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Note 8 - Derivative and Hedging Activities

6 Months Ended

Jun. 30, 2022

Notes to Financial Statements

Derivative Instruments and Hedging Activities Disclosure [Text Block]

NOTE 8 – DERIVATIVE AND HEDGING ACTIVITIES

ChoiceOne is exposed to certain risks relating to its ongoing business operations. ChoiceOne utilizes interest rate derivatives as part of its asset liability management strategy to help manage its interest rate risk position. Derivative instruments represent contracts between parties that result in one party delivering cash to the other party based on a notional amount and an underlying term (such as a rate, security price or price index) as specified in the contract. The amount of cash delivered from one party to the other is determined based on the interaction of the notional amount of the contract with the underlying term. Derivatives are also implicit in certain contracts and commitments.

ChoiceOne currently uses interest rate swaps and interest rate caps to manage its exposure to certain fixed and variable rate assets and variable rate liabilities.

ChoiceOne recognizes derivative financial instruments in the consolidated financial statements at fair value regardless of the purpose or intent for holding the instrument. ChoiceOne records derivative assets and derivative liabilities on the balance sheet within other assets and other liabilities, respectively. Changes in the fair value of derivative financial instruments are either recognized in income or in shareholders’ equity as a component of accumulated other comprehensive income or loss depending on whether the derivative financial instrument qualifies for hedge accounting and, if so, whether it qualifies as a fair value hedge or cash flow hedge.

Interest rate swaps

ChoiceOne uses interest rate swaps as part of its interest rate risk management strategy to add stability to net interest income and to manage its exposure to interest rate movements. Interest rate swaps designated as hedges involve the receipt of variable-rate amounts from a counterparty in exchange for ChoiceOne making fixed-rate payments or the receipt of fixed-rate amounts from a counterparty in exchange for ChoiceOne making variable rate payments, over the life of the agreements without the exchange of the underlying notional amount.

In the first six months of 2022, ChoiceOne entered into two pay-floating/receive-fixed interest rate swaps (the “Pay Floating Swap Agreements”) for a total notional amount of $200.0 million that were designated as cash flow hedges. These derivatives hedge the variable cash flows of specifically identified available-for-sale securities, cash and loans. The Pay Floating Swap Agreements were determined to be highly effective during the periods presented and therefore no amount of ineffectiveness has been included in net income. The Pay Floating Swap Agreements will pay a coupon rate equal to SOFR while receiving a fixed coupon rate of 2.41%.

In the first six months of 2022, ChoiceOne entered into one forward starting pay-fixed/receive-floating interest rate swap (the “Pay Fixed Swap Agreement”) for a notional amount of $200.0 million that was designated as a cash flow hedge. This derivative hedges the risk of variability in cash flows attributable to forecasted payments on future deposits or floating rate borrowings indexed to the SOFR Rate. The Pay Fixed Swap Agreement is two years forward starting with an eight-year term set to expire in 2032. The Pay Fixed Swap Agreements will pay a fixed coupon rate of 2.75% while receiving the SOFR Rate.

Interest rate caps

ChoiceOne also uses interest rate caps to provide stability to net interest income and to manage its exposure to interest rate movements. Interest rate caps designated as hedges involve the payment of a fixed premium by ChoiceOne who will then receive payment equivalent to the spread between the current rate and the strike rate until the conclusion of the term from the counterparty.

In the first six months of 2022, ChoiceOne entered into four forward starting interest rate cap agreements with a total notional amount of $200.0 million (“SOFR Cap Agreements”). Three of the SOFR Cap Agreements with a total notional amount of $100.0 million are designated as fair value hedges and hedge against changes in the fair value of certain fixed rate tax-exempt municipal bonds. ChoiceOne utilizes the interest rate caps as hedges against adverse changes in interest rates on the designated securities attributable to fluctuations in the SOFR rate above 2.68%, as applicable. An increase in the benchmark interest rate hedged reduces the fair value of these assets. The remaining SOFR Cap Agreement with a notional amount of $100.0 million is designated as a cash flow hedge and hedges against the risk of variability in cash flows attributable to fluctuations in the SOFR rate above 2.68% for forecasted payments on future deposits or borrowings indexed to the SOFR Rate. All of the SOFR Cap Agreements are two year forward starting with an eight year term set to expire in 2032.

	June 30, 2022					December 31, 2021
(Dollars in thousands)	Balance Sheet Location		Fair Value			Balance Sheet Location		Fair Value
Derivatives designated as hedging instruments
Interest rate contracts	Other Assets		$	14,209		Other Assets		$	-
Interest rate contracts	Other Liabilities		$	2,393		Other Liabilities		$	-

		Location and Amount of Gain or (Loss)								Location and Amount of Gain or (Loss)
		Recognized in Income on Fair Value and Cash Flow Hedging Relationships								Recognized in Income on Fair Value and Cash Flow Hedging Relationships
		Three months ended June 30, 2022								Six months ended June 30, 2022
		Interest Income				Interest Expense				Interest Income				Interest Expense
Total amounts of income and expense line items presented in the consolidated statements of income in which the effects of fair value or cash flow hedges are recorded		$	422			$	(155	)		$	422			$	(155	)

Gain or (loss) on fair value hedging relationships:
Interest rate contracts:
Hedged items		$	(71	)		$	-			$	-			$	-
Derivatives designated as hedging instruments		$	71			$	-			$	-			$	-
Amount excluded from effectiveness testing recognized in earnings based on amortization approach		$	(153	)		$	-			$	(153	)		$	-

Gain or (loss) on cash flow hedging relationships:
Interest rate contracts:
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income		$	-			$	-			$	-			$	-
Amount excluded from effectiveness testing recognized in earnings based on amortization approach		$	-			$	(155	)		$	-			$	(155	)