NOTE 13 – DERIVATIVE FINANCIAL INSTRUMENTS

Derivative financial instruments are negotiated contracts entered into by two issuing counterparties containing specific agreement terms, including the underlying instrument, amount, exercise price, and maturities.

The Company is exposed to certain risks relating to its ongoing business operations. The primary risk managed by using derivative financial instruments is interest rate risk. Interest rate swaps are entered into to manage interest rate risk associated with the Company’s variable-rate borrowings and variable-rate loans.

The derivatives and hedge accounting guidance requires that the Company recognize all derivative financial instruments as either assets or liabilities at fair value in the consolidated balance sheets. In accordance with this guidance, the Company designated certain interest rate swaps on variable-rate borrowings and variable-rate loans as cash flow hedges. The gain or loss on interest rate swaps designated as cash flow hedging instruments are reported as a component of accumulated other comprehensive income (loss) and reclassified into earnings in the same period or periods during which the hedged transactions affect earnings.

During the years ended December 31, 2017 and 2018 and the three months ended March 31, 2019, the Company had an interest rate swap contract with a notional amount of $10,000,000 designated as a cash flow hedge on variable-rate loans. Beginning April 1, 2019, this hedging relationship was no longer considered highly effective, and the Company discontinued hedge accounting. In accordance with hedge accounting guidance, the net unrealized gain associated with the discontinued hedging relationship, recorded within accumulated other comprehensive income, will be reclassified into earnings as the hedged forecasted transactions affect earnings, through April 7, 2020. On June 25, 2019, the Company cancelled the interest rate swap agreement and received $174,000 to settle the financial instrument. As of December 31, 2019, the remaining unrealized gain recognized as a component of accumulated other comprehensive income was $52,000.

As of December 31, 2019, the Company also had interest rate swap contracts with a total notional amount of $17,000,000 designated as a cash flow hedge on variable-rate borrowings. As of December 31, 2019, these interest rate swap contracts had contractual maturities between 2024 and 2025. As of December 31, 2019, the Company had cash pledged of $710,000, held on deposit at counterparties.

The Company also entered into interest rate swap contracts with several borrowers on variable-rate loans, on which the Company has offsetting interest rate swap contracts. These interest rate swap contracts with borrowers have a total notional value of $138,356,000 and $112,947,000 as of December 31, 2019 and 2018, respectively, and the offsetting interest rate swap contracts entered into by the Company have a total notional value of $138,356,000 and $112,947,000 as of December 31, 2019 and 2018, respectively. As of December 31, 2019, the interest rate swap contracts with borrowers on variable-rate loans had contractual maturities between 2022 and 2042. As of December 31, 2019 and 2018, the Company had $8,713,000 and $589,000, respectively, of securities pledged and held in safekeeping at the counterparty. While these interest rate swap derivatives generally worked together as an economic interest rate hedge, 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.

As of December 31, the fair values of the Company’s derivative instrument assets and liabilities related to interest rate swap contracts are summarized as follows:


	December 31, 2019		December 31, 2018
Designated as cash flow hedges:	(dollars in thousands)
Fair value recorded in other assets	$	—	$	151
Fair value recorded in other liabilities		(676)		—
Total	$	(676)	$	151

Not designated as hedging instruments:
Fair value recorded in other assets	$	8,642	$	3,074
Fair value recorded in other liabilities		(8,642)		(3,074)
Total	$	—	$	—

For the years ended December 31, the effect of interest rate contracts designated as cash flow hedges on the consolidated statements of income are summarized as follows:


Location of gross gain (loss) reclassified	Amounts of gross gain (loss)
from accumulated other	reclassified from accumulated
comprehensive income to income	other comprehensive income
	Year Ended December 31,
	2019		2018		2017
Designated as cash flow hedges:	(dollars in thousands)
Taxable loan interest income	$	116	$	175	$	275
Subordinated debentures interest expense		(29)		—		(108)
Total	$	87	$	175	$	167

For the years ended December 31, the effect of interest rate contracts not designated as hedging instruments recognized in other noninterest income on the consolidated statements of income are summarized as follows:


	Year Ended December 31,
	2019		2018		2017
Not designated as hedging instruments:	(dollars in thousands)
Gross gains	$	13,537	$	1,758	$	1,468
Gross losses		(13,500)		(1,758)		(1,468)
Net gains (losses)	$	37	$	—	$	—