Southwest Airlines 2009 Annual Report Download - page 54

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provided, is classified as a component of “Accrued liabilities” in the Consolidated Balance Sheet. The long-term
portion of these financial derivative instruments, or $115 million, net of cash collateral provided, is included in
“Other deferred liabilities.” The fair values of the derivative instruments, depending on the type of instrument,
were determined by use of present value methods or standard option value models with assumptions about
commodity prices based on those observed in underlying markets. An immediate ten-percent increase or decrease
in underlying fuel-related commodity prices from the December 31, 2009 (for all years from 2010 through 2013),
prices would correspondingly change the fair value of the commodity derivative instruments in place by up to
approximately $217 million. Fluctuations in the related commodity derivative instrument cash flows may change
by more or less than this amount based upon further fluctuations in futures prices as well as related income tax
effects. In addition, this does not consider changes in cash collateral provided to or by counterparties, which
would fluctuate in an amount equal to or less than this amount, depending on the type of collateral arrangement
in place with each counterparty. This sensitivity analysis uses industry standard valuation models and holds all
inputs constant at December 31, 2009, levels, except underlying futures prices.
The Company’s credit exposure related to fuel derivative instruments is represented by the fair value of
contracts with a net positive fair value to the Company at the reporting date. At such times, these outstanding
instruments expose the Company to credit loss in the event of nonperformance by the counterparties to the
agreements. To manage credit risk, the Company selects and will periodically review counterparties based on
credit ratings, limits its exposure to a single counterparty with collateral support agreements, and monitors the
market position of the program and its relative market position with each counterparty. However, if one or more
of these counterparties were in a liability position to the Company and were unable to meet their obligations, any
open derivative contracts with the counterparty could be subject to early termination, which could result in
substantial losses for the Company. At December 31, 2009, the Company had agreements with all of its
counterparties containing early termination rights triggered by credit rating thresholds and/or bilateral collateral
provisions whereby security is required if market risk exposure exceeds a specified threshold amount based on
the counterparty’s credit rating. The Company also had agreements with counterparties in which cash deposits
and/or pledged aircraft are required to be posted whenever the net fair value of derivatives associated with those
counterparties exceeds specific thresholds — cash is either posted by the counterparty if the value of derivatives
is an asset to the Company, or is posted by the Company if the value of derivatives is a liability to the Company.
The following table provides the fair values of fuel derivatives, amounts posted as collateral, and applicable
collateral posting threshold amounts as of December 31, 2009, at which such postings are triggered:
Counterparty (CP)
(in millions) A B C D E Total
Fair value of fuel derivatives ........... $ (199) $ (300) $ (27) $ 18 $ 30 $(478)
Cash collateral held by CP ............. 205 125 — — — 330
Aircraft collateral pledged to CP ........ — 183 — — — 183
If credit rating is investment grade, fair
value of fuel derivative level at which:
Cash is provided to CP ............ 0to(300) 0 to (125) >(75) >(75) N/A
or >(700) or >(582)
Cash is received from CP .......... >40 >150 >200*** >125 N/A
Aircraft is pledged to CP .......... (300) to (700) (125) to (582) N/A N/A N/A
If credit rating is non-investment grade,
fair value of fuel derivative level at
which:
Cash is provided to CP ............ 0to(300) 0 to (125) zero* zero* zero**
or >(700) or >(582)
Cash is received from CP .......... zero* zero* zero* zero* zero**
Aircraft is pledged to CP .......... (300) to (700) (125) to (582) N/A N/A N/A
* Cash collateral is provided at 100 percent of fair value of fuel derivative contracts.
** If either party is rated below investment grade by two of the three major rating agencies, a cash collateral
agreement would be negotiated with the CP.
*** Thresholds may vary based on changes in credit ratings within investment grade.
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