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Derivative Financial Instruments | 3 Months Ended
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Mar. 31, 2019
Derivative Financial Instruments |
Derivative Financial Instruments | 11. Derivative Financial Instruments The Company enters into derivative contracts primarily to manage its interest rate risk, as well as for customer accommodation purposes. Derivatives used for risk management purposes consist of interest rate swaps that are designated as either a fair value hedge or a cash flow hedge. The derivatives are recognized on the unaudited interim consolidated balance sheets as either assets or liabilities at fair value. Derivatives entered into for customer accommodation purposes consist of various free-standing interest rate derivative products and foreign exchange contracts. The Company is party to master netting arrangements with its financial institution counterparties; however, the Company does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The following table summarizes notional amounts and fair values of derivatives held by the Company as of March 31, 2019 and December 31, 2018:
|  | March 31, 2019 |  | December 31, 2018
|  |  |  |  | Fair Value |  |  |  |  | Fair Value
|  | Notional |  | Asset |  | Liability |  | Notional |  | Asset |  | Liability
(dollars in thousands) |  | Amount |  | Derivatives(1) |  | Derivatives(2) |  | Amount |  | Derivatives(1) |  | Derivatives(2)
Derivatives designated as hedging instruments: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest rate swaps |  | $ | 23,892 |  | $ | — |  | $ | (352) |  | $ | 41,317 |  | $ | 31 |  | $ | (44)
Derivatives not designated as hedging instruments: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest rate swaps |  |  | 2,334,559 |  |  | 29,034 |  |  | (1,897) |  |  | 2,269,247 |  |  | 12,305 |  |  | (12,007)
Funding swap |  |  | 64,395 |  |  | — |  |  | (1,839) |  |  | 62,039 |  |  | — |  |  | (2,607)
Foreign exchange contracts |  |  | 2,473 |  |  | 3 |  |  | (2) |  |  | 1,191 |  |  | — |  |  | (34)
| (1) |  | The positive fair values of derivative assets are included in other assets.
| (2) |  | The negative fair values of derivative liabilities are included in other liabilities.
Certain interest rate swaps noted above, are cleared through clearinghouses, rather than directly with counterparties. Those transactions cleared through a clearinghouse require initial margin collateral and variation margin payments depending on the contracts being in a net asset or liability position. The amount of initial margin cash collateral posted by the Company was $29.2 million and $2.1 million as of March 31, 2019 and December 31, 2018, respectively. Effective January 3, 2017, the Chicago Mercantile Exchange (“CME”) amended its rulebook to legally characterize variation margin payments, for derivative contracts that are referred to as settled-to-market (“STM”), as settlements of the derivative’s mark-to-market exposure and not collateral. Based on these changes, the Company has treated the CME variation margin as a settlement, which has resulted in a decrease in our cash collateral, and a corresponding decrease in our derivative asset and liability. The change was applied prospectively effective January 3, 2017. As of March 31, 2019 and December 31, 2018, the CME variation margin was $0.8 million and $0.5 million, respectively. Effective January 16, 2018, the London Clearing House (“LCH”) also amended its rulebook to legally characterize variation margin payments, for derivative contracts that are referred to as STM, as settlements of the derivative’s mark-to-market exposure and not collateral. Consistent with the CME’s amended requirements discussed above, the Company has treated the LCH variation margin as a settlement, which has resulted in a decrease in our cash collateral, and a corresponding decrease in our derivative asset and liability. The change was applied prospectively effective January 16, 2018. As of March 31, 2019 and December 31, 2018, the LCH variation margin was $26.3 million and $0.6 million, respectively. As of March 31, 2019, the Company pledged nil in financial instruments and $30.7 million in cash as collateral for interest rate swaps. As of December 31, 2018, the Company pledged $26.2 million in financial instruments and $2.6 million in cash as collateral for interest rate swaps. As of March 31, 2019 and December 31, 2018, the cash collateral includes the excess initial margin for interest rate swaps cleared through clearinghouses and cash collateral for interest rate swaps with financial institution counterparties. Fair Value Hedges To manage the risk related to the Company’s net interest margin, interest rate swaps are utilized to hedge certain fixed-rate loans. These swaps have maturity, amortization and prepayment features that correspond to the loans hedged, and are designated and qualify as fair value hedges. Any gain or loss on the swaps, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, is recognized in current period earnings. At March 31, 2019, the Company carried one interest rate swap with a notional amount of $23.9 million with a negative fair value of $0.4 million that was categorized as a fair value hedge for a commercial and industrial loan. The Company received a USD Prime floating rate and paid a fixed rate of 2.90%. The swap matures in 2023. At December 31, 2018, the Company carried interest rate swaps with notional amounts totaling $41.3 million with a positive fair value of nil and a negative fair value of nil that were categorized as fair value hedges for commercial and industrial loans and commercial real estate loans. The following table shows the gains and losses recognized in income related to derivatives in fair value hedging relationships for the three months ended March 31, 2019 and 2018:
|  | Gains (losses) recognized in the |  |  |  |  |  |
|  | consolidated statements of |  | March 31,
(dollars in thousands) |  | income line item |  | 2019 |  | 2018
Gains (losses) on fair value hedging relationships recognized in Interest Income(1): |  |  |  |  |  |  |  |
Recognized on interest rate swap |  | Loans and lease financing |  | $ | (342) |  | $ | —
Recognized on hedged item |  | Loans and lease financing |  |  | 262 |  |  | —
Gains (losses) on fair value hedging relationships recognized in Noninterest Income(2): |  |  |  |  |  |  |  |
Recognized on interest rate swap |  | Other |  | $ | — |  | $ | 550
Recognized on hedged item |  | Other |  |  | — |  |  | (763)
| (1) |  | In connection with the adoption of ASU 2017-12, beginning January 1, 2019, gain (loss) amounts for the interest rate swap qualifying as fair value hedging and the hedged item are included in Loans and Lease Financing Interest Income.
| (2) |  | Prior to January 1, 2019, gain (loss) amounts for the interest rate swaps qualifying as fair value hedging and the hedged items were included in Other Noninterest Income.
As of March 31, 2019 and December 31, 2018, the following amounts were recorded in the unaudited interim consolidated balance sheets related to the cumulative basis adjustments for fair value hedges:
|  |  |  | Cumulative Amount of Fair Value |
|  |  |  |  |  |  |  |  |  | Hedging Adjustment Included in the |
|  | Carrying Amount of the Hedged Asset |  | Carrying Amount of the Hedged Asset |
(dollars in thousands) |  | March 31, 2019 |  | December 31, 2018 |  | March 31, 2019 |  | December 31, 2018 |
Line Item in the Consolidated Balance Sheets in Which the Hedged Item is Included |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans and leases |  | $ | 24,448 |  | $ | 42,496 |  | $ | 544 |  | $ | 293 |
Cash Flow Hedges During 2018, the Company carried two interest rate swaps with notional amounts totaling $150.0 million, in order to reduce exposure to interest rate increases associated with short-term fixed-rate liabilities. The Company received 6-month LIBOR and paid fixed rates ranging from 2.98% to 3.03%. The swaps matured in December 2018. As of March 31, 2019 and December 31, 2018, the Company no longer held any cash flow hedges. The interest rate swaps designated as cash flow hedges resulted in net interest expense of $0.5 million during the three months ended March 31, 2018. The Company utilized interest rate swaps to reduce exposure to interest rates associated with short-term fixed-rate liabilities. The Company entered into interest rate swaps paying fixed rates and receiving LIBOR. The LIBOR index corresponded to the short-term fixed-rate nature of the liabilities being hedged. If interest rates rose, the increase in interest received on the swaps offset increases in interest costs associated with these liabilities. By hedging with interest rate swaps, the Company minimized the adverse impact on interest expense associated with increasing rates on short-term liabilities. The interest rate swaps were designated and qualified as cash flow hedges. The effective portion of the gain or loss on the interest rate swaps was reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. There were no recognized expenses related to the ineffective portion of the change in fair value of derivatives designated as a cash flow hedge during the three months ended March 31, 2018. The following table summarizes the effect of cash flow hedging relationships for the three months ended March 31, 2018:
|  | March 31,
(dollars in thousands) |  | 2018
Pretax gains recognized in other comprehensive income on derivatives (effective portion) |  | $ | 738
There were no gains or losses reclassified from accumulated other comprehensive loss to earnings during the three months ended March 31, 2018. Free-Standing Derivative Instruments For the derivatives that are not designated as hedges, changes in fair value are reported in current period earnings. The following table summarizes the impact on pretax earnings of derivatives not designated as hedges, as reported on the unaudited interim consolidated statements of income for the three months ended March 31, 2019 and 2018.
|  | Net gains (losses) recognized |  |  |  |  |  |
|  | in the consolidated statements |  | March 31,
(dollars in thousands) |  | of income line item |  | 2019 |  | 2018
Derivatives Not Designated As Hedging Instruments: |  |  |  |  |  |  |  |
Interest rate swaps |  | Other noninterest income |  | $ | 16 |  | $ | 404
Funding swap |  | Other noninterest income |  |  | 5 |  |  | (84)
Foreign exchange contracts |  | Other noninterest income |  |  | — |  |  | (63)
As of March 31, 2019, the Company carried multiple interest rate swaps with notional amounts totaling $2.3 billion, all of which were related to the Company’s customer swap program, with a positive fair value of $29.0 million and a negative fair value of $1.9 million. The Company received 1-month and 3-month LIBOR and paid fixed rates ranging from 2.02% to 5.78%. The swaps mature between November 2019 and January 2039. As of December 31, 2018, the Company carried multiple interest rate swaps with notional amounts totaling $2.3 billion, including $2.2 billion related to the Company’s customer swap program, with a positive fair value of $12.3 million and a negative fair value of $12.0 million. The Company received 1-month and 3-month LIBOR and paid fixed rates ranging from 2.02% to 5.78%. These swaps resulted in net interest expense of nil and $0.2 million for the three months ended March 31, 2019 and 2018, respectively. The Company’s customer swap program is designed by offering customers a variable-rate loan that is swapped to fixed-rate through an interest rate swap. The Company simultaneously executes an offsetting interest rate swap with a swap dealer. Upfront fees on the dealer swap are recorded in other noninterest income and totaled $0.8 million and $3.2 million for the three months ended March 31, 2019 and 2018, respectively. Interest rate swaps related to the program had asset fair values of $29.0 million and $12.3 million as of March 31, 2019 and December 31, 2018, respectively, and liability fair values of $1.9 million and $11.2 million as of March 31, 2019 and December 31, 2018, respectively. In conjunction with the 2016 sale of Class B restricted shares of common stock issued by Visa, the Company entered into a funding swap agreement with the buyer that requires payment to the buyer in the event Visa reduces each member bank’s Class B conversion rate to unrestricted Class A common shares. On June 28, 2018, Visa additionally funded its litigation escrow account, thereby reducing each member bank’s Class B conversion rate to unrestricted Class A common shares. Accordingly, on July 5, 2018, Visa announced a decrease in conversion rate from 1.6483 to 1.6298 effective June 28, 2018. In July 2018, the Company made a payment of approximately $0.7 million to the buyer as a result of the reduction in the Visa Class B conversion rate. Under the terms of the funding swap agreement, the Company will make monthly payments to the buyer based on Visa’s Class A stock price and the number of Visa Class B restricted shares that were sold until the date on which the covered litigation is settled. A derivative liability (“Visa derivative”) of $1.8 million and $2.6 million was included in the unaudited interim consolidated balance sheets at March 31, 2019 and December 31, 2018, respectively, to provide for the fair value of this liability. There were no sales of these shares prior to 2016. See “Note 17. Fair Value” for more information. Counterparty Credit Risk By using derivatives, the Company is exposed to counterparty credit risk if counterparties to the derivative contracts do not perform as expected. If a counterparty fails to perform, the Company’s counterparty credit risk is equal to the amount reported as a derivative asset, net of cash or other collateral received, and net of derivatives in a loss position with the same counterparty to the extent master netting arrangements exist. The Company minimizes counterparty credit risk through credit approvals, limits, monitoring procedures, executing master netting arrangements and obtaining collateral, where appropriate. Counterparty credit risk related to derivatives is considered in determining fair value. The Company’s interest rate swap agreements include bilateral collateral agreements with collateral requirements which begin with exposures in excess of $0.5 million. For each counterparty, the Company reviews the interest rate swap collateral daily. Collateral for customer interest rate swap agreements, calculated as the pledged asset less loan balance, requires valuation of the pledged asset. Counterparty credit risk adjustments of $0.1 million were recognized during both the three months ended March 31, 2019 and 2018. Credit-Risk Related Contingent Features Certain of our derivative contracts contain provisions whereby if the Company’s credit rating were to be downgraded by certain major credit rating agencies as a result of a merger or material adverse change in the Company’s financial condition, the counterparty could require an early termination of derivative instruments in a net liability position. The aggregate fair value of all derivative instruments with such credit-risk related contingent features that are in a net liability position was $1.6 million and $0.8 million at March 31, 2019 and December 31, 2018, respectively, for which we posted $1.5 million and $0.5 million, respectively, in collateral in the normal course of business. If the Company’s credit rating had been downgraded as of March 31, 2019 and December 31, 2018, we may have been required to settle the contracts in an amount equal to their fair value.

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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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