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Fair Value Measurements
 9 Months Ended
Jun. 30, 2011
Fair Value Measurements [Abstract]  
Fair Value Measurements

Fair value is determined based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in TVA’s principal market, or in the absence of a principal market, the most advantageous market for the asset or liability in an orderly transaction between market participants.  TVA uses market or observable inputs as the preferred source of values, followed by assumptions based on hypothetical transactions in the absence of market inputs.

Valuation Techniques

The measurement of fair value results in classification into a hierarchy by the inputs used to determine the fair value as follows:

Level 1
—
 
 
Unadjusted quoted prices in active markets accessible by the reporting entity for identical assets or liabilities.  Active markets are those in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing.
 
Level 2
 
—
 
 
Pricing inputs other than quoted market prices included in Level 1 that are based on observable market data and that are directly or indirectly observable for substantially the full term of the asset or liability.  These include quoted market prices for similar assets or liabilities, quoted market prices for identical or similar assets in markets that are not active, adjusted quoted market prices, inputs from observable data such as interest rate and yield curves, volatilities and default rates observable at commonly quoted intervals, and inputs derived from observable market data by correlation or other means.
 
Level 3
—
 
 
Pricing inputs that are unobservable, or less observable, from objective sources.  Unobservable inputs are only to be used to the extent observable inputs are not available.  These inputs maintain the concept of an exit price from the perspective of a market participant and should reflect assumptions of other market participants.  An entity should consider all market participant assumptions that are available without unreasonable cost and effort.  These are given the lowest priority and are generally used in internally developed methodologies to generate management's best estimate of the fair value when no observable market data is available.
 

A financial instrument's level within the fair value hierarchy (where Level 3 is the lowest and Level 1 is the highest) is based on the lowest level of input significant to the fair value measurement.

The following sections describe the valuation methodologies TVA uses to measure different financial instruments at fair value.  Except for gains and losses on SERP assets, all changes in fair value of these assets and liabilities have been reflected as changes in Regulatory assets, Regulatory liabilities, or Accumulated other comprehensive loss on TVA’s Balance Sheet as of June 30, 2011, and Statements of Changes in Proprietary Capital for the three and nine months ended June 30, 2011.  Except for gains and losses on SERP assets, there has been no impact to the Statements of Operations for the three and nine months ended June 30, 2011, or the Statements of Cash Flows for the nine months ended June 30, 2011, related to these fair value measurements.

Investments

At June 30, 2011, TVA’s investment funds were composed of $1.3 billion of securities classified as trading and measured at fair value and $2 million of equity investments not required to be measured at fair value.  Trading securities are held in the NDT, ART, and SERP.  The NDT holds funds for the ultimate decommissioning of TVA’s nuclear power plants.  The ART holds funds for the costs related to the future closure and retirement of TVA’s long-lived assets.  TVA established a SERP for certain executives in critical positions to provide supplemental pension benefits tied to compensation that exceeds limits imposed by Internal Revenue Service (“IRS”) rules applicable to the qualified defined benefit pension plan.  The NDT and SERP are invested in securities generally designed to achieve a return in line with overall equity market performance.  The ART is presently invested to achieve a return in line with fixed-income market performance.

The NDT, ART, and SERP are composed of multiple types of investments and are managed by external institutional managers.  Most U.S. and international equities, Treasury inflation-protected securities, real estate investment trust (“REIT”) securities, cash securities, and certain derivative instruments are measured based on quoted exchange prices in active markets and are classified as Level 1 valuations.  Fixed-income investments, high-yield fixed-income investments, currencies, and most derivative instruments are non-exchange traded and are classified as Level 2 valuations.  These measurements are based on market and income approaches with observable market inputs.
 
Private partnership investments may include venture capital, buyout, mezzanine or subordinated debt, restructuring or distressed debt, and special situations.  Investments in private partnerships generally involve a three- to four-year period where the investor contributes capital. This is followed by a period of distribution, typically over several years. The investment period is generally, at a minimum, a 10-year or longer investment commitment.  The NDT had unfunded commitments related to private partnerships of $82 million at June 30, 2011.  These investments have no redemption or limited redemption options and may also restrict the NDT’s ability to liquidate its investment interest.  The private partnerships and other similar alternative investments are reported at fair value which is derived by independent appraisals or judgment of the general partners of each such investment. The inputs used in estimating the fair value of the limited partnerships include the original transaction prices, recent transactions in the same or similar instruments, completed or pending third-party transactions in the underlying investments of comparable issuers, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt capital markets, and changes in financial ratios or cash flows of the limited partnerships. The fair value of these investments may also be adjusted to reflect illiquidity and/or non-transferability, with the amount of such discounts estimated by the general partners in the absence of market information. Due to the lack of observable inputs, the determination of the fair value by the general partners may differ materially from the value ultimately realized from the private partnership investments. TVA classifies its interest in these types of investment as Level 3 within the fair value hierarchy. 

Commingled funds represent investment funds comprising multiple individual financial instruments.  The commingled funds held by the NDT and SERP consist either of a single class of security, such as equity, debt, or foreign currency securities, or multiple classes of securities.  All underlying positions in these commingled funds are either exchange traded (Level 1) or measured using observable inputs for similar instruments (Level 2).  The fair value of commingled funds is based on net asset values (“NAV”) per fund share (the unit of account), derived from the prices of the underlying securities in the funds.  These commingled funds can be liquidated at the measurement date NAV price and are classified as Level 2 valuations.  Required notification periods range from zero to 30 days.  The funds can be redeemed unless doing so would violate regulations to which the fund is subject, would be unreasonable or impracticable, or would be seriously prejudicial to the fund.

Realized and unrealized gains and losses on trading securities are recognized in current earnings and are based on average cost.  The SERP had unrealized gains (losses) of less than $(1) million and $4 million for the three and nine months ended June 30, 2011, respectively, compared with unrealized gains (losses) of $(2) million and $1 million for the three and nine months ended June 30, 2010, respectively.  The gains and losses of the NDT and ART are subsequently reclassified to a regulatory liability or asset account in accordance with TVA’s regulatory accounting policy.  The NDT had unrealized (losses) of $(8) million and $(61) million for the three months ended June 30, 2011 and 2010, respectively, and the ART had an unrealized (loss) of $(1) million for the three months ended June 30, 2011, compared to an unrealized gain of less than $1 million for the three months ended June 30, 2010.

 Currency Swaps, Swaption, and Interest Rate Swaps

See Note 12 — Cash Flow Hedging Strategy for Currency Swaps and Derivatives Not Receiving Hedge Accounting Treatment for a discussion of the nature, purpose, and contingent features of TVA’s currency swaps, swaption, and interest rate swaps.

The currency swaps and interest rate swaps are classified as Level 2 valuations and are valued based on income approaches using observable market inputs for similar instruments.  The swaption is classified as a Level 3 valuation and is valued based on an income approach.  The valuation is computed using a broker-provided pricing model utilizing interest and volatility rates.  While most of the fair value measurement is based on observable inputs, volatility for TVA’s swaption is generally unobservable.  Therefore, the valuation is derived from an observable volatility measure with adjustments.

Commodity Contract and Commodity Derivatives

Commodity Contract Derivatives. These contracts are classified as Level 3 valuations and are valued based on income approaches.  TVA develops an overall coal price forecast using widely-used short-term and mid-range market data from an external pricing specialist in addition to long-term internal estimates.  To value the volume option component of applicable coal contracts, TVA uses a Black-Scholes pricing model which includes inputs from overall coal price forecasts, contract-specific terms, and other market inputs.

Commodity Derivatives Under Financial Trading Program.  These contracts are valued based on market approaches which utilize Chicago Mercantile Exchange (“CME”) quoted prices and other observable inputs.  Futures and options contracts settled on the CME are classified as Level 1 valuations.  Swap contracts are valued using a pricing model based on CME inputs and are subject to nonperformance risk outside of the exit price.  These contracts are classified as Level 2 valuations.
 
See Note 12 — Derivatives Not Receiving Hedge Accounting Treatment — Commodity Derivatives and Derivatives Under Financial Trading Program for a discussion of the nature and purpose of coal contracts and derivatives under TVA’s FTP.

Nonperformance Risk. The impact of nonperformance risk, which includes credit risk, considers changes in current market conditions, readily available information on nonperformance risk, letters of credit, collateral, other arrangements available, and the nature of master netting arrangements.  TVA is a counterparty to currency swaps, a swaption, interest rate swaps, commodity contracts, and other derivatives which subject TVA to nonperformance risk.  Nonperformance risk on the majority of investments and certain exchange-traded instruments held by TVA is incorporated into the exit price that is derived from quoted market data that is used to mark the investment to market.

Nonperformance risk for most of TVA’s derivative instruments is an adjustment to the initial asset/liability fair value.  TVA adjusts for nonperformance risk, both of TVA (for liabilities) and the counterparty (for assets), by applying a Credit Valuation Adjustment (“CVA”).  TVA determines an appropriate CVA for each applicable financial instrument based on the term of the instrument and TVA’s or counterparty’s credit rating as obtained from Moody’s.  For companies that do not have an observable credit rating, TVA uses internal analysis to assign a comparable rating to the company.  TVA discounts each financial instrument using the historical default rate (as reported by Moody’s for CY 1983 to CY 2010) for companies with a similar credit rating over a time period consistent with the remaining term of the contract.  The application of CVAs resulted in a $77 million decrease in the fair value of assets and a $2 million decrease in the fair value of liabilities at June 30, 2011.
 
The following tables set forth by level, within the fair value hierarchy, TVA's financial assets and liabilities that were measured at fair value on a recurring basis as of June 30, 2011, and September 30, 2010.  Financial assets and liabilities have been classified in their entirety based on the lowest level of input that is significant to the fair value measurement.  TVA's assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the determination of the fair value of the assets and liabilities and their classification in the fair value hierarchy levels.

Fair Value Measurements
 
   
At June 30, 2011
Assets
 
Quoted Prices in Active Markets for
Identical Assets
(Level 1)
  
Significant Other
Observable Inputs
(Level 2)
  
Significant
Unobservable
Inputs
(Level 3)
  
Netting(1)
  
Total
Description
                
Currency swaps
 $—  $14  $—  $—  $14 
Investments
                 
 
Equity securities
  106   —   —   —   106 
Debt securities
                  
U.S. government corporations and agencies
  110   39   —   —   149 
Corporate debt securities
  —   240   —   —   240 
Residential mortgage-backed securities
  —   19   —   —   19 
Commercial mortgage-backed securities
  —   4   —   —   4 
Collateralized debt obligations
  —   5   —   —   5 
Private partnerships
  —   —   18   —   18 
Commingled funds(2)
                  
Equity security commingled funds
  —   451   —   —   451 
Debt security commingled funds
  —   224   —   —   224 
Other commingled funds
  —   38   —   —   38 
Total investments
  216   1,020   18   —   1,254 
Commodity contract derivatives
  —   —   383   —   383 
Commodity derivatives under FTP
                  
Futures contracts
  —   —   —   —   — 
Swap contracts
  —   34   —   (9)  25 
Option contracts
  —   —   —   —   — 
Total commodity derivatives under FTP
  —   34   —   (9)  25 
 
Total
 $216  $1,068  $401  $(9) $1,676 
                    
   
Quoted Prices in Active Markets for Identical Liabilities
(Level 1)
  
Significant Other Observable Inputs
(Level 2)
  
Significant Unobservable Inputs
(Level 3)
  
Netting(1)
  
Total
Liabilities
 
Description
                    
Currency swaps
 $—  $44  $—  $—  $44 
Interest rate swaps
  —   259   —   —   259 
Swaption
  —   —   629   —   629 
Commodity contract derivatives
  —   —   259   —   259 
Commodity derivatives under FTP
                  
Futures contracts
  6   —   —   —   6 
Swap contracts
  —   169   —   (9)  160 
Option contracts
  1   —   —   —   1 
Total commodity derivatives under FTP
  7   169   —   (9)  167 
Total
 
 $ 7   $472  $888  $(9) $1,358 
 
Notes
(1) Due to the right of setoff and method of settlement, TVA elects to record commodity derivatives under the FTP based on its net commodity position with the counterparty or broker.
(2) Commingled funds represent investment funds comprising multiple individual financial instruments and are classified in the table based on their existing investment portfolio as of the measurement date. Commingled funds exclusively composed of one class of security are classified in that category. Commingled funds comprising multiple classes of securities are classified as “other commingled funds.”
 
 
Fair Value Measurements
 
                 
   
At September 30, 2010
 
Assets
               
Description
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Netting (1)
 
Total
 
                 
                 
Investments
               
Equity securities
 $96  $-  $-  $-  $96 
Debt securities
                    
U.S. government corporations and agencies
  136   57   -   -   193 
Corporate debt securities
  -   193   -   -   193 
Residential mortgage-backed securities
  -   22   -   -   22 
Commercial mortgage-backed securities
  -   2   -   -   2 
Collateralized debt obligations
  -   3   -   -   3 
Private partnerships
  -   -   13   -   13 
Commingled funds (2)
                    
Equity security commingled funds
  -   340   -   -   340 
Debt security commingled funds
  -   209   -   -   209 
Foreign currency commingled funds
  -   12   -   -   12 
Other commingled funds
  -   45   -   -   45 
Total investments
  232   883   13   -   1,128 
Commodity contract derivatives
  -   -   152   -   152 
Commodity derivatives under FTP
                    
Futures contracts
  2   -   -   -   2 
Swap contracts
  -   9   -   (1)  8 
Total commodity derivatives under FTP
  2   9   -   (1)  10 
Total
 $234  $892  $165  $(1) $1,290 
                      
Liabilities
                    
Description
 
Quoted Prices in Active Markets for Identical Liabilities
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Netting (1)
 
Total
 
                      
Currency swaps
 $-  $81  $-  $-  $81 
Interest rate swaps
  -   371   -   -   371 
Swaption
  -   -   804   -   804 
Commodity contract derivatives
  -   -   49   -   49 
Commodity derivatives under FTP
                    
Futures contracts
  21   -   -   -   21 
Swap contracts
  15   227   -   (1)  241 
Option contracts
  2   -   -   -   2 
Total commodity derivatives under FTP
  38   227   -   (1)  264 
Total
 $38  $679  $853  $(1) $1,569 
                      
 
Note
(1) Due to the right of setoff and method of settlement, TVA elects to record commodity derivatives under the FTP based on its net commodity position with the counterparty or broker.
(2) Commingled funds represent investment funds comprising multiple individual financial instruments and are classified in the table based on their existing investment portfolio as of the measurement date.  Commingled funds exclusively composed of one class of security are classified in that category. Commingled funds comprising multiple classes of securities are classified as "other commingled funds."
 
 
  
The following table presents a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3):

Fair Value Measurements Using Significant Unobservable Inputs
 
 
   
Three Months Ended June 30, 2011
  
Nine Months Ended June 30, 2011
 
   
Private
Partnerships
  
Commodity Contract Derivatives
  
Swaption
  
Private
Partnerships
  
Commodity Contract Derivatives
  
Swaption
 
                    
Balances at the beginning of the period
 $14  $73  $(554) $13  $103  $(804)
Purchases
  4   —   —   13   —   — 
Issuances
  —   —   —   —   —   — 
Settlements
  —   —   —   (7)  —   — 
Total gains or losses (realized or unrealized):
                        
Net unrealized gains (losses) deferred as regulatory assets and liabilities
  —   51   (75)  (1)  21   175 
Balances at June 30, 2011
 $18  $124  $(629) $18  $124  $(629)
                          
 

 
   
Three Months Ended June 30, 2010
  
Nine Months Ended June 30, 2010
 
   
Private
Partnerships
  
Commodity Contract Derivatives
  
Swaption
  
Private
Partnerships
  
Commodity Contract Derivatives
  
Swaption
 
                    
Balances at the beginning of the period
 $—  $—  $(448) $—  $7  $(592)
Purchases
  2   —   —   2   —   — 
Issuances
  —   —   —   —   —   — 
Settlements
  —   —   —   —   —   — 
Total gains or losses (realized or unrealized):
                        
Net unrealized gains (losses) deferred as regulatory assets and liabilities
  —   13   (226)  —   6   ( 82)
Balances at June 30, 2010
 $2  $13  $(674) $2  $13  $(674)

 

           There were no realized gains or losses related to the instruments measured at fair value using significant unobservable inputs that affected net income during the three and nine months ended June 30, 2011.  All unrealized gains and losses related to these instruments have been reflected as increases or decreases in regulatory assets and liabilities.  See Note 6.
 
Other Financial Instruments Not Recorded at Fair Value

TVA uses the methods and assumptions described below to estimate the fair value of each significant class of financial instrument.  The fair market value of the financial instruments held at June 30, 2011, and September 30, 2010, may not be representative of the actual gains or losses that will be recorded when these instruments mature or are called or presented for early redemption.  The estimated values of TVA’s financial instruments not recorded at fair value at June 30, 2011, and September 30, 2010, were as follows:

Estimated Values of Financial Instruments
 
 
   
At June 30, 2011
  
At September 30, 2010
 
   
Carrying
Amount
  
Fair
Value
  
Carrying
Amount
  
Fair
Value
 
              
Loans and other long-term receivables, net
 $75  $69  $68  $60 
                  
Long-term debt (including current portion), net
  23,961   26,208   23,397   27,193 

Because of the short-term maturity of cash and cash equivalents, restricted cash and investments, and short-term debt, the carrying amounts of these instruments approximate their fair values.

Fair value of long-term debt traded in the public market is determined by multiplying the par value of the debt by the indicative market price at the balance sheet date.

Fair values for loans and other long-term receivables are estimated by determining the present value of future cash flows using a discount rate equal to lending rates for similar loans made to borrowers with similar credit ratings and for similar remaining maturities, where applicable.