10. Derivative Financial Instruments
Interest Rate Caps
In April 2011, the Company entered into interest rate cap agreements for an aggregate notional amount of $600 million in order to hedge the variability of cash flows related to a portion of the Company’s floating rate indebtedness. These cap agreements, effective in March 2012, hedge a portion of contractual floating rate interest commitments through the expiration of the agreements in March 2013. Pursuant to the agreements, the Company has capped LIBOR at 3.5% with respect to the aggregate notional amount of $600 million. In the event LIBOR exceeds 3.5% the Company will pay interest at the capped rate. In the event LIBOR is less than 3.5%, the Company will pay interest at the prevailing LIBOR. In fiscal 2012, the Company paid interest under the Term Loan at the prevailing LIBOR.
Interest Rate Swaps
In April 2011, the Company entered into floating-to-fixed interest rate swap agreements for an initial aggregate notional amount of $600 million to limit exposure to interest rate increases related to a portion of the Company’s floating rate indebtedness once the Company’s interest rate cap agreements expire. These swap agreements, effective March 2013, hedge a portion of contractual floating rate interest commitments through the expiration of the agreements in March 2016. As a result of the agreements, the Company’s effective fixed interest rate on the notional amount of floating rate indebtedness will be 3.56% plus the then applicable margin.
Fair Value
As of the effective date, the Company designated the interest rate cap and interest rate swap agreements as cash flow hedges. As cash flow hedges, unrealized gains are recognized as assets while unrealized losses are recognized as liabilities. The interest rate cap and interest rate swap agreements are highly correlated to the changes in interest rates to which the Company is exposed. Unrealized gains and losses on these instruments are designated as effective or ineffective. The effective portion of such gains or losses is recorded as a component of accumulated other comprehensive income or loss, while the ineffective portion of such gains or losses will be recorded as a component of interest expense. Future realized gains and losses in connection with each required interest payment will be reclassified from accumulated other comprehensive income or loss to interest expense.
The fair values of the interest rate cap and swap agreements are estimated using industry standard valuation models using market-based observable inputs, including interest rate curves (level 2). A summary of the recorded assets (liabilities) included in the condensed consolidated balance sheet is as follows:
| February 2, 2013 |
January 28, 2012 |
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Interest rate caps (included in other assets) |
$ | — | $ | 6 | ||||
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Interest rate swaps (included in other liabilities) |
$ | (33,266 | ) | $ | (30,358 | ) | ||
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Accumulated other comprehensive loss, net of tax |
$ | 20,189 | $ | 18,963 | ||||
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A rollforward of the accumulated other comprehensive loss, net of tax recorded is as follows:
| February 2, 2013 |
January 28, 2012 |
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Accumulated other comprehensive loss, net of tax at the beginning of the year |
$ | (18,963 | ) | $ | — | |||
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Unrealized loss on cash flow hedge, net of tax |
(1,777 | ) | (18,963 | ) | ||||
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Reclassifications to interest expense, net |
551 | — | ||||||
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Accumulated other comprehensive loss, net of tax at the end of the year |
$ | (20,189 | ) | $ | (18,963 | ) | ||
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With respect to its interest rate swaps, the Company expects to reclassify unrealized losses of approximately $7 million, net of tax, previously recorded in accumulated other comprehensive loss, thereby increasing interest expense by $12 million in its Consolidated Statement of Operations and Comprehensive Income (Loss) in fiscal 2013.