Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

( Mark One )

x QUARTERLY REPORT PURSUANT TO SECTION 13, 15(d), OR 37 OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2009

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____ to ____

Commission file number 000-52313

TENNESSEE VALLEY AUTHORITY

(Exact name of registrant as specified in its charter)


A corporate agency of the United States created by an act of Congress ( State or other jurisdiction of incorporation or organization )		62-0474417 ( IRS Employer Identification No .)

400 W. Summit Hill Drive Knoxville, Tennessee ( Address of principal executive offices )		37902 ( Zip Code )

(865) 632-2101

( Registrant’s telephone number, including area code )

None

( Former name, former address and former fiscal year, if changed since last report )

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13, 15(d), or 37 of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o	Accelerated filer o
Non-accelerated filer x ( Do not check if a smaller reporting company )	Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

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GLOSSARY OF COMMON ACRONYMS	3
FORWARD-LOOKING INFORMATION	4
GENERAL INFORMATION	5

PART I – FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS	6
Statements of Operations (Unaudited)	6
Balance Sheets (Unaudited)	7
Statements of Cash Flows (Unaudited)	8
Statements of Changes in Proprietary Capital (Unaudited)	9
Notes to Financial Statements (Unaudited)	10

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	35
Executive Summary	35
Challenges During 2010	36
Liquidity and Capital Resources	38
Results of Operations	41
Critical Accounting Policies and Estimates	44
Changes in Ratemaking Impacting Accounting	44
Fair Value Measurements	45
New Accounting Standards and Interpretations	47
Corporate Governance	48
Legislative and Regulatory Matters	48
Environmental Matters	49
Legal	51

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	51

Item 4. CONTROLS AND PROCEDURES	51
Disclosure Controls and Procedures	51
Changes in Internal Control over Financial Reporting	51

PART II – OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS	52

Item 1A. RISK FACTORS	52

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	52

Item 3. DEFAULTS UPON SENIOR SECURITIES	52

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	52

Item 5. OTHER INFORMATION	52

Item 6. EXHIBITS	53

Signatures	54
Exhibit Index	55

GLOSSARY OF COMMON ACRONYMS
The following terms or acronyms frequently used in this Form 10-Q are defined below:

Term or Acronym		Definition
AFUDC		Allowance for funds used during construction
ASLB		Atomic Safety Licensing Board
ART		Asset retirement trust
ARO		Asset retirement obligation
BEST		Bellefonte Efficiency and Sustainability Team
BREDL		Blue Ridge Environmental Defense League
CAA		Clean Air Act
CAIR		Clean Air Interstate Rule
CAMR		Clean Air Mercury Rule
CCP		Coal combustion products
CERCLA		Comprehensive Environmental Response, Compensation, and Liability Act
CME		Chicago Mercantile Exchange
CO 2		Carbon dioxide
CVA		Credit valuation adjustment
CY		Calendar year
EPA		Environmental Protection Agency
FASB		Financial Accounting Standards Board
FCA		Fuel cost adjustment
FTP		Financial Trading Program
GAAP		Accounting principles generally accepted in the United States of America
GHG		Greenhouse gas
GW		Gigawatt
GWh		Gigawatt hour(s)
KDAQ		Kentucky Division for Air Quality
kWh		Kilowatt hour(s)
LIBOR		London Interbank Offered Rate
MD&A		Management’s Discussion and Analysis of Financial Condition and Results of Operations
MtM		Mark-to-market
MW		Megawatt
Moody’s		Moody’s Investors Service, Inc.
mmBtu		Million British thermal unit(s)
NDT		Nuclear decommissioning trust
NEPA		National Environmental Policy Act
NOV		Notice of Violation
NO x		Nitrogen oxides
NPDES		National Pollutant Discharge Elimination System
NRC		Nuclear Regulatory Commission
NSR		New Source Review
PCB		Polychlorinated biphenyls
REIT		Real estate investment trust
SACE		Southern Alliance of Clean Energy
SCR		Selective catalytic reduction systems
SERP		Supplemental executive retirement plan
Seven States		Seven States Power Corporation
SO 2		Sulfur dioxide
S&P		Standard & Poor’s Rating Services
SSSL		Seven States Southaven, LLC
TDEC		Tennessee Department of Environment and Conservation

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FORWARD-LOOKING INFORMATION

This Quarterly Report on Form 10-Q (“Quarterly Report”) contains forward-looking statements relating to future events and future performance. All statements other than those that are purely historical may be forward-looking statements. In certain cases, forward-looking statements can be identified by the use of words such as “may,” “will,” “should,” “expect,” “anticipate,” “believe,” “intend,” “project,” “plan,” “predict,” “assume,” “forecast,” “estimate,” “objective,” “possible,” “probably,” “likely,” “potential,” or other similar expressions.

Although the Tennessee Valley Authority (“TVA”) believes that the assumptions underlying the forward-looking statements are reasonable, TVA does not guarantee the accuracy of these statements. Numerous factors could cause actual results to differ materially from those in the forward-looking statements. These factors include, among other things:

•

New or changed laws, regulations, and administrative orders, including those related to environmental matters, and the costs of complying with these new or changed, as well as existing, laws, regulations, and administrative orders;

•

Unplanned contributions to TVA’s pension or other post-retirement benefit plans or to TVA’s nuclear decommissioning trust (“NDT”);

•

Significant delays or cost overruns associated with the cleanup and recovery activities associated with the ash spill at TVA’s Kingston Fossil Plant (“Kingston”) or in construction of generation and transmission assets;

•

Fines, penalties, and settlements associated with the Kingston ash spill;

•

The outcome of legal and administrative proceedings, including, but not limited to, proceedings involving the Kingston ash spill and the North Carolina public nuisance case;

•

Significant changes in demand for electricity;

•

Loss of customers;

•

The continued operation, performance, or failure of TVA’s generation, transmission, and related assets (including facilities such as coal combustion product facilities);

•

Disruption of fuel supplies, which may result from, among other things, weather conditions, production or transportation difficulties, labor challenges, or environmental regulations affecting TVA’s fuel suppliers;

•

Purchased power price volatility and disruption of purchased power supplies;

•

Events at transmission lines and other facilities not operated by TVA, including those that affect the supply of water to TVA’s generation facilities;

•

Inability to obtain regulatory approval for the construction or operation of assets;

•

Weather conditions;

•

Events at a nuclear facility, even one that is not operated by or licensed to TVA;

•

Catastrophic events such as fires, earthquakes, solar events, floods, tornadoes, pandemics, wars, terrorist activities, and other similar events, especially if these events occur in or near TVA’s service area;

•

Reliability and creditworthiness of counterparties;

•

Changes in the market price of commodities such as coal, uranium, natural gas, fuel oil, crude oil, construction materials, electricity, and emission allowances;

•

Changes in the market price of equity securities, debt securities, and other investments;

•

Changes in interest rates, currency exchange rates, and inflation rates;

•

Rising pension and health care costs;

•

Increases in TVA’s financial liability for decommissioning its nuclear facilities and retiring other assets;

•

Changes in the market for TVA’s debt, changes in TVA’s credit rating, or limitations on TVA’s ability to borrow money;

•

Changes in the economy and volatility in financial markets;

•

Inability to eliminate identified deficiencies in TVA’s systems, standards, controls, and corporate culture;

•

Ineffectiveness of TVA’s disclosure controls and procedures and its internal control over financial reporting;

•

Changes in accounting standards including any change that would eliminate TVA’s ability to use regulatory accounting;

•

Problems attracting and retaining a qualified workforce;

•

Changes in technology;

•

Differences between estimates of revenues and expenses and actual revenues and expenses incurred; and

•

Unforeseeable events.

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See also Item 1A, Risk Factors, and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in TVA’s Annual Report Form 10-K for the fiscal year ended September 30, 2009 (the “Annual Report”) and Part I, Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Part II, Item 1A, Risk Factors, in this Quarterly Report. New factors emerge from time to time, and it is not possible for management to predict all such factors or to assess the extent to which any factor or combination of factors may impact TVA’s business or cause results to differ materially from those contained in any forward-looking statement.

TVA undertakes no obligation to update any forward-looking statement to reflect developments that occur after the statement is made.

GENERAL INFORMATION

Fiscal Year

Unless otherwise indicated, years (2010, 2009, etc.) in this Quarterly Report refer to TVA’s fiscal years ending September 30. References to years that are preceded by “CY” are to calendar years.

Notes

References to “Notes” are to the Notes to Financial Statements contained in Part I, Item 1, Financial Statements in this Quarterly Report.

Available Information

TVA's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports are available on TVA's web site, free of charge, as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (“SEC”). TVA's web site is www.tva.gov. Information contained on TVA’s web site shall not be deemed to be incorporated into, or to be a part of, this Quarterly Report. TVA's SEC reports are also available to the public without charge from the web site maintained by the SEC at www.sec.gov. In addition, the public may read and copy any reports or other information that TVA files with or furnishes to the SEC at the SEC’s Public Reference Room at 100 F Street N.E., Washington, D.C. 20549. The public may obtain information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

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PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TENNESSEE VALLEY AUTHORITY

STATEMENTS OF OPERATIONS (UNAUDITED )

For the three months ended December 31

(in millions)

	2009			2008

Operating revenues
Sales of electricity
Municipalities and cooperatives	$	1,945		$	2,569
Industries directly served		348			442
Federal agencies and other		27			38
Other revenue		29			28
Total operating revenues		2,349			3,077
Operating expenses
Fuel and purchased power		608			1,383
Operating and maintenance		754			590
Depreciation, amortization, and accretion		411			396
Tax equivalents		105			148
Environmental cleanup costs – Kingston ash spill		—			525
Total operating expenses		1,878			3,042

Operating income		471			35

Other income (expense), net		6			(9	)

Interest expense
Interest on debt and leaseback obligations		336			334
Amortization of debt discount, issue, and reacquisition costs, net		5			5
Allowance for funds used during construction and nuclear fuel expenditures		(14	)		(8	)
Net interest expense		327			331

Net income (loss)	$	150		$	(305	)

The accompanying notes are an integral part of these financial statements.

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TENNESSEE VALLEY AUTHORITY

BALANCE SHEETS (UNAUDITED )

(in millions)

ASSETS
	December 31			September 30
	2009			2009
Current assets	(Unaudited)
Cash and cash equivalents	$	250		$	201
Restricted cash and investments		9			—
Accounts receivable, net		1,093			1,303
Inventories and other, net		1,020			961
Total current assets		2,372			2,465

Property, plant, and equipment
Completed plant		41,412			41,286
Less accumulated depreciation		(18,376	)		(18,086	)
Net completed plant		23,036			23,200
Construction in progress		2,876			2,600
Nuclear fuel and capital leases		1,056			961
Total property, plant, and equipment, net		26,968			26,761

Investment funds		1,019			983

Regulatory and other long-term assets
Deferred nuclear generating units		2,249			2,347
Other regulatory assets		6,972			7,287
Subtotal		9,221			9,634
Other long-term assets		205			174
Total regulatory and other long-term assets		9,426			9,808

Total assets	$	39,785		$	40,017

LIABILITIES AND PROPRIETARY CAPITAL

Current liabilities
Accounts payable and accrued liabilities	$	1,806		$	2,108
Environmental cleanup costs - Kingston ash spill		317			348
Collateral funds held		9			–
Accrued interest		334			401
Current portion of leaseback obligations		460			463
Current portion of energy prepayment obligations		105			105
Short-term debt, net		1,057			844
Current maturities of long-term debt		8			8
Total current liabilities		4,096			4,277

Long-term liabilities
Other long-term liabilities		4,517			4,805
Regulatory liabilities		124			130
Environmental cleanup costs - Kingston ash spill		300			354
Asset retirement obligations		2,717			2,683
Leaseback obligations		939			940
Energy prepayment obligations		796			822
Total long-term liabilities		9,393			9,734

Long-term debt, net		21,878			21,788

Total liabilities		35,367			35,799

Proprietary capital
Appropriation investment		4,698			4,703
Retained earnings		3,442			3,291
Accumulated other comprehensive loss		(18	)		(75	)
Accumulated net expense of nonpower programs		(3,704	)		(3,701	)
Total proprietary capital		4,418			4,218

Total liabilities and proprietary capital	$	39,785		$	40,017

The accompanying notes are an integral part of these financial statements.

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TENNESSEE VALLEY AUTHORITY

STATEMENTS OF CASH FLOWS ( UNAUDITED)

For the three months ended December 31

(in millions)

	2009			2008

Cash flows from operating activities
Net income (loss)	$	150		$	(305	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities
Depreciation, amortization, and accretion		416			401
Nuclear refueling outage amortization		31			29
Amortization of nuclear fuel		57			51
Non-cash retirement benefit expense		91			35
Prepayment credits applied to revenue		(26	)		(26	)
Fuel cost adjustment deferral		(202	)		395
Environmental cleanup costs - Kingston ash spill – non-cash		16			525
Changes in current assets and liabilities
Accounts receivable, net		217			(12	)
Inventories and other		(65	)		(133	)
Accounts payable and accrued liabilities		(191	)		(19	)
Accrued interest		(67	)		(129	)
Refueling outage costs		—			(30	)
Other, net		14			(13	)
Net cash provided by operating activities		441			769

Cash flows from investing activities
Construction expenditures		(534	)		(421	)
Nuclear fuel expenditures		(126	)		(168	)
Change in restricted cash and investments		—			(17	)
Change in collateral funds		—			(455	)
Purchases of investments, net		—			(1	)
Loans and other receivables
Advances		(11	)		(2	)
Repayments		7			2
Other, net		1			—
Net cash used in investing activities		(663	)		(1,062	)

Cash flows from financing activities
Long-term debt
Issues		82			39
Redemptions and repurchases		(4	)		(2,000	)
Short-term issues, net		213			2,208
Payments on leases and leaseback financing		(11	)		(4	)
Financing costs, net		(2	)		(1	)
Payments to U.S. Treasury		(7	)		(8	)
Other		—			(1	)
Net cash provided by financing activities		271			233

Net change in cash and cash equivalents		49			(60	)
Cash and cash equivalents at beginning of period		201			213

Cash and cash equivalents at end of period	$	250		$	153

The accompanying notes are an integral part of these financial statements.

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TENNESSEE VALLEY AUTHORITY

STATEMENTS OF CHANGES IN PROPRIETARY CAPITAL (UNAUDITED)

For the three months ended December 31, 2009 and 2008

(in millions)

	Appropriation Investment			Retained Earnings			Accumulated Other Comprehensive Loss			Accumulated Net Expense of Stewardship Programs			Total			Comprehensive (Loss) Income

Balance at September 30, 2008	$	4,723		$	2,571		$	(37	)	$	(3,694	)	$	3,563
Net loss		–			(304	)		–			(1	)		(305	)	$	(305	)
Other comprehensive loss
Net unrealized loss on future cash flow hedges		—			—			(364	)		—			(364	)		(364	)
Reclassification to earnings from cash flow hedges		—			—			191			—			191			191
Total other comprehensive loss																	(173	)
Total comprehensive loss																$	(478	)
Return on Power Facility Appropriation Investment		–			(3	)		–			–			(3	)
Return of Power Facility Appropriation Investment		(5	)		–			—			–			(5	)

Balance at December 31, 2008 (unaudited)	$	4,718		$	2,264		$	(210	)	$	(3,695	)	$	3,077

Balance at September 30, 2009	$	4,703		$	3,291		$	(75	)	$	(3,701	)	$	4,218
Net income (loss)		–			153			–			(3	)		150		$	150
Other comprehensive income
Net unrealized gain on future cash flow hedges								68						68			68
Reclassification to earnings from cash flow hedges								(11	)					(11	)		(11	)
Total other comprehensive income																	57
Total comprehensive income																$	207
Return on Power Facility Appropriation Investment		–			(2	)		–			–			(2	)
Return of Power Facility Appropriation Investment		(5	)		–			–			–			(5	)

Balance at December 31, 2009 (unaudited)	$	4,698		$	3,442		$	(18	)	$	(3,704	)	$	4,418

The accompanying notes are an integral part of these financial statements.

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NOTES TO FINANCIAL STATEMENTS (UNAUDITED )

(Dollars in millions except where noted)

Note No.		Page No.
1	Summary of Significant Accounting Policies	10
2	Impact of New Accounting Standards and Interpretations	11
3	Accounts Receivable	13
4	Inventories and Other, Net	13
5	Other Long-Term Assets	13
6	Cost-Based Regulation	13
7	Kingston Fossil Plant Ash Spill	15
8	Other Long-Term Liabilities	16
9	Asset Retirement Obligations	16
10	Debt	17
11	Seven States Power Corporation Obligation	18
12	Risk Management Activities and Derivative Transactions	18
13	Fair Value Measurements	25
14	Other Income (Expense), Net	30
15	Benefit Plans	30
16	Legal Proceedings	31
17	Subsequent Events	34

1. Summary of Significant Accounting Policies

General

In response to a proposal by President Franklin D. Roosevelt, in 1933, the U.S. Congress created the Tennessee Valley Authority (“TVA”), a government corporation. TVA was created among other things, to improve navigation on the Tennessee River, reduce the damage from destructive flood waters within the Tennessee River System and downstream on the lower Ohio and Mississippi Rivers, further the economic development of TVA’s service area in the southeastern United States, and sell the electricity generated at the facilities TVA operates.

Today, TVA operates the nation’s largest public power system and supplies power in most of Tennessee, northern Alabama, northeastern Mississippi, and southwestern Kentucky and in portions of northern Georgia, western North Carolina, and southwestern Virginia to a population of nearly nine million people.

TVA also manages the Tennessee River and its tributaries — the United States’s fifth largest river system — to provide, among other things, year-round navigation, flood damage reduction, and affordable and reliable electricity. Consistent with these primary purposes, TVA also manages the river system to provide recreational opportunities, adequate water supply, improved water quality, and economic development.

The power program has historically been separate and distinct from the stewardship programs. TVA is required to be self-supporting from power revenues and proceeds from power financings, such as proceeds from the issuance of bonds, notes, and other evidences of indebtedness (“Bonds”). Although TVA does not currently receive congressional appropriations, it is required to make annual payments to the U.S. Treasury in repayment of, and as a return on, the government’s appropriation investment in TVA power facilities (the “Power Facility Appropriation Investment”). In the 1998 Energy and Water Development Appropriations Act, Congress directed TVA to fund essential stewardship activities related to its management of the Tennessee River system and related properties with power funds in the event that there were insufficient appropriations or other available funds to pay for such activities in any fiscal year. Congress has not provided any appropriations to TVA to fund such activities since 1999. Consequently, during 2000, TVA began paying for essential stewardship activities primarily with power revenues, with the remainder funded with user fees and other forms of revenues derived in connection with those activities. These activities related to essential stewardship properties do not meet the criteria of an operating segment under the accounting principles generally accepted in the United States of America (“GAAP"). Accordingly, these assets and properties are included as part of the power program, TVA’s only operating segment.

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Power rates are established by the TVA Board of Directors (“TVA Board”) as authorized by the Tennessee Valley Authority Act of 1933, as amended, 16 U.S.C. §§ 831-831ee (as amended, the “TVA Act”). The TVA Act requires TVA to charge rates for power that will produce gross revenues sufficient to provide funds for operation, maintenance, and administration of its power system; payments to states and counties in lieu of taxes; debt service on outstanding indebtedness; payments to the U.S. Treasury in repayment of and as a return on the Power Facility Appropriation Investment; and such additional margin as the TVA Board may consider desirable for investment in power system assets, retirement of outstanding Bonds in advance of maturity, additional reduction of the Power Facility Appropriation Investment, and other purposes connected with TVA’s power business. In setting TVA’s rates, the TVA Board is charged by the TVA Act to have due regard for the primary objectives of the TVA Act, including the objective that power shall be sold at rates as low as are feasible. Rates set by the TVA Board are not subject to review or approval by any state or federal regulatory body.

Basis of Presentation

TVA prepares its interim financial statements in conformity with GAAP for interim financial information. Accordingly, TVA’s interim financial statements do not include all of the information and notes required by GAAP for complete financial statements. Because the accompanying interim financial statements do not include all of the information and footnotes required by GAAP for complete financial statements, they should be read in conjunction with the audited financial statements for the year ended September 30, 2009, and the notes thereto, which are contained in TVA’s Annual Report on Form 10-K for the year ended September 30, 2009 (the “Annual Report”). In the opinion of management, all adjustments (consisting of items of a normal recurring nature) considered necessary for fair presentation are included.

Use of Estimates

The preparation of financial statements requires TVA to estimate the effects of various matters that are inherently uncertain as of the date of the financial statements. Although the financial statements are prepared in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the amounts of revenues and expenses reported during the reporting period. Each of these estimates varies in regard to the level of judgment involved and its potential impact on TVA’s financial results. Estimates are deemed critical either when a different estimate could have reasonably been used, or where changes in the estimate are reasonably likely to occur from period to period, and such use or change would materially impact TVA’s financial condition, results of operations, or cash flows. TVA’s critical accounting policies are also discussed in Note 1 in the Annual Report .

Fiscal Year

TVA’s fiscal year ends September 30. Unless otherwise indicated, years (2010, 2009, etc.) refer to TVA’s fiscal years. References to years that are preceded by “CY” are to calendar years.

2. Impact of New Accounting Standards and Interpretations

The following accounting standards and interpretations became effective for TVA during the first quarter of 2010.

Fair Value Measurements . In September 2006, the Financial Accounting Standards Board (“FASB”) issued guidance for measuring assets and liabilities that currently require fair value measurement. The guidance also responds to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The guidance applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. The guidance establishes a fair value hierarchy that prioritizes the information used to develop measurement assumptions. In February 2008, FASB issued guidance that delayed the effective date of the fair value accounting changes for nonfinancial assets and nonfinancial liabilities except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. Effective October 1, 2009, TVA adopted these fair value accounting changes for its nonfinancial assets and nonfinancial liabilities. The adoption of this guidance did not materially impact TVA’s financial condition, results of operations, or cash flows.

In August 2009, FASB issued guidance regarding fair value measurements of liabilities . The guidance clarifies how the fair value of a liability should be measured when a quoted price in an active market for the identical liability either is or is not available. Additionally, the guidance clarifies how to consider a restriction when estimating the various measurement techniques results. These changes became effective for TVA on October 1, 2009. The adoption of this guidance did not materially impact TVA's financial condition, results of operations, or cash flows.

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In September 2009, FASB issued guidance regarding fair value measurements for certain alternative investments, such as interests in hedge funds, private equity funds, real estate funds, venture capital funds, offshore fund vehicles, and funds of funds. The guidance allows reporting entities to use net asset value per share to estimate the fair value of these investments as a practical expedient. The guidance also requires disclosures by major category of investment about the attributes of the investments, such as the nature of any restrictions on the investor's ability to redeem its investments at the measurement date, any unfunded commitments, and the investment strategies of the investees. These changes became effective for TVA on October 1, 2009. The adoption of this guidance did not materially impact TVA’s financial condition, results of operations, or cash flows.

Business Combinations . In December 2007, FASB issued guidance that changes the accounting for business combinations. The guidance establishes principles and requirements for determining how an enterprise recognizes and measures the fair value of certain assets and liabilities acquired in a business combination, including non-controlling interests, contingent consideration, and certain acquired contingencies. The guidance also requires acquisition-related transaction expenses and restructuring costs to be expensed as incurred rather than capitalized as a component of the business combination. In April 2009, FASB issued additional guidance to amend and clarify the initial recognition and measurement, subsequent measurement and accounting, and related disclosures arising from contingencies in a business combination. This guidance became effective for TVA on October 1, 2009. The adoption of this guidance did not materially impact TVA’s financial condition, results of operations, or cash flows but will impact the accounting for any future business acquisitions.

Noncontrolling Interests . In December 2007, FASB issued guidance that introduces significant changes in the accounting for noncontrolling interests (formerly minority interests) in a partially-owned consolidated subsidiary. The guidance also changes the accounting for and reporting for the deconsolidation of a subsidiary. The guidance requires that a noncontrolling interest in a consolidated subsidiary be displayed in the consolidated statement of financial position as a separate component of equity. The guidance also requires that earnings attributed to the noncontrolling interests be reported as part of consolidated earnings, and requires disclosure of the attribution of consolidated earnings to the controlling and noncontrolling interests on the face of the consolidated income statement. These changes became effective for TVA on October 1, 2009. The adoption of this guidance did not materially impact TVA’s financial condition, results of operations, or cash flows but will impact the accounting for any future noncontrolling interests.

The following accounting standards have been issued, but as of December 31, 2009, were not effective and had not been adopted by TVA.

Transfers of Financial Assets . In June 2009, FASB issued guidance regarding accounting for transfers of financial assets. This guidance eliminates the concept of a qualifying special-purpose entity (“QSPE”) and subjects those entities to the same consolidation guidance as other variable interest entities (“VIEs”). The guidance changes the eligibility criteria for certain transactions to qualify for sale accounting and the accounting for certain transfers. The guidance also establishes broad disclosure objectives and requires extensive specific disclosures related to the transfers. These changes will become effective for TVA for any transfers of financial assets occurring on or after October 1, 2010. TVA does not believe adoption of this guidance will materially affect its financial condition, results of operations, or cash flows.

Variable Interest Entities . In June 2009, FASB issued guidance that changes the consolidation guidance for VIEs. The guidance eliminates the consolidation scope exception for QSPEs. The statement amends the triggering events to determine if an entity is a VIE, establishes a primarily qualitative model for determining the primary beneficiary of the VIE, and requires on-going assessments of whether the reporting entity is the primary beneficiary. These changes will become effective for TVA on October 1, 2010, and will apply to all entities determined to be VIEs as of and subsequent to the date of adoption. TVA does not believe adoption of this guidance will materially affect its financial condition, results of operations, or cash flows.

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3. Accounts Receivable

Accounts receivable primarily consist of amounts due from customers for power sales. The table below summarizes the types and amounts of receivables:

Accounts Receivable
	At December 31, 2009			At September 30, 2009

Power receivables billed	$	173		$	309
Power receivables unbilled		869			940
Total power receivables		1,042			1,249

Other receivables		53			56
Allowance for uncollectible accounts		(2	)		(2	)
Net accounts receivable	$	1,093		$	1,303

4. Inventories and Other, Net

The table below summarizes the types and amounts of TVA’s inventories and other current assets :

Inventories
	At December 31, 2009			At September 30, 2009

Fuel inventory	$	572		$	535
Materials and supplies inventory		423			422
Emission allowance inventory		12			12
Allowance for inventory obsolescence		(50	)		(50	)
Prepaids and other		63			42
Inventories and other, net	$	1,020		$	961

5. Other Long-Term Assets

The table below summarizes the types and amounts of TVA’s Other long-term assets:

Other Long-Term Assets
	At December 31, 2009		At September 30, 2009
Loans and long-term receivables, net	$	81	$	77
Currency swap assets		41		7
Coal contract derivative assets		78		87
Other long-term assets		5		3
Total other long-term assets	$	205	$	174

6. Cost-Based Regulation

Regulatory assets generally represent incurred costs that have been deferred because such costs are probable of future recovery in customer rates. These regulatory assets are included in Deferred nuclear generating units and Other regulatory assets on the December 31, 2009 and September 30, 2009 Balance Sheets. Regulatory liabilities generally represent obligations to make refunds to customers for previous collections for costs that are not likely to be incurred or deferral of gains that will be credited to customers in future periods. These regulatory liabilities are included in Accounts Payable and Accrued liabilities and Regulatory liabilities on the December 31, 2009 Balance Sheets. Components of Other regulatory assets and regulatory liabilities are summarized in the table below.

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TVA Regulatory Assets and Liabilities
	At December 31, 2009		At September 30, 2009
Regulatory Assets:
Deferred other post-retirement benefit costs	$	293	$	298
Deferred pension costs		3,713		3,764
Nuclear decommissioning costs		898		909
Non-nuclear decommissioning costs		366		351
Debt reacquisition costs		191		195
Unrealized losses relating to TVA’s Financial Trading Program		110		85
Unrealized losses on coal contract derivatives		54		70
Unrealized losses on certain swap and swaption contracts		280		498
Environmental cleanup costs - Kingston ash spill		917		933
Deferred outage costs		114		144
Deferred capital lease asset costs		36		40
Subtotal		6,972		7,287
Deferred nuclear generating units		2,249		2,347
Total	$	9,221	$	9,634

Regulatory Liabilities:
Unrealized gains on coal contract derivatives	$	78	$	87
Capital lease liabilities		21		26
Unrealized gains relating to TVA’s Financial Trading Program		25		17
Subtotal		124		130
Reserve for future generation		66		67
Accrued tax equivalents		53		81
Fuel cost adjustment liability: short-term		620		822

Total	$	863	$	1,100

Fuel Cost Adjustment. The fuel cost adjustment (“FCA”) provides a mechanism to regularly alter rates to reflect changing fuel and purchased power costs. There is typically a lag between the occurrence of a change in fuel and purchased power costs and the reflection of the change in rates. As of December 31, 2009, TVA had recognized a short-term regulatory liability of $620 million with no long-term regulatory liability related to the FCA. This short-term regulatory liability represents excess revenues collected to offset fuel and purchased power costs. The excess revenue is driven by market commodity prices being lower than those forecasted. This short-term FCA regulatory liability balance is included in Accounts payable and accrued liabilities on the Balance Sheets at December 31, 2009.

In August 2009, the TVA Board approved a revision to the FCA formula. Starting with the October 1, 2009 billing period, all adjustments to the FCA have been made on a monthly basis instead of a quarterly basis. This allows the FCA rate to be more closely aligned with TVA’s costs. The FCA formula also contains a deferred account which is used to reconcile the difference between actual and forecasted fuel and purchased power costs in the FCA. The difference between the amounts is included in the deferred account, and starting with the October 1, 2009 billing period, 50 percent of the account has been disbursed or collected on a monthly basis instead of a quarterly basis. This change to a monthly FCA formula is expected to result in smaller reconciliations and faster liquidation of any balances in the account. With the change to the monthly FCA formula on October 1, 2009, the remaining balance in the existing deferred liability account balance at that date from the quarterly FCA formula of approximately $822 million is being liquidated over a nine-month period from October 1, 2009 through June 30, 2010.

Deferred Outage Costs . TVA’s investment in the fuel used in its nuclear units is being amortized and accounted for as a component of fuel expense. Nuclear refueling outage and maintenance costs already incurred have historically been deferred and amortized on a straight-line basis over the estimated period until the next refueling outage. In August 2009, the TVA Board approved a change in the accounting for deferred outage costs. Beginning October 1, 2010, outage costs are no longer deferred as a regulatory asset and are being expensed as incurred. Previously deferred outage costs continue to be amortized as the remaining amounts are collected in rates.

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7. Kingston Fossil Plant Ash Spill

The Event . On December 22, 2008, approximately five million cubic yards of water and coal fly ash flowed out of the ash pond at the Kingston Fossil Plant (“Kingston”) onto approximately 300 acres, primarily Watts Bar Reservoir and shoreline property owned by the United States and managed by TVA, but also structurally damaged three homes, interrupted utility service, and blocked a local road. Fly ash is a coal combustion product of a coal-fired plant. Kingston used wet ash containment impoundments for fly ash.

TVA is conducting cleanup and recovery efforts in conjunction with federal and state agencies. Under the May 11, 2009 Administrative Order and Agreement on Consent (“Order and Agreement”) entered into by TVA and the Environmental Protection Agency (“EPA”) under the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), TVA retains its status as a lead federal agency, but TVA's work is subject to review and approval by the EPA, in consultation with the Tennessee Department of Environment and Conservation (“TDEC”). Under the Order and Agreement, response actions are classified into three categories: time-critical removal; non-time-critical removal; and remedial actions. Generally, removal of the ash from the Emory River is time-critical. TVA estimates that this work will be completed in 2010. Removal of the remaining ash is considered to be non-time-critical. TVA estimates that this work will be completed in 2013. Once the removal actions are completed, TVA will be required to assess the site and determine whether any additional actions may be needed at Kingston or the surrounding impacted area. This assessment and any additional activities found to be necessary are considered the remedial actions.

Insurance . TVA has property and excess liability insurance programs in place that may cover some of the Kingston ash spill costs. The insurers for each of these programs have been notified of the event. Although three of the insurers that provide liability insurance have denied coverage, TVA is working with its insurers to provide information, on the event and its cause to determine applicable coverage. As a result, no estimate for potential insurance recovery has been accrued.

Claims and Litigation . Fifty-seven lawsuits based on the Kingston ash spill have been filed, and one of these has been voluntarily dismissed. All of the remaining cases are pending in the United States District Court for the Eastern District of Tennessee. See Note 16 .

Financial Impact . TVA has recorded an estimate in the amount of $933 million for the cost of cleanup related to this event. TVA originally charged this amount to expense in 2009 as follows: $525 million, $150 million, and $258 million during the three months ended December 31, 2008, March 31, 2009, and June 30, 2009, respectively. However, due to actions of the TVA Board in August 2009, the amount was reclassified as a regulatory asset during the fourth quarter of 2009 and will be charged to expense as it is collected in future rates over 15 years, beginning October 1, 2009. TVA has revised the estimated cost of the cleanup over the course of the project consistent with receipt of better information as the remediation work has progressed.

As work progresses and more information is available, TVA will review its estimates and revise them as appropriate. TVA currently estimates the recovery process will be completed in 2013. As such, TVA has accrued a portion of the estimate in current liabilities, with the remaining portion shown as a long-term liability on TVA’s December 31, 2009 Balance Sheets. Costs incurred since the event through December 31, 2009, totaled $316 million, resulting in a remaining estimated liability of $617 million at December 31, 2009.

The $933 million estimate currently includes, among other things, a reasonable estimate of costs related to ash dredging and processing, ash disposition, infrastructure repair, dredge cell repair, root cause analysis, certain legal and settlement costs, environmental impact studies and remediation, human health assessments, community outreach and support, regulatory oversight, cenosphere recovery, skimmer wall installation, construction of temporary ash storage areas, dike reinforcement, project management, and certain other remediation costs associated with the clean up. If the actual amount of ash removed is more or less than the estimate, the expense could change significantly as this affects the largest cost components of the estimate. The cost of the removal of the ash is in large part dependent on the final disposal plan, which is still in development by TVA and regulatory authorities.

Due to the uncertainty at this time of the final methods of disposal, a range of reasonable estimates has been developed by cost category and either the known amounts, most likely scenarios, or low end of the range for each category has been accumulated and evaluated to determine the total estimate. The costs related to loading, transport, and disposal of all time critical ash and final disposition of dredge cell closures are the ones most subject to change. It is not currently known exactly how much ash will need to be removed. The range of estimated costs varies from approximately $933 million to approximately $1.2 billion.

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TVA has not included the following categories of costs in the above estimate since it has determined that these costs are currently either not probable, not reasonably estimable, or not appropriately accounted for as part of the estimate accrual: fines or regulatory directives, outcome of lawsuits, future claims, long-term environmental impact costs, final long-term disposition of ash processing area, associated capital asset purchases, ash handling and disposition from current plant operations, costs of remediating any discovered mixed waste during ash removal process, and other costs not meeting the recognition criteria. As ash removal continues, it is possible that other environmentally sensitive material potentially in the river sediment before the ash spill may be uncovered. If other materials are identified, additional remediation not included in the above estimates may be required.

On January 26, 2010, the owners of the landfill in Perry County, Alabama that is receiving the ash dredged from the Emory River filed for Chapter 11 bankruptcy. At this time it is unclear whether this filing will cause TVA to incur any additional costs.

8. Other Long-Term Liabilities

The table below summarizes the types and amounts of liabilities:

Other Long-Term Liabilities
	At December 31, 2009		At September 30, 2009
Currency swap liabilities	$	17	$	51
Swaption liability		455		592
Interest rate swap liabilities		206		287
Coal contract derivative liabilities		72		80
Post-retirement and postemployment benefit obligations		3,656		3,678
Other long-term liability obligations		111		117
Total other long-term liabilities	$	4,517	$	4,805

9. Asset Retirement Obligations

During the first quarters of 2010 and 2009, TVA’s total asset retirement obligation (“ARO”) liability increased $34 million and $32 million, respectively, due primarily to accretion. The nuclear accretion of $26 million and $24 million and the non-nuclear accretion of $11 million and $8 million were deferred as regulatory assets. However, amounts equal to those collected in rates for the funding of the nuclear decommissioning trust (“NDT”) and the asset retirement trust (“ART”) are charged to accretion and depreciation expense. During the first quarter of 2010, $5 million of nuclear accretion and $9 million of non-nuclear accretion was expensed as these amounts were being collected in rates. The nuclear ARO liability as of December 31, 2009 was $1,863 million. The non-nuclear ARO liability as of December 31, 2009 was $854 million.

Reconciliation of Asset Retirement Obligation Liability Three Months Ended December 31
	2009			2008
Balance at beginning of period	$	2,683		$	2,318

Changes in nuclear estimates to future cash flows		—			–
Non-nuclear additional obligations		—			–
Changes in non-nuclear estimates to future cash flows		(3	)		–
		2,680			2,318
Add: ARO accretion
Nuclear accretion		26			24
Non-nuclear accretion		11			8
		37			32

Balance at end of period	$	2,717		$	2,350

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10. Debt

Debt Outstanding

The TVA Act authorizes TVA to issue Bonds in an amount not to exceed $30 billion at any time. Debt outstanding at December 31, 2009 and September 30, 2009, including translation losses of $41 million and $30 million, respectively, related to Bonds denominated in foreign currencies, consisted of the following:

Debt Outstanding
	At December 31, 2009			At September 30, 2009
Short-term debt
Discount notes (net of discount)	$	1,057		$	844
Current maturities of long-term debt		8			8
Total short-term debt, net		1,065			852

Long-term debt
Long-term		22,101			22,012
Unamortized discount		(223	)		(224	)
Total long-term debt, net		21,878			21,788

Total outstanding debt	$	22,943		$	22,640

Debt Securities Activity

The table below summarizes TVA’s long-term Bond activity for the period from October 1, 2009, to December 31, 2009.

	Date	Amount		Interest Rate
Issuances:
electronotes ®	First Quarter 2010	$	82		4.38	%

Redemptions/Maturities:
electronotes ®	First Quarter 2010	$	1		3.24	%
2009 Series A	November 2009		2		2.25	%
2009 Series B	December 2009		1		3.77	%
		$	4

TVA also has access to a financing arrangement with the U.S. Treasury pursuant to the TVA Act. TVA and the U.S. Treasury entered into a memorandum of understanding under which the U.S. Treasury provides TVA with a $150 million credit facility. This credit facility matures on September 30, 2010, and is expected to be renewed. Access to this credit facility or other similar financing arrangements have been available to TVA since the 1960s. TVA plans to use the U.S. Treasury credit facility as a secondary source of liquidity. The interest rate on any borrowing under this facility is based on the average rate on outstanding marketable obligations of the United States with maturities from date of issue of one year or less. TVA did not borrow under the credit facility during 2009 or the three months ended December 31, 2009.

TVA also has short-term funding available in the form of two short-term revolving credit facilities of $1.0 billion each, one of which matures on May 12, 2010, and the other of which matures on November 8, 2010. The credit facilities accommodate the issuance of letters of credit. The interest rate on any borrowing and the fees on any letter of credit under these facilities are variable based on market factors and the rating of TVA’s senior unsecured long-term non -credit enhanced debt. TVA is required to pay an unused facility fee on the portion of the total $2.0 billion which TVA has not borrowed or committed under letters of credit. The fee fluctuates depending on the non-enhanced credit ratings on TVA’s senior unsecured long-term debt. At December 31, 2009 and September 30, 2009, there were $145 million and $103 million, respectively, of letters of credit outstanding under the facilities, and there were no outstanding borrowings. TVA anticipates renewing each credit facility as it matures.

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11. Seven States Power Corporation Obligation

Seven States Power Corporation ("Seven States"), through its subsidiary, Seven States Southaven, LLC ("SSSL"), exercised Seven States’s option to purchase an undivided 90 percent interest in a combined cycle combustion turbine facility in Southaven, Mississippi. As part of interim joint-ownership arrangements, Seven States has the right at any time during the interim period, and for any reason, to require TVA to buy back the Seven States interest in the facility (and the related assets). TVA will buy back the Seven States interest if long-term operational and power sales arrangements for the facility among TVA, Seven States, and SSSL, or alternative arrangements, are not in place by April 30, 2010. TVA’s buy-back obligation will terminate if such long-term arrangements are in place by that date or may be extended to a later date if alternative arrangements are put in place. In the event of a buy-back, TVA would re-acquire the Seven States interest in the facility and the related assets. As of February 3, 2010, long-term arrangements were not in place. TVA, Seven States, and SSSL, however, are discussing alternative arrangements that would extend TVA’s buy-back obligation to a later date even if long-term arrangements are not in place by April 30, 2010. Because of TVA’s continued ownership interest in the facility as well as the buy-back provisions, the transaction did not qualify as a sale and, accordingly, has been recorded as a leaseback obligation. As of December 31, 2009, the carrying amount of the obligation was approximately $412 million.

12. Risk Management Activities and Derivative Transactions

TVA recognizes certain of its derivative instruments as either assets or liabilities on its Balance Sheets at fair value. The accounting for changes in the fair value of these instruments depends on (1) whether the derivative instrument has been designated and qualifies for hedge accounting treatment and (2) if so, the type of hedge relationship (e.g., cash flow hedge).

TVA is exposed to various market risks. These market risks include risks related to commodity prices, investment prices, interest rates, currency exchange rates, inflation, and counterparty credit risk. 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 investment funds, it is TVA’s policy to enter into these derivative transactions solely for hedging purposes and not for speculative purposes.

Overview of Accounting Treatment

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
Derivatives in Cash Flow Hedging Relationship	Objective of Hedge Transaction	Accounting for Derivative Hedging Instrument	Amount of Mark-to-Market Gain (Loss) Recognized in Other Comprehensive Loss (“OCL”) Three Months Ended December 31					Amount of Exchange (Loss) Gain Reclassified from OCL to Interest Expense Three Months Ended December 31 (a)
			2009		2008			2009			2008

Currency swaps	To protect against changes in cash flows caused by changes in foreign currency exchange rates (exchange rate risk)	Cumulative unrealized gains and losses are recorded in OCL and reclassified to interest expense to the extent they are offset by cumulative gains and losses on the hedged transaction	$	68	$	(364	)	$	(11	)	$	191
Note (a) There were no ineffective portions or amounts excluded from effectiveness testing for any of the periods presented. Also see Note 13.

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Summary of Derivative Instruments That Do Not Receive Hedge Accounting Treatment
Derivative Type	Objective of Derivative	Accounting for Derivative Instrument	Amount of Gain (Loss) Recognized in Income on Derivatives Three Months Ended December 31 (a)
			2009			2008
Swaption	To protect against decreases in value of the embedded call (interest rate risk)	Gains and losses are recorded as regulatory assets or liabilities until settlement, at which time the gains/losses (if any) are recognized in gain/loss on derivative contracts.	$	—		$	—

Interest rate swaps	To fix short-term debt variable rate to a fixed rate (interest rate risk)	Gains and losses are recorded as regulatory assets or liabilities until settlement, at which time the gains/losses (if any) are recognized in gain/loss on derivative contracts.		—			—

Coal contract derivatives	To protect against fluctuations in market prices of purchased coal (price risk)	Gains and losses are recorded as regulatory assets or liabilities. They are recognized in fuel and purchased power expense when the related coal is used in production.(b)		—			—

Commodity derivatives under Financial Trading Program	To protect against fluctuations in market prices of purchased commodities (price risk)	Realized gains and losses are recorded in earnings as fuel and purchased power expense. Unrealized gains and losses are recorded as a regulatory asset/liability.		(50	)		(70	)
Notes (a) 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, 2009 and 2008. (b) Settlement fees associated with early contract termination are recognized in fuel and purchased power expense in the period incurred. Settlement fees with early contract terminations that qu alify for regulatory accounting are recorded as regulatory assets.

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Mark-to-Market Values of TVA Derivatives
	At December 31, 2009				At September 30, 2009

Derivatives that Receive Hedge Accounting Treatment:
	Balance			Balance Sheets Presentation	Balance			Balance Sheets Presentation
Currency swaps:
£200 million Sterling	$	(17	)	Other long-term liabilities	$	(33	)	Other long-term liabilities
£250 million Sterling		36		Other long-term assets		7		Other long-term assets
£150 million Sterling		5		Other long-term assets		(18	)	Other long-term liabilities

Derivatives that do Not Receive Hedge Accounting Treatment:
	Balance			Balance Sheets Presentation	Balance			Balance Sheets Presentation
Swaption:
$1.0 billion notional	$	(455	)	Other long-term liabilities	$	(592	)	Other long-term liabilities

Interest rate swaps:
$476 million notional		(197	)	Other long-term liabilities		(276	)	Other long-term liabilities
$42 million notional		(9	)	Other long-term liabilities		(11	)	Other long-term liabilities
Coal contract derivatives		6		Other long-term assets $78, Other long-term liabilities ($72)		7		Other long-term assets $87, Other long-term liabilities ($80)

Commodity derivatives under Financial Trading Program:
Margin cash account*		14		Inventories and other, net		28		Inventories and other, net
Unrealized losses, net		(85	)	Other regulatory assets ($110), Regulatory liabilities $25		(68	)	Other regulatory assets ($85), Regulatory liabilities $17
Note * In accordance with certain credit terms, TVA uses leveraging to trade financial instruments under the Financial Trading Program. Therefore, the margin cash account balance does not represent 100 percent of the net market value of the derivative positions outstanding as shown in the Commodity Derivatives Under Financial Trading Program table below.

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Cash Flow Hedging Strategy for Currency Swaps

To protect against the exchange rate risk related to three sterling denominated Bond transactions, TVA entered into foreign currency hedges at the time the Bond transactions occurred. TVA has the following currency swaps outstanding as of December 31, 2009:

Currency Swaps Outstanding As of December 31, 2009
Effective Date of Currency Swap Contract	Associated TVA Bond Issues – Currency Exposure	Expiration Date of Swap	Overall Effective Cost to TVA
2003	£150 million	2043	4.96%
2001	£250 million	2032	6.59%
1999	£200 million	2021	5.81%

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, the exchange loss on the Bond liability is offset by an exchange gain on the swap contract. All such exchange gains or losses are included in Long-term debt, net . The offsetting exchange losses or gains on the swap contracts are recognized in Accumulated other comprehensive loss. I f any loss (gain) were to be incurred as a result of the early termination of the foreign currency swap contract, any resulting charge (income) would be amortized over the remaining life of the associated Bond as a component of interest expense.

Derivatives Not Receiving Hedge Accounting Treatment

Swaption and Interest Rate Swaps

TVA has entered into four swaption transactions to monetize the value of call provisions on certain of its Bond issues. A swaption grants a third party the right to enter into a swap agreement with TVA under which TVA receives a floating rate of interest and pays the third party a fixed rate of interest equal to the interest rate on the Bond issue for which the call provision has been monetized by TVA.

•

In 2003, TVA monetized the call provisions on a $1.0 billion Bond issue by entering into a swaption agreement with a third party in exchange for $175 million (the “2003A Swaption”).

•

In 2003, TVA also monetized the call provisions on a $476 million Bond issue by entering into a swaption agreement with a third party in exchange for $81 million (the “2003B Swaption”).

•

In 2005, TVA monetized the call provisions on two electronotes ® issues ($42 million total par value) by entering into swaption agreements with a third party in exchange for $5 million (the “2005 Swaptions”).

In February 2004, the counterparty to the 2003B Swaption exercised its option to enter into an interest rate swap with TVA, effective April 10, 2004, requiring TVA to make fixed rate payments to the counterparty of 6.875 percent and the counterparty to make floating payments to TVA based on London Interbank Offered Rate (“LIBOR”). These payments are based on the notional principal amount of $476 million and began on June 15, 2004.

In February 2008, the counterparty to the 2005 Swaptions exercised its options to enter into interest rate swaps with TVA, effective March 11, 2008. Under the swaps, TVA is required to make fixed rate payments to the counterparty at 6.125 percent, and the counterparty is required to make floating payments to TVA based on LIBOR. These payments are based on a combined notional amount of $42 million and began on April 15, 2008.

On October 1, 2007, TVA began using regulatory accounting treatment to defer the mark-to-market gains and losses on these swap and swaption agreements to reflect that the gain or loss is included in the ratemaking formula when these transactions settle. The values of the swap and swaption agreements and related deferred unrealized gains and losses are recorded on TVA's Balance Sheets with realized gains or losses, if any, recorded on TVA's Statements of Operations . There were no realized gains or losses for the three months ended December 31, 2009 and 2008.

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For the three months ended December 31, 2009 and 2008, the changes in market value resulted in deferred unrealized gains (losses) on the value of interest rate swaps and swaption of $218 million and $(755) million, respectively. All net deferred unrealized gains (losses) are reclassified as regulatory liabilities (assets) on the Balance Sheets .

Coal Contract Derivatives

TVA enters into certain coal supply contracts that require delivery of fixed quantities of coal (base tons) at fixed prices. Most of these contracts are not required to be marked to market because (1) they are probable of physical delivery and (2) early net settlement is not probable. Coal contracts that do not qualify for this exception are marked to market on a quarterly basis as coal contract derivatives. Additionally, certain coal contracts also contain options that permit TVA to either increase or reduce the amounts of coal delivered within specified guidelines. Essentially, the option to take more or less coal represents a purchased option that is combined with the forward coal contract in a single supply contract. TVA marks to market the value of these contracts on a quarterly basis as coal contract derivatives.

At December 31, 2009 and September 30, 2009, TVA’s coal contract derivatives had net market values of approximately $6 million and $7 million, respectively, which TVA deferred as regulatory assets and liabilities on a gross basis. TVA will continue to defer all unrealized gains or losses related to these contracts and record only realized gains or losses as fossil fuel expense at the time the coal is used in production. The $6 million net market value of TVA’s coal contract derivatives at December 31, 2009, also includes a $15 million expected net settlement related to the early termination of a coal supply contract subsequent to December 31, 2009.

	Coal Contract Derivatives
	At December 31, 2009			At September 30, 2009
	Number of Contracts	Notional Amount (in tons)	Fair Value (MtM) (in millions)	Number of Contracts	Notional Amount (in tons)	Fair Value (MtM) (in millions)

Coal Contract Derivatives	12	30 million	$ 6	7	29 million	$ 7

Commodity Derivatives Under Financial Trading Program

TVA has a Financial Trading Program (“FTP”) under which it can 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 FCA 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 FCA 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. Under the FTP, TVA is prohibited from trading financial instruments for speculative purposes. At December 31, 2009, the only risks hedged under the FTP were the economic risks associated with the prices of natural gas, fuel oil, and crude oil.

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Commodity Derivatives Under Financial Trading Program
	At December 31, 2009					At September 30, 2009
	Notional Amount		Fair Value (MtM) (in millions)			Notional Amount		Fair Value (MtM) (in millions)
	Notional Amount		Fair Value (MtM) (in millions)			Notional Amount		Fair Value (MtM) (in millions)
Natural gas (in mmBtu)

Futures contracts
Fixed positions		—	$	(4	)		—	$	(5	)
Open positions at end of period		28,280,000		(27	)		30,020,000		(25	)
Net position at end of period		28,280,000		(31	)		30,020,000		(30	)

Swap contracts
Fixed positions		—		(3	)		—		(16	)
Open positions at end of period		122,850,000		(72	)		115,307,500		(36	)
Net position at end of period		122,850,000		(75	)		115,307,500		(52	)

Option contracts open at end of period		1,250,000		(1	)		7,300,000		1

Natural gas financial positions at end of period, net		152,380,000	$	(107	)		152,627,500	$	(81	)

Fuel oil/crude oil (in barrels)

Futures contracts open at end of period		297,000	$	5			398,000	$	3

Swap contracts open at end of period		1,609,000		15			1,660,000		7

Option contracts open at end of period		1,035,000		2			1,236,000		3

Fuel oil/crude oil financial positions at end of period, net		2,941,000	$	22			3,294,000	$	13

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 product.

Natural Gas

At December 31, 2009, TVA had natural gas hedges with notional volumes equivalent to 152,380,000 (in mmBtu), the market value of which was a net loss of $107 million. The unrealized loss of $110 million and unrealized gain of $3 million for the quarter ended December 31, 2009, were deferred as a regulatory asset and a regulatory liability, respectively. For the three months ended December 31, 2009, TVA recognized realized losses on natural gas hedges of $55 million, which were recorded as an increase to purchased power expense.

At September 30, 2009, TVA had natural gas hedges with notional volumes equivalent to 152,627,500 (in mmBtu), the market value of which was a net loss of $81 million. The unrealized loss of $84 million and unrealized gain of $3 million for the year ended September 30, 2009, were deferred as a regulatory asset and a regulatory liability, respectively. For the three months ended December 31, 2008, TVA recognized realized losses on natural gas hedges of $69 million, which were recorded as an increase to purchased power expense.

Fuel Oil/Crude Oil

At December 31, 2009, TVA had notional volumes of fuel oil/crude oil hedges equivalent to 2,941,000 (in barrels), the market value of which was a net gain of $22 million. The unrealized gain of $22 million for the quarter ended December 31, 2009, was deferred as a regulatory liability. For the three months ended December 31, 2009, TVA recognized realized gains on fuel oil/crude oil hedges of $5 million, which were recorded as a reduction of fossil fuel expense.

At September 30, 2009, TVA had notional volumes of fuel oil/crude oil hedges equivalent to 3,294,000 (in barrels), the market value of which was a net gain of $13 million. The unrealized loss of $1 million and unrealized gain of $14 million for the year ended September 30, 2009, were deferred as a regulatory asset and a regulatory liability, respectively. For the three months ended December 31, 2008, TVA recognized realized losses on fuel oil/crude oil hedges of less than $1 million, which were recorded as an increase to fossil fuel expense.

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Other Derivative Instruments

Other Commodity Derivatives

TVA enters into forward contracts that hedge cash flow exposures to market fluctuations in the price and delivery of certain commodities including coal, natural gas, fuel oil, crude oil, electricity, uranium, and construction commodities. TVA expects to take or make delivery, as appropriate, under these forward contracts. Accordingly, these contracts qualify for normal purchases and normal sales accounting.

Investment Fund Derivatives

Investment funds consist primarily of funds held in trusts designed to fund nuclear decommissioning requirements, asset retirement obligations, and the supplemental executive retirement plan (“SERP”). All securities in the trusts are classified as trading. See Note 13 for a discussion of the trusts’ objectives and the types of investments included in the various trusts. Derivative instruments in these trusts include swaps, futures, options, forwards, and other instruments. As of December 31, 2009 and September 30, 2009, the fair value of derivative instruments in these trusts was immaterial.

Collateral

TVA’s interest rate swaps, two of its currency swaps, and its swaption 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. These derivative instruments contain provisions which may adjust these thresholds based on the credit rating of TVA’s debt per Standard & Poor’s Rating Service (“S&P”) or Moody’s Investors Services, Inc. (“Moody’s”) and TVA’s continued status as a majority-owned U.S. government entity. If these credit risk-related contingent features were triggered, TVA could be required by its counterparties to provide additional collateral on these derivative instruments in net liability positions.

As of December 31, 2009, the aggregate fair value of all derivative instruments with credit-risk related contingent features that were in a liability position was $661 million. TVA’s collateral obligation as of December 31, 2009, under these arrangements was $5 million, for which TVA had posted $145 million under a letter of credit. The difference between the obligation and the collateral amount is due to the timing of the collateral posting. In January 2010, TVA reduced the posted letter of credit to $5 million. These letter of credit postings reduce the available balance in TVA’s two $1.0 billion revolving 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. If the credit risk-related contingent features underlying these agreements were triggered at December 31, 2009, TVA would have been required to post up to $516 million of additional collateral with its counterparties.

Concentration of Credit

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 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. The majority of TVA’s credit risk is limited to trade accounts receivable from delivered power sales to municipal and cooperative distributor customers, 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. Outstanding accounts receivable for the top seven customers at December 31, 2009, were $393 million, or 36 percent of total outstanding accounts receivable, and at September 30, 2009, were $528 million, or 41 percent of total outstanding accounts receivable.

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TVA is also exposed to credit risk from the banking and coal industries because multiple companies in these industries serve as counterparties to TVA in various derivative transactions. As of December 31, 2009, the swaption and all of TVA’s currency swaps, interest rates swaps, and commodity derivatives under the FTP were with counterparties whose Moody’s credit rating was “A2” or higher. As of December 31, 2009, all of the coal tonnage associated with TVA’s coal contract derivatives was with counterparties whose Moody’s credit rating, or TVA’s internal analysis when such information was unavailable, was “B2” or higher. To help ensure a reliable supply of coal, TVA had coal contracts with 19 different suppliers at December 31, 2009. The contracted supply of coal is sourced from multiple geographic regions of the United States and is to be delivered via various transportation methods (e.g., barge, rail, and truck).

13. 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

There are three main approaches to measuring the fair value of assets and liabilities: (1) the market approach; (2) the income approach; and (3) the cost approach. The market approach uses prices and other relevant information generated from market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future amounts to a single present value amount. The measurement is based on the value indicated by current market expectations about those future amounts of income. The cost approach is based on the amount that would currently be required to replace an asset. TVA uses the market approach and the income approach in its fair value measurements.

The valuation techniques used to measure fair value are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect TVA’s market assumptions. These two types of inputs create the following fair value hierarchy:

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 is based on the lowest level of input significant to the fair value measurement, where Level 1 is the highest and Level 3 is the lowest.

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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 2008) for companies with a similar credit rating over a time period consistent with the remaining term of the contract as of December 31, 2009.

The following sections describe the valuation methodologies TVA uses to measure different financial instruments at fair value. 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 B alance sheets as of December 31, 2009, and S tatements of changes in proprietary capital for the three months ended December 31, 2009. There has been no impact to the S tatements of operations or the S tatement s of cash flows related to these fair value measurements.

Investments

At December 31, 2009, TVA’s investment funds comprised $1.0 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. TVA holds trading securities in its NDT, ART, and SERP. The NDT holds funds for the ultimate decommissioning of its 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 is not creditable under the qualified pension plan. TVA has historically funded the annual calculated expense of the SERP. The NDT and SERP are invested in securities generally designed to achieve a return in line with broad 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. Most U.S. and international equities, Treasury inflation-protected securities, real estate investment trusts (“REITs”), cash securities, and certain derivative instruments are exchange-traded and are classified as Level 1 valuations. Fixed-income investments, high-yield fixed-income investments, commingled funds, currencies, and most derivative instruments are classified as Level 2 valuations. These measurements are based on market and income approaches with observable market inputs. The application of CVAs did not materially affect the fair value of TVA’s investments at December 31, 2009.

Gains and losses on trading securities are recognized in current earnings and are based on average cost. The gains and losses on 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 gains of $20 million for the three months ended December 31, 2009, and had unrealized losses of $73 million for the three months ended December 31, 2008. The ART had unrealized gains of less than $1 million for the three months ended December 31, 2009, and had unrealized losses of $1 million for the three months ended December 31, 2008. The SERP had unrealized gains of $1 million for the three months ended December 31, 2009, and had unrealized losses of $7 million for the three months ended December 31, 2008.

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.

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The currency swaps are classified as Level 2 valuations and are valued based on income approaches with observable market inputs. 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. The interest rate swaps are classified as Level 2 valuations and are valued based on income approaches. At December 31, 2009, the application of CVAs resulted in a decrease of $1 million in the fair value of the swaption and interest rate swap liabilities, and a decrease of $2 million in the fair values of the currency swap assets.

Coal Contract Derivatives and Commodity Derivatives Under TVA’s Financial Trading Program

See Note 12 — Derivatives Not Receiving Hedge Accounting Treatment — Coal Contract Derivatives and Commodity Derivatives Under Financial Trading Program for a discussion of the nature and purpose of coal contract derivatives and commodity derivatives under TVA’s Financial Trading Program.

Coal 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 market data from an external pricing specialist, long-term price forecasts developed with the assistance of a third-party valuation service, and other internal estimates. To value the volume option component of applicable coal contracts, TVA uses a Black-Scholes pricing model which includes inputs from the overall coal price forecast, contract-specific terms, and other market inputs. The application of CVAs resulted in a decrease of $2 million in the fair value of applicable coal contract derivatives in an asset position at December 31, 2009, and did not materially affect the fair value of applicable coal contract derivatives in a liability position at December 31, 2009.

Commodity Derivatives Under Financial Trading Program . These contracts are valued based on market approaches which utilize Chicago Mercantile Exchange (“CME”) quoted prices. Contracts settled on the CME (e.g., futures and options) are classified as Level 1 valuations. Contracts where nonperformance risk exists outside of the exit price (e.g., swaps and over-the-counter options) are measured with the incorporation of CVAs and are classified as Level 2 valuations. The application of CVAs did not materially affect the fair value of commodity derivatives under the FTP at December 31, 2009.

The following table sets 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 December 31, 2009. 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.

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Fair Value Measurements
	As of December 31, 2009										As of September 30, 2009
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		Total
Description			Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Netting 1		Total		Total

Investments:
Equity securities	$	84	$	1	$	—	$	—	$	85	$	83
Debt securities-U.S. government corporations and agencies		106		51		—		—		157		111
Corporate debt securities		—		193		—		—		193		203
Residential mortgage-backed securities		—		17		—		—		17		18
Commercial mortgage-backed securities		—		1		—		—		1		2
Collateralized debt obligations		—		6		—		—		6		6
Commingled funds 2 :
Equity security commingled funds		—		329		—		—		329		328
Debt security commingled funds		—		182		—		—		182		185
Foreign currency commingled funds		—		11		—		—		11		11
Other commingled funds		—		35		—		—		35		34
Currency swaps		—		41		—		—		41		7
Coal contract derivatives		—