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Derivative Financial Instruments

9 Months Ended

Sep. 30, 2021

Note 11: Derivative Financial Instruments

The Company utilizes interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position. Additionally, the Company enters into derivative financial instruments, including interest rate lock commitments issued to residential loan customers for loans that will be held for sale, forward sales commitments to sell residential mortgage loans to investors, and interest rate swaps with customers and other third parties. See “Note 12: Fair Value Measurements” for further discussion of the fair value measurement of such derivatives.

Interest Rate Swaps Designated as Cash Flow Hedges

The Company entered into derivative instruments designated as cash flow hedges. For a derivative instrument that is designated and qualifies as a cash flow hedge, the change in fair value of the derivative instrument is reported as a component of other comprehensive income (loss) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The change in fair value of components excluded from the assessment of effectiveness are recognized in current earnings.

Interest rate swaps with notional amounts totaling $50.0 million as of September 30, 2021, and $70.0 million as of December 31, 2020, were designated as cash flow hedges to hedge the risk of variability in cash flows (future interest payments) attributable to changes in the contractually specified 3-month LIBOR benchmark interest rate on the Company’s junior subordinated debt owed to unconsolidated trusts and were determined to be highly effective during the period. A $20.0 million swap matured on September 17, 2021, and the Company has one remaining swap. The gross aggregate fair value of the swaps of $1.7 million as of September 30, 2021, and $3.1 million as of December 31, 2020, is recorded in other liabilities in the unaudited Consolidated Balance Sheets, with changes in fair value recorded net of tax in other comprehensive income (loss). The Company expects its hedge to remain highly effective during the remaining term of the swap.

A summary of the interest-rate swaps designated as cash flow hedges is presented below (dollars in thousands):


	As of
	September 30,			December 31,
	2021			2020
Notional amount	$	50,000		$	70,000
Weighted average fixed pay rates		1.79	%		1.80	%
Weighted average variable 3-month LIBOR receive rates		0.12	%		0.22	%
Weighted average maturity, in years		2.96	yrs		2.85	yrs
Unrealized gains (losses), net of tax	$	(1,237)		$	(2,184)

Interest expense recorded on these swap transactions was $0.3 million and $0.9 million during the three and nine months ended September 30, 2021, respectively, and was $0.3 million and $0.5 million during the three and nine months ended September 30, 2020, respectively. The Company expects $0.2 million of the unrealized loss to be reclassified from OCI to interest expense during the next three months. This reclassified amount could differ from amounts actually recognized due to changes in interest rates, hedge de-designations, and the addition of other hedges subsequent to September 30, 2021.

The following table reflects the net gains (losses) recorded in accumulated other comprehensive income (loss) and the unaudited Consolidated Statements of Income relating to cash flow derivative instruments for the periods presented (dollars in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Interest rate contracts
Gain (loss) recognized in OCI, net of tax	$	(5)	$	14	$	336	$	(2,233)
(Gain) loss reclassified from OCI to interest expense, net of tax		206		192		611		42
Net change in unrealized gains (losses) on cash flow hedges	$	201	$	206	$	947	$	(2,191)

The Company pledged $1.8 million in cash to secure its obligation under these contracts as of September 30, 2021, compared to $3.2 million pledged as of December 31, 2020.

Interest Rate Lock Commitments

Interest rate lock commitments that meet the definition of derivative financial instruments under ASC Topic 815, Derivatives and Hedging, are carried at their fair values in other assets or other liabilities in the unaudited consolidated financial statements, with changes in the fair values of the corresponding derivative financial assets or liabilities recorded as either a charge or credit to current earnings during the period in which the changes occurred.

Forward Sales Commitments

The Company economically hedges mortgage loans held for sale and interest rate lock commitments issued to its residential loan customers related to loans that will be held for sale by obtaining corresponding best-efforts forward sales commitments with an investor to sell the loans at an agreed-upon price at the time the interest rate locks are issued to the customers. Forward sales commitments that meet the definition of derivative financial instruments under ASC Topic 815, Derivatives and Hedging, are carried at their fair values in other assets or other liabilities in the unaudited consolidated financial statements. While such forward sales commitments generally served as an economic hedge to mortgage loans held for sale and interest rate lock commitments, the Company did not designate them for hedge accounting treatment. Changes in fair value of the corresponding derivative financial asset or liability were recorded as either a charge or credit to current earnings during the period in which the changes occurred.

Amounts and fair values of mortgage banking derivatives included in the unaudited Consolidated Balance Sheets are summarized as follows (dollars in thousands):


		As of September 30, 2021				As of December 31, 2020
		Notional		Fair		Notional		Fair
	Location	Amount		Value		Amount		Value
Derivatives with positive fair value
Interest rate lock commitments	Other assets	$	31,480	$	538	$	45,004	$	1,201
Forward sales commitments	Other assets		117		1		978		32
Mortgage banking derivatives recorded in other assets		$	31,597	$	539	$	45,982	$	1,233

Derivatives with negative fair value
Interest rate lock commitments	Other liabilities	$	117	$	1	$	118	$	1
Forward sales commitments	Other liabilities		49,418		1,439		84,964		2,662
Mortgage banking derivatives recorded in other liabilities		$	49,535	$	1,440	$	85,082	$	2,663

Net gains (losses) relating to these derivative instruments are summarized as follows for the periods presented (dollars in thousands):


		Three Months Ended September 30,				Nine Months Ended September 30,
	Location	2021		2020		2021		2020
Net gains (losses)
Interest rate lock commitments	Mortgage revenue	$	537	$	1,405	$	1,502	$	8,467
Forward sales commitments	Mortgage revenue		(1,438)		(3,874)		(3,616)		(15,699)
Net gains (losses)		$	(901)	$	(2,469)	$	(2,114)	$	(7,232)

The impact of the net gains or losses on derivative financial instruments related to interest rate lock commitments issued to residential loan customers for loans that will be held for sale and forward sales commitments to sell residential mortgage loans to loan investors are almost entirely offset by a corresponding change in the fair value of loans held for sale.

Interest Rate Swaps Not Designated as Hedges

The Company may offer derivative contracts to its customers in connection with their risk management needs. The Company manages the risk associated with these contracts by entering into equal and offsetting derivative agreements with a third-party dealer. These contracts support variable rate, commercial loan relationships totaling $424.6 million and $395.0 million as of September 30, 2021, and December 31, 2020, respectively. These derivatives generally worked together as an economic interest rate hedge, but the Company did not designate them for hedge accounting treatment. Consequently, changes in fair value of the corresponding derivative financial asset or liability were recorded as either a charge or credit to current earnings during the period in which the changes occurred.

Amounts and fair values of derivative assets and liabilities related to customer interest rate swaps recorded in the unaudited Consolidated Balance Sheets are summarized as follows (dollars in thousands):


	As of September 30, 2021
	Derivative Asset				Derivative Liability
	Notional		Fair		Notional		Fair
	Amount		Value		Amount		Value
Derivatives not designated as hedging instruments
Interest rate swaps – pay floating, receive fixed	$	332,856	$	19,420	$	91,711	$	1,910
Interest rate swaps – pay fixed, receive floating		91,711		1,910		332,856		19,420
Total derivatives not designated as hedging instruments	$	424,567	$	21,330	$	424,567	$	21,330


	As of December 31, 2020
	Derivative Asset				Derivative Liability
	Notional		Fair		Notional		Fair
	Amount		Value		Amount		Value
Derivatives not designated as hedging instruments
Interest rate swaps – pay floating, receive fixed	$	394,954	$	32,685	$	—	$	—
Interest rate swaps – pay fixed, receive floating		—		—		394,954		32,685
Total derivatives not designated as hedging instruments	$	394,954	$	32,685	$	394,954	$	32,685

Changes in fair value of these derivative assets and liabilities are recorded in noninterest expense in the unaudited Consolidated Statements of Income and summarized as follows (dollars in thousands):


		Three Months Ended September 30,				Nine Months Ended September 30,
	Location	2021		2020		2021		2020
Interest rate swaps
Pay floating, receive fixed	Noninterest expense	$	(2,024)	$	(549)	$	(11,355)	$	25,790
Pay fixed, receive floating	Noninterest expense		2,024		549		11,355		(25,790)
Net change in fair value of interest rate swaps		$	—	$	—	$	—	$	—

The Company pledged $26.3 million in cash to secure its obligation under these contracts as of September 30, 2021, compared to $36.0 million pledged as of December 31, 2020.