DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

As of March 31, 2018, the Company held derivatives with a total notional amount of $2.8 billion. The Company had economic hedges and non-hedging derivatives totaling $2.5 billion and $0.3 billion, respectively, which are not designated as hedges for accounting purposes with changes in fair value recorded directly through earnings. Economic hedges included interest rate swaps totaling $2.0 billion, risk participation agreements with dealer banks of $0.2 billion, and $0.3 billion in forward commitment contracts.

As part of the Company’s risk management strategy, the Company enters into interest rate swap agreements to mitigate the interest rate risk inherent in certain of the Company’s assets and liabilities. Interest rate swap agreements involve the risk of dealing with both Bank customers and institutional derivative counterparties and their ability to meet contractual terms. The agreements are entered into with counterparties that meet established credit standards and contain master netting and collateral provisions protecting the at-risk party. The derivatives program is overseen by the Risk Management/Capital Committee of the Company’s Board of Directors. Based on adherence to the Company’s credit standards and the presence of the netting and collateral provisions, the Company believes that the credit risk inherent in these contracts was not significant at March 31, 2018.

The Company pledged collateral to derivative counterparties in the form of cash totaling $2.6 million and securities with an amortized cost of $14.5 million and a fair value of $14.5 million as of March 31, 2018. The Company does not typically require its commercial customers to post cash or securities as collateral on its program of back-to-back economic hedges. However certain language is written into the International Swaps Dealers Association, Inc. (“ISDA”) and loan documents where, in default situations, the Bank is allowed to access collateral supporting the loan relationship to recover any losses suffered on the derivative asset or liability. The Company may need to post additional collateral in the future in proportion to potential increases in unrealized loss positions.

Information about derivative assets and liabilities at March 31, 2018, follows:



			Weighted	Weighted Average Rate				Estimated
	Notional		Average			Contract		Fair Value
	Amount		Maturity	Received		pay rate		Asset (Liability)
	(In thousands)		(In years)					(In thousands)
Cash flow hedges:
Interest rate swaps on FHLB borrowings	$	—	0	—	%	—	%	$	—
Total cash flow hedges	—							—

Economic hedges:
Interest rate swap on tax advantaged economic development bond	10,590		11.7	2.03	%	5.09	%	(1,338		)
Interest rate swaps on loans with commercial loan customers	1,006,921		5.8	3.54	%	4.33	%	11,474
Reverse interest rate swaps on loans with commercial loan customers	1,006,921		5.8	4.33	%	3.54	%	(11,228		)
Risk participation agreements with dealer banks	167,795		7.0					(10		)
Forward sale commitments	309,493		0.2					(909		)
Total economic hedges	2,501,720							(2,011		)

Non-hedging derivatives:
Commitments to lend	296,247		0.2					6,531
Total non-hedging derivatives	296,247							6,531

Total	$	2,797,967						$	4,520

Information about derivative assets and liabilities at December 31, 2017, follows:



			Weighted	Weighted Average Rate				Estimated
	Notional		Average			Contract		Fair Value
	Amount		Maturity	Received		pay rate		Asset (Liability)
	(In thousands)		(In years)					(In thousands)
Cash flow hedges:
Interest rate swaps on FHLB borrowings	$	—	0	—	%	—	%	$	—
Total cash flow hedges	—							—

Economic hedges:
Interest rate swap on tax advantaged economic development bond	10,755		11.9	1.73	%	5.09	%	(1,649		)
Interest rate swaps on loans with commercial loan customers	943,795		5.9	3.26	%	4.25	%	(3,195		)
Reverse interest rate swaps on loans with commercial loan customers	943,795		5.9	4.25	%	3.26	%	3,204
Risk participation agreements with dealer banks	142,054		8.4					(26		)
Forward sale commitments	276,572		0.2					(123		)
Total economic hedges	2,316,971							(1,789		)

Non-hedging derivatives:
Commitments to lend	193,966		0.2					5,259
Total non-hedging derivatives	193,966							5,259

Total	$	2,510,937						$	3,470

Cash flow hedges

In the first quarter of 2017, the Company maintained six interest rate swap contracts with an aggregate notional value of $300 million with original durations of three years. This hedge strategy converted one month rolling FHLB borrowings based on the FHLB’s one month fixed interest rate to fixed interest rates, thereby protecting the Company from floating interest rate variability.

On February 7, 2017, the Company initiated and subsequently terminated all of its interest rate swaps associated with FHLB advances with 1-month LIBOR based floating interest rates of an aggregate notional amount of $300 million. As of March 31, 2017, the Company no longer held the FHLB advances associated with the interest rate swaps. As a result, the Company reclassified $6.6 million of losses from the effective portion of the unrealized changes in the fair value of the terminated derivatives from other comprehensive income to non-interest income as the forecasted transactions to the related FHLB advances will not occur.

For the periods presented prior to the termination, the effective portion of unrealized changes in the fair value of derivatives accounted for as cash flow hedges was reported in other comprehensive income. Each quarter, the Company assessed the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged item or transaction. Hedge ineffectiveness on interest rate swaps designated as cash flow hedges was immaterial to the Company’s financial statements during the three months ended March 31, 2017.

Amounts included in the Consolidated Statements of Income and in the other comprehensive income section of the Consolidated Statements of Comprehensive Income (related to interest rate derivatives designated as hedges of cash flows), were as follows:



	Three Months Ended March 31,
(In thousands)	2018		2017
Interest rate swaps on FHLB borrowings:
Unrealized (loss) recognized in accumulated other comprehensive loss	$	—	$	(449	)
Less: reclassification of unrealized (loss) from accumulated other comprehensive income to interest expense	—		(393		)
Less: reclassification of unrealized (loss) from accumulated other comprehensive income to other non-interest expense	—		(6,629		)
Net tax (expense) benefit on items recognized in accumulated other comprehensive income	—		(2,589		)
Other comprehensive gain (loss) recorded in accumulated other comprehensive income, net of reclassification adjustments and tax effects	$	—	$	3,984

Economic hedges

As of March 31, 2018, the Company has an interest rate swap with a $10.6 million notional amount to swap out the fixed rate of interest on an economic development bond bearing a fixed rate of 5.09%, currently within the Company’s trading portfolio under the fair value option, in exchange for a LIBOR-based floating rate. The intent of the economic hedge is to improve the Company’s asset sensitivity to changing interest rates in anticipation of favorable average floating rates of interest over the 21-year life of the bond. The fair value changes of the economic development bond are mostly offset by fair value changes of the related interest rate swap.

The Company also offers certain derivative products directly to qualified commercial borrowers. The Company economically hedges derivative transactions executed with commercial borrowers by entering into mirror-image, offsetting derivatives with third-party financial institutions. The transaction allows the Company’s customer to convert a variable-rate loan to a fixed rate loan. Because the Company acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts mostly offset each other in earnings. Credit valuation adjustments arising from the difference in credit worthiness of the commercial loan and financial institution counterparties totaled $237 thousand as of March 31, 2018. The interest income and expense on these mirror image swaps exactly offset each other.

The Company has risk participation agreements with dealer banks. Risk participation agreements occur when the Company participates on a loan and a swap where another bank is the lead. The Company gets paid a fee to take on the risk associated with having to make the lead bank whole on Berkshire’s portion of the pro-rated swap should the borrower default. Changes in fair value are recorded in current period earnings.

The Company utilizes forward sale commitments to hedge interest rate risk and the associated effects on the fair value of interest rate lock commitments and loans originated for sale. The forward sale commitments are accounted for as derivatives with changes in fair value recorded in current period earnings.

The Company uses the following types of forward sale commitments contracts:


•	Best efforts loan sales,


•	Mandatory delivery loan sales, and


•	To Be Announced (“TBA”) mortgage-backed securities sales.

A best efforts contract refers to a loan sale agreement where the Company commits to deliver an individual mortgage loan of a specified principal amount and quality to an investor if the loan to the underlying borrower closes. The Company may enter into a best efforts contract once the price is known, which is shortly after the potential borrower’s interest rate is locked.

A mandatory delivery contract is a loan sale agreement where the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. Generally, the Company may enter into mandatory delivery contracts shortly after the loan closes with a customer.

The Company may sell TBA mortgage-backed securities to hedge the changes in fair value of interest rate lock commitments and held for sale loans, which do not have corresponding best efforts or mandatory delivery contracts. These security sales transactions are closed once mandatory contracts are written. On the closing date the price of the security is locked-in, and the sale is paired-off with a purchase of the same security. Settlement of the security purchase/sale transaction is done with cash on a net-basis.

Non-hedging derivatives

The Company enters into interest rate lock commitments (“IRLCs”) for residential mortgage loans, which commit the Company to lend funds to a potential borrower at a specific interest rate and within a specified period of time. IRLCs that relate to the origination of mortgage loans that will be held for sale are considered derivative financial instruments under applicable accounting guidance. Outstanding IRLCs expose the Company to the risk that the price of the mortgage loans underlying the commitments may decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan. The IRLCs are free-standing derivatives which are carried at fair value with changes recorded in noninterest income in the Company’s consolidated statements of income. Changes in the fair value of IRLCs subsequent to inception are based on changes in the fair value of the underlying loan resulting from the fulfillment of the commitment and changes in the probability that the loan will fund within the terms of the commitment, which is affected primarily by changes in interest rates and the passage of time.

Amounts included in the Consolidated Statements of Income related to economic hedges and non-hedging derivatives were as follows:



	Three Months Ended March 31,
(In thousands)	2018			2017
Economic hedges
Interest rate swap on industrial revenue bond:
Unrealized gain recognized in other non-interest income	$	311		$	122

Interest rate swaps on loans with commercial loan customers:
Unrealized gain recognized in other non-interest income	14,669			1,098

Reverse interest rate swaps on loans with commercial loan customers:
Unrealized gain recognized in other non-interest income	(14,669		)	(1,098		)
(Unfavorable) Favorable change in credit valuation adjustment recognized in other non-interest income	237			(162		)

Risk participation agreements:
Unrealized gain recognized in other non-interest income	16			(18		)

Forward commitments:
Unrealized gain (loss) recognized in other non-interest income	(909		)	(1,251		)
Realized gain (loss) in other non-interest income	3,922			(2,906		)

Non-hedging derivatives
Commitments to lend
Unrealized gain recognized in other non-interest income	$	6,531		$	8,061
Realized gain in other non-interest income	603			8,774

Assets and Liabilities Subject to Enforceable Master Netting Arrangements

Interest Rate Swap Agreements (“Swap Agreements”)

The Company enters into swap agreements to facilitate the risk management strategies for commercial banking customers. The Company mitigates this risk by entering into equal and offsetting swap agreements with highly rated third party financial institutions. The swap agreements are free-standing derivatives and are recorded at fair value in the Company’s consolidated statements of condition. 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 master netting arrangements provide for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract. Collateral generally in the form of marketable securities is received or posted by the counterparty with net liability positions, respectively, in accordance with contract thresholds.

The Company had net asset positions with its financial institution counterparties totaling $12.2 million and $1.1 million as of March 31, 2018 and December 31, 2017, respectively. The Company had net asset positions with its commercial banking counterparties totaling $4.1 million and $8.6 million as of March 31, 2018 and December 31, 2017, respectively. The Company had net liability positions with its financial institution counterparties totaling $2.1 million and $5.9 million as of March 31, 2018 and December 31, 2017, respectively. The Company had net liability positions with its commercial banking counterparties totaling $15.3 million and $5.4 million as of March 31, 2018 and December 31, 2017. The collateral posted by the Company that covered liability positions was $2.1 million and $5.9 million as of March 31, 2018 and December 31, 2017, respectively.

The following table presents the assets and liabilities subject to an enforceable master netting arrangement as of March 31, 2018 and December 31, 2017:

Offsetting of Financial Assets and Derivative Assets



	Gross Amounts of		Gross Amounts Offset in the			Net Amounts of Assets Presented in the		Gross Amounts Not Offset in the Statements of Condition
	Recognized		Statements of			Statements of		Financial		Cash
(In thousands)	Assets		Condition			Condition		Instruments		Collateral Received		Net Amount
March 31, 2018
Interest Rate Swap Agreements:
Institutional counterparties	$	14,510	$	(2,286	)	$	12,224	$	—	$	—	$	12,224
Commercial counterparties	4,067		—			4,067		—		—		4,067
Total	$	18,577	$	(2,286	)	$	16,291	$	—	$	—	$	16,291

Offsetting of Financial Liabilities and Derivative Liabilities



	Gross Amounts of			Gross Amounts Offset in the		Net Amounts of Liabilities Presented in the			Gross Amounts Not Offset in the Statements of Condition
	Recognized			Statements of		Statements of			Financial		Cash
(In thousands)	Liabilities			Condition		Condition			Instruments		Collateral Pledged		Net Amount
March 31, 2018
Interest Rate Swap Agreements:
Institutional counterparties	$	(3,359	)	$	1,262	$	(2,097	)	$	—	$	2,097	$	—
Commercial counterparties	(15,453		)	157		(15,296		)	—		—		(15,296		)
Total	$	(18,812	)	$	1,419	$	(17,393	)	$	—	$	2,097	$	(15,296	)

Offsetting of Financial Assets and Derivative Assets



	Gross Amounts of		Gross Amounts Offset in the			Net Amounts of Assets Presented in the		Gross Amounts Not Offset in the Statements of Condition
	Recognized		Statements of			Statements of		Financial		Cash
(In thousands)	Assets		Condition			Condition		Instruments		Collateral Received		Net Amount
December 31, 2017
Interest Rate Swap Agreements:
Institutional counterparties	$	2,692	$	(1,622	)	$	1,070	$	—	$	—	$	1,070
Commercial counterparties	8,577		—			8,577		—		—		8,577
Total	$	11,269	$	(1,622	)	$	9,647	$	—	$	—	$	9,647

Offsetting of Financial Liabilities and Derivative Liabilities



	Gross Amounts of			Gross Amounts Offset in the		Net Amounts of Liabilities Presented in the			Gross Amounts Not Offset in the Statements of Condition
	Recognized			Statements of		Statements of			Financial		Cash
(In thousands)	Liabilities			Condition		Condition			Instruments		Collateral Pledged		Net Amount
December 31, 2017
Interest Rate Swap Agreements:
Institutional counterparties	$	(8,777	)	$	2,835	$	(5,942	)	$	3,982	$	1,960	$	—
Commercial counterparties	(5,375		)	2		(5,373		)	—		—		(5,373		)
Total	$	(14,152	)	$	2,837	$	(11,315	)	$	3,982	$	1,960	$	(5,373	)