Risk Management Activities and Derivative Transactions

TVA is exposed to various risks. These include risks related to commodity prices, investment prices, interest rates, currency exchange rates, and inflation as well as counterparty credit and performance risks. To help manage certain of these risks, TVA has entered into various derivative transactions, principally commodity option contracts, forward contracts, swaps, swaptions, futures, and options on futures. Other than certain derivative instruments in its trust investment funds, it is TVA’s policy to enter into these derivative transactions solely for hedging purposes and not for speculative purposes. TVA plans to continue to manage fuel price volatility through various methods, but is currently evaluating the future use of financial instruments.

Overview of Accounting Treatment

TVA recognizes certain of its derivative instruments as either assets or liabilities on its consolidated balance sheets at fair value. The accounting for changes in the fair value of these instruments depends on (1) whether TVA uses regulatory accounting to defer the derivative gains and losses, (2) whether the derivative instrument has been designated and qualifies for hedge accounting treatment, and (3) if so, the type of hedge relationship (for example, cash flow hedge).

The following tables summarize the accounting treatment that certain of TVA's financial derivative transactions receive:



Summary of Derivative Instruments That Receive Hedge Accounting Treatment (part 1) Amount of Mark-to-Market Gain (Loss) Recognized in OCI
			Three Months Ended December 31
Derivatives in Cash Flow Hedging Relationship	Objective of Hedge Transaction	Accounting for Derivative Hedging Instrument	2015			2014
Currency swaps	To protect against changes in cash flows caused by changes in foreign currency exchange rates (exchange rate risk)	Unrealized gains and losses are recorded in AOCI and reclassified to interest expense to the extent they are offset by gains and losses on the hedged transaction	$	(27	)	$	(15	)



Summary of Derivative Instruments That Receive Hedge Accounting Treatment (part 2) Amount of Gain (Loss) Reclassified from OCI to Interest Expense
	Three Months Ended December 31
Derivatives in Cash Flow Hedging Relationship	2015			2014
Currency swaps	$	(24	)	$	(38	)

Note

There were no ineffective portions or amounts excluded from effectiveness testing for any of the periods presented. Based on forecasted foreign currency exchange rates, TVA expects to reclassify approximately $44 million of losses from AOCI to interest expense within the next twelve months to offset amounts anticipated to be recorded in interest expense related to exchange gain on the debt.



Summary of Derivative Instruments That Do Not Receive Hedge Accounting Treatment Amount of Gain (Loss) Recognized in Income on Derivatives
			Three Months Ended December 31⁽¹⁾
Derivative Type	Objective of Derivative	Accounting for Derivative Instrument	2015			2014
Interest rate swaps	To fix short-term debt variable rate to a fixed rate (interest rate risk)	Mark-to-market gains and losses are recorded as regulatory assets or liabilities. Realized gains and losses are recognized in interest expense when payments are made or received on the swap settlement dates.	$	(28	)	$	(29	)

Commodity contract derivatives	To protect against fluctuations in market prices of purchased coal or natural gas (price risk)	Mark-to-market gains and losses are recorded as regulatory assets or liabilities. Realized gains and losses due to contract settlements are recognized in fuel expense as incurred.	—			—

Commodity derivatives under financial trading program ("FTP")	To protect against fluctuations in market prices of purchased commodities (price risk)	Mark-to-market gains and losses are recorded as regulatory assets or liabilities. Realized gains and losses are recognized in fuel expense or purchased power expense when the related commodity is used in production.	(36		)	(14		)

Notes

(1) All of TVA's derivative instruments that do not receive hedge accounting treatment have unrealized gains (losses) that would otherwise be recognized in income

but instead are deferred as regulatory assets and liabilities. As such, there was no related gain (loss) recognized in income for these unrealized gains (losses) for the three months ended December 31, 2015 and 2014.



Fair Values of TVA Derivatives
	At December 31, 2015				At September 30, 2015
Derivatives That Receive Hedge Accounting Treatment	Balance			Balance Sheet Presentation	Balance			Balance Sheet Presentation
Currency swaps
£200 million Sterling	$	(43	)	Other long-term liabilities	$	(41	)	Other long-term liabilities
£250 million Sterling	9			Other long-term assets	25			Other long-term assets
£150 million Sterling	(15		)	Other long-term liabilities	(6		)	Other long-term liabilities

	At December 31, 2015				At September 30, 2015
Derivatives That Do Not Receive Hedge Accounting Treatment	Balance			Balance Sheet Presentation	Balance			Balance Sheet Presentation
Interest rate swaps
$1.0 billion notional	(1,115		)	Other long-term liabilities	(1,177		)	Other long-term liabilities
$476 million notional	(412		)	Other long-term liabilities	(438		)	Other long-term liabilities
$42 million notional	(11		)	Other long-term liabilities	(12		)	Other long-term liabilities
Commodity contract derivatives	(138		)	Other long-term assets $4; Other long-term liabilities $(46); Accounts payable and accrued liabilities $(96)	(97		)	Other long-term assets $1; Other long-term liabilities $(17); Accounts payable and accrued liabilities $(81)
FTP
Derivatives under FTP⁽¹⁾	(101		)	Other current assets $(80); Other long-term liabilities $(9); Accounts payable and accrued liabilities $(12)	(116		)	Other current assets $(89); Other long-term liabilities $(10); Accounts payable and accrued liabilities $(17)

Note

(1) Fair values of certain derivatives under the FTP that were in net liability positions totaling $80 million and $89 million at December 31, 2015 and September 30, 2015, respectively, are recorded in TVA's margin cash accounts in Other current assets. These derivatives are transacted with futures commission merchants, and cash deposits have been posted to the margin cash accounts held with each futures commission merchant to offset the net liability positions in full.

Cash Flow Hedging Strategy for Currency Swaps

To protect against exchange rate risk related to three British pound sterling denominated Bond transactions, TVA entered into foreign currency hedges at the time the Bond transactions occurred. TVA had the following currency swaps outstanding as of December 31, 2015:



Currency Swaps Outstanding At December 31, 2015
Effective Date of Currency Swap Contract	Associated TVA Bond Issues Currency Exposure	Expiration Date of Swap	Overall Effective Cost to TVA
1999	£200 million	2021	5.81%
2001	£250 million	2032	6.59%
2003	£150 million	2043	4.96%

When the dollar strengthens against the British pound sterling, the exchange gain on the Bond liability is offset by an exchange loss on the swap contract. Conversely, when the dollar weakens against the British pound sterling, the exchange loss on the Bond liability is offset by an exchange gain on the swap contract. All such exchange gains or losses on the Bond liability are included in Long-term debt, net. The offsetting exchange losses or gains on the swap contracts are recognized in AOCI. If any gain (loss) were to be incurred as a result of the early termination of the foreign currency swap contract, the resulting income (expense) would be amortized over the remaining life of the associated Bond as a component of Interest expense.

Derivatives Not Receiving Hedge Accounting Treatment

Interest Rate Derivatives. TVA uses regulatory accounting treatment to defer the mark-to-market ("MtM") gains and losses on its interest rate swaps. The net deferred unrealized gains and losses are classified as regulatory assets or liabilities on TVA's consolidated balance sheets and are included in the ratemaking formula when the transactions settle. The values of these derivatives are included in Other long-term assets or Other long-term liabilities on the consolidated balance sheets, and realized gains and losses, if any, are included in TVA's consolidated statements of operations. For the three months ended December 31, 2015 and 2014, the changes in fair market value of the interest rate swaps resulted in deferred unrealized gains (losses) of $89 million and $(184) million, respectively.

Commodity Derivatives. TVA enters into certain derivative contracts for coal and natural gas that require physical delivery of the contracted quantity of the commodity. TVA marks to market all such contracts and defers the fair market values as regulatory assets or liabilities on a gross basis. At December 31, 2015, TVA's coal and natural gas contract derivatives both had terms of up to 3 years.



Commodity Contract Derivatives
	At December 31, 2015					At September 30, 2015
	Number of Contracts	Notional Amount	Fair Value (MtM)			Number of Contracts	Notional Amount	Fair Value (MtM)
Coal contract derivatives	12	20 million tons	$	(123	)	14	19 million tons	$	(98	)
Natural gas contract derivatives	30	132 million mmBtu	$	(15	)	33	134 million mmBtu	$	1

Derivatives Under FTP. While TVA is currently evaluating the use of financial instruments for price hedging, certain natural gas swaps with a maturity of two years or less remain as part of the suspended FTP. The FTP is designed to allow TVA to purchase and sell futures, swaps, options, and combinations of these instruments (as long as they are standard in the industry) to hedge TVA’s exposure to (1) the price of natural gas, fuel oil, electricity, coal, emission allowances, nuclear fuel, and other commodities included in TVA’s fuel cost adjustment calculation, (2) the price of construction materials, and (3) contracts for goods priced in or indexed to foreign currencies. The combined transaction limit for the fuel cost adjustment and construction material transactions is $130 million (based on one-day value at risk). In addition, the maximum hedge volume for the construction material transactions is 75 percent of the underlying net notional volume of the material that TVA anticipates using in approved TVA projects, and the market value of all outstanding hedging transactions involving construction materials is limited to $100 million at the execution of any new transaction. The portfolio value at risk limit for the foreign currency transactions is $5 million and is separate and distinct from the $130 million transaction limit discussed above. TVA's policy prohibits trading financial instruments under the FTP for speculative purposes.



Derivatives Under Financial Trading Program
	At December 31, 2015				At September 30, 2015
	Notional Amount	Fair Value (MtM) (in millions)			Notional Amount	Fair Value (MtM) (in millions)
Natural gas (in mmBtu)
Swap contracts	40,977,500	$	(101	)	51,495,000	$	(116	)

Note

Fair value amounts presented are based on the net commodity position with the counterparty. Notional amounts disclosed represent the net absolute value of contractual amounts.

TVA defers all FTP unrealized gains (losses) as regulatory liabilities (assets) and records only realized gains or losses to match the delivery period of the underlying commodity. In addition to the open commodity derivatives disclosed above, TVA had closed derivative contracts with market values of $(6) million at December 31, 2015, and $(11) million at September 30, 2015. TVA experienced the following unrealized and realized gains and losses related to the FTP at the dates and during the periods, as applicable, set forth in the tables below:



Financial Trading Program Unrealized Gains (Losses)
	At December 31, 2015			At September 30, 2015
FTP unrealized gains (losses) deferred as regulatory liabilities (assets)
Natural gas	$	(101	)	$	(116	)



Financial Trading Program Realized Gains (Losses)
	For the Three Months Ended December 31
	2015			2014
Decrease (increase) in fuel expense
Natural gas	$	(29	)	$	(12	)
Fuel oil/crude oil	—			1



Financial Trading Program Realized Gains (Losses)
	For the Three Months Ended December 31
	2015			2014
Decrease (increase) in purchased power expense
Natural gas	$	(7	)	$	(3	)

Offsetting of Derivative Assets and Liabilities

The amounts of TVA's derivative instruments as reported in the Consolidated Balance Sheets as of December 31, 2015, and September 30, 2015, are shown in the table below:



Derivative Assets and Liabilities
	As of December 31, 2015
	Gross Amounts of Recognized Assets/Liabilities		Gross Amounts Offset in the Balance Sheet ⁽¹⁾			Net Amounts of Assets/Liabilities Presented in the Balance Sheet ⁽²⁾
Assets
Currency swap(s)⁽³⁾⁽⁴⁾	$	9	$	—		$	9
Commodity derivatives under FTP	36		(36		)	—
Total derivatives subject to master netting or similar arrangement	45		(36		)	9
Total derivatives not subject to master netting or similar arrangement	4		—			4

Total	$	49	$	(36	)	$	13

Liabilities
Currency swap(s) ⁽⁴⁾	$	58	$	—		$	58
Interest rate swaps ⁽⁴⁾	1,538		—			1,538
Commodity derivatives under FTP	137		(116		)	21
Total derivatives subject to master netting or similar arrangement	1,733		(116		)	1,617
Total derivatives not subject to master netting or similar arrangement	142		—			142

Total	$	1,875	$	(116	)	$	1,759

	As of September 30, 2015
	Gross Amounts of Recognized Assets/Liabilities		Gross Amounts Offset in the Balance Sheet ⁽¹⁾			Net Amounts of Assets/Liabilities Presented in the Balance Sheet ⁽²⁾
Assets
Currency swap(s)⁽³⁾⁽⁴⁾	$	25	$	—		$	25
Commodity derivatives under FTP	49		(49		)	—
Total derivatives subject to master netting or similar arrangement	74		(49		)	25
Total derivatives not subject to master netting or similar arrangement	1		—			1

Total	$	75	$	(49	)	$	26

Liabilities
Currency swap(s) ⁽⁴⁾	$	47	$	—		$	47
Interest rate swaps ⁽⁴⁾	1,627		—			1,627
Commodity derivatives under FTP	165		(138		)	27
Total derivatives subject to master netting or similar arrangement	1,839		(138		)	1,701
Total derivatives not subject to master netting or similar arrangement	98		—			98

Total	$	1,937	$	(138	)	$	1,799

Notes

(1) Amounts primarily include counterparty netting of derivative contracts, margin account deposits for futures commission merchants transactions, and cash collateral received or paid in accordance with the accounting guidance for derivatives and hedging transactions.

(2) There are no derivative contracts subject to a master netting arrangement or similar agreement which are not offset in the balance sheets.

(3) At December 31, 2015 and September 30, 2015, there were no securities posted by a counterparty on TVA's behalf to partially secure the asset position(s) of currency swaps in accordance with the collateral requirements for these derivatives.

(4) Letters of credit of approximately $1.1 billion were posted as collateral at both December 31, 2015 and September 30, 2015, to partially secure the liability positions of one of the currency swaps and one of the interest rate swaps in accordance with the collateral requirements for these derivatives. TVA held $20 million and $15 million cash collateral in excess of collateral requirements at December 31, 2015 and September 30, 2015, respectively. Cash collateral held in excess of collateral requirements is recorded in Restricted cash and investments with a corresponding obligation of the same amount recorded in Accounts payable and accrued liabilities.

Other Derivative Instruments

Investment Fund Derivatives. Investment funds consist primarily of funds held in the Nuclear Decommissioning Trust ("NDT"), the Asset Retirement Trust ("ART"), the Supplemental Executive Retirement Plan ("SERP"), and the Long-Term Deferred Compensation Plan ("LTDCP"). All securities in the trusts are classified as trading. See Note 13 — Investment Funds for a discussion of the trusts' objectives and the types of investments included in the various trusts. These trusts may invest in derivative instruments which may include swaps, futures, options, forwards, and other instruments. At December 31, 2015 and September 30, 2015, the NDT held investments in forward contracts to purchase debt securities. The fair values of these derivatives were in net liability positions totaling $8 million and $59 million at December 31, 2015 and September 30, 2015, respectively.

At December 31, 2015 and September 30, 2015, the fair value of other derivative instruments in these trusts was not material to TVA's consolidated financial statements.

Collateral. TVA's interest rate swaps and currency swaps contain contract provisions that require a party to post collateral (in a form such as cash or a letter of credit) when the party's liability balance under the agreement exceeds a certain threshold. At December 31, 2015, the aggregate fair value of all derivative instruments with credit-risk related contingent features that were in a liability position was $1.6 billion. TVA's collateral obligations at December 31, 2015, under these arrangements were approximately $1.1 billion, for which TVA had posted approximately $1.1 billion in letters of credit. These letters of credit reduce the available balance under the related credit facilities. TVA's assessment of the risk of its nonperformance includes a reduction in its exposure under the contract as a result of this posted collateral.

For all of its derivative instruments with credit-risk related contingent features:


•	If TVA remains a majority-owned U.S. government entity but Standard & Poor's Financial Services, LLC ("S&P") or Moody's Investors Service, Inc. ("Moody's") downgrades TVA's credit rating to AA or Aa2, respectively, TVA's collateral obligations would likely increase by $22 million and


•	If TVA ceases to be majority-owned by the U.S. government, TVA's credit rating would likely be downgraded and TVA would be required to post additional collateral.

Counterparty Credit Risk

Credit risk is the exposure to economic loss that would occur as a result of a counterparty's nonperformance of its contractual obligations. Where exposed to counterparty credit risk, TVA analyzes the counterparty's financial condition prior to entering into an agreement, establishes credit limits, monitors the appropriateness of those limits, as well as any changes in the creditworthiness of the counterparty on an ongoing basis, and employs credit mitigation measures, such as collateral or prepayment arrangements and master purchase and sale agreements, to mitigate credit risk.

Credit of Customers. The majority of TVA's counterparty credit risk is associated with trade accounts receivable from delivered power sales to LPCs, all located in the Tennessee Valley region. To a lesser extent, TVA is exposed to credit risk from industries and federal agencies directly served and from exchange power arrangements with a small number of investor-owned regional utilities related to either delivered power or the replacement of open positions of longer-term purchased power or fuel agreements. TVA had concentrations of revenue from six LPCs that accounted for 32 percent of total operating revenue for both the three months ended December 31, 2015 and the three months ended December 31, 2014.

Credit of Derivative Counterparties. TVA has entered into physical and financial contracts that qualify as derivatives for hedging purposes, and TVA's NDT fund and qualified defined benefit pension plan have entered into derivative contracts for investment purposes. If a counterparty to one of TVA's hedging transactions defaults, TVA might incur substantial costs in connection with entering into a replacement hedging transaction. If a counterparty to the derivative contracts into which the NDT fund and the pension plan have entered for investment purposes defaults, the value of the investment could decline significantly or perhaps become worthless. TVA has concentrations of credit risk from the banking and coal industries because multiple companies in these industries serve as counterparties to TVA in various derivative transactions. At December 31, 2015, all of TVA's currency swaps, interest rate swaps, and commodity derivatives under the FTP were with banking counterparties whose Moody's credit rating was Baa1 or higher.

TVA classifies qualifying forward coal contracts as derivatives. At December 31, 2015, these contracts were with suppliers whose Moody's credit rating, or TVA’s internal analysis when such information was unavailable, ranged from Ca to Baa3. Emerging technologies, environmental regulations, and low gas prices have contributed to weak demand for coal. As a result, coal suppliers are facing increased financial pressure which has led to relatively poor credit ratings and bankruptcies. Continued difficulties by coal suppliers could result in consolidations, additional bankruptcies, restructuring, contract renegotiations, or other scenarios. Under these scenarios and TVA’s potential available responses, TVA does not anticipate a significant financial impact in obtaining continued fuel supply for its coal-fired generation. TVA does not have any derivative contracts with coal counterparties in an asset position as of December 31, 2015. See Derivatives Not Receiving Hedge Accounting Treatment above.

TVA currently utilizes two futures commission merchants ("FCMs") to clear commodity contracts, including futures, options, and similar financial derivatives. These transactions are executed under the FTP by the FCMs on exchanges on behalf of TVA. TVA maintains margin cash accounts with the FCMs. TVA makes deposits to the margin cash accounts to adequately cover any net liability positions on its derivatives transacted with the FCMs. See the note to the Fair Values of TVA Derivatives table above.

Credit of Suppliers. If one of TVA's fuel or purchased power suppliers fails to perform under the terms of its contract with TVA, TVA might lose the money that it paid to the supplier under the contract and have to purchase replacement fuel or power on the spot market, perhaps at a significantly higher price than TVA was entitled to pay under the contract. In addition, TVA might not be able to acquire replacement fuel or power in a timely manner and thus might be unable to satisfy its own obligations to deliver power. To help ensure a reliable supply of coal, TVA had coal contracts with multiple suppliers at December 31, 2015. The contracted supply of coal is sourced from multiple geographic regions of the United States and is to be delivered via various transportation methods (for example, barge, rail, and truck). Nuclear fuel requirements including uranium mining and milling, conversion services, enrichment services, and fabrication services are met from various suppliers, depending on type of service. TVA purchases the majority of its natural gas requirements from a variety of suppliers under short-term contracts.

TVA has a power purchase agreement that expires on March 31, 2032, with a supplier of electricity for 440 megawatts ("MW") of summer net capability from a lignite-fired generating plant. TVA has determined that the supplier has the equivalent of a non-investment grade credit rating; therefore, the supplier has provided credit assurance to TVA under the terms of the agreement.