Southwest Airlines 2009 Annual Report Download - page 83

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
December 31, 2009
swap contracts as Level 2. The Company determines the value of option contracts utilizing a standard option
pricing model based on inputs that are either readily available in public markets, can be derived from information
available in publicly quoted markets, or are quoted by financial institutions that trade these contracts. In
situations where the Company obtains inputs via quotes from financial institutions, it verifies the reasonableness
of these quotes via similar quotes from another financial institution as of each date for which financial statements
are prepared. The Company also considers counterparty credit risk and its own credit risk in its determination of
all estimated fair values. The Company has consistently applied these valuation techniques in all periods
presented and believes it has obtained the most accurate information available for the types of derivative
contracts it holds. Due to the fact that certain of the inputs used to determine the fair value of option contracts are
unobservable (principally implied volatility), the Company has categorized these option contracts as Level 3.
The Company’s interest rate derivative instruments also consist of OTC swap contracts. The inputs used to
determine the fair values of these contracts are obtained in quoted public markets. The Company has consistently
applied these valuation techniques in all periods presented.
The Company’s investments associated with its excess benefit plan consist of mutual funds that are publicly
traded and for which market prices are readily available. This plan is a deferred compensation plan designed to
hold Employee contributions in excess of limits established by Section 415 of the Internal Revenue Code. This
plan is funded through qualifying Employee contributions and it impacts the Company’s earnings through
changes in the fair value of plan assets.
All of the Company’s auction rate security instruments are reflected at estimated fair value in the
Consolidated Balance Sheet. At December 31, 2009, approximately $99 million of these instruments are
classified as available for sale securities and $75 million are classified as trading securities. The $75 million
classified as trading securities are subject to an agreement the Company entered into in December 2008, as
discussed below, and are included in “Short-term investments” in the Consolidated Balance Sheet. In periods
when an auction process successfully took place every 30-35 days, quoted market prices would be readily
available, which would qualify the securities as Level 1. However, due to events in credit markets beginning
during first quarter 2008, the auction events for most of these instruments failed, and, therefore, the Company has
subsequently determined the estimated fair values of these securities utilizing a discounted cash flow analysis or
other type of valuation model. During fourth quarter 2009, the Company performed a valuation for each of its
auction rate security instruments, considering, among other items, the collateralization underlying the security
investments, the expected future cash flows, including the final maturity, associated with the securities, and
estimates of the next time the security is expected to have a successful auction or return to full par value.
In association with this estimate of fair value, the Company has recorded a temporary unrealized decline in
fair value of $17 million, with an offsetting entry to AOCI. The Company currently believes that this temporary
decline in fair value is due entirely to market liquidity issues, because the underlying assets for the majority of
these auction rate securities held by the Company are almost entirely backed by the U.S. Government. In
addition, for the $99 million in instruments classified as available for sale, these auction rate securities
represented less than four percent of the Company’s total cash, cash equivalent, and investment balance at
December 31, 2009. The range of maturities for the Company’s auction rate securities are from 9 years to 38
years. Considering the relative significance of these securities in comparison to the Company’s liquid assets and
other sources of liquidity, the Company has no current intention of selling these securities nor does it expect to be
required to sell these securities before a recovery in their cost basis. For the $75 million in instruments classified
as trading securities, the Company is party to an agreement with the counterparty that allows the Company to put
the instruments back to the counterparty at full par value in June 2010. Part of this agreement also contains a line
of credit in which the Company can borrow up to the par value of any outstanding securities as a loan from the
counterparty that would be secured by the auction rate security instruments from that counterparty. This line of
credit was fully drawn as of December 31, 2009. Both the put option and the auction rate instruments are being
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