Windstream 2008 Annual Report Download - page 133

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies and Changes, Continued:
Derivative Instruments – SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as
amended, provides guidance on accounting for derivatives, including interest rate swaps. In addition, SFAS
No. 133 governs when a derivative or other financial instrument can be designated as a hedge, and requires
recognition of all derivative instruments at fair value. Accounting for the changes in fair value depends on
whether the derivative has been designated as, qualifies as and is effective as a hedge. Changes in fair value of the
effective portions of hedges should be recorded as a component of other comprehensive income in the current
period. Changes in fair values of the derivative instruments not qualifying as hedges, or of any ineffective portion
of hedges, should be recognized in earnings in the current period.
On July 17, 2006, in conjunction with issuing debt, Windstream entered into four identical pay fixed, receive
variable interest rate swap agreements totaling $1,600.0 million in notional value in order to mitigate the interest
rate risk inherent in its variable rate senior secured credit facilities. The four interest rate swap agreements
amortize quarterly to a notional value of $906.3 million at maturity on July 17, 2013. The variable rate received
resets on the seventeenth day of each quarter to the three-month LIBOR (London-Interbank Offered Rate). The
Company’s interest rate swap agreements are designated as cash flow hedges of the interest rate risk created by
the variable interest rate paid on Tranche B of the senior secured credit facilities, which matures on July 17, 2013.
The variable interest rate paid on Tranche B is based on the three-month LIBOR, and it also resets on the
seventeenth day of each quarter.
After the completion of a refinancing transaction in February 2007, a portion of one of the four interest rate swap
agreements with a notional value of $125.0 million ($105.0 million as of December 31, 2008) was de-designated
as the corresponding hedged item was repaid. Therefore, the undesignated portion of the swap agreement was no
longer an effective hedge of the variable interest rate paid on Tranche B.
Set forth below is information related to the Company’s interest rate swap agreements as of December 31:
(Millions, except for percentages) 2008 2007
Unamortized notional value:
Designated portion $ 1,176.2 $ 1,296.7
Undesignated portion $ 105.0 $ 115.8
Fair value of interest rate swap agreements (see Note 6):
Designated portion $ (144.8) $ (80.4)
Undesignated portion $ (8.6) $ (2.8)
Weighted average fixed rate paid 5.60% 5.60%
Variable rate received 4.55% 5.21%
The effectiveness of the Company’s cash flow hedges is assessed each quarter using the “Change in Variable Cash
Flow Method”, or Method 1, described in Derivatives Implementation Group (“DIG”) Issue No. G7, “Cash Flow
Hedges: Measuring the Ineffectiveness of a Cash Flow Hedge under Paragraph 30(b) When the Shortcut Method
Is Not Applied”. Method 1 utilizes the matched terms principle of measuring effectiveness, and requires the
floating-rate leg of the swap and the hedged variable cash flows of the asset or liability to be based on the same
interest rate index. It also requires the variable interest rates of both instruments to reset on the same dates.
Furthermore, there should be no other differences in the terms of the hedge and the hedged item, and the
likelihood of default by the interest rate swap counterparties must be assessed as being unlikely in order to
conclude that there is no ineffectiveness in the hedging relationship. The Company performs and documents this
assessment under Method 1 each quarter, and it concluded at December 31, 2008 that there was no ineffectiveness
to be recognized in earnings in any of its four interest rate swap agreements that are designated as hedges.
In accordance with SFAS No. 133, the Company recognizes all derivative instruments at fair value in the
accompanying consolidated balance sheets as either assets or liabilities depending on the rights or obligations
under the related contracts. Changes in the fair value of the effective portion of these derivative instruments were
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