05.5
Notes to Consolidated Financial Statements
20. MARKET RISK
The Company is exposed to market risk from changes in interest rates and foreign exchange rates. In order to manage the risk of interest rate and currency exchange rate fluctuations, the Company enters into various hedging transactions with highly rated financial institutions as authorized by the Company’s General Partner. The Company does not use financial instruments for trading purposes.
The Company established guidelines for risk assessment procedures and controls for the use of financial instruments. They include a clear segregation of duties with regard to execution on one side and administration, accounting and controlling on the other.
FOREIGN EXCHANGE RISK MANAGEMENT
The Company conducts business on a global basis in various currencies, though its operations are mainly in Germany and the United States. For financial reporting purposes, the Company has chosen the U.S. dollar as its reporting currency. Therefore, changes in the rate of exchange between the U.S. dollar and the local currencies in which the financial statements of the Company’s international operations are maintained affect its results of operations and financial position as reported in its consolidated financial statements.
The Company’s exposure to market risk for changes in foreign exchange rates relates to transactions such as sales and purchases. The Company has significant amounts of sales of products invoiced in euro from its European manufacturing facilities to its other international operations and, to a lesser extent, sales of products invoiced in other non functional currencies. This exposes the subsidiaries to fluctuations in the rate of exchange between the euro and the currency in which their local operations are conducted. For the purpose of hedging existing and foreseeable foreign exchange transaction exposures the Company enters into foreign exchange forward contracts and, on a small scale, foreign exchange options. The Company’s policy, which has been consistently followed, is that financial derivatives be used only for the purpose of hedging foreign currency exposure. As of December 31, 2008 the Company had no foreign exchange options.
In connection with intercompany loans in foreign currency the Company normally uses foreign exchange swaps thus assuring that no foreign exchange risks arise from those loans.
Changes in the fair value of foreign exchange forward contracts designated and qualifying as cash flow hedges of forecasted product purchases and sales are reported in accumulated other comprehensive income (loss). These amounts are subsequently reclassified into earnings as a component of cost of revenues, in the same period in which the hedged transaction affects earnings. After tax gains of $9,534 ($12,491 pretax) for the year ended December 31, 2008 are deferred in accumulated other comprehensive income and will mainly be reclassified into earnings during 2009. During 2008, the Company reclassified after tax gains of $2,452 ($3,296 pretax) from accumulated other comprehensive income (loss) into the statement of operations.
The notional amounts of foreign exchange forward contracts in place to hedge exposures from operations totaled $543,911 with a fair value of $21,227 as of December 31, 2008.
In connection with foreign currency denominated intercompany loans, the Company also entered into foreign exchange swaps with a notional amount of $285,932 having a fair value of $- 7,191 as of December 31, 2008. No hedge accounting is applied to these foreign exchange contracts. Accordingly, the respective foreign exchange swaps are recognized as assets or liabilities and changes in their fair values are recognized against earnings thus offsetting the changes in fair values of the underlying intercompany loans denominated in foreign currency.
As of December 31, 2008, the Company had foreign exchange derivatives with maturities of up to 25 months.
The Company is exposed to potential losses in the event of nonperformance by counterparties to financial instruments but does not expect any counterparty to fail to meet its obligations as the counterparties are banks which generally have ratings in the “A” Category or better. The current credit exposure of foreign exchange derivatives is represented by the fair value of those contracts with a positive fair value at the reporting date amounting to $53,631.
INTEREST RATE RISK MANAGEMENT
The Company enters into derivatives, particularly interest rate swaps and to a certain extent, interest options, to protect interest rate exposures arising from long-term debt at floating rates by effectively swapping them into fixed rates.
The Company may be exposed to potential losses in the event of nonperformance by counterparties to financial instruments but does not expect any counterparty to fail to meet its obligations as the counterparties are banks which generally have ratings in the “A” Category or better. The Company had no current credit exposure from interest rate derivatives as none of those contracts had a positive fair value at December 31, 2008.
CASH FLOW HEDGES OF VARIABLE RATE DEBT
The Company enters into interest rate swap agreements that are designated as cash flow hedges effectively converting the major part of variable interest rate payments due on the Company’s 2006 Senior Credit Agreement denominated in U.S. dollars into fixed interest rate payments. Those swap agreements, all of which expire at various dates between 2009 and 2012, in the notional amount of $2,850,000, effectively fix the Company’s variable interest rate exposure on the majority of its U.S. dollar-denominated revolving loans at an average interest rate of 4.37 % plus an applicable margin. After tax losses of $91,573 ($148,913 pretax) for the year ended December 31, 2008, were deferred in accumulated other comprehensive income. Interest payable and interest receivable under the swap agreements are accrued and recorded as an adjustment to interest expense.
FAIR VALUE HEDGES OF FIXED RATE DEBT
The Company entered into interest rate swap agreements that were designated as fair value hedges to hedge the risk of changes in the fair value of fixed interest rate borrowings effectively converting the fixed interest payments on Fresenius Medical Care Capital Trust ii trust preferred securities (see Note 11) denominated in U.S. dollars into variable interest rate payments. Since the critical terms of the interest rate swap agreements were identical to the terms of Fresenius Medical Capital Trust II trust preferred securities, the hedging relationship was highly effective and no ineffectiveness was recognized in earnings. The interest rate swap agreements were reported at fair value in the balance sheet. The reported amount of the hedged portion of the fixed rate trust preferred securities included an adjustment representing the fair value attributable to the interest rate risk being hedged. Changes in the fair value of interest rate swap contracts and trust preferred securities offset each other in the income statement. On February 1, 2008, the Fresenius Medical Care Capital Trust ii trust preferred securities were repaid and the interest rate swap agreements expired.
