Financial Instruments and Fair Value Measurements

3 Months Ended

Mar. 31, 2013

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 (in millions):

	March 31, 2013										December 31, 2012
	Total			Level 1		Level 2		Level 3			Total			Level 1		Level 2		Level 3
	UAL
Cash and cash equivalents	$	3,538		$	3,538	$	—	$	—		$	4,770		$	4,770	$	—	$	—
Short-term investments:
Asset-backed securities		762			—		762		—			715			—		715		—
Corporate debt		540			—		540		—			537			—		537		—
Certificates of deposit placed through an account registry service (“CDARS”)		399			—		399		—			367			—		367		—
Auction rate securities		108			—		—		108			116			—		—		116
U.S. government and agency notes		10			—		10		—			12			—		12		—
Other fixed income securities		33			—		33		—			26			—		26		—
Enhanced equipment trust certificates (“EETC”)		61			—		—		61			63			—		—		63
Fuel derivatives, net		73			—		73		—			46			—		46		—
Restricted cash		435			435		—		—			447			447		—		—
	United
Cash and cash equivalents	$	3,532		$	3,532	$	—	$	—		$	4,765		$	4,765	$	—	$	—
Short-term investments:
Asset-backed securities		762			—		762		—			715			—		715		—
Corporate debt		540			—		540		—			537			—		537		—
CDARS		399			—		399		—			367			—		367		—
Auction rate securities		108			—		—		108			116			—		—		116
U.S. government and agency notes		10			—		10		—			12			—		12		—
Other fixed income securities		33			—		33		—			26			—		26		—
EETC		61			—		—		61			63			—		—		63
Fuel derivatives, net		73			—		73		—			46			—		46		—
Restricted cash		435			435		—		—			447			447		—		—
Convertible debt derivative asset		413			—		—		413			268			—		—		268
Convertible debt option liability		(209	)		—		—		(209	)		(128	)		—		—		(128	)

The tables below present disclosures about the activity for “Level 3” financial assets and financial liabilities (in millions):

	Three Months Ended March 31,
	2013						2012
UAL	Auction Rate Securities			EETC			Auction Rate Securities			EETC
Balance at January 1	$	116		$	63		$	113		$	60
Settlements		(10	)		(2	)		—			(2	)
Gains (losses):
Reported in earnings—realized		2			—			—			—
Reported in earnings—unrealized		1			—			(1	)		—
Reported in other comprehensive income (loss)		(1	)		—			—			4
Balance at March 31	$	108		$	61		$	112		$	62

	Three Months Ended March 31,
	2013											2012
United	Auction Rate Securities			Convertible Debt Supplemental Derivative Asset		Convertible Debt Conversion Option Liability			EETC			Auction Rate Securities			Convertible Debt Supplemental Derivative Asset		Convertible Debt Conversion Option Liability			EETC
Balance at January 1	$	116		$	268	$	(128	)	$	63		$	113		$	193	$	(95	)	$	60
Purchases, sales, issuances and settlements (net)		(10	)		—		—			(2	)		—			—		—			(2	)
Gains and (losses):
Reported in earnings:
Realized		2			—		—			—			—			—		—			—
Unrealized		1			145		(81	)		—			(1	)		38		(24	)		—
Reported in other comprehensive income (loss)		(1	)		—		—			—			—			—		—			4
Balance at March 31	$	108		$	413	$	(209	)	$	61		$	112		$	231	$	(119	)	$	62

As of March 31, 2013, the Company’s auction rate securities, which had a par value of $125 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 the Company holds are senior obligations under the applicable indentures authorizing the issuance of the securities.

As of March 31, 2013, EETC securities had unrealized gains of $2 million. All changes in the fair value of these investments have been classified within accumulated other comprehensive income.

United’s debt-related derivatives presented in the tables above relate to (a) supplemental indenture agreements that provide that United’s convertible debt is convertible into shares of UAL common stock upon the terms and conditions specified in the indentures, and (b) the embedded conversion options in United’s convertible debt that are required to be separated and accounted for as though they are free-standing derivatives as a result of the United debt becoming convertible into the common stock of a different reporting entity. The derivatives described above relate to the 6% convertible junior subordinated debentures due 2030 and the 4.5% convertible notes due 2015. These derivatives are reported in United’s separate financial statements and eliminated in consolidation for UAL.

Derivative instruments and investments presented in the tables above have the same fair value as their carrying value. The table below presents the carrying values and estimated fair values of financial instruments not presented in the tables above (in millions):

	Fair Value of Debt by Fair Value Hierarchy Level
	March 31, 2013										December 31, 2012
	Carrying Amount		Fair Value								Carrying Amount		Fair Value
			Total		Level 1		Level 2		Level 3				Total		Level 1		Level 2		Level 3
UAL debt	$	11,261	$	13,020	$	—	$	8,028	$	4,992	$	12,252	$	13,419	$	—	$	8,045	$	5,374
United debt		10,862		11,745		—		6,753		4,992		11,850		12,460		—		7,086		5,374

Quantitative Information About Level 3 Fair Value Measurements (in millions)
Item	Fair Value at March 31, 2013			Valuation Technique	Unobservable Input	Range (Weighted Average)
Auction rate securities	$	108		Discounted Cash Flows	Credit risk premium (a) Illiquidity premium (b)	1% 5%
					Expected repayments (c)	Assumed repayment in years 2013 through 2036
EETC		61		Discounted Cash Flows	Structure credit risk (d)	6%
Convertible debt derivative asset		413		Binomial Lattice Model	Expected volatility (e) Own credit risk (f)	45% - 60% (47%) 6%
Convertible debt option liability		(209	)	Binomial Lattice Model	Expected volatility (e) Own credit risk (f)	45% - 60% (47%) 6%

(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 values 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 United 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	United 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.