FINANCIAL DERIVATIVE INSTRUMENTS

Fuel contracts

Airline operators are inherently dependent upon energy to operate and, therefore, are impacted by changes in jet fuel prices. Furthermore, jet fuel and oil typically represent one of the largest operating expenses for airlines. The Company endeavors to acquire jet fuel at the lowest possible cost and to reduce volatility in operating expenses through its fuel hedging program. Although the Company may periodically enter into jet fuel derivatives for short-term timeframes, because jet fuel is not widely traded on an organized futures exchange, there are limited opportunities to hedge directly in jet fuel for time horizons longer than approximately 6 to 12 months into the future. However, the Company has found that financial derivative instruments in other commodities, such as West Texas Intermediate (“WTI”) crude oil, Brent crude oil, and refined products, such as heating oil and unleaded gasoline, can be useful in decreasing its exposure to jet fuel price volatility. The Company does not purchase or hold any financial derivative instruments for trading or speculative purposes.

The Company has used financial derivative instruments for both short-term and long-term time frames and primarily uses a mixture of purchased call options, collar structures (which include both a purchased call option and a sold put option), call spreads (which include a purchased call option and a sold call option), and fixed price swap agreements in its portfolio.

The Company evaluates its hedge volumes strictly from an “economic” standpoint and thus does not consider whether the hedges have qualified or will qualify for hedge accounting. The Company defines its “economic” hedge as the net volume of fuel derivative contracts held, including the impact of positions that have been offset through sold positions, regardless of whether those contracts qualify for hedge accounting. The level at which the Company is hedged for a particular period is also dependent on current market prices for that period, as well as the types of derivative instruments held and the strike prices of those instruments.

For the three months ended March 31, 2013, the Company had fuel derivative instruments in place for a small portion of its fuel consumption. As of March 31, 2013, the Company had fuel derivative instruments in place to provide coverage for approximately 82 percent of its remaining 2013 estimated fuel consumption. The following table provides information about the Company’s volume of fuel hedging for the years 2013 through 2017 on an “economic” basis considering current market prices:



	Fuel hedged as of
	March 31, 2013	Hedged commodity type as of
Period (by year)	(gallons in millions)(a)	March 31, 2013
Remainder of 2013	1,118	Brent crude oil and Gulf Coast jet fuel
2014	1,444	WTI crude and Brent crude oil
2015	597	WTI crude and Brent crude oil
2016	886	Brent crude oil
2017	619	WTI crude and Brent crude oil

(a) The Company determines gallons hedged based on market prices and forward curves as of March 31, 2013. Due to the types of derivatives utilized by the Company, these volumes may vary significantly as market prices fluctuate.

Upon proper qualification, the Company accounts for its fuel derivative instruments as cash flow hedges. Generally, utilizing hedge accounting, all periodic changes in fair value of the derivatives designated as hedges that are considered to be effective are recorded in AOCI until the underlying jet fuel is consumed. See Note 6. To the extent that the periodic changes in the fair value of the derivatives are ineffective, the ineffective portion is recorded to Other (gains) losses, net, in the unaudited Condensed Consolidated Statement of Comprehensive Income. Likewise, if a hedge ceases to qualify for hedge accounting, any change in the fair value of derivative instruments since the last reporting period is recorded to Other (gains) losses, net, in the unaudited Condensed Consolidated Statement of Comprehensive Income in the period of the change; however, any amounts previously recorded to AOCI would remain there until such time as the original forecasted transaction occurs, at which time these amounts would be reclassified to Fuel and oil expense. In a situation where it becomes probable that a fuel hedged forecasted transaction will not occur, any gains and/or losses that have been recorded to AOCI would be required to be immediately reclassified into earnings. The Company did not have any such situations occur during 2012 or during the three months ended March 31, 2013.

All cash flows associated with purchasing and selling fuel derivatives are classified as Other operating cash flows in the unaudited Condensed Consolidated Statement of Cash Flows. The following table presents the location of all assets and liabilities associated with the Company’s derivative instruments within the unaudited Condensed Consolidated Balance Sheet:



		Asset derivatives				Liability derivatives
	Balance Sheet	Fair value at		Fair value at		Fair value at		Fair value at
(in millions)	location	3/31/2013		12/31/2012		3/31/2013		12/31/2012
Derivatives designated as hedges*
Fuel derivative contracts (gross)	Prepaid expenses and other current assets	$	42	$	—	$	—	$	—
Fuel derivative contracts (gross)	Other assets	292		355		10		16
Interest rate derivative contracts	Other assets	29		31		—		—
Interest rate derivative contracts	Other noncurrent liabilities	—		—		115		126
Total derivatives designated as hedges		$	363	$	386	$	125	$	142
Derivatives not designated as hedges*
Fuel derivative contracts (gross)	Prepaid expenses and other current assets	$	259	$	375	$	261	$	327
Fuel derivative contracts (gross)	Other assets	112		233		222		351
Fuel derivative contracts (gross)	Accrued liabilities	—		10		—		60
Fuel derivative contracts (gross)	Other noncurrent liabilities	—		—		12		—
Total derivatives not designated as hedges		$	371	$	618	$	495	$	738
Total derivatives		$	734	$	1,004	$	620	$	880

* Represents the position of each trade before consideration of offsetting positions with each counterparty and does not include the impact of cash collateral deposits provided to or received from counterparties. See discussion of credit risk and collateral following in this Note.

In addition, the Company had the following amounts associated with fuel derivative instruments and hedging activities in its unaudited Condensed Consolidated Balance Sheet:



	Balance Sheet	March 31,		December 31,
(in millions)	location	2013		2012
Cash collateral deposits provided to counterparties for interest rate contracts - noncurrent	Offset against Other noncurrent liabilities	$	61	$	89
Receivable from third parties for fuel contracts - noncurrent	Other assets	54		54
Prepaid settlements for fuel contracts - current	Prepaid expenses and other current assets	—		15

All of the Company's fuel derivative instruments and interest rate swaps are subject to agreements that follow the netting guidance in the applicable accounting for Derivatives and Hedging. The types of derivative instruments the Company has determined are subject to netting requirements in the accompanying unaudited Condensed Consolidated Balance Sheet are those in which the Company pays or receives cash for transactions with the same counterparty that settle on the same day and in the same currency via one net payment or receipt. For cash collateral held by the Company or provided to counterparties, the Company nets such amounts against the fair value of the Company's derivative portfolio by each counterparty. The Company has elected to utilize netting for both its fuel derivative instruments and interest rate swap agreements and also classifies such amounts as either current or noncurrent, based on the net fair value position with each of the Company's counterparties in the unaudited Condensed Consolidated Balance Sheet.

The Company's application of its netting policy associated with cash collateral differs depending on whether its derivative instruments are in a net asset position or a net liability position. If its fuel derivative instruments are in a net asset position with a counterparty, cash collateral amounts held are first netted against current outstanding derivative amounts associated with that counterparty until that balance is zero, and then any remainder is applied against the fair value of noncurrent outstanding derivative instruments. If the Company's fuel derivative instruments are in a net liability position with the counterparty, cash collateral amounts provided are first netted against noncurrent outstanding derivative amounts associated with that counterparty until that balance is zero, and then any remainder is applied against the fair value of current outstanding derivative instruments. At March 31, 2013 and December 31, 2012, no cash collateral deposits, letters of credit, and/or aircraft collateral were provided by or held by the Company associated with its outstanding fuel derivative instruments.

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 derivative instruments, as well as the Company's and its counterparty's credit ratings. The Company has also elected to present its interest rate swap agreement cash collateral utilizing a net presentation. As of March 31, 2013, $56 million had been provided to one counterparty associated with interest rate derivatives based on the Company's outstanding net liability derivative position with that counterparty. In addition, in connection with interest rate swaps entered into by AirTran, $5 million had been provided to one counterparty at March 31, 2013, as a result of the outstanding net liability derivative position with that counterparty. The outstanding interest rate net derivative positions with all other counterparties at March 31, 2013, were assets to the Company.

The Company has the following recognized financial assets and financial liabilities resulting from those transactions that meet the scope of the disclosure requirements as necessitated by applicable accounting guidance for Balance Sheet Offsetting.



Offsetting of Derivative Assets
(in millions)
		(i)		(ii)			(iii) = (i) + (ii)			(i)		(ii)			(iii) = (i) + (ii)
		March 31, 2013								December 31, 2012
Description	Balance Sheet location	Gross amounts of recognized assets		Gross amounts offset in the Balance Sheet			Net amounts of assets presented in the Balance Sheet			Gross amounts of recognized assets		Gross amounts offset in the Balance Sheet			Net amounts of assets presented in the Balance Sheet
Fuel derivative contracts	Prepaid expenses and other current assets	$	301	$	(261	)	$	40	(a)	$	375	$	(327	)	$	48	(a)
Fuel derivative contracts	Other assets	$	404	$	(232	)	$	172		$	588	$	(367	)	$	221
Fuel derivative contracts	Accrued liabilities	$	—	$	—		$	—		$	10	$	(10	)	$	—
Interest rate derivative contracts	Other assets	$	29	$	—		$	29		$	31	$	—		$	31

(a) Amounts included in Prepaid expenses and other current assets.



Offsetting of Derivative Liabilities
(in millions)
		(i)		(ii)			(iii) = (i) + (ii)		(i)		(ii)			(iii) = (i) + (ii)
		March 31, 2013							December 31, 2012
Description	Balance Sheet location	Gross amounts of recognized liabilities		Gross amounts offset in the Balance Sheet			Net amounts of liabilities presented in the Balance Sheet		Gross amounts of recognized liabilities		Gross amounts offset in the Balance Sheet			Net amounts of liabilities presented in the Balance Sheet
Fuel derivative contracts	Prepaid expenses and other current assets	$	261	$	(261	)	$	—	$	327	$	(327	)	$	—
Fuel derivative contracts	Other assets	$	232	$	(232	)	$	—	$	367	$	(367	)	$	—
Fuel derivative contracts	Accrued liabilities	$	—	$	—		$	—	$	60	$	(10	)	$	50
Fuel derivative contracts	Other noncurrent liabilities	$	12	$	—		$	12	$	—	$	—		$	—
Interest rate derivative contracts	Other noncurrent liabilities	$	115	$	(61	)	$	54	$	126	$	(89	)	$	37

The net amounts of derivative assets and liabilities are reconciled to the individual line item amounts presented in the unaudited Condensed Consolidated Balance Sheet in Note 7.

The following tables present the impact of derivative instruments and their location within the unaudited Condensed Consolidated Statement of Comprehensive Income for the three months ended March 31, 2013 and 2012:



Derivatives in cash flow hedging relationships
	(Gain) loss recognized in AOCI on derivative (effective portion)								(Gain) loss reclassified from AOCI into income (effective portion)(a)						(Gain) loss recognized in income on derivatives (ineffective portion)(b)
	Three months ended								Three months ended						Three months ended
	March 31,								March 31,						March 31,
(in millions)	2013				2012				2013			2012			2013		2012
Fuel derivative contracts	$	29		*	$	(136	)	*	$	26	*	$	23	*	$	10	$	32
Interest rate derivatives	(3		)	*	(2		)	*	5		*	4		*	—		—
Total	$	26			$	(138	)		$	31		$	27		$	10	$	32

*Net of tax

(a) Amounts related to fuel derivative contracts and interest rate derivatives are included in Fuel and oil and Interest expense, respectively.

(b) Amounts are included in Other (gains) losses, net.



Derivatives not in cash flow hedging relationships
	(Gain) loss
	recognized in income on
	derivatives
	Three months ended					Location of (gain) loss
	March 31,					recognized in income
(in millions)	2013		2012			on derivatives
Fuel derivative contracts	$	61	$	(208	)	Other (gains) losses, net

The Company also recorded expense associated with premiums paid for fuel derivative contracts that settled/expired during the three months ended March 31, 2013 and 2012 of $5 million and $6 million, respectively. These amounts are excluded from the Company’s measurement of effectiveness for related hedges and are included as a component of Other (gains) losses, net, in the unaudited Condensed Consolidated Statement of Comprehensive Income.

The fair values of the derivative instruments, depending on the type of instrument, were determined by the use of present value methods or option value models with assumptions about commodity prices based on those observed in underlying markets or provided by third parties. Included in the Company’s cumulative net unrealized losses from fuel hedges as of March 31, 2013, were approximately $57 million in unrealized losses, net of taxes, which are expected to be realized in earnings during the twelve months subsequent to March 31, 2013. In addition, as of March 31, 2013, the Company had already recognized cumulative net gains due to ineffectiveness and derivatives that did not qualify for hedge accounting treatment totaling $64 million, net of taxes. These net gains were recognized during the three months ended March 31, 2013 and prior periods, and are reflected in Retained earnings as of March 31, 2013, but the underlying derivative instruments will not expire/settle until second quarter 2013 or future periods.

Interest rate swaps

The Company is party to certain interest rate swap agreements that are accounted for as either fair value hedges or cash flow hedges, as defined in the applicable accounting guidance for derivative instruments and hedging. The interest rate swap agreements accounted for as fair value hedges qualify for the “shortcut” method of accounting for hedges, which dictates that the hedges are assumed to be perfectly effective, and, thus, there is no ineffectiveness to be recorded in earnings. For the Company’s interest rate swap agreements accounted for as cash flow hedges, ineffectiveness is required to be measured at each reporting period. The ineffectiveness associated with all of the Company’s, including AirTran’s, interest rate cash flow hedges for all periods presented was not material.

In March 2013, the Company prepaid a portion of AirTran's floating-rate aircraft secured term loans. See Note 11. A portion of the floating-rate debt had been effectively converted to a fixed rate via interest rate swap agreements which were to expire between 2016 and 2020. As a result of the prepayment, the Company released the AOCI balance related to the cash flow hedges of approximately $2 million to earnings during first quarter 2013, resulting in an increase in interest expense.

Credit risk and collateral

Credit exposure related to fuel derivative instruments is represented by the fair value of contracts that are an asset 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, the Company has not experienced any significant credit loss as a result of counterparty nonperformance in the past. To manage credit risk, the Company selects and periodically reviews counterparties based on credit ratings, limits its exposure with respect to each counterparty, and monitors the market position of the fuel hedging program and its relative market position with each counterparty. At March 31, 2013, the Company had agreements with all of its active counterparties containing early termination rights and/or bilateral collateral provisions whereby security is required if market risk exposure exceeds a specified threshold amount based on the counterparty credit rating. The Company also had agreements with counterparties in which cash deposits, letters of credit, and/or pledged aircraft are required to be posted whenever the net fair value of derivatives associated with those counterparties exceeds specific thresholds. The following table provides the fair values of fuel derivatives, amounts posted as collateral, and applicable collateral posting threshold amounts as of March 31, 2013, at which such postings are triggered:

Counterparty (CP)

(in millions)

Other(a)

Total

Fair value of fuel derivatives

200

Cash collateral held (by) CP

—

Aircraft collateral pledged to CP

—

Letters of credit (LC)

—

Option to substitute LC for aircraft

(340) to (740)(d)

>(125)(d)

N/A

Option to substitute LC for cash

N/A

(100) to (150)(e)

N/A

>(50)(e)

N/A

If credit rating is investment

grade, fair value of fuel

derivative level at which:

Cash is provided to CP

(40) to (340) or >(740)

0 to (125) or >(625)

>(50)

>(75)

>(50)

Cash is received from CP

>75

>150

>175(c)

>125(c)

>200

>30

Aircraft or cash can be pledged to

CP as collateral

(340) to (740)(d)

(125) to (625)(d)

N/A

If credit rating is non-investment

grade, fair value of fuel derivative

level at which:

Cash is provided to CP

(40) to (340) or >(740)

0 to (125) or >(625)

(b)

Cash is received from CP

(b)

Aircraft can be pledged to CP as

collateral

(340) to (740)

(125) to (625)

N/A

(a) Individual counterparties with fair value of fuel derivatives <$20 million.

(b) Cash collateral is provided at 100 percent of fair value of fuel derivative contracts.

(d) The Company has the option of providing cash, letters of credit, or pledging aircraft as collateral. No cash, letters of credit, or aircraft were pledged as collateral with such counterparties as of March 31, 2013.

(e) The Company has the option of providing cash or letters of credit as collateral. No cash or letters of credit were pledged as collateral with such counterparties as of March 31, 2013.