Southwest Airlines 2004 Annual Report Download - page 60

SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)
""Fuel hedge contracts'' and the long-term portion is cantly lower than the Ñxed longer term rates on the
classiÑed as ""Other assets'' in the Consolidated Balance Company's long-term debt. The Company's interest
Sheet. The fair value of the derivative instruments, rate swap agreements qualify as fair value hedges, as
depending on the type of instrument, was determined by deÑned by SFAS 133. The fair value of the interest rate
the use of present value methods or standard option swap agreements, which are adjusted regularly, are
value models with assumptions about commodity prices recorded in the Consolidated Balance Sheet, as neces-
based on those observed in underlying markets. sary, with a corresponding adjustment to the carrying
value of the long-term debt. The fair value of the
As of December 31, 2004, the Company had interest rate swap agreements, excluding accrued inter-
approximately $416 million in unrealized gains, net of est, at December 31, 2004, was a liability of approxi-
tax, in ""Accumulated other comprehensive income mately $16 million. This amount is recorded in ""Other
(loss)'' related to fuel hedges. Included in this total are deferred liabilities'' in the Consolidated Balance Sheet.
approximately $246 million in net unrealized gains that In accordance with fair value hedging, the oÅsetting
are expected to be realized in earnings during 2005. entry is an adjustment to decrease the carrying value of
long-term debt. See Note 7.
Interest Rate Swaps Ì During 2003, the Company
entered into interest rate swap agreements relating to its Outstanding Ñnancial derivative instruments ex-
$385 million 6.5% senior unsecured notes due 2012 and pose the Company to credit loss in the event of nonper-
$375 million 5.496% Class A-2 pass-through certiÑ- formance by the counterparties to the agreements.
cates due 2006. The Öoating rate paid under each However, the Company does not expect any of the
agreement is set in arrears. Under the Ñrst agreement, counterparties to fail to meet their obligations. The
the Company pays the London InterBank OÅered Rate credit exposure related to these Ñnancial instruments is
(LIBOR) plus a margin every six months and receives represented by the fair value of contracts with a positive
6.5% every six months on a notional amount of fair value at the reporting date. To manage credit risk,
$385 million until 2012. The average Öoating rate paid the Company selects and periodically reviews
under this agreement during 2004 is estimated to be counterparties based on credit ratings, limits its expo-
4.490 percent based on actual and forward rates at sure to a single counterparty, and monitors the market
December 31, 2004. Under the second agreement, the position of the program and its relative market position
Company pays LIBOR plus a margin every six months with each counterparty. At December 31, 2004, the
and receives 5.496% every six months on a notional Company had agreements with seven counterparties
amount of $375 million until 2006. Based on actual and containing early termination rights and/or bilateral
forward rates at December 31, 2004, the average Öoat- collateral provisions whereby security is required if
ing rate paid under this agreement during 2004 is market risk exposure exceeds a speciÑed threshold
estimated to be 4.695 percent. amount or credit ratings fall below certain levels. At
December 31, 2004, the Company held $330 million in
During 2004, the Company entered into an inter- cash collateral deposits and $150 million in
est rate swap agreement relating to its $350 million U.S. Treasury Bills, under these bilateral collateral pro-
5.25% senior unsecured notes due 2014. Under this visions. These collateral deposits serve to decrease, but
agreement, the Company pays LIBOR plus a margin not totally eliminate, the credit risk associated with the
every six months and receives 5.25% every six months Company's hedging program. The cash deposits are
on a notional amount of $350 million until 2014. The included in ""Accrued liabilities'' on the Consolidated
Öoating rate is set in advance. The average Öoating rate Balance Sheet and are included as ""Operating cash
paid under this agreement during 2004 was Öows'' in the Consolidated Statement of Cash Flows. In
2.814 percent. accordance with SFAS 140, ""Accounting for Transfers
The primary objective for the Company's use of and Servicing of Financial Assets and Extinguishments
interest rate hedges is to reduce the volatility of net of Liabilities'', the U.S. Treasury Bills, supplied as non-
interest income by better matching the repricing of its cash collateral by counterparties, are not reÖected on the
assets and liabilities. Concurrently, the Company's in- Company's Consolidated Balance Sheet.
terest rate hedges are also intended to take advantage of
market conditions in which short-term rates are signiÑ-
42