Southwest Airlines 2010 Annual Report Download - page 67

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During January 2011, the Company made the decision to forego its option under the agreement with one
counterparty (Counterparty B in the above table) to use some of its aircraft as collateral in lieu of cash and has
provided additional cash to that counterparty to meet its collateral obligation based on the fair value of its
outstanding fuel derivative instruments. This decision, which can be changed at any time under the existing
agreement with that counterparty, was made because the Company has an adequate amount of cash on hand
available to cover its total collateral requirement and has determined it would be less costly to provide the cash
instead of aircraft, due to the nominal additional charges it must pay if aircraft are utilized as collateral. The
additional amount of cash provided as of January 19, 2011, was $108 million.
The Company also has agreements with each of its counterparties associated with its outstanding interest
rate swap agreements in which cash collateral may be required based on the fair value of outstanding interest rate
swaps, as well as the Company’s and its counterparty’s credit ratings. As of December 31, 2010, no cash
collateral had been provided to or received from counterparties associated with the Company’s interest rate
derivatives. If the Company’s credit rating had been below investment grade as of December 31, 2010, it would
have been required to provide $4 million in cash collateral to one counterparty based on its outstanding net
liability derivative position with that counterparty. The outstanding interest rate net derivative positions with all
other counterparties at December 31, 2010 were assets to the Company.
Due to the significance of the Company’s fuel hedging program and the emphasis that it places on utilizing
fuel derivatives to reduce its fuel price risk, the Company has created a system of governance and management
oversight and has put in place a number of internal controls designed so that procedures are properly followed
and accountability is present at the appropriate levels. For example, the Company has put in place controls
designed to: (i) create and maintain a comprehensive risk management policy; (ii) provide for proper
authorization by the appropriate levels of management; (iii) provide for proper segregation of duties;
(iv) maintain an appropriate level of knowledge regarding the execution of and the accounting for derivative
instruments; and (v) have key performance indicators in place in order to adequately measure the performance of
its hedging activities. The Company believes the governance structure that it has in place is adequate given the
size and sophistication of its hedging program.
Financial market risk
The vast majority of the Company’s assets are aircraft, which are long-lived. The Company’s strategy is to
maintain a conservative balance sheet and grow capacity steadily and profitably under the right conditions. While
the Company uses financial leverage, it strives to maintain a strong balance sheet and has a “BBB” rating with
Fitch and Standard & Poor’s, and a “Baa3” credit rating with Moody’s as of December 31, 2010. The Company’s
1999 and 2004 French Credit Agreements do not give rise to significant fair value risk but do give rise to interest
rate risk because these borrowings were originally issued as floating-rate debt. In addition, as disclosed in Note
10 to the Consolidated Financial Statements, the Company has converted certain of its long-term debt to floating
rate debt by entering into interest rate swap agreements. As of December 31, 2010, this included the Company’s
$385 million 6.5% senior unsecured notes due 2012, the $350 million 5.25% senior unsecured notes due 2014,
the $300 million 5.125% senior unsecured notes due 2017, the $100 million 7.375% senior unsecured debentures
due 2027, the $400 million 10.5% secured notes due 2011, and the $300 million 5.75% senior unsecured Notes
due 2016. Although there is interest rate risk associated with these floating rate borrowings, the risk for the 1999
and 2004 French Credit Agreements is somewhat mitigated by the fact that the Company may prepay this debt
under certain conditions. See Notes 6 and 7 to the Consolidated Financial Statements for more information on the
material terms of the Company’s short-term and long-term debt.
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