DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Risk Management Objectives of Using Derivatives

Customers is exposed to certain risks arising from both its business operations and economic conditions. Customers manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and durations of its assets and liabilities. Specifically, Customers enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Customers' derivative financial instruments are used to manage differences in the amount, timing, and duration of Customers' known or expected cash receipts and its known or expected cash payments principally related to certain borrowings. Customers also has interest-rate derivatives resulting from a service provided to certain qualifying customers, and therefore, they are not used to manage Customers' interest-rate risk in assets or liabilities. Customers manages a matched book with respect to its derivative instruments used in this customer service in order to minimize its net risk exposure resulting from such transactions.

Cash Flow Hedges of Interest Rate Risk

Customers' objectives in using interest-rate derivatives are to add stability to interest expense and to manage exposure to interest-rate movements. To accomplish this objective, Customers primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for Customers making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

The changes in the fair value of derivatives designated and qualifying as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. To date, such derivatives were used to hedge the variable cash flows associated with the forecasted issuances of debt.

Customers discontinues cash flow hedge accounting if it is probable the forecasted hedged transactions will not occur in the initially identified time period. At such time, the associated gains and losses deferred in accumulated other comprehensive income are reclassified immediately into earnings and any subsequent changes in the fair value of such derivatives are recognized directly in earnings. During the three months ended September 30, 2018, Customers recognized gains of $2.8 million in other non-interest income on discontinued cash flow hedge accounting for three interest rate swaps with notional amounts totaling $500 million.

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on Customers' variable-rate debt. Customers expects to reclassify $1.0 million from accumulated other comprehensive income as a reduction to interest expense during the next 12 months.

Customers is hedging its exposure to the variability in future cash flows for forecasted transactions over a maximum period of 33 months (excluding forecasted transactions related to the payment of variable interest on existing financial instruments).

At September 30, 2018, Customers had eight outstanding interest rate derivatives with notional amounts totaling $835.0 million that were designated as cash flow hedges of interest rate risk. At December 31, 2017, Customers had nine outstanding interest rate derivatives with notional amounts totaling $550.0 million that were designated as cash flow hedges of interest rate risk. The outstanding cash flow hedges at September 30, 2018 expire between October 2018 and July 2021.

Derivatives Not Designated as Hedging Instruments

Customers executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies (typically the loan customers will swap a floating-rate loan for a fixed-rate loan). The customer interest rate swaps are simultaneously offset by interest rate swaps that Customers executes with a third party in order to minimize interest rate risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting third-party market swaps are recognized directly in earnings. At September 30, 2018, Customers had 98 interest rate swaps with an aggregate notional amount of $956.8 million related to this program. At December 31, 2017, Customers had 76 interest rate swaps with an aggregate notional amount of $800.5 million related to this program.

Customers enters into residential mortgage loan commitments in connection with its consumer mortgage banking activities to fund mortgage loans at specified rates and times in the future. These commitments are short-term in nature and generally expire in 30 to 60 days. The residential mortgage loan commitments that relate to the origination of mortgage loans that will be held for sale are considered derivative instruments under the applicable accounting guidance and are reported at fair value, with changes in fair value recorded directly in earnings. At September 30, 2018 and December 31, 2017, Customers had an outstanding notional balance of residential mortgage loan commitments of $6.1 million and $2.7 million, respectively.

Customers has also purchased and sold credit derivatives to either hedge or participate in the performance risk associated with some of its counterparties. These derivatives are not designated as hedging instruments and are reported at fair value, with changes in fair value recorded directly in earnings. At September 30, 2018 and December 31, 2017, Customers had outstanding notional balances of credit derivatives of $95.5 million and $80.5 million, respectively.

Fair Value of Derivative Instruments on the Balance Sheet

The following tables present the fair value of Customers' derivative financial instruments as well as their presentation on the balance sheet as of September 30, 2018 and December 31, 2017.



	September 30, 2018
	Derivative Assets			Derivative Liabilities
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
(amounts in thousands)
Derivatives designated as cash flow hedges:
Interest rate swaps	Other assets	$	3,859	Other liabilities	$	—
Total		$	3,859		$	—
Derivatives not designated as hedging instruments:
Interest rate swaps	Other assets	$	18,596	Other liabilities	$	15,653
Credit contracts	Other assets	36		Other liabilities	31
Residential mortgage loan commitments	Other assets	122		Other liabilities	—
Total		$	18,754		$	15,684



	December 31, 2017
	Derivative Assets			Derivative Liabilities
	Balance Sheet			Balance Sheet
	Location	Fair Value		Location	Fair Value
(amounts in thousands)
Derivatives designated as cash flow hedges:
Interest rate swaps	Other assets	$	816	Other liabilities	$	1,140
Total		$	816		$	1,140
Derivatives not designated as hedging instruments:
Interest rate swaps	Other assets	$	8,776	Other liabilities	$	8,897
Credit contracts	Other assets	100		Other liabilities	37
Residential mortgage loan commitments	Other assets	60		Other liabilities	—
Total		$	8,936		$	8,934

Effect of Derivative Instruments on Comprehensive Income

The following tables present the effect of Customers' derivative financial instruments on comprehensive income for the three and nine months ended September 30, 2018 and 2017.



	Three Months Ended September 30, 2018
	Income Statement Location	Amount of Income (Loss) Recognized in Earnings
(amounts in thousands)
Derivatives not designated as hedging instruments:
Interest rate swaps	Other non-interest income	$	1,139
Credit contracts	Other non-interest income	156
Residential mortgage loan commitments	Mortgage banking income	(11		)
Total		$	1,284



	Three Months Ended September 30, 2017
	Income Statement Location	Amount of Income (Loss) Recognized in Earnings
(amounts in thousands)
Derivatives not designated as hedging instruments:
Interest rate swaps	Other non-interest income	$	91
Credit contracts	Other non-interest income	(6		)
Residential mortgage loan commitments	Mortgage banking income	1
Total		$	86



	Nine Months Ended September 30, 2018
	Income Statement Location	Amount of Income Recognized in Earnings
(amounts in thousands)
Derivatives not designated as hedging instruments:
Interest rate swaps	Other non-interest income	$	1,472
Credit contracts	Other non-interest income	119
Residential mortgage loan commitments	Mortgage banking income	62
Total		$	1,653



	Nine Months Ended September 30, 2017
	Income Statement Location	Amount of Income (Loss) Recognized in Earnings
(amounts in thousands)
Derivatives not designated as hedging instruments:
Interest rate swaps	Other non-interest income	$	429
Credit contracts	Other non-interest income	(5		)
Residential mortgage loan commitments	Mortgage banking income	58
Total		$	482



	Three Months Ended September 30, 2018
	Amount of Gain (Loss) Recognized in OCI on Derivatives (1)		Location of Gain (Loss) Reclassified from Accumulated OCI into Income	Amount of Gain (Loss) Reclassified from Accumulated OCI into Income
(amounts in thousands)
Derivatives in cash flow hedging relationships:
Interest rate swaps	$	3,006	Interest expense	$	(303	)
			Other non-interest income (2)	2,822
Total				$	2,519



	Three Months Ended September 30, 2017
	Amount of Gain (Loss) Recognized in OCI on Derivatives (1)		Location of Gain (Loss) Reclassified from Accumulated OCI into Income	Amount of Gain (Loss) Reclassified from Accumulated OCI into Income
(amounts in thousands)
Derivatives in cash flow hedging relationships:
Interest rate swaps	$	104	Interest expense	$	(572	)



	Nine Months Ended September 30, 2018
	Amount of Gain (Loss) Recognized in OCI on Derivatives (1)		Location of Gain (Loss) Reclassified from Accumulated OCI into Income	Amount of Gain (Loss) Reclassified from Accumulated OCI into Income
(amounts in thousands)
Derivative in cash flow hedging relationships:
Interest rate swaps	$	5,055	Interest expense	$	(175	)
			Other non-interest income (2)	2,822
Total				$	2,647



	Nine Months Ended September 30, 2017
	Amount of Gain (Loss) Recognized in OCI on Derivatives (1)			Location of Gain (Loss) Reclassified from Accumulated OCI into Income	Amount of Gain (Loss) Reclassified from Accumulated OCI into Income
(amounts in thousands)
Derivative in cash flow hedging relationships:
Interest rate swaps	$	(115	)	Interest expense	$	(2,166	)

(1) Amounts presented are net of taxes. See NOTE 4 - CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) for total effect on other comprehensive income (loss) from derivatives designated as cash flow hedges for the periods presented.

(2) Includes income recognized from discontinued cash flow hedges.

Credit-risk-related Contingent Features

By entering into derivative contracts, Customers is exposed to credit risk. The credit risk associated with derivatives executed with customers is the same as that involved in extending the related loans and is subject to the same standard credit policies. To mitigate the credit-risk exposure to major derivative dealer counterparties, Customers only enters into agreements with those counterparties that maintain credit ratings of high quality.

Agreements with major derivative dealer counterparties contain provisions whereby default on any of Customers' indebtedness would be considered a default on its derivative obligations. Customers also has entered into agreements that contain provisions under which the counterparty could require Customers to settle its obligations if Customers fails to maintain its status as a well/adequately capitalized institution. As of September 30, 2018, all derivatives with major derivative dealer counterparties were in a net asset position.

Disclosures about Offsetting Assets and Liabilities

The following tables present derivative instruments that are subject to enforceable master netting arrangements. Customers' interest rate swaps with institutional counterparties are subject to master netting arrangements and are included in the table below. Interest rate swaps with commercial banking customers and residential mortgage loan commitments are not subject to master netting arrangements and are excluded from the table below. Customers has not made a policy election to offset its derivative positions.

Offsetting of Financial Assets and Derivative Assets

At September 30, 2018



	Gross Amount of Recognized Assets		Gross Amounts Offset in the Consolidated Balance Sheet		Net Amounts of Assets Presented in the Consolidated Balance Sheet		Gross Amounts Not Offset in the Consolidated Balance Sheet				Net Amount
	Gross Amount of Recognized Assets		Gross Amounts Offset in the Consolidated Balance Sheet				Financial Instruments		Cash Collateral Received		Net Amount
(amounts in thousands)
Description
Interest rate swap derivatives with institutional counterparties	$	20,688	$	—	$	20,688	$	—	$	19,330	$	1,358

Offsetting of Financial Liabilities and Derivative Liabilities

At September 30, 2018



	Gross Amount of Recognized Liabilities		Gross Amounts Offset in the Consolidated Balance Sheet		Net Amounts of Liabilities Presented in the Consolidated Balance Sheet		Gross Amounts Not Offset in the Consolidated Balance Sheet
	Gross Amount of Recognized Liabilities		Gross Amounts Offset in the Consolidated Balance Sheet				Financial Instruments		Cash Collateral Pledged		Net Amount
(amounts in thousands)
Description
Interest rate swap derivatives with institutional counterparties	$	1,924	$	—	$	1,924	$	—	$	2	$	1,922

Offsetting of Financial Assets and Derivative Assets

At December 31, 2017



	Gross Amount of Recognized Assets		Gross Amounts Offset in the Consolidated Balance Sheet		Net Amounts of Assets Presented in the Consolidated Balance Sheet		Gross Amounts Not Offset in the Consolidated Balance Sheet				Net Amount
	Gross Amount of Recognized Assets		Gross Amounts Offset in the Consolidated Balance Sheet				Financial Instruments		Cash Collateral Received		Net Amount
(amounts in thousands)
Description
Interest rate swap derivatives with institutional counterparties	$	5,930	$	—	$	5,930	$	—	$	5,070	$	860

Offsetting of Financial Liabilities and Derivative Liabilities

At December 31, 2017



	Gross Amount of Recognized Liabilities		Gross Amounts Offset in the Consolidated Balance Sheet		Net Amounts of Liabilities Presented in the Consolidated Balance Sheet		Gross Amounts Not Offset in the Consolidated Balance Sheet				Net Amount
	Gross Amount of Recognized Liabilities		Gross Amounts Offset in the Consolidated Balance Sheet				Financial Instruments		Cash Collateral Pledged		Net Amount
(amounts in thousands)
Description
Interest rate swap derivatives with institutional counterparties	$	5,058	$	—	$	5,058	$	—	$	4,872	$	186