DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

As part of its overall asset and liability management strategy, the Company uses derivative instruments to minimize fluctuations in earnings and cash flows caused by interest rate volatility. The Company’s interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets or liabilities so the changes in interest rates do not have a significant effect on net interest income. Thus all of the Company's derivative contracts are considered to be interest rate contracts.

The Company recognizes its derivative instruments on the consolidated balance sheet at fair value. On the date the derivative instrument is entered into, the Company designates whether the derivative is part of a hedging relationship (i.e., cash flow or fair value hedge). The Company formally documents relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking hedge transactions. The Company also assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting the changes in cash flows or fair values of hedged items. Changes in fair value of derivative instruments that are highly effective and qualify as cash flow hedges are recorded in other comprehensive income or loss.

The Company offers derivative products in the form of interest rate swaps, to commercial loan customers to facilitate their risk management strategies. These instruments are executed through Master Netting Arrangements ("MNA") with financial institution counterparties or Risk Participation Agreements ("RPA") with commercial bank counterparties, for which the Company assumes a pro rata share of the credit exposure associated with a borrower's performance related to the derivative contract with the counterpary.

Information about derivative assets and liabilities at December 31, 2019 and December 31, 2018, follows:



	December 31, 2019
	Notional Amount		Weighted Average Maturity	Fair Value Asset (Liability)			Location Fair Value Asset (Liability)
	(in thousands)		(in years)	(in thousands)
Cash flow hedges:
Interest rate swap on deposits	$	100,000	4.6	$	(1,311	)	Other liabilities
Total cash flow hedges	100,000			(1,311		)

Fair value hedges:
Interest rate swap on securities	37,190		9.6	593			Other liabilities
Total fair value hedges	37,190			593

Economic hedges:
Forward sale commitments	11,228		0.1	(84		)	Other liabilities
Customer Loan Swaps - MNA Counterparty	135,598		7.5	(4,669		)	(1)
Customer Loan Swaps - RPA Counterparty	69,505		8.8	(3,377		)	(1)
Customer Loan Swaps - Customer	205,103		8.1	8,046			(1)
Total economic hedges	421,434			(84		)

Non-hedging derivatives:
Interest rate lock commitments	21,748		0.1	59			Other assets
Total non-hedging derivatives	21,748			59

Total	$	580,372		$	(743	)


(1)	Customer loan derivatives are subject to MNA or RPA arrangements with financial institution counterparties, thus assets and liabilities with the counterparty are netted for financial statement presentation.



	December 31, 2018
	Notional Amount		Weighted Average Maturity	Fair Value Asset (Liability)			Location Fair Value Asset (Liability)
	(in thousands)		(in years)	(in thousands)
Cash flow hedges:
Interest rate caps agreements	$	90,000	4.1	$	803		Other liabilities
Total cash flow hedges	90,000			803

Non-hedging derivatives:
Interest rate lock commitments	957		0.1	8			Other assets
Customer loan derivative liability	45,641		9.9	(1,353		)	(1)
Customer loan derivative asset	45,641		9.9	1,353			(1)
Total non-hedging derivatives	92,239			8

Total	$	182,239		$	811


(1)	Customer loan derivatives are subject to MNA or RPA arrangements with financial institution counterparties, thus assets and liabilities with the counterparty are netted for financial statement presentation.

As of December 31, 2019, and 2018, the following amounts were recorded on the balance sheet related to cumulative basis adjustments for fair value hedges:



	Location of Hedged Item on Balance Sheet	Carrying Amount of Hedged Assets (Liabilities)		Cumulative Amount of Fair Value Hedging Adjustment in Carrying Amount
December 31, 2019
Fair value hedges:
Interest rate swap on securities	Securities Available for Sale	$	39,026	$	523

December 31, 2018
Fair value hedges:
Interest rate swap on securities	Securities Available for Sale	$	—	$	—

Information about derivative assets and liabilities for December 31, 2019 and December 31, 2018, follows:



	Twelve Months Ended December 31, 2019
(in thousands)	Amount of Gain (Loss) Recognized in Other Comprehensive Income			Location of Gain (Loss) Reclassified from Other Comprehensive Income	Amount of Gain (Loss) Reclassified from Other Comprehensive Income⁽¹⁾		Location of Gain (Loss) Recognized in Income	Amount of Gain (Loss) Recognized in Income
Cash flow hedges:
Interest rate cap agreements	$	—		Acquisition, restructuring, and other expenses	$	3,156	Interest expense	$	(603	)
Interest rate swap on deposits	2,291			Interest expense	—		Interest expense	(2		)
Total cash flow hedges	2,291				3,156			(605		)

Fair value hedges:
Interest rate swap on securities	(523		)	Interest income	—		Interest income	7
Total fair value hedges	(523		)		—			7

Economic hedges:
Forward commitments	—			Other income	—		Other income	(84		)
Total economic hedges	—				—			(84		)

Non-hedging derivatives:
Interest rate lock commitments	—			Other Income	—		Other Income	52
Total non-hedging derivatives	—				—			52

Total	$	1,768			$	3,156		$	(630	)


(1)	As of December 31, 2019 the Company does not expect any gains or losses from accumulated other comprehensive income into earnings withing the next 12 months.



	Twelve Months Ended December 31, 2018
(in thousands)	Amount of Gain (Loss) Recognized in Other Comprehensive Income		Location of Gain (Loss) Reclassified from Other Comprehensive Income	Amount of Gain (Loss) Reclassified from Other Comprehensive Income⁽¹⁾		Location of Gain (Loss) Recognized in Income	Amount of Gain (Loss) Recognized in Income
Cash flow hedges:
Interest rate cap agreements	$	486	Acquisition, restructuring, and other expenses	$	—	Interest expense	$	(519	)
Total cash flow hedges	486			—			(519		)

Economic hedges:
Forward commitments	—		Other income	—		Other income	221
Total economic hedges	—			—			—

Non-hedging derivatives:
Interest rate lock commitments	—		Other Income	—		Other Income	9
Total non-hedging derivatives	—			—			9

Total	$	486		$	—		$	(510	)


(1)	As of December 31, 2019 the Company does not expect any gains or losses from accumulated other comprehensive income into earnings withing the next 12 months.

Cash flow hedges

Interest rate cap agreements

In 2014, interest rate cap agreements were purchased to limit the Company’s exposure to rising interest rates on four rolling, three-month borrowings indexed to three-month LIBOR. Under the terms of the agreements, the Company paid total premiums of $4.6 million for the right to receive cash flow payments if three-month LIBOR rises above the caps of 3.00%, thus effectively ensuring interest expense on the borrowings at maximum rates of 3.00% for the duration of the agreements. The interest rate cap agreements were designated as cash flow hedges, however the caps were terminated in the fourth quarter of 2019, with $3.2 million recognized in acquisition, restructuring and other expenses.The caps were terminated because it was probable that the original forecasted transaction would not occur by the end of the original specified period.

Interest rate swaps on deposits

In March and November 2019, the Company entered into interest rate swaps on brokered deposits (the "SWAPS") to limit its exposure to rising interest rates over a five year term. Under the terms of the agreement, the Company has two swaps each with a $50.0 million notional amount and pays a fixed interest rate of 2.46% and 1.55% respectively, and the financial institution counterparty pays the Company interest on the three-month LIBOR rate. The Company designated the swap as a cash flow hedge.

Fair value hedges

For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument as well as the offsetting loss or gain on the hedged asset or liability attributable to the hedged risk are recognized in current earnings. The Company utilizes interest rate swaps designated as fair value hedges to mitigate the effect of changing interest rates on the fair values of fixed rate callable securities available-for-sale. The hedging strategy on securities converts the fixed interest rates to LIBOR-based variable interest rates. These derivatives are designated as partial term hedges of selected cash flows covering specified periods of time prior to the call dates of the hedged securities. During 2019, the Company entered into eight swap transactions with a notional amount of $37.2 million designated as fair value hedges. These derivatives are intended to protect against the effects of changing interest rates on the fair values of fixed rate securities. The fixed rates on the transactions have a weighted average of 1.696%.

Economic hedges

Forward sale commitments

The Company utilizes forward sale commitments on residential mortgage loans to hedge interest rate risk and the associated effects on the fair value of interest rate lock commitments and loans originated for sale. The forward sale commitments are accounted for as derivatives. The Company typically uses a combination of best efforts and mandatory delivery contracts. The contracts are loan sale agreements where the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. Generally, the Company may enter into contracts just prior to the loan closing with a customer.

Customer loan derivatives

The Company enters into customer loan derivatives to facilitate the risk management strategies for commercial banking customers. The Company mitigates this risk by entering into equal and offsetting loan swap agreements with highly rated third-party financial institutions. The Company is party to master netting arrangements with its financial institutional counterparties and the Company offsets assets and liabilities under these arrangements for financial statement presentation purposes.

The master netting arrangements provide for a single net settlement of all loan swap agreements, as well as collateral or cash funds, in the event of default on, or termination of, any one contract with that counterparty. Collateral is provided by cash or securities received or posted by the counterparty with net liability positions, respectively, in accordance with contract thresholds. Currently, the Company has posted cash of $10.7 million with counterparties.

The below table describes the potential effect of master netting arrangements on the consolidated balance sheet and the financial collateral pledged for these arrangements:



	Gross Amounts Offset in the Consolidated Balance Sheet
(in thousands)	Derivative Liabilities			Derivative Assets		Cash Collateral Pledged		Net Amount
As of December 31, 2019
Customer Loan Derivatives:
MNA counterparty	$	(4,669	)	$	4,669	$	10,700	$	—
RPA counterparty	(3,377		)	3,377		—		—
Total	$	(8,046	)	$	8,046	$	10,700	$	—

Non-hedging derivatives

Interest rate lock commitments

The Company enters into interest rate lock commitments (“IRLCs”) for residential mortgage loans, which commit the Company to lend funds to a potential borrower at a specific interest rate and within a specified period of time. IRLCs relate to the origination of residential mortgage loans that are held for sale are considered derivative financial instruments under applicable accounting guidance. Outstanding IRLCs expose the Company to the risk that the price of the mortgage loans underlying the commitments may decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan. The IRLCs are free-standing derivatives which are carried at fair value with changes recorded in non-interest income in the Company’s Consolidated Statements of Income. Changes in the fair value of IRLCs subsequent to inception are based on; (i) changes in the fair value of the underlying loan resulting from the fulfillment of the commitment and (ii) changes in the probability when the loan will fund within the terms of the commitment, which is affected primarily by changes in interest rates and the passage of time.