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 has suspended its Financial Trading Program ("FTP") and no longer uses financial instruments to hedge risks related to commodity prices; however, TVA plans to continue to manage fuel price volatility through other methods and to periodically reevaluate its suspended FTP program for 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 June 30					Nine Months Ended June 30
Derivatives in Cash Flow Hedging Relationship	Objective of Hedge Transaction	Accounting for Derivative Hedging Instrument	2016			2015		2016			2015
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	$	(90	)	$	62	$	(144	)	$	(12	)



Summary of Derivative Instruments That Receive Hedge Accounting Treatment (part 2) Amount of Gain (Loss) Reclassified from OCI to Interest Expense
	Three Months Ended June 30					Nine Months Ended June 30
Derivatives in Cash Flow Hedging Relationship	2016			2015		2016			2015
Currency swaps	$	(63	)	$	53	$	(109	)	$	(31	)

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 $35 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 June 30⁽¹⁾						Nine Months Ended June 30⁽¹⁾
Derivative Type	Objective of Derivative	Accounting for Derivative Instrument	2016			2015			2016			2015
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.	$	(27	)	$	(28	)	$	(82	)	$	(85	)

Commodity derivatives under financial trading program	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.	(22		)	(30		)	(78		)	(69		)

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 and nine months ended June 30, 2016 and 2015.



Fair Values of TVA Derivatives
	At June 30, 2016				At September 30, 2015
Derivatives That Receive Hedge Accounting Treatment	Balance			Balance Sheet Presentation	Balance			Balance Sheet Presentation
Currency swaps
£200 million Sterling	$	(79	)	Other long-term liabilities	$	(41	)	Other long-term liabilities
£250 million Sterling	(44		)	Other long-term liabilities	25			Other long-term assets
£150 million Sterling	(44		)	Other long-term liabilities	(6		)	Other long-term liabilities

	At June 30, 2016				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	(1,369		)	Other long-term liabilities	(1,177		)	Other long-term liabilities
$476 million notional	(531		)	Other long-term liabilities	(438		)	Other long-term liabilities
$42 million notional	(12		)	Other long-term liabilities	(12		)	Other long-term liabilities
Commodity contract derivatives	(177		)	Other current assets $8; Other long-term assets $4; Other long-term liabilities $(72); Accounts payable and accrued liabilities $(117)	(97		)	Other long-term assets $1; Other long-term liabilities $(17); Accounts payable and accrued liabilities $(81)
FTP
Derivatives under FTP⁽¹⁾	(52		)	Other current assets $(41); Other long-term liabilities $(4); Accounts payable and accrued liabilities $(7)	(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 $41 million and $89 million at June 30, 2016 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 June 30, 2016:



Currency Swaps Outstanding At June 30, 2016
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 June 30, 2016 and 2015, the changes in fair market value of the interest rate swaps resulted in deferred unrealized gains (losses) of $(112) million and $278 million, respectively. For the nine months ended June 30, 2016 and 2015, the changes in fair market value of the interest rate swaps resulted in deferred unrealized losses of $285 million and $71 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 June 30, 2016, TVA's coal and natural gas contract derivatives both had terms of up to three years.



Commodity Contract Derivatives
	At June 30, 2016					At September 30, 2015
	Number of Contracts	Notional Amount	Fair Value (MtM)			Number of Contracts	Notional Amount	Fair Value (MtM)
Coal contract derivatives	17	22 million tons	$	(183	)	14	19 million tons	$	(98	)
Natural gas contract derivatives	33	154 million mmBtu	$	6		33	134 million mmBtu	$	1

Derivatives Under FTP. While TVA has suspended its FTP and no longer uses financial instruments to hedge risks related to commodity prices, certain natural gas swaps with a maturity of two years or less remain as part of the suspended FTP.



Derivatives Under Financial Trading Program
	At June 30, 2016				At September 30, 2015
	Notional Amount	Fair Value (MtM) (in millions)			Notional Amount	Fair Value (MtM) (in millions)
Natural gas (in mmBtu)
Swap contracts	27,642,500	$	(52	)	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 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 $(5) million at June 30, 2016, 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 June 30, 2016			At September 30, 2015
FTP unrealized gains (losses) deferred as regulatory liabilities (assets)
Natural gas	$	(52	)	$	(116	)



Financial Trading Program Realized Gains (Losses)
	Three Months Ended June 30						Nine Months Ended June 30
	2016			2015			2016			2015
Decrease (increase) in fuel expense
Natural gas	$	(18	)	$	(24	)	$	(62	)	$	(56	)
Fuel oil/crude oil	—			—			—			1



Financial Trading Program Realized Gains (Losses)
	Three Months Ended June 30						Nine Months Ended June 30
	2016			2015			2016			2015
Decrease (increase) in purchased power expense
Natural gas	$	(4	)	$	(6	)	$	(16	)	$	(14	)

Offsetting of Derivative Assets and Liabilities

The amounts of TVA's derivative instruments as reported in the consolidated balance sheets as of June 30, 2016, and September 30, 2015, are shown in the table below:



Derivative Assets and Liabilities
	As of June 30, 2016
	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⁾	$	—	$	—		$	—
Commodity derivatives under FTP	14		(14		)	—
Total derivatives subject to master netting or similar arrangement	14		(14		)	—
Total derivatives not subject to master netting or similar arrangement	12		—			12

Total	$	26	$	(14	)	$	12

Liabilities
Currency swap(s) ⁽³⁾	$	167	$	—		$	167
Interest rate swaps ⁽³⁾	1,912		—			1,912
Commodity derivatives under FTP	66		(55		)	11
Total derivatives subject to master netting or similar arrangement	2,145		(55		)	2,090
Total derivatives not subject to master netting or similar arrangement	189		—			189

Total	$	2,334	$	(55	)	$	2,279

	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⁾	$	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) ⁽³⁾	$	47	$	—		$	47
Interest rate swaps ⁽³⁾	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 that are not offset in the consolidated balance sheets.

(3) Letters of credit of approximately $1.2 billion and $1.1 billion were posted as collateral at June 30, 2016, and September 30, 2015, respectively, 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. At June 30, 2016, TVA held no cash collateral in excess of collateral requirements. At September 30, 2015, TVA held $15 million of cash collateral in excess of collateral requirements. 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. The fair values of these derivatives were in net asset positions totaling $14 million at June 30, 2016, and in net liability positions totaling $59 million at September 30, 2015.

At June 30, 2016 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 June 30, 2016, the aggregate fair value of all derivative instruments with credit-risk related contingent features that were in a liability position was $2.1 billion. TVA's collateral obligations at June 30, 2016, under these arrangements were approximately $1.4 billion, for which TVA had posted approximately $1.2 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 revenue from six LPCs that accounted for 33 percent of total operating revenue for the nine months ended both June 30, 2016 and June 30, 2015.

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. 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.

To help ensure a reliable supply of coal, TVA had coal contracts with multiple suppliers at June 30, 2016. The contracted supply of coal is sourced from multiple geographic regions of the United States and is to be delivered via various transportation methods (i.e., barge, rail, and truck). Emerging technologies, environmental regulations, and low natural 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, restructurings, 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 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.

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 June 30, 2016, all of TVA's commodity derivatives under the FTP, currency swaps, and interest rate swaps were with banking counterparties whose Moody's credit ratings were A3 or higher.

TVA classifies qualified forward coal and natural gas contracts as derivatives. See Derivatives Not Receiving Hedge Accounting Treatment above. At June 30, 2016, the coal contracts were with counterparties whose Moody's credit rating, or TVA’s internal analysis when such information was unavailable, ranged from Ca or D, respectively, to Ba3. At June 30, 2016, the natural gas contracts were with counterparties whose ratings ranged from B1 to A3. See Credit of Suppliers for discussion of challenges facing the coal industry. TVA's total value for derivative contracts with coal counterparties in an asset position as of June 30, 2016, was less than $1 million.

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.