DERIVATIVE FINANCIAL INSTRUMENTS

3 Months Ended

Mar. 31, 2024

Derivative Instruments and Hedging Activities Disclosure [Abstract]

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Company may enter 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. The Company's derivative financial instruments are used as risk management tools by the Company to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s investment securities and borrowings and are not used for trading or speculative purposes.

The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company uses interest rate swaps and interest rate caps as part of its interest rate risk management strategy.

Interest rate swaps designated as cash flow hedges involve limiting the Company's exposure to fluctuations in future cash flows through the receipt of fixed or variable amounts from a counterparty in exchange for the Company making variable-rate or fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. The Company discontinues cash flow hedge accounting if it is probable the forecasted hedged transactions will not occur in the initially identified time period due to circumstances. Upon discontinuance, the associated gains and losses deferred in AOCI are reclassified immediately into earnings and subsequent changes in the fair value of the cash flow hedge are recognized in earnings.

At March 31, 2024 and December 31, 2023, the Company had two interest rate swaps designated as cash flow hedges with a total notional value of $125.0 million, which included a pay-fixed hedge with a notional value of $75.0 million for the purpose of hedging variable cash flows associated with the Company's borrowings and a pay-floating hedge of $50.0 million for the purpose of hedging the variable cash flows of selected AFS securities or loans. During the three months ended March 31, 2024, the Company did not enter into new interest rate swaps designated as cash flow hedges.

Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. The gain or loss on the fair value hedge, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized in current earnings as the fair value changes. When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability.

At March 31, 2024 and December 31, 2023, the Company had three pay-fixed interest rate swaps on certain closed portfolio loans with our commercial clients with a total notional value of $100.0 million. The commercial loans are scheduled to mature at various dates ranging from December 2026 to October 2054. The interest rate swaps are designated as fair value hedges and allow the Company to offer long-term fixed rate loans to commercial clients while mitigating the interest rate risk of a long-term asset by converting fixed rate interest payments to floating rate interest payments indexed to a synthetic U.S. SOFR rate. During the three months ended March 31, 2024, the Company did not enter into new interest rate swaps designated as fair value hedges.

The Company enters into interest rate swap agreements that allow its commercial loan customers to effectively convert a variable-rate commercial loan agreement to a fixed-rate commercial loan agreement. Under these agreements, the Company

enters into a variable-rate loan agreement with a customer in addition to an interest rate swap agreement, which serves to effectively swap the customer’s variable-rate loan into a fixed-rate loan. In addition, the Company may enter into interest rate caps that allow its commercial loan customers to gain protection against significant interest rate increases and provide an upper limit, or cap, on the variable interest rate. The Company then enters into a corresponding swap or cap agreement with a third party in order to economically hedge its exposure through the customer agreement. The interest rate swaps and interest rate caps with both the customers and third parties are not designated as hedges and are marked through earnings. At March 31, 2024, the Company had 35 customer and 35 corresponding third-party broker interest rate derivatives not designated as a hedging instrument with an aggregate notional amount of $504.3 million compared to $444.8 million in notional amount of such derivative instruments at December 31, 2023. The Company entered into one new interest rate swap with a commercial loan customer and recognized swap fee income of $199 thousand during the three months ended March 31, 2024. The Company entered into zero new interest rate swaps during the three months ended March 31, 2023. Swap fee income is included in noninterest income in the unaudited condensed consolidated statements of income.

At March 31, 2024 and December 31, 2023, the Company had cash collateral of $7.0 million and $6.6 million with third parties for certain of these derivatives, respectively. At March 31, 2024 and December 31, 2023, the Company received cash collateral of $9.2 million and $4.4 million from a counterparty for these derivatives, respectively.

The Company also may enter into risk participation agreements with a financial institution counterparty for an interest rate derivative contract related to a loan in which the Company may be a participant or the agent bank. The risk participation agreement provides credit protection to the agent bank should the borrower fail to perform on its interest rate derivative contracts with the agent bank. The Company manages its credit risk on the risk participation agreement by monitoring the creditworthiness of the borrower, which is based on the same credit review process as though the Company had entered into the derivative instruments directly with the borrower. The notional amount of such risk participation agreement reflects the Company’s pro-rata share of the derivative instrument, consistent with its share of the related participated loan. At March 31, 2024 and December 31, 2023, the Company had four risk participation agreements with sold protection with a notional value of $32.9 million and $32.7 million, respectively. In addition, the Company had five risk participations with purchased protection with a notional value of $23.9 million at March 31, 2024 compared to three risk participations with purchased protection with a notional value of $11.0 million at December 31, 2023. The Company entered into two risk participation agreements with purchased protection during the three months ended March 31, 2024. The Company did not enter into new risk participations during the three months ended March 31, 2023.

As a part of its normal residential mortgage operations, the Company will enter into an interest rate lock commitment with a potential borrower. The Company may enter into a corresponding commitment with an investor to sell that loan at a specific price shortly after origination. In accordance with FASB ASC 820, adjustments are recorded through earnings to account for the net change in fair value of these transactions for the held for sale loan pipeline. The fair value of held for sale loans can vary based on the interest rate locked with the customer and the current market interest rate at the balance sheet date.

The following table summarizes the fair value of the Company's derivative instruments at March 31, 2024 and December 31, 2023:


	March 31, 2024					December 31, 2023
	Notional Amount		Balance Sheet Location	Fair Value		Notional Amount		Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments:
Cash flow hedge designation:
Interest rate swaps -FHLB advances	$	75,000	Other assets	$	1,486	$	75,000	Other assets	$	135
Interest rate swaps - AFS securities	50,000		Other liabilities	(348)		50,000		Other liabilities	(426)
Fair value hedge designation:
Interest rate swaps - commercial loans	75,000		Other assets	53		—		Other assets	—
Interest rate swaps - commercial loans	25,000		Other liabilities	(43)		100,000		Other liabilities	(1,718)
Total derivatives designated as hedging instruments				$	1,148				$	(2,009)

Derivatives not designated as hedging instruments:
Interest rate swaps	$	246,281	Other assets	$	11,563	$	216,485	Other assets	$	11,157
Interest rate swaps	246,281		Other liabilities	(11,616)		216,485		Other liabilities	(11,253)
Purchased options – rate cap	5,885		Other assets	9		5,909		Other assets	8
Written options – rate cap	5,885		Other liabilities	(8)		5,909		Other liabilities	(8)
Risk participations - sold credit protection	32,878		Other liabilities	(37)		32,722		Other liabilities	(59)
Risk participations - purchased credit protection	23,884		Other assets	86		11,035		Other assets	28
Interest rate lock commitments with customers	1,985		Other assets	56		2,181		Other assets	55
Forward sale commitments	517		Other liabilities	(2)		688		Other assets	(4)
Total derivatives not designated as hedging instruments				$	51				$	(76)

The following table presents the carrying amount and associated cumulative basis adjustment related to the application of fair value hedge accounting that is included in the carrying amount of hedged assets as of March 31, 2024 and 2023.


	Carrying Amounts of Hedged Assets				Cumulative Amounts of Fair Value Hedging Adjustments Included in the Carrying Amounts of the Hedged Assets
	Three Months Ended March 31,				Three Months Ended March 31,
	2024		2023		2024		2023
Commercial loans	$	100,000	$	—	$	(9)	$	—

The following tables summarize the effect of the Company's derivative financial instruments on OCI and net income for the three months ended March 31, 2024 and 2023:


	Amount of Gain Recognized in OCI on Derivative
	Three Months Ended March 31,
		2024		2023
Derivatives in cash flow hedging relationships:
Interest rate products		$	1,428	$	319
Total		$	1,428	$	319


	Amount of Loss Reclassified from AOCI into Income			Location of Loss Recognized from AOCI into Income
	Three Months Ended March 31,
		2024		2023
Derivatives in cash flow hedging relationships:
Interest rate products		$	—	$	—	Interest income
Total		$	—	$	—


	Amount of Gain (Loss) Recognized in Income			Location of Gain (Loss) Recognized in Income
	Three Months Ended March 31,
		2024		2023
Derivatives designated as hedging instruments
Fair value hedge designation:
Interest rate swaps - commercial loans (1)		$	3	n/a		Interest income on loans

Derivatives not designated as hedging instruments:
Interest rate products		$	44	$	(159)	Other operating expenses
Risk participation agreements		81		(10)		Other operating expenses
Interest rate lock commitments with customers		2		22		Mortgage banking activities
Forward sale commitments		2		(132)		Mortgage banking activities
Total derivatives not designated as hedging instruments		$	129	$	(279)
(1) Amount includes the net of the change in the fair value of the interest rate swaps hedging commercial loans and the change in the carrying value included in the hedged commercial loans.

The following table is a summary of components for interest rate swaps designated as hedging instruments at March 31, 2024 and December 31, 2023:


	Weighted Average Pay Rate		Weighted Average Receive Rate		Weighted Average Maturity in Years
March 31, 2024
Cash flow hedge designation:
Interest rate swaps - FHLB advances	3.49	%	5.32	%	4.0
Interest rate swaps - AFS securities	5.32	%	3.73	%	0.5
Fair value hedge designation:
Interest rate swaps - commercial loans	4.12	%	5.32	%	3.4
December 31, 2023
Cash flow hedge designation:
Interest rate swaps - FHLB advances	3.49	%	5.34	%	4.3
Interest rate swaps - AFS securities	5.34	%	3.73	%	0.7
Fair value hedge designation:
Interest rate swaps - commercial loans	4.12	%	5.34	%	3.7