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Note 14 - Financial Derivatives | 12 Months Ended
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Dec. 31, 2020
Notes to Financial Statements |
Derivative Instruments and Hedging Activities Disclosure [Text Block] |
14. | Financial Derivatives
The Company does not speculate on the future direction of interest rates. As part of the Company’s asset and liability management, however, the Company enters into financial derivatives to seek to mitigate exposure to interest rate risks related to its interest-earning assets and interest-bearing liabilities. The Company believes that these transactions, when properly structured and managed, may provide a hedge against inherent interest rate risk in assets or liabilities and against risk in specific transactions of the Company. In such instances, the Company may protect its position through the purchase or sale of interest rate futures contracts for a specific cash or interest rate risk position. Other hedging transactions may be implemented using interest rate swaps, interest rate caps, floors, financial futures, forward rate agreements, and options on futures or bonds. Prior to considering any hedging activities, the Company seeks to analyze the costs and benefits of the hedge in comparison to other viable alternative strategies. All hedges will require an assessment of basis risk and must be approved by the Bancorp or the Bank’s Investment Committee. The Company follows ASC Topic 815 that establishes accounting and reporting standards for financial derivatives, including certain financial derivatives embedded in other contracts, and hedging activities. It requires the recognition of all financial derivatives as assets or liabilities in the Company’s Consolidated Balance Sheets and measurement of those financial derivatives at fair value. The accounting treatment of changes in fair value is dependent upon whether or not a financial derivative is designated as a hedge and, if so, the type of hedge. Fair value is determined using third-party models with observable market data. For derivatives designated as cash flow hedges, changes in fair value are recognized in other comprehensive income and are reclassified to earnings when the hedged transaction is reflected in earnings. For derivatives designated as fair value hedges, changes in the fair value of the derivatives are reflected in current earnings, together with changes in the fair value of the related hedged item if there is a highly effective correlation between changes in the fair value of the interest rate swaps and changes in the fair value of the underlying asset or liability that is intended to be hedged. If there is not a highly effective correlation between changes in the fair value of the interest rate swap and changes in the fair value of the underlying asset or liability that is intended to be hedged, then only the changes in the fair value of the interest rate swaps are reflected in the Company’s consolidated financial statements. The Company offers various interest rate derivative contracts to its customers. When derivative transactions are executed with its customers, the derivative contracts are offset by paired trades with third-party financial institutions including with central counterparties (“CCP”). Certain derivative contracts entered with CCPs are settled-to-market daily to the extent the CCP’s rulebooks legally characterize the variation margin as settlement. Derivative contracts are intended to allow borrowers to lock in attractive intermediate and long-term fixed rate financing while not increasing the interest rate risk to the Company. These transactions are generally not linked to specific Company assets or liabilities on the Consolidated Balance Sheets or to forecasted transactions in a hedging relationship and, therefore, are economic hedges. The contracts are marked to market at each reporting period. The changes in fair values of the derivative contracts traded with third-party financial institutions are expected to be largely comparable to the changes in fair values of the derivative transactions executed with customers throughout the terms of these contracts, except for the credit valuation adjustment component. The Company records credit valuation adjustments on derivatives to properly reflect the variances of credit worthiness between the Company and the counterparties, considering the effects of enforceable master netting agreements and collateral arrangements. In May 2014, the Bancorp entered into five interest rate swap contracts in the notional amount of $119.1 million for a period of ten years. The objective of these interest rate swap contracts, which were designated as hedging instruments in cash flow hedges, was to hedge the quarterly interest payments on the Bancorp’s $119.1 million of Junior Subordinated Debentures that had been issued to five trusts, throughout the ten-year period beginning in June 2014 and ending in June 2024, from the risk of variability of these payments resulting from changes in the three-month LIBOR interest rate. As of December 31, 2020, and 2019, the ineffective portion of these interest rates swaps was not significant. The notional amount and net unrealized loss of the Company’s cash flow derivative financial instruments as of December 31, 2020, and December 31, 2019, were as follows:
|  | December 31, 2020 |  |  | December 31, 2019 |
|  | ($ in thousands) |
Cash flow swap hedges: |  |  |
Notional |  | $ | 119,136 |  |  | $ | 119,136 |
Weighted average fixed rate-pay |  |  | 2.61 | % |  |  | 2.61 | %
Weighted average variable rate-receive |  |  | 0.44 | % |  |  | 2.26 | %
Unrealized loss, net of taxes (1) |  | $ | (6,890 | ) |  | $ | (3,412 | )
|  | Year ended |
|  | December 31, 2020 |  |  | December 31, 2019 |
Periodic net settlement of swaps (2) |  | $ | 2,193 |  |  | $ | 200 |
(1)-Included in other comprehensive income.
(2)-the amount of periodic net settlement of interest rate swaps was included in interest expense.
As of December 31, 2020, the Bank’s outstanding interest rate swap contracts had a notional amount of $478.3 million for various terms from three to ten years. The Bank entered into these interest rate swap contracts that are matched to individual fixed-rate commercial real estate loans in the Bank’s loan portfolio. These contracts have been designated as hedging instruments to hedge the risk of changes in the fair value of the underlying commercial real estate loans due to changes in interest rates. The swap contracts are structured so that the notional amounts reduce over time to match the contractual amortization of the underlying loan and allow prepayments with the same pre-payment penalty amounts as the related loan. As of December 31, 2020, and 2019, the ineffective portion of these interest rate swaps was not significant. The notional amount and net unrealized loss of the Company’s fair value derivative financial instruments as of December 31, 2020, and December 31, 2019, were as follows:
|  | December 31, 2020 |  |  | December 31, 2019 |
|  | ($ in thousands) |
Fair value swap hedges: |  |  |
Notional |  | $ | 478,266 |  |  | $ | 579,584 |
Weighted average fixed rate-pay |  |  | 4.56 | % |  |  | 4.71 | %
Weighted average variable rate spread |  |  | 2.46 | % |  |  | 2.62 | %
Weighted average variable rate-receive |  |  | 3.11 | % |  |  | 4.87 | %
Net unrealized loss (1) |  | $ | (15,082 | ) |  | $ | (7,205 | )
|  | Year ended |
|  | December 31, 2020 |  |  | December 31, 2019 |
Periodic net settlement of SWAPs (2) |  | $ | (7,719 | ) |  | $ | 996 |
(1)-the amount is included in other non-interest income.
(2)-the amount of periodic net settlement of interest rate swaps was included in interest income.
The Company has designated as a partial-term hedging election $25.0 million of a pool of loans with a notational value of $44.7 million as of December 31, 2020. The loans are not expected to be affected by prepayment, defaults, or other factors affecting the timing and amount of cash flows under the last-of-layer method. The Company has entered into a pay-fixed and receive 1-Month LIBOR interest rate swap to convert the last-of-layer $25.0 million portion of a $44.7 million fixed rate loan tranche in order to reduce the Company’s exposure to higher interest rates for the last-of-layer tranche. As of December 31, 2020, the last-of-layer loan tranche had a fair value basis adjustment of $342 thousand. The interest rate swap converts this last-of-layer tranche into a floating rate instrument. The Company’s risk management objective with respect to this last-of-layer interest rate swap is to reduce interest rate exposure as to the last-of-layer tranche. Interest rate swap contracts involve the risk of dealing with institutional derivative counterparties and their ability to meet contractual terms. Institutional counterparties must have a strong credit profile and be approved by the Company’s Board of Directors. The Company’s credit exposure on interest rate swaps is limited to the net favorable value and interest payments of all swaps by each counterparty. Credit exposure may be reduced by the amount of collateral pledged by the counterparty. The Bancorp’s interest rate swaps have been assigned by the counterparties to a derivatives clearing organization and daily margin is indirectly maintained with the derivatives clearing organization. Cash posted as collateral by the Bancorp related to derivative contracts totaled $11.9 million as of December 31, 2020 and $7.1 million as of December 31, 2019. The Company enters into foreign exchange forward contracts with various counterparties to mitigate the risk of fluctuations in foreign currency exchange rates for foreign exchange certificates of deposit or foreign exchange contracts entered into with our clients. These contracts are not designated as hedging instruments and are recorded at fair value in our Consolidated Balance Sheets. Changes in the fair value of these contracts as well as the related foreign exchange certificates of deposit and foreign exchange contracts are recognized immediately in net income as a component of non-interest income. Period end gross positive fair values are recorded in other assets and gross negative fair values are recorded in other liabilities. The notional mount and fair value of the Company’s derivative financial instruments not designated as hedging instruments as of December 31, 2020, and December 31, 2019, were as follows:
|  | December 31, 2020 |  |  | December 31, 2019 |
Derivative financial instruments not designated as hedging instruments: |  | ($ in thousands) |
Notional amounts: |  |  |  |  |  |  |  |
Option contracts |  | $ | — |  |  | $ | 908 |
Spot, forward, and swap contracts with positive fair value |  | $ | 151,244 |  |  | $ | 146,397 |
Spot, forward, and swap contracts with negative fair value |  | $ | 132,813 |  |  | $ | 127,003 |
Fair value: |  |  |  |  |  |  |  |
Option contracts |  | $ | — |  |  | $ | (7 | )
Spot, forward, and swap contracts with positive fair value |  | $ | 4,658 |  |  | $ | 2,411 |
Spot, forward, and swap contracts with negative fair value |  | $ | (2,200 | ) |  | $ | (1,415 | )

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- Definition The entire disclosure for derivative instruments and hedging activities including, but not limited to, risk management strategies, non-hedging derivative instruments, assets, liabilities, revenue and expenses, and methodologies and assumptions used in determining the amounts. + References Reference 1: http://fasb.org/us-gaap/role/ref/legacyRef -Publisher FASB -Name Accounting Standards Codification -Topic 815 -URI http://asc.fasb.org/topic&trid=2229140 + Details
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