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Other Derivatives

6 Months Ended

Jun. 30, 2020

Note 7. Other Derivatives

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.

Cash Flow Hedges of Interest Rate Risk

The Company uses interest rate swap agreements to assist in its interest rate risk management. The Company’s objective in using interest rate derivatives designated as cash flow hedges is to add stability to interest expense and to better manage its exposure to interest rate movements. To accomplish this objective, the Company utilizes interest rate swaps as part of its interest rate risk management strategy intended to mitigate the potential risk of rising interest rates on the Bank’s cost of funds. The notional amounts of the interest rate swaps designated as cash flow hedges do not represent amounts exchanged by the counterparties, but rather, the notional amount is used to determine, along with other terms of the derivative, the amounts to be exchanged between the counterparties. The interest rate swaps are designated as cash flow hedges and involve the receipt of variable rate amounts from one counterparty in exchange for the Company making fixed payments. The Company’s intent is to hedge its exposure to the variability in potential future interest rate conditions on existing financial instruments.

For derivatives designated as cash flow hedges, changes in the fair value of the derivative are initially reported in other comprehensive income (outside of earnings), net of tax, and subsequently reclassified to earnings when the hedged transaction affects earnings. The Company assesses 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 transactions.

As of June 30, 2020 and December 31, 2019, the Company had one designated cash flow hedge notional interest rate swap transaction outstanding amounting to $100 million associated with the Company’s variable rate deposits. The Company recognized $829 thousand in noninterest income during March 2019 due to the termination of two of its interest rate swap transactions as part of the Company’s asset liability strategy as well as declines in market interest rates.

Amounts reported in accumulated other comprehensive income related to designated cash flow hedge derivatives will be reclassified to interest income/expense as interest payments are made/received on the Company’s variable-rate assets/liabilities. During the next twelve months, the Company estimates (based on existing interest rates) that $1.3 million will be reclassified as an increase in interest expense.

Non-designated Hedges

Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers. The Company executes interest rate caps and swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings.

The Company entered into credit risk participation agreements ("RPAs") with institutional counterparties, under which the Company assumes its pro-rata share of the credit exposure associated with a borrower's performance related to interest rate derivative contracts. The fair value of RPAs is calculated by determining the total expected asset or liability exposure of the derivatives to the borrowers and applying the borrowers' credit spread to that exposure. Total expected exposure incorporates both the current and potential future exposure of the derivatives, derived from using observable inputs, such as yield curves and volatilities.

Credit-risk-related Contingent Features

The Company has agreements with each of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, then the Company could also be declared in default on its derivative obligations.

The Company is exposed to credit risk in the event of nonperformance by the interest rate derivative counterparty. The Company minimizes this risk by entering into derivative contracts with only large, stable financial institutions, and the Company has not experienced, and does not expect, any losses from counterparty nonperformance on the interest rate derivatives. The Company monitors counterparty risk in accordance with the provisions of ASC Topic 815, "Derivatives and Hedging." In addition, the interest rate derivative agreements contain language outlining collateral-pledging requirements for each counterparty. Collateral must be posted when the market value exceeds certain threshold limits.

The interest rate derivative agreements detail: 1) that collateral be posted when the market value exceeds certain threshold limits associated with the secured party’s exposure; 2) if the Company defaults on any of its indebtedness (including default where repayment of the indebtedness has not been accelerated by the lender), then the Company could also be declared in default on its derivative obligations; 3) if the Company fails to maintain its status as a well-capitalized institution then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements.

As of June 30, 2020, the aggregate fair value of the derivative contract with credit risk contingent features (i.e., containing collateral posting or termination provisions based on our capital status) that was in a net liability position totaled $6.1 million. The Company has a minimum collateral posting threshold with its derivative counterparty. As of June 30, 2020, the Company was required to post collateral totaling $1.9 million with its derivative counterparty against its obligations under this agreement. If the Company had breached any provisions under the agreement at June 30, 2020, it could have been required to settle its obligations under the agreement at the termination value.

The table below identifies the balance sheet category and fair value of the Company’s designated cash flow hedge derivative instruments and non-designated hedges as of June 30, 2020 (unaudited) and December 31, 2019.


	June 30,2020						December 31,2019
	Notional				Balance Sheet	Notional				Balance Sheet
Derivatives designated as hedging instruments	Amount		Fair Value		Category	Amount		Fair Value		Category
Interest rate product	$	100,000	$	1,330	Other Liabilities	$	100,000	$	206	Other Liabilities

Derivatives not designated as hedging instruments

(dollars in thousands)
Interest rate product	$	154,447	$	4,523	Other Assets	$	56,806	$	311	Other Assets

(dollars in thousands)
Interest rate product	$	154,447	$	4,818	Other Liabilities	$	56,806	$	319	Other Liabilities
Other Contracts		27,150		150	Other Liabilities		27,384		86	Other Liabilities
	$	181,597	$	4,968	Other Liabilities	$	84,190	$	405	Other Liabilities

The table below presents the pre-tax net gains (losses) of the Company’s designated cash flow hedges for the three and six months ended June 30, 2020 and 2019 (unaudited):


The Effect of Fair Value and Cash Flow Hedge Accounting on Accumulated Other Comprehensive Income
					Location of Gain or (Loss)	Amount of Gain or (Loss)
	Amount of (Loss) Recognized in				Recognized from	Reclassified from Accumulated OCI
	OCI on Derivative				Accumulated Other	into Income
Derivatives in Subtopic 815-20 Hedging	Three Months Ended June 30,				Comprehensive Income into	Three Months Ended June 30,
Relationships (dollars in thousands)	2020		2019		Income	2020		2019
Derivatives in Cash Flow Hedging Relationships
Interest Rate Products	$	(27)	$	(834)	Interest Expense	$	(394)	$	313
Total	$	(27)	$	(834)		$	(394)	$	313

					Location of Gain or (Loss)
					Recognized from
					Accumulated Other	Amount of Gain or (Loss)
	Amount of (Loss) Recognized in				Comprehensive Income into	Reclassified from Accumulated OCI
	OCI on Derivative				Income	into Income
Derivatives in Subtopic 815-20 Hedging	Six Months Ended June 30,					Six Months Ended June 30,
Relationships (dollars in thousands)	2020		2019			2020		2019
Derivatives in Cash Flow Hedging Relationships
Interest Rate Products	$	(1,548)	$	(1,867)	Interest Expense	$	(366)	$	775
Interest Rate Products		—		—	Gain on sale of investment securities		—		829
Total	$	(1,548)	$	(1,867)		$	(366)	$	1,604

The table below presents the effect of the Company’s derivative financial instruments on the Consolidated Statements of Operations for the three and six months ended June 30, 2020 and 2019 (unaudited):


The Effect of Fair Value and Cash Flow Hedge Accounting on the Statements of Operation
	Location and Amount of Gain or (Loss) Recognized in Income on
	Fair Value and Cash Flow Hedging Relationships (in 000's)
	Three Months Ended June 30,				Six Months Ended June 30,
	2020		2019		2020		2019		2019

	Interest				Interest		Interest		Gain on sale of
	Expense				Expense		Expense		investment securities
Total amounts of income and expense line items presented in the statement of financial performance in which the effects of fair value or cash flow hedges are recorded	$	(394)	$	313	$	(366)	$	775	$	829

Gain or (loss) on cash flow hedging relationships in Subtopic 815-20
Interest contracts
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income	$	(394)	$	313	$	(366)	$	775	$	—
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income as a result that a forecasted transaction is no longer probable of occurring	$	—	$	—	$	—	$	—	$	829
Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income - Included Component	$	(394)	$	313	$	(366)	$	775	$	—
Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income - Excluded Component	$	—	$	—	$	—	$	—	$	—

Effect of Derivatives Not Designated as Hedging Instruments on the Statements of Operation

Amount of Gain or (Loss)

Amount of (Loss)

Recognized in Income on

Location of Gain or

Derivative

Derivatives Not Designated as Hedging

(Loss) Recognized in

Three Months Ended June 30,

Six Months Ended June 30,

Instruments under Subtopic 815-20

Income on Derivative

2020

2019

2020

2019

Interest Rate Products

Other income / (expense)

(118)

—

(286)

—

Other Contracts

Other income / (expense)

(29)

(64)

(42)

Total

(116)

(29)

(350)

(42)

Balance Sheet Offsetting: Our designated cash flow hedge interest rate derivatives are eligible for offset in the Consolidated Balance Sheets and are subject to master netting arrangements. Our derivative transactions with counterparties are generally executed under International Swaps and Derivative Association (“ISDA”) master agreements which include “right of set-off” provisions. In such cases there is generally a legally enforceable right to offset recognized amounts and there may be an intention to settle such amounts on a net basis. The Company generally offsets such financial instruments for financial reporting purposes. The table below presents a gross presentation, the effects of offsetting, and a net presentation of the Company’s cash flow hedge derivatives as of June 30, 2020 (unaudited) and December 31, 2019.

As of June 30, 2020

Net

Amounts of

Gross

Assets

Gross Amounts Not Offset in the

Gross

Amounts

presented

Balance Sheet

Amounts of

Offset in

in the

Cash

Recognized

the Balance

Balance

Financial

Collateral

Net

Offsetting of Derivative Assets (dollars in thousands)

Assets

Sheet

Instruments

Posted

Amount

Derivatives

4,523

—

4,523

—

4,523

Net

Amounts of

Gross

Liabilities

Gross Amounts Not Offset in the

Gross

Amounts

presented

Balance Sheet

Amounts of

Offset in

in the

Cash

Recognized

the Balance

Balance

Financial

Collateral

Net

Offsetting of Derivative Liabilities (dollars in thousands)

Liabilities

Sheet

Instruments

Posted

Amount

Derivatives

6,297

—

6,297

—

2,170

4,127

As of December 31, 2019

Net

Amounts of

Gross

Assets

Gross Amounts Not Offset in the

Gross

Amounts

presented

Balance Sheet

Amounts of

Offset in

in the

Cash

Recognized

the Balance

Balance

Financial

Collateral

Net

Offsetting of Derivative Assets (dollars in thousands)

Assets

Sheet

Instruments

Posted

Amount

Derivatives

311

—

311

—

311

Net

Amounts of

Gross

Liabilities

Gross Amounts Not Offset in the

Gross

Amounts

presented

Balance Sheet

Amounts of

Offset in

in the

Cash

Recognized

the Balance

Balance

Financial

Collateral

Net

Offsetting of Derivative Liabilities (dollars in thousands)

Liabilities

Sheet

Instruments

Posted

Amount

Derivatives

611

—

611

—

500

111