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Derivative Instruments and Hedging Activities
 9 Months Ended
Sep. 30, 2014
Derivative Instruments and Hedging Activities

Note 9. Derivative Instruments and Hedging Activities

The Company primarily uses derivative instruments 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. 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. These derivative instruments may consist of interest rate swaps, floors, caps, collars, futures, forward contracts, and written and purchased options. Derivative instruments are subject to counterparty credit risk due to 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. Derivative contracts may be executed only with exchanges or counterparties approved by the Company’s Asset/Liability Management Committee.

As of September 30, 2014, the Company’s derivative instruments consisted of IRLCs, forward sale loan commitments, and interest rate swaps. Generally, derivative instruments help 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.

 

IRLCs and forward sale loan commitments. In the normal course of business, the Company enters into interest rate lock commitments (“IRLCs”) with customers on mortgage loans intended to be sold in the secondary market and commitments to sell those originated mortgage loans. 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 date we issue the commitment 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 rise and increase when interest rates decline. The fair values of the Company’s IRLCs and forward sale loan commitments are recorded at fair value as a component of other assets and other liabilities in the consolidated balance sheets. These derivatives do not qualify as hedging instruments; therefore, changes in fair value are recorded in earnings.

Interest rate swaps. The Company uses interest rate swap contracts to modify its exposure to interest rate risk caused by changes in the London InterBank Offered Rate (“LIBOR”) curve in relation to certain designated fixed rate loans. These instruments are used to convert these fixed rate loans to an effective floating rate. If the LIBOR rate falls below the loan’s stated fixed rate for a given period, the Company will owe the floating rate payer the notional amount times the difference between LIBOR and the stated fixed rate. If LIBOR is above the stated rate for a given period, the Company will receive payments based on the notional amount times the difference between LIBOR and the stated fixed rate. The Company’s interest rate swaps qualify as fair value hedging instruments; therefore, changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings in the same period.

The Company entered into a fifteen-year, $4.34 million notional interest rate swap agreement in February 2014 and a ten-year, $3.50 million notional interest rate swap agreement in October 2013. The swap agreements, which are accounted for as fair value hedges, and the loans hedged by the agreements are recorded at fair value. The fair value hedges were effective as of September 30, 2014.

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

 

    September 30, 2014     December 31, 2013     September 30, 2013  
(Amounts in thousands)   Notional or Contractual
Amount		     Notional or Contractual
Amount		     Notional or Contractual
Amount		  

Derivatives designated as hedges:

      

Interest rate swaps

   $ 7,819      $ 3,453      $ —     

Derivatives not designated as hedges:

      

IRLCs

     2,948        3,677        1,094   

Forward sale loan commitments

     4,094        4,560        —     
 

 

 

    

 

 

    

 

 

  

Total derivatives not designated as hedges

     7,042        8,237        1,094   
 

 

 

    

 

 

    

 

 

  

Total derivatives

   $ 14,861      $ 11,690      $ 1,094   
 

 

 

    

 

 

    

 

 

  

The following table presents the fair values of the Company’s derivative instruments as of the dates indicated:

 

     September 30, 2014      December 31, 2013      September 30, 2013  
(Amounts in thousands)    Derivative
Assets		      Derivative
Liabilities		      Derivative
Assets		      Derivative
Liabilities		      Derivative
Assets		      Derivative
Liabilities		  

Derivatives designated as hedges:

                  

Interest rate swaps

    $ —         $ 189       $ 43       $ —         $ —         $ —     

Derivatives not designated as hedges:

                  

IRLCs

      —           7         —           41         19         19   

Forward sale loan commitments

      7         —           41         —           —           —     
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

  

Total derivities not designated as hedges

      7         7         41         41         19         19   
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

  

Total derivaties

    $ 7       $ 196       $ 84       $ 41       $ 19       $ 19   
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

  

 

The following table presents the effect of the Company’s derivative and hedging activity, if applicable, on the statement of income in the periods indicated:

 

          Three Months Ended      Nine Months Ended  
     Income Statement    September 30,      September 30,  
(Amounts in thousands)   

Location

    2014      2013      2014      2013  

Derivatives designated as hedges:

               

Interest rate swaps

    Other income    $ —         $ —         $ —         $ —     

Derivatives not designated as hedges:

               

IRLCs

    Other income      —           307         —           (128 ) 

Forward sale loan commitments

    Other income      —           —           —           —     
     

 

 

     

 

 

     

 

 

     

 

 

  

Total derivatives not designated as hedges

         —           307         —           (128 ) 
     

 

 

     

 

 

     

 

 

     

 

 

  

Total derivatives

       $ —         $ 307       $ —         $ (128 )