Derivative Financial Instruments

The Corporation offers interest rate swap products directly to qualified commercial borrowers. The Corporation economically hedges client derivative transactions by entering into offsetting interest rate swap contracts executed with a third party. Derivative transactions executed as part of this program are not designated as accounting hedge relationships and are marked-to-market through earnings each period. The derivative contracts have mirror-image terms, which results in the positions’ changes in fair value primarily offsetting through earnings each period. The credit risk and risk of non-performance embedded in the fair value calculations is different between the dealer counterparties and the commercial borrowers which may result in a difference in the changes in the fair value of the mirror-image swaps. The Corporation incorporates credit valuation adjustments to appropriately reflect both its own non-performance risk and the counterparty’s risk in the fair value measurements. When evaluating the fair value of its derivative contracts for the effects of non-performance and credit risk, the Corporation considered the impact of netting and any applicable credit enhancements such as collateral postings, thresholds and guarantees.

At December 31, 2017, the aggregate amortizing notional value of interest rate swaps with various commercial borrowers was $53.4 million. The Corporation receives fixed rates and pays floating rates based upon LIBOR on the swaps with commercial borrowers. These interest rate swaps mature between September 2018 and May 2034. Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. These commercial borrower swaps were reported on the Consolidated Balance Sheets as a derivative asset of $942,000, included in accrued interest receivable and other assets as of December 31, 2017. In the event of default on a commercial borrower interest rate swap by the counterparty, a right of offset exists to allow for the commercial borrower to set off amounts due against the related commercial loan. As of December 31, 2017, no interest rate swaps were in default and therefore all values for the commercial borrower swaps are recorded on a gross basis on the Consolidated Balance Sheets.

At December 31, 2017, the aggregate amortizing notional value of interest rate swaps with dealer counterparties was also $53.4 million. The Corporation pays fixed rates and receives floating rates based upon LIBOR on the swaps with dealer counterparties. These interest rate swaps mature in September 2018 through May 2034. Dealer counterparty swaps were reported on the Consolidated Balance Sheets as a net derivative liability of $942,000, included in accrued interest payable and other liabilities as of December 31, 2017. The gross amount of dealer counterparty swaps was $942,000 as no right of offset existed with the dealer counterparty swaps as of December 31, 2017.

The table below provides information about the balance sheet location and fair value of the Corporation’s derivative instruments to qualified commercial borrowers as of December 31, 2017 and 2016.

Interest Rate Swap Contracts

Asset Derivatives

Liability Derivatives

Balance Sheet Location

Fair Value

Balance Sheet Location

Fair Value

(In Thousands)

Derivatives not designated as hedging instruments

December 31, 2017

Accrued interest receivable and other assets

942

Accrued interest payable and other liabilities

942

December 31, 2016

Accrued interest receivable and other assets

352

Accrued interest payable and other liabilities

352

These derivative instruments held by the Corporation for the year ended December 31, 2017 were not considered hedging instruments. All changes in the fair value of these instruments are recorded in other non-interest income. Given the mirror-image terms of the outstanding derivative portfolio, the change in fair value for the years ended December 31, 2017, 2016 and 2015 had an insignificant impact to the Consolidated Statements of Income.

During the fourth quarter of 2017, the Corporation also entered into an interest rate swap to manage interest rate risk and reduce the cost of match-funding certain long-term fixed rate loans. This derivative contract involves the receipt of floating rate interest from a counterparty in exchange for the Corporation making fixed-rate payments over the life of the agreement, without the exchange of the underlying notional value. This instrument is designated as a cash flow hedge as the receipt of floating rate interest from the counterparty is used to manage interest rate risk associated with forecasted issuances of short-term FHLB advances. The change in the fair value of this hedging instrument is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged transaction affects earnings.

As of December 31, 2017, the Corporation had one outstanding interest rate swap designated as a cash flow hedge with an aggregate notional value of $22.0 million. This interest rate swap matures in December 2027. A pre-tax unrealized loss of $122,000 was recognized in accumulated other comprehensive income for the year ended December 31, 2017 and there was no ineffective portion of this hedge. No interest rate swaps designated as cash flow hedges were outstanding during 2016.