Derivative Financial Instruments

9 Months Ended

Sep. 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 $0.9 million at September 30, 2011 and an asset of $0.7 million at December 31, 2010.

Cross — Currency Interest Rate Swap Agreement

In September 2011, our cross-currency interest rate swap agreement to hedge a portion of our net Euro investment in Hexcel SASU (France) matured, resulting in a $5.2 million payment.  This agreement was accounted for as a hedge of the foreign currency exposure of a net investment in a foreign operation and to the extent it was effective, gains and losses were 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 were recorded.  All other changes, including any difference in current interest, were excluded from the assessment of effectiveness and were included in operating income as a component of interest expense.  We received interest in U.S. dollars quarterly and paid interest in Euros on the same day.  U.S. interest was based on the three month LIBOR.  Euro interest was based on the three month EURIBOR.  The fair value of the swap at December 31, 2010 was a liability of $3.0 million.  A net impact to interest expense related to the excluded portion of the derivative recorded in the third quarter of 2011 and 2010 was not material.  A net credit to interest expense of $0.2 million and a net charge to interest expense of $0.2 million related to the excluded portion of the derivative were recorded in the first nine 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 third quarters of 2011 and 2010, respectively.  Net charges to interest expense of $0.6 million and $0.2 million related to the interest coupons were recorded during the first nine months of 2011 and 2010, respectively.  The net amounts included in the CTA adjustments during the third quarter and nine-month period of 2011 were a gain of $3.3 million and a loss of $10.1 million, respectively.  The net amounts included in the CTA adjustment during the third quarter and nine-month period of 2010 were losses of $7.0 million and gains of $3.6 million, respectively.

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 March 2014.  The aggregate notional amount of these contracts was $133.5 million and $124.2 million at September 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, losses of $5.2 million and gains of $2.2 million, were recorded in other comprehensive income (“OCI”) for the three months and nine months ended September 30, 2011, respectively, and gains of $10.0 million and losses of $0.9 million for the three and nine-month periods ended September 30, 2010, respectively.  We excluded the forward points from the effectiveness assessment and recorded them as a reduction of interest expense of $0.9 million for the quarter and $0.8 million for the nine months ended September 30, 2011, and an increase to interest expense of $0.6 million and $0.4 million for the quarter and nine months ended September 30, 2010. The carrying amount of these contracts was $2.0 million classified as other assets and $2.4 million classified in other liabilities on the Consolidated Balance Sheet at September 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 September 30, 2011 and 2010, we recognized net gains of $1.7 million and net losses of $1.4 million, respectively, recorded in sales and cost of sales.  During the nine months ended September 30, 2011 and 2010, we recognized net gains of $2.9 million and net losses of $5.5 million, respectively, recorded in sales and cost of sales.

In addition, we enter into foreign exchange forward contracts which are not designated as hedges.  The change in the fair value of the derivatives is recorded in the statement of operations. 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.  There are no credit contingency features in these derivatives.  During the quarters ended September 30, 2011 and 2010, we recognized net foreign exchange losses of $6.5 million and foreign exchange gains of $9.3 million, respectively, in the Consolidated Statements of Operations; which primarily offset the transactional gains or losses arising from the remeasurement of non-functional monetary assets and liabilities.  During the nine-month periods ended September 30, 2011 and 2010, we recognized net foreign exchange gains of $1.2 million and $1.6 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 nine months ended September 30, 2011 and 2010 was as follows:

	Quarter Ended September 30,						Nine Months Ended September 30,
(In millions)	2011			2010			2011			2010
Unrealized gains (losses) at beginning of period, net of tax	$	4.7		$	(6.7	)	$	(0.2	)	$	(1.4	)
(Gains) losses reclassified to net sales	(1.1		)	1.1			(2.2		)	4.2
Increase (decrease) in fair value	(4.3		)	7.6			1.7			(0.8		)
Unrealized gains (losses) at end of period, net of tax	$	(0.7	)	$	2.0		$	(0.7	)	$	2.0

As of September 30, 2011, unrealized losses recorded in “accumulated other comprehensive income,” net of tax, were $0.7 million, of which $0.1 million are expected to be reclassified into earnings over the next twelve months as the hedged sales are recorded.