Financial Instruments and Fair Value Measurements

9 Months Ended

Sep. 30, 2012

Financial Instruments and Fair Value Measurements

NOTE 6—FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS

The table below presents disclosures about the financial assets and financial liabilities measured at fair value on a recurring basis in the Company’s financial statements as of September 30, 2012 and December 31, 2011 (in millions):

	September 30, 2012										December 31, 2011
	Total			Level 1		Level 2		Level 3			Total			Level 1		Level 2			Level 3
	UAL
Cash and cash equivalents	$	5,129		$	5,129	$	—	$	—		$	6,246		$	6,246	$	—		$	—
Short-term investments:
Asset-backed securities		647			—		647		—			478			—		478			—
Corporate debt		340			—		340		—			515			—		515			—
Certificates of deposit placed through an account registry service (“CDARS”)		404			—		404		—			355			—		355			—
Auction rate securities		115			—		—		115			113			—		—			113
U.S. government and agency notes		15			—		15		—			22			—		22			—
Other fixed income securities		30			—		30		—			33			—		33			—
Enhanced equipment trust certificates (“EETC”)		62			—		—		62			60			—		—			60
Fuel derivatives, net		33			—		33		—			73			—		73			—
Foreign currency derivatives		—			—		—		—			(1	)		—		(1	)		—
Restricted cash		471			471		—		—			569			569		—			—
	United
Cash and cash equivalents	$	3,005		$	3,005	$	—	$	—		$	3,458		$	3,458	$	—		$	—
Short-term investments:
Asset-backed securities		16			—		16		—			29			—		29			—
Corporate debt		140			—		140		—			138			—		138			—
CDARS		156			—		156		—			87			—		87			—
U.S. government and agency notes		8			—		8		—			5			—		5			—
Other fixed income securities		26			—		26		—			16			—		16			—
EETC		62			—		—		62			60			—		—			60
Fuel derivatives, net		24			—		24		—			44			—		44			—
Restricted cash		354			354		—		—			433			433		—			—
	Continental
Cash and cash equivalents	$	2,119		$	2,119	$	—	$	—		$	2,782		$	2,782	$	—		$	—
Short-term investments:
Asset-backed securities		631			—		631		—			449			—		449			—
Corporate debt		200			—		200		—			377			—		377			—
CDARS		248			—		248		—			268			—		268			—
Auction rate securities		115			—		—		115			113			—		—			113
U.S. government and agency notes		7			—		7		—			17			—		17			—
Other fixed income securities		4			—		4		—			17			—		17			—
Fuel derivatives, net		9			—		9		—			29			—		29			—
Foreign currency derivatives		—			—		—		—			(1	)		—		(1	)		—
Restricted cash		116			116		—		—			135			135		—			—
Convertible debt derivative asset		202			—		—		202			193			—		—			193
Convertible debt option liability		(91	)		—		—		(91	)		(95	)		—		—			(95	)

The tables below present disclosures about the activity for “Level 3” financial assets and financial liabilities for the three and nine months ended September 30 (in millions):

	Three Months Ended September 30,
	2012					2011
UAL (a)	Auction Rate Securities		EETC			Auction Rate Securities			EETC
Balance at June 30	$	112	$	63		$	121		$	65
Settlements		—		(2	)		—			(2	)
Gains (losses):
Reported in earnings—unrealized		1		—			1			—
Reported in other comprehensive income (loss)		2		1			(1	)		(3	)
Balance at September 30	$	115	$	62		$	121		$	60

(a) For 2012 and 2011, United’s only Level 3 recurring measurements are the above EETCs.

	Nine Months Ended September 30,
	2012					2011
UAL (a)	Auction Rate Securities		EETC			Auction Rate Securities		EETC
Balance at January 1	$	113	$	60		$	119	$	66
Settlements		—		(5	)		—		(4	)
Gains (losses):
Reported in earnings—unrealized		—		—			2		—
Reported in other comprehensive income (loss)		2		7			—		(2	)
Balance at September 30	$	115	$	62		$	121	$	60

(a) For 2012 and 2011, United’s only Level 3 recurring measurements are the above EETCs.

	Three Months Ended September 30,
	2012								2011
Continental	Auction Rate Securities		Convertible Debt Supplemental Derivative Asset (a)			Convertible Debt Conversion Option Liability (a)			Auction Rate Securities			Convertible Debt Supplemental Derivative Asset (a)			Convertible Debt Conversion Option Liability (a)
Balance at June 30	$	112	$	289		$	(147	)	$	121		$	251		$	(143	)
Sales		—		—			—			—			—			—
Gains (losses):
Reported in earnings—unrealized		1		(87	)		56			1			(52	)		40
Reported in other comprehensive income (loss)		2		—			—			(1	)		—			—
Balance at September 30	$	115	$	202		$	(91	)	$	121		$	199		$	(103	)

(a) These derivatives are not designated as hedges. The Convertible Debt Supplemental Derivative Asset is classified in “Other Asset—Other, net”, and the Convertible Debt Conversion Option Liability is classified in “Other liabilities and deferred credits—Other” in Continental’s consolidated balance sheets. The earnings impact is classified in “Nonoperating income (expense)—Miscellaneous, net” in Continental’s statements of consolidated operations.

	Nine Months Ended September 30,
	2012							2011
Continental	Auction Rate Securities		Convertible Debt Supplemental Derivative Asset (a)		Convertible Debt Conversion Option Liability (a)			Auction Rate Securities		Convertible Debt Supplemental Derivative Asset (a)			Convertible Debt Conversion Option Liability (a)
Balance at January 1	$	113	$	193	$	(95	)	$	119	$	286		$	(164	)
Sales		—		—		—			—		—			—
Gains (losses):
Reported in earnings—unrealized		—		9		4			2		(87	)		61
Reported in other comprehensive income (loss)		2		—		—			—		—			—
Balance at September 30	$	115	$	202	$	(91	)	$	121	$	199		$	(103	)

(a) These derivatives are not designated as hedges. The Convertible Debt Supplemental Derivative Asset is classified in “Other Asset—Other, net”, and the Convertible Debt Conversion Option Liability is classified in “Other liabilities and deferred credits—Other” in Continental’s consolidated balance sheets. The earnings impact is classified in “Nonoperating income (expense)—Miscellaneous, net” in Continental’s statements of consolidated operations.

As of September 30, 2012, Continental’s auction rate securities, which had a par value of $135 million, were variable-rate debt instruments with contractual maturities generally greater than ten years and with interest rates that reset every 7, 28 or 35 days, depending on the terms of the particular instrument. These securities are backed by pools of student loans guaranteed by state-designated guaranty agencies and reinsured by the U.S. government. All of the auction rate securities that Continental holds are senior obligations under the applicable indentures authorizing the issuance of the securities.

As of September 30, 2012, United’s EETC securities had unrealized gains of $1 million. All changes in the fair value of these investments have been classified within accumulated other comprehensive income.

Continental’s debt-related derivatives presented in the tables above relate to (a) supplemental indenture agreements that provide that Continental’s convertible debt, which was previously convertible into shares of Continental common stock, is convertible into shares of UAL common stock upon the terms and conditions specified in the indentures, and (b) the embedded conversion options in Continental’s convertible debt that are required to be separated and accounted for as though they are free-standing derivatives as a result of the Continental debt becoming convertible into the common stock of a different reporting entity. These derivatives are reported in Continental’s separate financial statements and eliminated in consolidation for UAL.

The table below presents the carrying values and estimated fair values of financial instruments not presented in the tables above as of September 30, 2012 and December 31, 2011 (in millions):

	Fair Value of Debt by Fair Value Hierarchy Level
	September 30, 2012										December 31, 2011
	Carrying Amount		Fair Value								Carrying Amount		Fair Value
			Total		Level 1		Level 2		Level 3				Total		Level 1		Level 2		Level 3
UAL debt	$	11,296	$	12,320	$	—	$	7,015	$	5,305	$	11,682	$	11,992	$	—	$	859	$	11,133
United debt		5,169		5,436		—		1,994		3,442		5,745		5,630		—		—		5,630
Continental debt		5,724		6,050		—		4,187		1,863		5,528		5,503		—		—		5,503

Quantitative Information About Level 3 Fair Value Measurements as of September 30, 2012 ($ in millions)

Item	Fair Value at September 30, 2012			Valuation Technique	Unobservable Input	Range (Weighted Average)
Auction rate securities	$	115		Discounted Cash Flows	Credit risk premium (a)	1%
					Illiquidity premium (b)	5%
					Expected repayments (c)	Assumed repayment in years 2013 through 2036
EETC		62		Discounted Cash Flows	Structure credit risk (d)	6% - 7% (7%)
Convertible debt derivative asset		202		Binomial Lattice Model	Expected volatility (e)	45% - 60% (48%)
					Own credit risk (f)	7% - 10% (8%)
Convertible debt option liability		(91	)	Binomial Lattice Model	Expected volatility (e)	45% - 60% (49%)
					Own credit risk (f)	7% - 10% (8%)

(a) Represents the credit risk premium component of the discount rate that the Company has determined market participants would use in pricing the investments.

(b) Represents the illiquidity premium component of the discount rate that the Company has determined market participants would use in pricing the investments.

(c) Represents the estimated timing of principal repayments used in the discounted cash flow model.

(d) Represents the credit risk premium of the EETC structure above the risk-free rate that the Company has determined market participants would use in pricing the instruments.

(e) Represents the range in volatility estimates that the Company has determined market participants would use when pricing the instruments.

(f) Represents the range of Company-specific risk adjustments that the Company has determined market participants would use as a model input.

Valuation Processes—Level 3 Measurements—The Company’s internal valuation group is responsible for determining the fair value of financial instruments. Depending on the instrument, the valuation group utilizes discounted cash flow methods or option pricing methods as indicated above. Valuations using discounted cash flow methods are generally conducted by the valuation group. Valuations using option pricing models are generally provided to the Company by third-party valuation experts. Each reporting period, the valuation group reviews the unobservable inputs used by third-party valuation experts for reasonableness utilizing relevant information available to the Company from other published sources. The Company has a formal process to review changes in fair value for satisfactory explanation.

Sensitivity Analysis—Level 3 Measurements—Changes in the unobservable input values would be unlikely to cause material changes in the fair value of the auction rate securities and EETCs.

The significant unobservable inputs used in the fair value measurement of the Continental convertible debt derivative assets and liabilities are the UAL stock expected volatility and the Company’s own credit risk. Significant increases (decreases) in expected volatility would result in a higher (lower) fair value measurement. Significant increases (decreases) in the Company’s own credit risk would result in a lower (higher) fair value measurement. A change in one of the inputs would not necessarily result in a directionally similar change in the other.

Fair value of the financial instruments included in the tables above was determined as follows:

Description	Fair Value Methodology
Cash and Cash Equivalents	The carrying amounts approximate fair value because of the short-term maturity of these assets.
Short - term Investments, Investments, and Restricted Cash	Fair value is based on (a) the trading prices of the investment or similar instruments, (b) an income approach, which uses valuation techniques to convert future amounts into a single present amount based on current market expectations about those future amounts when observable trading prices are not available, or (c) internally-developed models of the expected future cash flows related to the securities. These assets have maturities of less than one year except for the EETCs, auction rate securities and corporate debt.
Fuel Derivatives	Derivative contracts are privately negotiated contracts and are not exchange traded. Fair value measurements are estimated with option pricing models that employ observable inputs. Inputs to the valuation models include contractual terms, market prices, yield curves, fuel price curves and measures of volatility, among others.
Foreign Currency Derivatives	Fair value is determined with a formula utilizing observable inputs. Significant inputs to the valuation models include contractual terms, risk-free interest rates and forward exchange rates.
Debt	Fair values were based on either market prices or the discounted amount of future cash flows using our current incremental rate of borrowing for similar liabilities.
Convertible Debt Derivative Asset and Option Liability	The Company used a binomial lattice model to value the conversion options and the supplemental derivative assets. Significant binomial model inputs that are not objectively determinable include volatility and discount rate.