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Derivative Instruments and Hedging Activities
 12 Months Ended
Dec. 31, 2012
Derivative Instruments and Hedging Activities
Note 14. Derivative Instruments and Hedging Activities

The Company uses derivative instruments primarily to protect against the risk of adverse price or interest rate movements on the value of certain assets and liabilities and on future cash flows. These derivatives may consist of interest rate swaps, floors, caps, collars, futures, forward contracts, and written and purchased options. Derivative instruments represent contracts between parties that usually require little or no initial net investment and result in one party delivering cash or another asset to the other party based on a notional amount and an underlying asset as specified in the contract. Derivative assets and liabilities are recorded at fair value on the balance sheet.

Like other financial instruments, derivatives contain an element of credit risk due to the possibility the Company may incur a loss if a counterparty fails to meet its contractual obligations. This risk is measured as the expected positive replacement value of contracts. All derivative contracts may be executed only with exchanges or counterparties approved by the Company’s Asset/Liability Management Committee.

The primary derivative instrument the Company uses is interest rate lock commitments (“IRLCs”). Generally, this instrument helps the Company manage exposure to market risk and meet customer financing needs. Market risk represents the possibility that economic value or net interest income will be adversely affected by fluctuations in external factors such as interest rates, market-driven loan rates, prices, or other economic factors.

IRLC: In the normal course of business, the Company sells originated mortgage loans into the secondary mortgage loan market. The Company enters into IRLCs to provide potential borrowers an interest rate guarantee. Once a mortgage loan is closed and funded, it is included within loans held for sale and awaits sale and delivery into the secondary market. From the loan closing date through the date of sale into the secondary market, the Company has exposure to interest rate movement resulting from the risk that interest rates will change from the rate quoted to the borrower. Due to these interest rate fluctuations, the Company’s balance of mortgage loans held for sale is subject to changes in fair value. Typically, the fair value of these loans declines when interest rates increase and rise when interest rates decrease.

The following table presents the aggregate contractual or notional amounts of derivative financial instruments as of the dates indicated:

 

     December 31,
2012		      December 31,
2011		  
(Amounts in thousands)              

Derivatives not designated as hedges IRLC’s

    $ 14,841       $ 9,155   

The following table presents the fair value of derivative financial instruments as of the dates indicated:

 

     December 31, 2012      December 31, 2011  
(Amounts in thousands)    Balance Sheet
Location		    Fair
Value		      Balance Sheet
Location		    Fair
Value		  

Asset derivatives

            

Derivatives not designated as hedges

            

IRLCs

    Other assets    $ 144       Other assets    $ 135   
     

 

 

        

 

 

  

Total

       $ 144          $ 135   
     

 

 

        

 

 

  

Liability derivatives

            

Derivatives not designated as hedges

            

IRLCs

    Other liabilities    $ 16       Other liabilities    $ 6   
     

 

 

        

 

 

  

Total

       $ 16          $ 6   
     

 

 

        

 

 

  

Effect of Derivatives and Hedging Activities on the Income Statement. For the years ended December 31, 2012 and 2011, the Company determined there was no amount of ineffectiveness on cash flow hedges. The following table details gains recognized in income on derivatives for the dates indicated:

 

     Income  Statement
Location		      December 31,  
(Amounts in thousands)       2012      2011  

Derivatives not designated as hedges

         

IRLCs

      Other income       $ —         $ 160   
     

 

 

     

 

 

  

Total

       $  —         $ 160   
     

 

 

     

 

 

  

Counterparty Credit Risk. Like other financial instruments, derivatives contain an element of “credit risk.” Credit risk is the possibility that the Company will incur a loss because a counterparty, which may be a bank, a broker-dealer or a customer, fails to meet its contractual obligations. This risk is measured as the expected positive replacement value of contracts. All derivative contracts may be executed only with exchanges or counterparties approved by the Company’s Asset/Liability Management Committee.