Southwest Airlines 2008 Annual Report Download - page 80

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
“shortcut” method of accounting for hedges, as
defined by SFAS 133. Under the “shortcut” method,
the hedges are assumed to be perfectly effective, and,
thus, there is no ineffectiveness to be recorded in
earnings. The following table contains the floating
rates paid during 2008, based on actual and forward
rates at December 31, 2008, under these agreements:
Debt instrument
Fixed rate
associated
with debt
instrument
Average
floating
rate
paid in
2008
$385 million Notes due 2012 . . 6.5% 4.72%
$350 million Notes due 2014 . . 5.25% 4.29%
$300 million Notes due 2017 . . 5.125% 2.95%
$100 million Debentures due
2027 ................... 7.375% 4.70%
During 2008, the Company also entered into an
interest rate swap agreement concurrent with its entry
into a twelve-year, $600 million floating-rate Term
Loan Agreement. Under this swap agreement, which
is accounted for as a cash flow hedge, the interest
rate on the term loan is effectively fixed for its entire
term at 5.223 percent and ineffectiveness is required
to be measured each reporting period.
The fair values of the interest rate swap
agreements, which are adjusted regularly, have been
aggregated by counterparty for classification in the
Consolidated Balance Sheet. Agreements totaling an
asset of $84 million are classified as a component of
“Other assets” with a corresponding adjustment to
the carrying value of the long-term debt. Agreements
totaling a net liability of $3 million are classified as a
component of “Other deferred liabilities.” The
corresponding adjustment related to the net liability
associated with the Company’s fair value hedges, is
to the carrying value of the long-term debt. The
corresponding adjustment related to the net liability
associated with the Company’s cash flow hedge is to
“Accumulated other comprehensive income (loss).”
This adjustment totaled $46 million, net of tax, at
December 31, 2008. See Note 7.
Credit risk and collateral
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. However, in such
cases, the Company does not expect any of the
counterparties to fail to meet its obligations and has
not experienced any significant credit loss as a result
of counterparty nonperformance in the past. To
manage credit risk, the Company selects and will
periodically review counterparties based on credit
ratings, limits its exposure to a single counterparty,
and monitors the market position of the program and
its relative market position with each counterparty.
At December 31, 2008, the Company had agreements
with eight counterparties containing early termination
rights and/or bilateral collateral provisions whereby
security is required if market risk exposure exceeds a
specified threshold amount or credit ratings fall
below certain levels. As of December 31, 2008, the
Company had active portfolios with three of these
counterparties. Based on the Company’s current
investment grade credit rating, for one counterparty,
these collateral provisions require cash deposits to be
posted whenever the net fair value of derivatives
associated with that counterparty exceed a specific
threshold pursuant to which cash is either posted by
the counterparty if the value of derivatives is an asset
to the Company, or posted by the Company if the
value of derivatives is a liability to the Company.
During fourth quarter 2008, the modification of
the Company’s fuel hedge portfolio, in combination
with the amendment to one of the Company’s
counterparty agreements, has significantly reduced
the Company’s current exposure to cash collateral
requirements. Previously, if the Company became
obligated to post collateral as security for its potential
obligations under the agreement, all such collateral
was required to be cash. Under the agreement, as
amended, until January 1, 2010, if the Company
becomes obligated to post collateral for obligations in
amounts of up to $300 million and in excess of $700
million, the Company will continue to be required to
post cash collateral; however, if the Company
becomes obligated to post collateral for obligations in
amounts between $300 million and $700 million, the
Company has pledged 20 of its Boeing 737-700
aircraft as collateral in lieu of cash.
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