Financial Derivative Instruments

The Company uses derivatives to manage risks associated with certain assets and liabilities arising from the potential adverse impact of fluctuations in global fuel prices, interest rates and foreign currencies.

In addition, in 2013, the Company recognized in its Consolidated Balance Sheets the financial effect of the net interest owed to the trusts that issued the Company’s enhanced equipment trust certificates. The characteristics of the net interest obligation resulted in the obligation meeting the definition of a derivative instrument under ASC Topic 815, Derivatives and Hedging (ASC 815).

Fuel Risk Management

The Company’s operations are inherently dependent upon the price and availability of aircraft fuel. To manage economic risks associated with fluctuations in aircraft fuel prices, the Company periodically enters into derivative financial instruments. During the three and nine months ended September 30, 2014, the Company primarily used heating oil puts and swaps to hedge its aircraft fuel expense. These derivative instruments were not designated as hedges under ASC Topic 815, Derivatives and Hedging (ASC 815), for hedge accounting treatment. As a result, any changes in fair value of these derivative instruments are adjusted through other nonoperating income (expense) in the period of change.

The following table reflects the amount of realized and unrealized gains and losses recorded as nonoperating income (expense) in the unaudited Consolidated Statements of Operations.



	Three months ended September 30,						Nine months ended September 30,
Fuel derivative contracts	2014			2013			2014			2013
	(in thousands)
Losses realized at settlement	$	(4,632	)	$	(3,790	)	$	(6,530	)	$	(11,226	)
Reversal of prior period unrealized amounts	56			4,278			(1,816		)	5,472
Unrealized gains (losses) that will settle in future periods	(23,316		)	2,048			(20,160		)	(5,177		)
Gains (losses) on fuel derivatives recorded as Nonoperating income (expense)	$	(27,892	)	$	2,536		$	(28,506	)	$	(10,931	)

Interest Rate Risk Management

The Company is exposed to market risk from adverse changes in interest rates associated with its long-term debt obligations. Market risk associated with fixed-rate and variable-rate long-term debt relates to the potential reduction in fair value and negative impact to future earnings, respectively, from an increase in interest rates.

To limit the Company’s exposure to interest rate risk inherent in one of its variable-rate debt instruments, which was used to finance an aircraft delivered in 2013, the Company entered into a forward starting interest rate swap agreement. The interest rate swap agreement is designated as a cash flow hedge under ASC 815.

The Company believes that its interest rate derivative contract will continue to be effective in offsetting changes in cash flow attributable to the hedged risk. The Company reclassified $0.2 million and $0.6 million in net losses from AOCI to interest expense during the three and nine months ended September 30, 2014, respectively. The Company expects to reclassify a net loss of approximately $0.7 million into earnings over the next 12 months from AOCI based on the values at September 30, 2014.

Foreign Currency Exchange Rate Risk Management

The Company is subject to foreign currency exchange rate risk due to revenues and expenses denominated in foreign currencies, with the primary exposures being the Japanese Yen and Australian Dollar. To manage exchange rate risk, the Company executes its international revenue and expense transactions in the same foreign currency to the extent practicable.

The Company enters into foreign currency forward contracts, certain of which are designated as cash flow hedges under ASC 815, to further manage the effects of fluctuating exchange rates. The effective portion of the gain or loss of designated cash flow hedges is reported as a component of AOCI and reclassified into earnings in the same period in which the related sales are recognized as passenger revenue. The effective portion of the foreign currency forward contracts represents the change in fair value of the hedge that offsets the change in the fair value of the hedged item. To the extent the change in the fair value of the hedge does not perfectly offset the change in the fair value of the hedged item, the ineffective portion of the hedge is immediately recognized as nonoperating income (expense). Foreign currency forward contracts that are not designated as cash flow hedges are recorded at fair value, and any changes in fair value are recognized as other nonoperating income (expense) in the period of change.

The Company believes that its foreign currency forward contracts that are designated as cash flow hedges will continue to be effective in offsetting changes in cash flow attributable to the hedged risk. The Company reclassified $1.3 million and $6.5 million in gains from AOCI to passenger revenue during the three and nine months ended September 30, 2014, respectively. The Company expects to reclassify a net gain of approximately $8.1 million into earnings over the next 12 months from AOCI based on the values at September 30, 2014.

Negative Arbitrage Derivative

In 2013, the Company created two pass-through trusts, which issued $444.5 million aggregate principal amount of EETCs. See Note 10 for further information related to the EETCs. In accordance with the related agreements, the Company is obligated to pay the interest that accrues on the proceeds and is also entitled to the benefits of the income generated from the same proceeds. The difference between the interest owed to the pass-through trusts and the interest generated from the proceeds introduces an element of variability that could cause the associated cash flows to fluctuate. This variability requires the Company’s obligation to the trusts to be recognized as a derivative in the Company’s unaudited consolidated financial statements. During the three and nine months ended September 30, 2014, approximately $3.2 million and $12.4 million of the derivative was reduced in connection with the interest payments made to the trusts, respectively.

The following tables present the gross fair value of asset and liability derivatives that are designated as hedging instruments under ASC 815 and derivatives that are not designated as hedging instruments under ASC 815, as well as the net derivative positions and location of the asset and liability balances within the unaudited Consolidated Balance Sheets.

Derivative position as of September 30, 2014



	Balance Sheet Location	Notional Amount	Final Maturity Date	Gross fair value of assets		Gross fair value of (liabilities)			Net derivative position
		(in thousands)		(in thousands)
Derivatives designated as hedges
Interest rate derivative	Prepaid expenses and other	$59,000 U.S. dollars	April 2023	$	73	$	—		$	73
	Long-term prepayments and other (1)			379		—			379
Foreign currency derivatives	Prepaid expenses and other	7,218,469 Japanese Yen 52,209 Australian Dollars	September 2015	7,448		(14		)	7,434
	Long-term prepayments and other	3,384,130 Japanese Yen 9,707 Australian Dollars	August 2016	2,514		—			2,514
Derivatives not designated as hedges									0
Foreign currency derivatives	Prepaid expenses and other	9,415,313 Japanese Yen 48,981 Australian Dollars	September 2015	1,529		(104		)	1,425
	Long-term prepayments and other	3,910,000 Japanese Yen 9,700 Australian Dollars	August 2016	360		—			360
Fuel derivative contracts	Other accrued liabilities	93,211 gallons	September 2015	899		(19,569		)	(18,670		)
Negative arbitrage derivative	Other accrued liabilities	$444,540 U.S. dollars	January 2015	—		(500		)	(500		)


(1)	Represents the noncurrent portion of the $59.0 million interest rate derivative with final maturity in April 2023.

Derivative position as of December 31, 2013



	Balance Sheet Location	Notional Amount	Final Maturity Date	Gross fair value of assets		Gross fair value of (liabilities)			Net derivative position
		(in thousands)		(in thousands)
Derivatives designated as hedges
Interest rate derivative	Prepaid expenses and other	$63,800 U.S. dollars	April 2023	$	196	$	—		$	196
	Long-term prepayments and other (1)			925		—			925
Foreign currency derivatives	Prepaid expenses and other	10,500,321 Japanese Yen 10,895,370 Korean Won 62,659 Australian Dollars 4,821 New Zealand Dollars	December 2014	9,946		(450		)	9,496
	Long-term prepayments and other	1,980,949 Japanese Yen 16,681 Australian Dollars	May 2015	1,673		—			1,673
Derivatives not designated as hedges
Foreign currency derivatives	Prepaid expenses and other	6,180 Japanese Yen 58 Australian Dollars	December 2014	577		(229		)	348
	Other accrued liabilities			298		(509		)	(211		)
Fuel derivative contracts	Prepaid expenses and other	84,714 gallons	December 2014	13,587		(7,494		)	6,093
Negative arbitrage derivative	Other accrued liabilities	$444,540 U.S. dollars	January 2015	—		(12,250		)	(12,250		)
	Other liabilities and deferred credits (2)			—		(615		)	(615		)

(1) Represents the noncurrent portion of the $64 million interest rate derivative with final maturity in April 2023.

(2) Represents the noncurrent portion of the $445 million negative arbitrage derivative with final maturity in January 2015.

The following table reflects the impact of cash flow hedges designated for hedge accounting treatment and their location within the unaudited Consolidated Statements of Comprehensive Income.



	(Gain) loss recognized in AOCI on derivatives (effective portion)					(Gain) loss reclassified from AOCI into income (effective portion)						(Gain) loss recognized in nonoperating (income) expense (ineffective portion)
	Three months ended September 30,					Three months ended September 30,						Three months ended September 30,
	2014			2013		2014			2013			2014		2013
	(in thousands)
Foreign currency derivatives	$	(12,428	)	$	3,960	$	(1,297	)	$	(3,005	)	$	—	$	—
Interest rate derivatives	(283		)	82		201			217			—		—



	(Gain) loss recognized in AOCI on derivatives (effective portion)						(Gain) loss reclassified from AOCI into income (effective portion)						(Gain) loss recognized in nonoperating (income) expense (ineffective portion)
	Nine months ended September 30,						Nine months ended September 30,						Nine months ended September 30,
	2014			2013			2014			2013			2014		2013
	(in thousands)
Foreign currency derivatives	$	(4,720	)	$	(10,204	)	$	(6,523	)	$	(6,395	)	$	—	$	(61	)
Interest rate derivatives	668			(929		)	618			440			—		—

Risk and Collateral

The financial derivative instruments expose the Company to possible credit loss in the event the counterparties to the agreements fail to meet their obligations. To manage such credit risks, the Company (1) selects its counterparties based on past experience and credit ratings, (2) limits its exposure to any single counterparty, and (3) periodically monitors the market position and credit rating of each counterparty. Credit risk is deemed to have a minimal impact on the fair value of the derivative instruments as cash collateral would be provided by the counterparties based on the current market exposure of the derivative.

The Company's agreements with its counterparties also requires the posting of cash collateral in the event the aggregate value of the Company's positions exceeds certain exposure thresholds that are based upon certain liquidity metrics of the Company. The aggregate fair value of the Company's derivative instruments that contain credit-risk related contingent features that are in a net liability position as of September 30, 2014 was $18.7 million.

ASC 815 requires a reporting entity to elect a policy of whether to offset rights to reclaim cash collateral or obligations to return cash collateral against derivative assets and liabilities executed with the same counterparty under a master netting agreement, or present such amounts on a gross basis. The Company’s accounting policy is to present its derivative assets and liabilities on a net basis, including any collateral posted with the counterparty. The Company had $7.0 million of collateral posted with one of its counterparties as of September 30, 2014, and no collateral posted with counterparties as of December 31, 2013.

The Company is also subject to market risk in the event these financial instruments become less valuable in the market. However, changes in the fair value of the derivative instruments will generally offset the change in the fair value of the hedged item, limiting the Company’s overall exposure.