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DERIVATIVE FINANCIAL INSTRUMENTS | 12 Months Ended
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Dec. 31, 2011
DERIVATIVE FINANCIAL INSTRUMENTS |
DERIVATIVE FINANCIAL INSTRUMENTS |
7. DERIVATIVE FINANCIAL INSTRUMENTS The following table summarizes the fair value and balance sheet classification of derivative instruments as of December 31, 2011 and 2010. The notional amount of the contract is not recorded on the consolidated balance sheets, but is used as the basis for determining the amount of interest payments to be exchanged between the counterparties. If the counterparty fails to perform, the Company's counterparty credit risk is equal to the amount reported as a derivative asset. The valuation methodology of derivative instruments is disclosed in Note 3 to the Company's consolidated financial statements presented elsewhere in this report.
|  | Fair Values of Derivative Instruments |
--- | --- | --- | ---
|  | December 31, 2011 |  | December 31, 2010 |
|  | Notional Amount |  | Derivative Assets(1) |  | Derivative Liabilities(1) |  | Notional Amount |  | Derivative Assets(1) |  | Derivative Liabilities(1) |
|  | (In thousands) |
Derivatives designated as hedging instruments: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest rate swaps on certificates of deposit—fair value |  | $ | 200,000 |  | $ | 998 |  | $ | 639 |  | $ | — |  | $ | — |  | $ | — |
Total derivatives designated as hedging instruments |  | $ | 200,000 |  | $ | 998 |  | $ | 639 |  | $ | — |  | $ | — |  | $ | — |
Derivatives not designated as hedging instruments: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Equity swap agreements |  | $ | 22,709 |  | $ | 202 |  | $ | 204 |  | $ | 22,884 |  | $ | 206 |  | $ | 210 |
Foreign exchange options |  |  | 85,614 |  |  | 3,899 |  |  | 2,430 |  |  | 85,614 |  |  | 5,084 |  |  | 3,239 |
Interest rate swaps |  |  | 485,196 |  |  | 19,476 |  |  | 19,924 |  |  | 4,098 |  |  | 13 |  |  | 14 |
Short-term foreign exchange contracts |  |  | 210,295 |  |  | 1,403 |  |  | 967 |  |  | 92,625 |  |  | 1,220 |  |  | 1,035 |
Total derivatives not designated as hedging instruments |  | $ | 803,814 |  | $ | 24,980 |  | $ | 23,525 |  | $ | 205,221 |  | $ | 6,523 |  | $ | 4,498 |
(1) Derivative assets include the estimated gain to settle a derivative contract plus net interest receivable. Derivative liabilities include the estimated loss to settle a derivative contract. Derivatives Designated as Hedging Instruments Interest Rate Swaps on Certificates of Deposit—The Company is exposed to changes in the fair value of certain of its fixed-rate certificates of deposit due to changes in the benchmark interest rate, LIBOR. During 2011, the Company entered into four $50.0 million receive-fixed, pay-variable interest rate swaps with major brokerage firms as fair value hedges of four $50.0 million fixed-rate certificates of deposit with the same maturity dates. Interest rate swaps designated as fair value hedges involve the receipt of fixed-rate amounts from a counterparty in exchange for the Company making variable-rate payments over the life of the agreements without the exchange of the underlying notional amount. As of December 31, 2011 the total notional amount of the interest rate swaps on the certificates of deposit was $200.0 million, respectively. The fair values of the interest rate swaps amounted to a $998 thousand asset and $639 thousand liability as of December 31, 2011. During the year ended December 31, 2011, the Company recognized a net loss of $891 thousand in interest expense related to hedge ineffectiveness. The Company also recognized a net reduction to interest expense of $2.5 million for the year ended December 31, 2011 related to net settlements on the derivatives. Derivatives Not Designated as Hedging Instruments Equity Swap Agreements—In December 2007, the Company entered into two equity swap agreements with a major investment brokerage firm to economically hedge against market fluctuations in an equity index certificate of deposit product offered to bank customers which has a term of 5 years and pays interest based on the performance of the HSCEI. Under ASC 815, a certificate of deposit that pays interest based on changes in an equity index is a hybrid instrument with an embedded derivative (i.e. equity call option) that must be accounted for separately from the host contract (i.e. the certificate of deposit). In accordance with ASC 815, both the embedded equity call options on the certificates of deposit and the freestanding equity swap agreements are marked-to-market each reporting period with resulting changes in fair value recorded in the condensed consolidated statements of income. As of December 31, 2011 and December 31, 2010, the notional amounts of the equity swap agreements totaled $22.7 million and $22.9 million, respectively. The fair values of the equity swap agreements and embedded derivative liability for these derivative contracts amounted to $202 thousand and $204 thousand, respectively, as of December 31, 2011, compared to $206 thousand and $210 thousand, respectively, as of December 31, 2010. Foreign Exchange Options—During 2010, the Company entered into foreign exchange option contracts with major brokerage firms to economically hedge against currency exchange rate fluctuations in a certificate of deposit product available to bank customers beginning in the first quarter of 2010. This product, which has a term of 5 years, pays interest based on the performance of the Chinese currency Renminbi ("RMB") relative to the U.S. Dollar. Under ASC 815, a certificate of deposit that pays interest based on changes in currency exchange rates is a hybrid instrument with an embedded derivative that must be accounted for separately from the host contract (i.e. the certificate of deposit). In accordance with ASC 815, both the embedded derivative instruments and the freestanding foreign exchange option contracts are marked-to-market each reporting period with resulting changes in fair value reported in the consolidated statements of income. As of December 31, 2011 and December 31, 2010 the notional amount of the foreign exchange options totaled $85.6 million and $85.6 million, respectively. The fair values of the foreign exchange options and embedded derivative liability for these contracts amounted to a $3.9 million asset and a $2.4 million liability as of December 31, 2011. The fair values of the foreign exchange options and embedded derivative liability for these contracts amounted to a $5.1 million asset and $3.2 million liability as of December 31, 2010. Interest Rate Swaps—Since the fourth quarter of 2010, the Company has entered into pay-fixed, receive-variable swap contracts with institutional counterparties to economically hedge against an interest rate swap product offered to bank customers. This product allows borrowers to lock in attractive intermediate and long-term interest rates by entering into a pay-fixed, receive-variable swap contract with the Company, resulting in the customer obtaining a synthetic fixed rate loan. The Company does not assume any interest rate risk since the swap agreements mirror each other. As of December 31, 2011 and December 31, 2010 the notional amount of the interest rate swaps with the institutional counterparties totaled $485.2 million and $4.1 million, respectively. The interest rate swap agreements are marked-to-market each reporting period with resulting changes in fair value reported in the consolidated statements of income. The fair values of the interest rate swap contracts with the institutional counterparty and the bank customers amounted to a $19.5 million asset and $19.9 million liability, respectively, as of December 31, 2011. The fair values of the interest rate swap contracts with the institutional counterparty and the bank customers amounted to a $13 thousand asset and $14 thousand liability, respectively, as of December 31, 2010. Short-term Foreign Exchange Contracts—The Company also enters into short-term forward foreign exchange contracts on a regular basis to economically hedge against foreign exchange rate fluctuations. As of December 31, 2011 and December 31, 2010, the notional amount of the foreign exchange contracts totaled $210.3 million and $92.6 million, respectively. The fair values of the short-term foreign exchange contracts amounted to a $1.4 million asset and $1.0 million liability, respectively, as of December 31, 2011. The fair values of the foreign exchange contracts amounted to a $1.2 million asset and $1.0 million liability, respectively, as of December 31, 2010. The table below presents the effect of the Company's derivative financial instruments on the consolidated statements of income for the year ended December 31, 2011 and 2010:
|  |  |  | Year Ended December 31, |
--- | --- | --- | --- | --- | ---
|  | Location in Consolidated Statements of Operations |
|  | 2011 |  | 2010 |  | 2009 |
|  |  |  | (In thousands) |
Derivatives designated as hedging instruments |  |  |  |  |  |  |  |  |  |  |  |
Interest rate swaps on certificates of deposit—fair value |  | Interest expense |  | $ | 2,930 |  | $ | — |  | $ | — |
|  | Total net income |  | $ | 2,930 |  | $ | — |  | $ | — |
Derivatives not designated as hedging instruments |  |  |  |  |  |  |  |  |  |  |  |
Equity swap agreements |  | Noninterest expense |  | $ | 2 |  | $ | (138 | ) | $ | 312 |
Foreign exchange options |  | Noninterest income |  |  | (392 | ) |  | — |  |  | — |
Foreign exchange options |  | Noninterest expense |  |  | 16 |  |  | — |  |  | — |
Interest rate swaps |  | Noninterest income |  |  | (447 | ) |  | — |  |  | — |
Short-term foreign exchange contracts |  | Noninterest income |  |  | 251 |  |  | 180 |  |  | — |
|  | Total net (expense) income |  | $ | (570 | ) | $ | 42 |  | $ | 312 |
Credit Risk-Related Contingent Features—The Company has agreements with some of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations. The Company also has agreements with some of its derivative counterparties that contain a provision where if the Company fails to maintain its status as a well/adequately capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements. Similarly, the Company could be required to settle its obligations under certain of its agreements if the Company was issued a notice of prompt corrective action. As of December 31, 2011 the termination value of applicable derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $18.3 million. If the Company had breached any of these provisions at December 31, 2011, it could have been required to settle its obligations under the agreements at the termination value.

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- Definition The entire disclosure for the entity's entire derivative instruments and hedging activities. Describes an entity's risk management strategies, derivatives in hedging activities and non-hedging derivative instruments, the assets, obligations, liabilities, revenues and expenses arising therefrom, and the amounts of and methodologies and assumptions used in determining the amounts of such items. + References Reference 1: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Statement of Financial Accounting Standard (FAS) -Number 133 -Paragraph 44 -LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy. 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