Derivative Financial Instruments

6 Months Ended

Jun. 30, 2013

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Financial Instruments

Derivative Financial Instruments

The Company has floating rate long-term debt (see Note 6 - Long-Term Debt). Such debt exposes the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense also generally decreases. The Company uses interest rate swaps in an attempt to manage its exposure to fluctuations in interest rate movements. The Company’s primary objective in managing interest rate risk is to decrease the volatility of its earnings and cash flows affected by changes in the underlying rates. The Company does not use derivative financial instruments for speculative purposes.

In March 2007, Level 3 Financing, Inc. entered into two interest rate swap agreements to hedge the interest payments on $1 billion notional amount of floating rate debt. The Company had designated these interest rate swap agreements as cash flow hedges. The two interest rate swap agreements are with different counterparties and are for $500 million each. The arrangements began in April 2007 and mature in January 2014. Under the terms of these arrangements, the Company receives interest payments based on rolling three month LIBOR terms and pays interest at the fixed rate of 4.93% under one arrangement and approximately 4.92% under the other.

Interest Rate Derivative	Number of Instruments	Notional (dollars in millions)
Interest rate swaps	Two	$	1,000

On a quarterly basis through August 6, 2012, the Company evaluated the effectiveness of the hedges by measuring the extent to which the change in the variable portion of the interest rate swaps offset the changes in interest expense paid due to fluctuations in the LIBOR-based interest rate. Prior to August 6, 2012, these derivatives were deemed effective cash flow hedges and hedge ineffectiveness was not material in any periods presented. As a result, the change in the fair value of the interest rate swap agreements was reflected in Accumulated Other Comprehensive Income ("AOCI") and was subsequently reclassified into earnings through an interest expense yield adjustment, as interest expense on the hedged debt obligation was incurred.

As a result of the refinancing of the Tranche A Term Loan on August 6, 2012, the two interest rate swap agreements maturing in early 2014 that had effectively hedged changes in the interest rate on a portion of the Tranche A Term Loan were deemed "ineffective" under GAAP and cash flow hedge accounting was discontinued. After August 6, 2012, the Company has recorded the change in the fair value of the swaps in Other Income in its Consolidated Statement of Operations until maturity of the swaps in early 2014. For the three and six months ended June 30, 2013, the Company recognized a loss of $1 million, in Other, net in the Company's Consolidated Statement of Operations.

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the consolidated balance sheets (dollars in millions):

	Liability Derivatives
	June 30, 2013			December 31, 2012
Derivatives not designated as hedging instruments	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Interest rate swap agreements	Other current liabilities	$	34	Other non-current liabilities	$	56

The amount of net gains (losses) recognized in Accumulated Other Comprehensive Income (Loss), including reclassification gains (losses) consists of the following (dollars in millions):

Derivatives designated as hedging instruments	2013		2012
Cash flow hedging contracts
Three Months Ended June 30,	$	—	$	9
Six Months Ended June 30,	$	—	$	16

The amount of gains (losses) reclassified from Accumulated Other Comprehensive Income (Loss) to earnings (effective portions) consists of the following (dollars in millions):

Derivatives designated as hedging instruments	Statement of Operations Location	2013		2012
Cash flow hedging contracts
Three Months Ended June 30,	Interest Expense	$	—	$	(11	)
Six Months Ended June 30,	Interest Expense	$	—	$	(22	)

The Company is exposed to credit related losses in the event of non-performance by counterparties. The counterparties to the financial derivatives the Company has entered into are major institutions with investment grade credit ratings. The Company evaluates counterparty credit risk before entering into any hedge transaction and continues to closely monitor the financial market and the risk that its counterparties will default on their obligations. This credit risk is generally limited to the unrealized gains in such contracts, should any of these counterparties fail to perform as contracted.