filings.toolsItem 7A. Quantitative and Qualitative Disclosures About Market Risk
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to various market risks, including the potential loss arising from adverse changes in interest rates and foreign currency exchange rates, specifically the GBP. We use derivative financial instruments in the normal course of business to mitigate interest rate and foreign currency risk. We do not use derivative financial instruments for speculative or trading purposes. Derivatives are recorded on the consolidated balance sheets at fair value (see Note 24 to the Consolidated Financial Statements).
To illustrate the effect of movements in the interest rate and foreign currency markets, we performed a market sensitivity analysis on our hedging instruments. We applied various basis point spreads to the underlying interest rate curves and foreign currency exchange rates of the derivative portfolio in order to determine the change in fair value. Assuming a one percentage point change in the underlying interest rate curve and foreign currency exchange rates, the estimated change in fair value of each of the underlying derivative instruments would not exceed $6 million. See Note 24 to the Consolidated Financial Statements for additional analysis details.
Interest Rate Risk
At December 31, 2015, we are exposed to market risks related to fluctuations in interest rates primarily on variable rate debt, which has been predominately hedged through interest rate swap contracts.
Interest rate fluctuations will generally not affect our future earnings or cash flows on our fixed rate debt and assets until their maturity or earlier prepayment and refinancing. If interest rates have risen at the time we seek to refinance our fixed rate debt, whether at maturity or otherwise, our future earnings and cash flows could adversely be affected by additional borrowing costs. Conversely, lower interest rates at the time of refinancing may reduce our overall borrowing costs. However, interest rate changes will affect the fair value of our fixed rate instruments. Conversely, changes in interest rates on variable rate debt and investments would change our future earnings and cash flows, but not significantly affect the fair value of those instruments. Assuming a one percentage point increase in the interest rate related to the variable-rate debt and variable-rate investments, and assuming no other changes in the outstanding balance as of December 31, 2015, our annual interest expense would increase by approximately $3 million, or less than $0.01 per common share on a diluted basis.
Foreign Currency Exchange Rate Risk
At December 31, 2015, our exposure to foreign currencies primarily relates to U.K. investments in leased real estate, senior notes and related GBP denominated cash flows. Our foreign currency exposure is partially mitigated through the use of GBP denominated borrowings and foreign currency swap contracts. Based solely on our operating results for the three months ended December 31, 2015, including the impact of existing hedging arrangements, if the value of the GBP relative to the U.S. dollar were to increase or decrease by 10% compared to the average exchange rate during the quarter ended December 31, 2015, our cash flows would have decreased or increased, as applicable, by less than $1 million.
Market Risk
We have investments in marketable debt securities classified as held-to-maturity because we have the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are recorded at amortized cost and adjusted for the amortization of premiums and discounts through maturity. We consider a variety of factors in evaluating an other-than-temporary decline in value, such as: the length of time and the extent to which the market value has been less than our current adjusted carrying value; the issuer’s financial condition, capital strength and near-term prospects; any recent events specific to that issuer and economic conditions of its industry; and our investment horizon in relationship to an anticipated near-term recovery in the market value, if any. At December 31, 2015, both the fair value and carrying value of marketable debt securities were $103 million.
The principal amount and the average interest rates for our loans receivable and debt categorized by maturity dates is presented in the table below. The fair value for our senior unsecured notes payable is based on prevailing market prices. The fair value estimates for loans receivable and mortgage debt payable are based on discounting future cash flows utilizing current rates for loans and debt of the same type and remaining maturity.
The table below summarizes the principal amounts and fair values of our financial instruments exposed to interest rate risk (dollars in thousands):
| Maturity | |||||||||||||||||||||||||
| 2016 | 2017 | 2018 | 2019 | 2020 | Thereafter | Total | Fair Value | ||||||||||||||||||
| Assets: | |||||||||||||||||||||||||
| Loans receivable (USD) | $ | 15,244 | $ | 37,038 | $ | 276,789 | $ | — | $ | — | $ | — | $ | 329,071 | $ | 330,380 | |||||||||
| Weighted average interest rate | 8.50 | % | 8.50 | % | 11.23 | % | — | % | — | % | — | % | 10.79 | % | |||||||||||
| Loans receivable (GBP)(1) | $ | — | $ | 42,253 | $ | — | $ | 397,419 | $ | — | $ | — | $ | 439,672 | $ | 439,672 | |||||||||
| Weighted average interest rate | — | % | 6.00 | % | — | % | 7.56 | % | — | % | — | % | 7.41 | % | |||||||||||
| Debt securities held to maturity (USD) | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 17,776 | $ | 17,776 | $ | 17,776 | |||||||||
| Weighted average interest rate | — | % | — | % | — | % | — | % | — | % | 4.43 | % | 4.43 | % | |||||||||||
| Debt securities held to maturity (GBP)(2) | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 85,182 | $ | 85,182 | $ | 85,182 | |||||||||
| Weighted average interest rate | — | % | — | % | — | % | — | % | — | % | 12.25 | % | 12.25 | % | |||||||||||
| Liabilities(3): | |||||||||||||||||||||||||
| Variable rate debt: | |||||||||||||||||||||||||
| Line of credit (GBP)(4) | $ | — | $ | — | $ | 397,432 | $ | — | $ | — | $ | — | $ | 397,432 | $ | 397,432 | |||||||||
| Weighted average interest rate | — | % | — | % | 1.72 | % | — | % | — | % | — | % | 1.72 | % | |||||||||||
| Term loans (GBP)(5) | $ | 202,034 | $ | — | $ | — | $ | 324,434 | $ | — | $ | — | $ | 526,468 | $ | 526,468 | |||||||||
| Weighted average interest rate | 1.71 | % | — | % | — | % | 1.48 | % | — | % | — | % | 1.57 | % | |||||||||||
| Mortgage debt payable (USD) | $ | 25,102 | $ | — | $ | — | $ | — | $ | — | $ | 45,610 | $ | 70,712 | $ | 74,433 | |||||||||
| Weighted average interest rate | 1.69 | % | — | % | — | % | — | % | — | % | 0.03 | % | 0.62 | % | |||||||||||
| Fixed rate debt: | |||||||||||||||||||||||||
| Senior unsecured notes payable (USD)(6) | $ | 900,000 | $ | 750,000 | $ | 600,000 | $ | 450,000 | $ | 800,000 | $ | 5,700,000 | $ | 9,200,000 | $ | 9,390,668 | |||||||||
| Weighted average interest rate | 4.88 | % | 5.88 | % | 6.70 | % | 3.75 | % | 2.63 | % | 4.36 | % | 4.50 | % | |||||||||||
| Mortgage debt payable (USD) | $ | 238,711 | $ | 593,569 | $ | 4,870 | $ | — | $ | 931 | $ | 24,117 | $ | 862,198 | $ | 890,735 | |||||||||
| Weighted average interest rate | 6.50 | % | 5.69 | % | 5.90 | % | — | % | 5.75 | % | 5.87 | % | 5.92 | % | |||||||||||
| Interest rate derivatives assets | |||||||||||||||||||||||||
| (liabilities): | |||||||||||||||||||||||||
| Variable rate mortgage debt: | |||||||||||||||||||||||||
| Variable to fixed (USD) | $ | (761) | $ | — | $ | — | $ | — | $ | (5,430) | $ | — | $ | (6,191) | $ | (6,191) | |||||||||
| Weighted average pay rate | 5.95 | % | — | % | — | % | — | % | 3.82 | % | — | % | 4.08 | % | |||||||||||
| Weighted average receive rate | 2.03 | % | — | % | — | % | — | % | 1.65 | % | — | % | 1.70 | % | |||||||||||
| Variable rate Term Loans: | |||||||||||||||||||||||||
| Variable to fixed (GBP) | $ | (60) | $ | 196 | $ | — | $ | — | $ | — | $ | — | $ | 136 | $ | 136 | |||||||||
| Weighted average pay rate | 1.81 | % | 1.79 | % | — | % | — | % | — | % | — | % | 1.78 | % | |||||||||||
| Weighted average receive rate | 1.71 | % | 1.74 | % | — | % | — | % | — | % | — | % | 1.76 | % |
| (1) | Represents approximately £301 million translated into USD. |
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| (2) | Represents approximately £58 million translated into USD. |
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| (3) | Excludes $94 million of other debt that represents life care bonds and demand notes that have no scheduled maturities. |
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| (4) | Represents approximately £270 million translated into USD. |
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| (5) | Represents approximately £357 million translated into USD. |
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| (6) | In February 2016, we repaid $500 million of senior unsecured notes from the proceeds from our December 2015 senior unsecured notes issuance. |
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