FINANCIAL DERIVATIVE INSTRUMENTS

9 Months Ended

Sep. 30, 2020

Derivative Instruments and Hedging Activities Disclosure [Abstract]

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 represents 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 24 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 timeframes, 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), put spreads (which include a purchased put option and a sold put option), and fixed price swap agreements in its portfolio. Although the use of collar structures and swap agreements can reduce the overall cost of hedging, these instruments carry more risk than purchased call options in that the Company could end up in a liability position when the collar structure or swap agreement settles. With the use of purchased call options and call spreads, the Company cannot be in a liability position at settlement, but does not have coverage once market prices fall below the strike price of the purchased call option.

For the purpose of evaluating its net cash spend for jet fuel and for forecasting its future estimated jet fuel expense, 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 economically 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 example, the Company may enter into "out-of-the-money" option contracts (including "catastrophic" protection), which may not generate intrinsic gains at settlement if market prices do not rise above the option strike price. Therefore, even though the Company may have an economic hedge in place for a particular period, that hedge may not produce any hedging gains at settlement and may even produce hedging losses depending on market prices, the types of instruments held, and the strike prices of those instruments.

For the three and nine months ended September 30, 2020, the Company had fuel derivative instruments in place for up to 42 percent and 67 percent, respectively, of its fuel consumption. As of September 30, 2020, the Company also had fuel derivative instruments in place to provide coverage at varying price levels. The following table provides information about the Company’s volume of fuel hedging on an economic basis:

Maximum fuel hedged as of

September 30, 2020

Derivative underlying commodity type as of

Period (by year)

(gallons in millions) (a)

September 30, 2020

Remainder of 2020

325

WTI crude oil, Brent crude oil, and Heating oil

2021

1,283

WTI crude oil and Brent crude oil

2022

1,220

WTI crude oil and Brent crude oil

Beyond 2022

630

WTI crude oil and Brent crude oil

(a) Due to the types of derivatives utilized by the Company and different price levels of those contracts, these volumes represent the maximum economic hedge in place and may vary significantly as market prices and the Company's flight schedule fluctuates.

Upon proper qualification, the Company accounts for its fuel derivative instruments as cash flow hedges. All periodic changes in fair value of the derivatives designated as hedges are recorded in Accumulated other comprehensive income (loss) ("AOCI") until the underlying jet fuel is consumed. See Note 5.

The Company's results are subject to the possibility that the derivatives will no longer qualify for hedge accounting, in which case any change in the fair value of derivative instruments since the last reporting period would be recorded in Other (gains) losses, net, in the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) 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. Factors that have and may continue to lead to the loss of hedge accounting include: significant fluctuation in energy prices, significant weather events affecting refinery capacity and the production of refined products, and the volatility of the different types of products the Company uses in hedging. Increased volatility in these commodity markets for an extended period of time, especially if such volatility were to worsen, could cause the Company to lose hedge accounting altogether for the commodities used in its fuel hedging program, which would create further volatility in the Company’s GAAP financial results. However, even though derivatives may not qualify for hedge accounting, the Company continues to hold the instruments as management believes derivative instruments continue to afford the Company the opportunity to stabilize jet fuel costs. When the Company has sold derivative positions in order to effectively "close" or offset a derivative already held as part of its fuel derivative instrument portfolio, any subsequent changes in fair value of those positions are marked to market through earnings. Likewise, any changes in fair value of those positions that were offset by entering into the sold positions and were de-designated as hedges are concurrently marked to market through earnings. However, any changes in value related to hedges that were deferred as part of AOCI while designated as a hedge would remain until the originally forecasted transaction occurs. 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 will be required to be immediately reclassified into earnings. During the first nine months of 2020, as a result of the drastic drop in demand for air travel due to the COVID-19 pandemic, the Company's forecast for 2020 and 2021 fuel purchases and consumption was significantly reduced, causing the Company to be in an estimated "over–hedged" position for second, third, and fourth quarter 2020, and full year 2021. Therefore, the Company de–designated a portion of its fuel hedges related to these periods, and has reclassified approximately $22 million and $38 million in losses from AOCI into Other (gains) losses, net, during the three and nine months ended September 30, 2020, respectively. The Company did not have any such situations occur during 2019.

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	9/30/2020		12/31/2019		9/30/2020		12/31/2019
Derivatives designated as hedges (a)
Fuel derivative contracts (gross)	Prepaid expenses and other current assets	$	4	$	48	$	—	$	—
Fuel derivative contracts (gross)	Other assets	101		62		—		—



Interest rate derivative contracts	Other assets	—		2		—		—
Interest rate derivative contracts	Accrued liabilities	—		—		—		5
Interest rate derivative contracts	Other noncurrent liabilities	—		—		11		1
Total derivatives designated as hedges				$	105	$	112	$	11	$	6
Derivatives not designated as hedges (a)
Fuel derivative contracts (gross)	Prepaid expenses and other current assets	$	2	$	—	$	—	$	—
Fuel derivative contracts (gross)	Other assets	2		—		—		—


Interest rate derivative contracts	Accrued liabilities	—		—		28		—

Total derivatives not designated as hedges		$	4	$	—	$	28	$	—
Total derivatives		$	109	$	112	$	39	$	6

(a) 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.

The following table presents the amounts recorded on the unaudited Condensed Consolidated Balance Sheet related to fair value hedges:


Balance Sheet location of hedged item	Carrying amount of the hedged liabilities						Cumulative amount of fair value hedging adjustment included in the carrying amount of the hedged liabilities (a)
	September 30,						September 30,
(in millions)	2020		2019		2020		2019
Current maturities of long-term debt	$	500	$	300	$	—	$	2
Long-term debt less current maturities	—		501		18		18
	$	500	$	801	$	18	$	20

(a) At September 30, 2020 and 2019, these amounts include the cumulative amount of fair value hedging adjustments remaining for which hedge accounting has been discontinued, of $18 million and $19 million, respectively.

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	September 30,		December 31,
(in millions)	location	2020		2019
Cash collateral deposits held from counterparties for fuel contracts - current	Offset against Prepaid expenses and other current assets	$	1	$	10
Cash collateral deposits held from counterparties for fuel contracts - noncurrent	Offset against Other assets	26		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 standards 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 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. 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 asset 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. As of September 30, 2020, no cash collateral deposits were provided by or held by the Company based on its outstanding interest rate swap agreements.

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)
		September 30, 2020											December 31, 2019
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	$	6	$	(1)	$	5		$	48	$	(10)	$	38
Fuel derivative contracts	Other assets	$	103	$	(26)	$	77	(a)	$	62	$	(15)	$	47	(a)



Interest rate derivative contracts	Other assets	$	—	$	—	$	—	(a)	$	2	$	—	$	2	(a)

(a) 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 10.


Offsetting of derivative liabilities
(in millions)
		(i)		(ii)		(iii) = (i) + (ii)			(i)		(ii)		(iii) = (i) + (ii)
		September 30, 2020											December 31, 2019
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	$	1	$	(1)	$	—		$	10	$	(10)	$	—
Fuel derivative contracts	Other assets	$	26	$	(26)	$	—	(a)	$	15	$	(15)	$	—	(a)




Interest rate derivative contracts	Accrued liabilities	$	28	$	—	$	28	(a)	$	5	$	—	$	5	(a)
Interest rate derivative contracts	Other noncurrent liabilities	$	11	$	—	$	11		$	1	$	—	$	1

(a) 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 10.

The following tables present the impact of derivative instruments and their location within the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) for the three and nine months ended September 30, 2020 and 2019:


Location and amount recognized in income on cash flow and fair value hedging relationships
	Three months ended September 30, 2020								Three months ended September 30, 2019
(in millions)	Fuel and oil		Other (gains)/losses, net		Interest expense		Fuel and oil		Interest expense
Total	$	18	$	22	$	2	$	19	$	8

Loss on cash flow hedging relationships:
Commodity contracts:
Amount of loss reclassified from AOCI into income	18		22		—		19		—
Interest contracts:
Amount of loss reclassified from AOCI into income	—		—		—		—		2

Impact of fair value hedging relationships:
Interest contracts:
Hedged items	—		—		4		—		6
Derivatives designated as hedging instruments	—		—		(2)		—		—


Location and amount recognized in income on cash flow and fair value hedging relationships
	Nine months ended September 30, 2020										Nine months ended September 30, 2019
(in millions)	Fuel and oil		Other (gains)/losses, net		Interest expense		Fuel and oil		Interest expense
Total	$	54	$	38	$	6	$	28	$	21

Loss on cash flow hedging relationships
Commodity contracts:
Amount of loss reclassified from AOCI into income	54		38		—		28		—
Interest contracts:
Amount of loss reclassified from AOCI into income	—		—		1		—		3

Impact of fair value hedging relationships:
Interest contracts:
Hedged items	—		—		11		—		17
Derivatives designated as hedging instruments	—		—		(6)		—		1


Derivatives designated and qualified in cash flow hedging relationships
	(Gain) loss recognized in AOCI on derivatives, net of tax
	Three months ended
	September 30,
(in millions)	2020		2019
Fuel derivative contracts	$	17	$	95
Interest rate derivatives	(3)		17
Total	$	14	$	112


Derivatives designated and qualified in cash flow hedging relationships
	Loss recognized in AOCI on derivatives, net of tax
	Nine months ended
	September 30,
(in millions)	2020		2019
Fuel derivative contracts	$	91	$	83
Interest rate derivatives	30		43
Total	$	121	$	126


Derivatives not designated as hedges
	(Gain) loss recognized in income on derivatives

	Three months ended					Location of (gain) loss recognized in income on derivatives
	September 30,
(in millions)	2020		2019
Fuel derivative contracts	$	1	$	—	Other (gains) losses, net
Interest rate derivatives	(1)		—		Other (gains) losses, net
Total	$	—	$	—


Derivatives not designated as hedges
	Loss recognized in income on derivatives

	Nine months ended					Location of loss recognized in income on derivatives
	September 30,
(in millions)	2020		2019
Fuel derivative contracts	$	2	$	—	Other (gains) losses, net
Interest rate derivatives	28		—		Other (gains) losses, net
Total	$	30	$	—

The Company also recorded expense associated with premiums paid for fuel derivative contracts that settled/expired during the three and nine months ended September 30, 2020 and 2019. Fuel derivatives that qualify for hedge accounting are recorded to Fuel and oil expense. Fuel derivatives that do not qualify for hedge accounting are recorded to Other (gains) and losses, net. The following tables present the impact of premiums paid for fuel derivative contracts and their location within the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) during the period the contract settles:


	Premium expense recognized in income on derivatives

	Three months ended					Location of premium expense recognized in income on derivatives
	September 30,
(in millions)	2020		2019
Fuel derivative contracts designated as hedges	$	13	$	20	Fuel and oil
Fuel derivative contracts not designated as hedges	$	11	$	—	Other (gains) losses, net


	Premium expense recognized in income on derivatives

	Nine months ended					Location of premium expense recognized in income on derivatives
	September 30,
(in millions)	2020		2019
Fuel derivative contracts designated as hedges	$	51	$	75	Fuel and oil
Fuel derivative contracts not designated as hedges	$	22	$	—	Other (gains) losses, net

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 September 30, 2020, recorded in AOCI, were approximately $53 million in unrealized losses, net of taxes, which are expected to be realized in earnings during the twelve months subsequent to September 30, 2020.

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. Several of the Company's interest rate swap agreements 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.

During first quarter 2019, the Company entered into 12 separate forward-starting interest rate swap agreements related to a series of 12 Boeing 737 MAX 8 aircraft leases with deliveries originally scheduled between July 2019 and February 2020. These lease contracts exposed the Company to interest rate risk as the rental payments were subject to adjustment and would become fixed based on the 9-year swap rate at the time of delivery. The primary objective of these interest rate derivatives, which qualified as cash flow hedges, was to hedge the forecasted monthly rental payments. These swap agreements provided for a single payment at maturity based upon the change in the 9-year swap rate between the execution date and the termination date. All 12 swap agreements were terminated during third quarter 2019, resulting in $32 million being "frozen" in AOCI. As a result of the extenuating circumstances involving the MAX aircraft, which are outside the control of the Company, these amounts will be recognized in earnings when the original forecasted transaction occurs, which remains probable.

During third quarter 2019, the Company entered into 12 separate forward-starting interest rate swap agreements, related to a series of 12 Boeing 737 MAX 8 aircraft leases. The third quarter 2019 swaps contain similar terms as the third quarter 2019 terminated swaps discussed above, except that the related 737 MAX 8 deliveries were scheduled to occur between June 2020 and September 2020. During the first nine months of 2020, all 12 of the aircraft leases became no longer probable to be received within the scheduled delivery range. Therefore, the 12 associated swap agreements were de-designated and $14 million and $31 million were "frozen" in AOCI during the three and nine months ended September 30, 2020, respectively. These amounts will be recognized in earnings when the original forecasted transaction occurs, which continues to be probable. The mark-to-market changes for these swap agreements are now being recorded in earnings, resulting in a $1 million unrealized gain and a $28 million unrealized loss to Other (gains) and losses, net, in the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) for the three and nine months ended September 30, 2020, respectively. In addition, 6 of the 12 swap agreements were terminated on June 30, 2020, resulting in $31 million paid to the counterparty. The remaining 6 swap agreements were terminated on September 30, 2020, resulting in $28 million owed to the counterparty, which was recorded as an Accrued liability within the unaudited Condensed Consolidated Balance Sheet as of September 30, 2020.

For the Company’s interest rate swap agreements that do not qualify for the "shortcut" or "critical terms match" methods of accounting, ineffectiveness is assessed at each reporting period. If hedge accounting is achieved, all periodic changes in fair value of the interest rate swaps are recorded in AOCI.

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 September 30, 2020, 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 and letters of credit were required to be posted as collateral

whenever the net fair value of derivatives associated with those counterparties exceeds specific thresholds. In certain cases, the Company has the ability to substitute among these different forms of collateral at its discretion.

The following table provides the fair values of fuel derivatives, amounts posted as collateral, and applicable collateral posting threshold amounts as of September 30, 2020, at which such postings are triggered:

Counterparty (CP)

(in millions)

Other (a)

Total

Fair value of fuel derivatives

109

Cash collateral held from CP

—

Letters of credit (LC)

—

Option to substitute LC for cash

N/A

(75) to (150) or >(550)(b)

(125) to (150) or >(550)(c)

(c)

N/A

If credit rating is investment
grade, fair value of fuel
derivative level at which:

Cash is provided to CP

>(100)

>(50)

(75) to (150) or >(550)(d)

(125) to (150) or >(550)(d)

>(40)

>(65)(d)

Cash is received from CP

>0(d)

>150(d)

>250(d)

>(125)(d)

>100(d)

>70(d)

Cash can be pledged to
CP as collateral

(200) to (600)(e)

N/A

(150) to (550)(b)

N/A

If credit rating is non-investment
grade, fair value of fuel derivative level at which:

Cash is provided to CP

(0) to (200) or >(600)

(f)

(0) to (150) or >(550)

(f)

Cash is received from CP

(f)

Cash can be pledged to
CP as collateral

(200) to (600)

N/A

(150) to (550)

N/A

(a) Individual counterparties with fair value of fuel derivatives < $9 million.

(b) The Company has the option of providing cash or letters of credit as collateral.

(d) Thresholds may vary based on changes in credit ratings within investment grade.

(e) The Company has the option of providing cash as collateral.

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