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 the asset or liability'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 1 is the highest and Level 3 is the lowest) 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 and LTDCP assets, all changes in fair value of these assets and liabilities have been recorded as changes in regulatory assets, regulatory liabilities, or AOCI on TVA's consolidated balance sheets and consolidated statements of comprehensive income (loss). Except for gains and losses on SERP and LTDCP assets, there has been no impact to the consolidated statements of operations or the consolidated statements of cash flows related to these fair value measurements.

Investment Funds

At June 30, 2016, Investment funds were composed of $2.1 billion of securities classified as trading and measured at fair value and less than $1 million of equity investments not required to be measured at fair value. Trading securities are held in the NDT, ART, SERP, and LTDCP. The NDT holds funds for the ultimate decommissioning of TVA's nuclear power plants. The ART holds funds primarily for the costs related to the future closure and retirement of TVA's other long-lived assets. The balances in the NDT and ART were $1.6 billion and $455 million, respectively, at June 30, 2016.

TVA established a SERP for certain executives in critical positions to provide supplemental pension benefits tied to compensation that exceeds limits set by Internal Revenue Service rules applicable to the qualified defined benefit pension plan. The LTDCP is designed to provide long-term incentives to executives to encourage them to stay with TVA and to provide competitive levels of total compensation to such executives. The NDT and SERP are invested in securities generally designed to achieve a return in line with overall equity market performance, and the ART and LTDCP are invested in securities generally designed to achieve a return in line with overall debt and equity market performance.

The NDT, ART, SERP, and LTDCP 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 securities, and 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 holdings of investments in private real estate, venture capital, buyout, mezzanine or subordinated debt, restructuring or distressed debt, and special situations through funds managed by third-party investment managers. 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, ten years or longer. The NDT had unfunded commitments related to private partnerships of $75 million at June 30, 2016. These investments have no redemption or limited redemption options and may also have imposed restrictions on the NDT’s ability to liquidate its investment. There are no readily available quoted exchange prices for these investments. The fair value of the investments is based on TVA’s ownership percentage of the fair value of the underlying investments as provided by the investment managers. These investments are typically valued on a quarterly basis. TVA’s private partnership investments are valued at net asset values ("NAV") as a practical expedient for fair value. TVA classifies its interest in these types of investments as Private partnerships measured at net asset value in the fair value hierarchy.

Commingled funds represent investment funds comprising multiple individual financial instruments. The commingled funds held by the NDT, ART, SERP, and LTDCP consist of either a single class of securities, such as equity, debt, or foreign currency securities, or multiple classes of securities. All underlying positions in these commingled funds are either exchange traded or measured using observable inputs for similar instruments. The fair value of commingled funds is based on NAV per fund share (the unit of account), derived from the prices of the underlying securities in the funds. These commingled funds can be redeemed at the measurement date NAV and are classified as Commingled funds measured at net asset value in the fair value hierarchy.

Realized and unrealized gains and losses on trading securities are recognized in current earnings and are based on average cost. The gains and losses of the NDT and ART are subsequently reclassified to a regulatory asset or liability account in accordance with TVA's regulatory accounting policy. See Note 1 — Cost-Based Regulation. TVA recorded unrealized gains and losses related to its trading securities held as of the end of each period as follows:



Unrealized Investment Gains (Losses)
		Three Months Ended June 30					Nine Months Ended June 30
Fund	Financial Statement Presentation	2016		2015			2016		2015

SERP	Other income (expense)	$	1	$	—		$	1	$	—
LTDCP	Other income (expense)	—		—			—		(1		)
NDT	Regulatory asset	12		(19		)	60		15
ART	Regulatory asset	2		(3		)	11		12

Currency 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 and interest rate swaps. These swaps are classified as Level 2 valuations and are valued based on income approaches using observable market inputs for similar instruments.

Commodity Contract Derivatives and Commodity Derivatives Under FTP

Commodity Contract Derivatives. Most of these contracts are valued based on market approaches which utilize short- and mid-term market-quoted prices from an external industry brokerage service. A small number of these contracts are valued based on a pricing model using long-term price estimates from TVA's coal price forecast. To value the volume option component of applicable coal contracts, TVA uses a Black-Scholes pricing model which includes inputs from the forecast, contract-specific terms, and other market inputs. These contracts are classified as Level 3 valuations.

Commodity Derivatives Under FTP. These contracts are valued based on market approaches which utilize Chicago Mercantile Exchange ("CME") quoted prices and other observable inputs. 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 FTP for a discussion of the nature and purpose of coal contracts and derivatives under TVA's FTP.

Nonperformance Risk

The assessment 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, 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 credit valuation adjustments ("CVAs"). TVA determines an appropriate CVA for each applicable financial instrument based on the term of the instrument and TVA's or the 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 counterparty. TVA discounts each financial instrument using the historical default rate (as reported by Moody's for CY 1983 to CY 2015) 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 $1 million decrease in the fair value of assets and a $2 million decrease in the fair value of liabilities at June 30, 2016.

Fair Value Measurements

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, 2016, and September 30, 2015. 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, 2016
Assets	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total

Investments
Equity securities	$	189	$	—	$	—	$	189
Debt securities
U.S. government corporations and agencies	83		33		—		116
Corporate debt securities	—		341		—		341
Residential mortgage-backed securities	—		13		—		13
Commercial mortgage-backed securities	—		7		—		7
Collateralized debt obligations	—		32		—		32
Institutional mutual funds	83		—		—		83
Forward debt securities contracts	—		14		—		14
Private partnerships measured at net asset value⁽¹⁾	—		—		—		246
Commingled funds measured at net asset value⁽¹⁾	—		—		—		1,084
Total investments	355		440		—		2,125
Currency swap(s) ⁽²⁾	—		—		—		—
Commodity contract derivatives	—		12		—		12
Commodity derivatives under FTP⁽²⁾
Swap contracts	—		—		—		—

Total	$	355	$	452	$	—	$	2,137

Liabilities	Quoted Prices in Active Markets for Identical Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total

Currency swap(s) ⁽²⁾	$	—	$	167	$	—	$	167
Interest rate swaps	—		1,912		—		1,912
Commodity contract derivatives	—		6		183		189
Commodity derivatives under FTP⁽²⁾
Swap contracts	—		11		—		11

Total	$	—	$	2,096	$	183	$	2,279

Notes

(1) Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.

(2) 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 FCM. Deposits are made to TVA's margin cash accounts held with each FCM to offset any net liability positions in full for derivatives that are transacted with FCMs. TVA records currency swaps net of cash collateral received from or paid to the counterparty, to the extent such amount is not recorded in Accounts payable and accrued liabilities. See Note 12 — Offsetting of Derivative Assets and Liabilities.



Fair Value Measurements At September 30, 2015
Assets	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Total

Investments
Equity securities	$	166	$	—		$	—	$	166
Debt securities
U.S. government corporations and agencies	203		31			—		234
Corporate debt securities	—		225			—		225
Residential mortgage-backed securities	—		17			—		17
Commercial mortgage-backed securities	—		7			—		7
Collateralized debt obligations	—		29			—		29
Institutional mutual funds	91		—			—		91
Forward debt securities contracts	—		(59		)	—		(59		)
Private partnerships measured at net asset value⁽¹⁾	—		—			—		240
Commingled funds measured at net asset value⁽¹⁾	—		—			—		1,061
Total investments	460		250			—		2,011
Currency swap(s) ⁽²⁾	—		25			—		25
Commodity contract derivatives	—		1			—		1
Commodity derivatives under FTP⁽²⁾
Swap contracts	—		—			—		—

Total	$	460	$	276		$	—	$	2,037

Liabilities	Quoted Prices in Active Markets for Identical Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Total

Currency swap(s) ⁽²⁾	$	—	$	47		$	—	$	47
Interest rate swaps	—		1,627			—		1,627
Commodity contract derivatives	—		—			98		98
Commodity derivatives under FTP⁽²⁾
Swap contracts	—		27			—		27

Total	$	—	$	1,701		$	98	$	1,799

Notes

TVA uses internal valuation specialists for the calculation of its commodity contract derivatives fair value measurements classified as Level 3. Analytical testing is performed on the change in fair value measurements each period to ensure the valuation is reasonable based on changes in general market assumptions. Significant changes to the estimated data used for unobservable inputs, in isolation or combination, may result in significant variations to the fair value measurement reported.

The following table presents a reconciliation of all commodity contract derivatives measured at fair value on a recurring basis using significant unobservable inputs (Level 3):



Fair Value Measurements Using Significant Unobservable Inputs
	Commodity Contract Derivatives
	Three Months Ended June 30			Nine Months Ended June 30
Balance at beginning of period	$	(154	)	$	(85	)
Purchases	—			—
Issuances	—			—
Sales	—			—
Settlements	—			—
Net unrealized gains (losses) deferred as regulatory assets and liabilities	26			(43		)
Balance at June 30, 2015	$	(128	)	$	(128	)

Balance at beginning of period	$	(187	)	$	(98	)
Purchases	—			—
Issuances	—			—
Sales	—			—
Settlements	—			—
Net unrealized gains (losses) deferred as regulatory assets and liabilities	4			(85		)
Balance at June 30, 2016	$	(183	)	$	(183	)

The following table presents quantitative information related to the significant unobservable inputs used in the measurement of fair value of TVA's assets and liabilities classified as Level 3 in the fair value hierarchy:



Quantitative Information about Level 3 Fair Value Measurements
	Fair Value at June 30 2016		Valuation Technique(s)	Unobservable Inputs	Range

Assets
Commodity contract derivatives	$	—	Pricing model	Coal supply and demand	0.4 - 0.7 billion tons/year
				Long-term market prices	$9.45 - $76.25/ton
Liabilities
Commodity contract derivatives	$	183	Pricing model	Coal supply and demand	0.4 - 0.7 billion tons/year
				Long-term market prices	$9.45 - $76.25/ton



Quantitative Information about Level 3 Fair Value Measurements
	Fair Value at September 30 2015		Valuation Technique(s)	Unobservable Inputs	Range

Assets
Commodity contract derivatives	$	—	Pricing model	Coal supply and demand	0.8 - 1.0 billion tons/year
				Long-term market prices	$10.64 - $103.41/ton
Liabilities
Commodity contract derivatives	$	98	Pricing model	Coal supply and demand	0.8 - 1.0 billion tons/year
				Long-term market prices	$10.64 - $103.41/ton

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 values of the financial instruments held at June 30, 2016, and September 30, 2015, 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 fair values of TVA's financial instruments not recorded at fair value at June 30, 2016, and September 30, 2015, were as follows:



Estimated Values of Financial Instruments Not Recorded at Fair Value
		At June 30, 2016				At September 30, 2015
	Valuation Classification	Carrying Amount		Fair Value		Carrying Amount		Fair Value
EnergyRight^®receivables (including current portion)	Level 2	$	143	$	147	$	156	$	162

Loans and other long-term receivables, net (including current portion)	Level 2	$	171	$	160	$	129	$	117

EnergyRight^®financing obligation (including current portion)	Level 2	$	167	$	188	$	185	$	208

Unfunded loan commitments	Level 2	$	—	$	9	$	—	$	9

Membership interest of variable interest entity subject to mandatory redemption (including current portion)	Level 2	$	36	$	47	$	37	$	47

Long-term outstanding power bonds (including current maturities), net	Level 2	$	22,515	$	28,549	$	22,649	$	25,468

Long-term debt of variable interest entities (including current maturities), net	Level 2	$	1,251	$	1,484	$	1,266	$	1,407

Due to the short-term maturity of Cash and cash equivalents, Restricted cash and investments, and Short-term debt, net (each considered a Level 1 valuation classification), the carrying amounts of these instruments approximate their fair values.

The fair value for loans and other long-term receivables is 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.

The 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. The fair value of other long-term debt and membership interests of variable interest entity subject to mandatory redemption is estimated by determining the present value of future cash flows using current market rates for similar obligations, giving effect to credit ratings and remaining maturities.