million classified in other liabilities on the Consolidated Balance Sheet at June 30, 2011 and $2.3 million in other assets and $2.6 million classified in other liabilities at December 31, 2010.  During the three months ended June 30, 2011 and 2010, we recognized net gains of $1.8 million and net losses of $2.6 million, respectively, recorded in sales and cost of sales.  During the six months ended June 30, 2011 and 2010, we recognized net gains of $1.3 million and net losses of $4.1 million, respectively, recorded in sales and cost of sales.

In addition, we enter into foreign exchange forward contracts which are not designated as hedges.  These are used to provide an offset to transactional gains or losses arising from the remeasurement of non-functional monetary assets and liabilities, such as accounts receivable.  The change in the fair value of the derivatives is recorded in the statement of operations.  There are no credit contingency features in these derivatives.  During the quarters ended June 30, 2011 and 2010, we recognized net foreign exchange gains of $2.7 million and net foreign exchange losses of $4.8 million, respectively, in the Consolidated Statements of Operations.  During the six-month periods ended June 30, 2011 and 2010, we recognized net foreign exchange gains of $7.7 million and net foreign exchange losses of $7.7 million respectively, in the Consolidated Statements of Operations.  Asset and liability derivatives not designated as hedging instruments were not material.

The change in fair value of our foreign currency forward exchange contracts under hedge designations recorded, net of tax, within accumulated other comprehensive income for the quarters and six months ended June 30, 2011 and 2010 was as follows:

	Quarter Ended June 30,						Six Months Ended June 30,
(In millions)	2011			2010			2011			2010
Unrealized gains (losses) at beginning of period, net of tax	$	3.8		$	(4.5	)	$	(0.2	)	$	(1.4	)
(Gains) losses reclassified to net sales	(1.5		)	2.0			(1.1		)	3.1
Increase (decrease) in fair value	2.4			(4.2		)	6.0			(8.4		)
Unrealized gains (losses) at end of period, net of tax	$	4.7		$	(6.7	)	$	4.7		$	(6.7	)

As of June 30, 2011, unrealized gains recorded in “accumulated other comprehensive income,” net of tax, were $4.7 million, of which $3.4 million are expected to be reclassified into earnings over the next twelve months as the hedged sales are recorded.