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Derivative Instruments and Hedging Activities
 9 Months Ended 12 Months Ended
Sep. 30, 2019
Dec. 31, 2018
THE DAYTON POWER AND LIGHT COMPANY [Member]    
Derivative Instruments and Hedging Activities Derivative Instruments and Hedging Activities

In the normal course of business, DP&L enters into interest rate hedges to manage the interest rate risk of our variable rate debt. All of our derivative instruments are used for risk management purposes and are designated as cash flow hedges if they qualify under FASC 815 for accounting purposes. In prior periods, we have used commodity derivatives principally to manage the risk of changes in market prices for commodities.

Cash Flow Hedges
As part of our risk management processes, we identify the relationships between hedging instruments and hedged items, as well as the risk management objective and strategy for undertaking various hedge transactions. The fair values of cash flow hedges determined by current public market prices will continue to fluctuate with changes in market prices up to contract expiration. With the adoption of ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted improvements to Accounting for Hedging Activities effective January 1, 2019, we will no longer be required to calculate effectiveness and thus the entire change in the fair value of a hedging instrument will be recorded in other comprehensive income and amounts deferred will be reclassified to earnings in the same income statement line as the hedged item in the period in which it settles.

As of September 30, 2019, we have two interest rate swaps to hedge the variable interest on our $140.0 million variable interest rate tax-exempt First Mortgage Bonds. The interest rate swaps have a combined notional amount of $140.0 million and settle monthly based on a one-month LIBOR. On March 29, 2018, we settled $60.0 million of these interest rate swaps due to the partial repayment of the underlying debt and a gain of $0.8 million was recorded as a reduction to interest expense. Since the swap was partially settled, the remaining swaps were de-designated and then re-designated with a new hypothetical derivative. The AOCI associated with the remaining swaps will be amortized out of AOCI into interest expense over the remaining life of the underlying debt.

The following tables provide information concerning gains or losses recognized in AOCI for the cash flow hedges for the three and nine months ended September 30, 2019 and 2018:
 
 
Three months ended
 
 
September 30, 2019
 
September 30, 2018
 
 
Interest
 
Interest
$ in millions (net of tax)
 
Rate Hedge
 
Rate Hedge
Beginning accumulated derivative gains / (losses) in AOCI
 
$
(0.3
)
 
$
1.6

Net losses associated with current period hedging transactions
 
(0.1
)
 
—

Net gains reclassified to earnings
 
 
 
 
Interest expense
 
—

 
(0.2
)
Ending accumulated derivative gains / (losses) in AOCI
 
$
(0.4
)
 
$
1.4

 
 
 
 
 
 
 
Nine months ended
 
 
September 30, 2019
 
September 30, 2018
 
 
Interest
 
Interest
$ in millions (net of tax)
 
Rate Hedge
 
Rate Hedge
Beginning accumulated derivative gains in AOCI
 
$
0.6

 
$
1.4

Net gains / (losses) associated with current period hedging transactions
 
(0.9
)
 
0.5

Net gains reclassified to earnings
 
 
 
 
Interest expense
 
(0.1
)
 
(0.5
)
Ending accumulated derivative gains / (losses) in AOCI
 
$
(0.4
)
 
$
1.4

 
 
 
 
 
Portion expected to be reclassified to earnings in the next twelve months
 
$
(0.2
)
 
 
Maximum length of time that we are hedging our exposure to variability in future cash flows related to forecasted transactions (in months)
 
11

 
 


Net gains or losses associated with the ineffective portion of the hedging transactions were immaterial in the prior year period presented.

Financial Statement Effect
DP&L has elected not to offset derivative assets and liabilities and not to offset net derivative positions against the right to reclaim cash collateral pledged (an asset) or the obligation to return cash collateral received (a liability) under derivative agreements. The fair value derivative position of DP&L's interest rate swaps are as follows:
Fair Values of Derivative Instruments
at September 30, 2019
 
 
 
 
 
 
Gross Amounts Not Offset in the Condensed Balance Sheets
 
 
$ in millions
 
Hedging Designation
 
Gross Fair Value as presented in the Condensed Balance Sheets (a)
 
Financial Instruments with Same Counterparty in Offsetting Position
 
Cash Collateral
 
Net Fair Value
Assets
 
 
 
 
 
 
 
 
 
 
Short-term derivative positions (presented in Prepayments and other current assets)
Interest rate swap
 
Designated
 
$
0.2

 
$
—

 
$
—

 
$
0.2

Total assets
 
 
 
$
0.2

 
$
—

 
$
—

 
$
0.2


(a)    Includes credit valuation adjustment.

Fair Values of Derivative Instruments
at December 31, 2018
 
 
 
 
 
 
Gross Amounts Not Offset in the Condensed Balance Sheets
 
 
$ in millions
 
Hedging Designation
 
Gross Fair Value as presented in the Condensed Balance Sheets (a)
 
Financial Instruments with Same Counterparty in Offsetting Position
 
Cash Collateral
 
Net Fair Value
Assets
 
 
 
 
 
 
 
 
 
 
Short-term derivative positions (presented in Prepayments and other current assets)
Interest rate swaps
 
Designated
 
$
0.9

 
$
—

 
$
—

 
$
0.9

 
 
 
 
 
 
 
 
 
 
 
Long-term derivative positions (presented in Other non-current assets)
Interest rate swaps
 
Designated
 
0.6

 
—

 
—

 
0.6

Total assets
 
 
 
$
1.5

 
$
—

 
$
—

 
$
1.5


(a)    Includes credit valuation adjustment.

Any prior year ineffectiveness on the interest rate hedges and the monthly settlement of the interest rate hedges is recorded in interest expense within the Condensed Statements of Operations.

In the normal course of business, DP&L enters into various financial instruments, including derivative financial instruments. We use derivatives principally to manage the interest rate risk associated with our long-term debt. The derivatives that we use to economically hedge these risks are governed by our risk management policies for forward and futures contracts. Our net positions are continually assessed within our structured hedging programs to determine whether new or offsetting transactions are required. We monitor and value derivative positions monthly as part of our risk management processes. We use published sources for pricing, when possible, to mark positions to market. All of our derivative instruments are used for risk management purposes and are designated as cash flow hedges if they qualify under FASC 815 for accounting purposes.

DP&L's interest rate swaps are designated as a cash flow hedge. At December 31, 2018 and 2017, the principal balance of the interest rate hedges was $140.0 million and $200.0 million, respectively.

Cash Flow Hedges
As part of our risk management processes, we identify the relationships between hedging instruments and hedged items, as well as the risk management objective and strategy for undertaking various hedge transactions. The fair values of cash flow hedges determined by current public market prices will continue to fluctuate with changes in market prices up to contract expiration. The effective portion of the hedging transaction is recognized in AOCI and transferred to earnings using specific identification of each contract when the forecasted hedged transaction takes place or when the forecasted hedged transaction is probable of not occurring. The ineffective portion of the cash flow hedge is recognized in earnings in the current period. All risk components were considered to determine the hedge effectiveness of the cash flow hedges. With the adoption of ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted improvements to Accounting for Hedging Activities effective January 1, 2019, we will no longer be required to calculate effectiveness and thus the entire change in the fair value of a hedging instrument will be recorded in other comprehensive income and amounts deferred will be reclassified to earnings in the same income statement line as the hedged item in the period in which it settles.

We have two interest rate swaps to hedge the variable interest on our $140.0 million variable interest rate tax-exempt First Mortgage Bonds. The interest rate swaps have a combined notional amount of $140.0 million and will settle monthly based on a one-month LIBOR. As of December 31, 2017, the interest rate swaps had a combined notional amount of $200.0 million. On March 29, 2018, we settled $60.0 million of these interest rate swaps due to the partial repayment of the underlying debt and a gain of $0.8 million was recorded as a reduction to interest expense. Since the swap was partially settled, the remaining swaps were de-designated and then re-designated with a new hypothetical derivative. The AOCI associated with the remaining swaps will be amortized out of AOCI into interest expense over the remaining life of the underlying debt.

We use the income approach to value the swaps, which consists of forecasting future cash flows based on contractual notional amounts and applicable and available market data as of the valuation date. The most common market data inputs used in the income approach include volatilities, spot and forward benchmark interest rates (LIBOR). Forward rates with the same tenor as the derivative instrument being valued are generally obtained from published sources, with these forward rates being assessed quarterly at a portfolio-level for reasonableness versus comparable published rates. We reclassify gains and losses on the swaps out of AOCI and into earnings in those periods in which hedged interest payments occur.

The following tables provide information on gains or losses recognized in AOCI for the cash flow hedges for the periods indicated:
 
 
Years ended December 31,
 
 
2018
 
2017
 
2016
$ in millions (net of tax)
 
Interest Rate
Hedges
 
Power
 
Interest Rate
Hedges
 
Power
 
Interest Rate
Hedges
Beginning accumulated derivative gain / (loss) in AOCI
 
$
1.4

 
$
(4.3
)
 
$
1.6

 
$
9.2

 
$
2.0

 
 
 
 
 
 
 
 
 
 
 
Net gains / (losses) associated with current period hedging transactions
 
(0.1
)
 
11.9

 
0.5

 
15.7

 
0.4

Net gains / (losses) reclassified to earnings:
 
 
 
 
 
 
 
 
 
 
Interest expense
 
(0.7
)
 
—

 
(0.7
)
 
—

 
(0.8
)
Loss from discontinued operations
 
—

 
(5.5
)
 
—

 
(29.2
)
 
—

Transfer of generation assets to subsidiary of parent
 
—

 
(2.1
)
 
—

 
—

 
—

Ending accumulated derivative gain / (loss) in AOCI
 
$
0.6

 
$
—

 
$
1.4

 
$
(4.3
)
 
$
1.6

 
 
 
 
 
 
 
 
 
 
 
Portion expected to be reclassified to earnings in the next twelve months
 
$
0.7

 
 
 
 
 
 
 
 
Maximum length of time that we are hedging our exposure to variability in future cash flows related to forecasted transactions (in months)
 
20

 
 
 
 
 
 
 
 


Net gains or losses associated with the ineffective portion of the hedging transactions were immaterial in the periods presented.

DP&L has elected not to offset derivative assets and liabilities and not to offset net derivative positions against the right to reclaim cash collateral pledged (an asset) or the obligation to return cash collateral received (a liability) under derivative agreements. The fair value derivative position of DP&L's interest rate swaps are as follows:
 
 
 
 
 
December 31,
 
Hedging Designation
 
Balance sheet classification
 
2018
 
2017
Interest rate hedges in a Current asset position
Cash Flow Hedge
 
Other prepayments and current assets
 
 
 
 
Gross Fair Value as presented in the Balance Sheets
 
 
 
 
$
0.9

 
$
—

 
 
 
 
 
 
 
 
Interest rate hedges in a non-current asset position
Cash Flow Hedge
 
Other deferred assets
 
 
 
 
Gross Fair Value as presented in the Balance Sheets
 
 
 
 
$
0.6

 
$
1.5