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Derivative Financial Instruments and Hedging Activities
 9 Months Ended
Sep. 30, 2016
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Financial Instruments and Hedging Activities
Derivative Financial Instruments and Hedging Activities

We have entered into interest rate swap agreements, primarily as an asset/liability management strategy, in order to mitigate the changes in the fair value of specified long-term fixed-rate loans (or firm commitments to enter into long-term fixed-rate loans) caused by changes in interest rates. These hedges allow us to offer long-term fixed-rate loans to customers without assuming the interest rate risk of a long-term asset. Converting our fixed-rate interest payments to floating-rate interest payments, generally benchmarked to the one-month U.S. dollar LIBOR index, protects us against changes in the fair value of our loans associated with fluctuating interest rates.

The fixed-rate payment features of the interest rate swap agreements are generally structured at inception to mirror substantially all of the provisions of the hedged loan agreements. These interest rate swaps, designated and qualified as fair value hedges, are carried on the consolidated statements of condition at their fair value in other assets (when the fair value is positive) or in other liabilities (when the fair value is negative). The unrealized gain or loss in fair value of the hedged fixed-rate loan due to LIBOR interest rate movements is recorded as an adjustment to the hedged loan.

From time to time, we make firm commitments to enter into long-term fixed-rate loans with borrowers backed by yield maintenance agreements and simultaneously enter into forward interest rate swap agreements with correspondent banks to mitigate the change in fair value of the yield maintenance agreement. Prior to loan funding, yield maintenance agreements with net settlement features that meet the definition of a derivative are considered as non-designated hedges and are carried on the consolidated statements of condition at their fair value in other assets (when the fair value is positive) or in other liabilities (when the fair value is negative). The offsetting changes in the fair value of the forward swap and the yield maintenance agreement are recorded in interest income. When the fixed-rate loans are originated, the forward swaps are designated to offset the change in fair value in the loans. Subsequent to the point of the swap designations, the related yield maintenance agreements are no longer considered derivatives. Their fair value at the designation date is recorded in other assets and is amortized using the effective yield method over the life of the respective designated loans.

The net effect of the change in fair value of interest rate swaps, the amortization of the yield maintenance agreements and the change in the fair value of the hedged loans result in an insignificant amount of hedge ineffectiveness recognized in interest income.

Our credit exposure, if any, on interest rate swap asset positions is limited to the fair value (net of any collateral pledged to us) and interest payments of all swaps by each counterparty. Conversely, when an interest rate swap is in a liability position exceeding a certain threshold, we may be required to post collateral to the counterparty in an amount determined by the agreements. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values.

As of September 30, 2016, we had five interest rate swap agreements, which are scheduled to mature in June 2031, October 2031, July 2032, August 2037 and October 2037. All of our derivatives are accounted for as fair value hedges. The notional amounts of the interest rate contracts are equal to the notional amounts of the hedged loans. In September 2016, one interest rate swap scheduled to mature in August 2020 was terminated as the hedged loan was paid off. In April 2016, one interest rate swap scheduled to mature in June 2020 was terminated as the hedged loan was paid off. In both cases, prepayment fees were collected from the borrowers to settle our interest rate swap liability, resulting in no net gain or loss on the terminations of the swaps and loan pay-offs. Our interest rate swap payments are settled monthly with counterparties. Accrued interest on the swaps totaled $15 thousand and $28 thousand as of September 30, 2016 and December 31, 2015, respectively. Information on our derivatives follows:
 
Asset derivatives
 
Liability derivatives
(in thousands)
September 30, 2016
December 31, 2015
 
September 30, 2016
December 31, 2015
Fair value hedges:
 
 
 
 
 
Interest rate contracts notional amount
$
—

$
4,407

 
$
19,928

$
22,187

Interest rate contracts fair value1
$
—

$
3

 
$
2,480

$
1,658


 
Three months ended
(in thousands)
September 30, 2016
September 30, 2015
Increase (decrease) in value of designated interest rate swaps recognized in interest income
$
241

$
(813
)
Payment on interest rate swaps recorded in interest income
(132
)
(231
)
(Decrease) increase in value of hedged loans recognized in interest income
(268
)
905

Decrease in value of yield maintenance agreement recognized against interest income
(67
)
(13
)
Net loss on derivatives recognized against interest income 2
$
(226
)
$
(152
)
 
Nine months ended
(in thousands)
September 30, 2016
September 30, 2015
Decrease in value of designated interest rate swaps recognized in interest income
$
(825
)
$
(393
)
Payment on interest rate swaps recorded in interest income
(445
)
(700
)
Increase in value of hedged loans recognized in interest income
1,022

453

Decrease in value of yield maintenance agreement recognized against interest income
(90
)
(39
)
Net loss on derivatives recognized against interest income 2
$
(338
)
$
(679
)

1 See Note 3 for valuation methodology.
2 Includes hedge ineffectiveness loss of $94 thousand and gain of $79 thousand for the quarters ended September 30, 2016 and September 30, 2015, respectively. Ineffectiveness gains of $107 thousand and $21 thousand were recorded in interest income during the nine months ended September 30, 2016 and September 30, 2015, respectively. Changes in value of swaps were included in the assessment of hedge effectiveness. Hedge ineffectiveness is the measure of the extent to which the change in the fair value of the hedging instruments does not exactly offset the change in the fair value of the hedged items from period to period.

Our derivative transactions with counterparties are under International Swaps and Derivative Association (“ISDA”) master agreements that include “right of set-off” provisions. “Right of set-off” provisions are legally enforceable rights to offset recognized amounts and there may be an intention to settle such amounts on a net basis. We do not offset such financial instruments for financial reporting purposes.

Information on financial instruments that are eligible for offset in the consolidated statements of condition follows:
Offsetting of Financial Assets and Derivative Assets
 
 
Gross Amounts
Net Amounts of
Gross Amounts Not Offset in
 
 
Gross Amounts
Offset in the
Assets Presented
the Statements of Condition
 
 
of Recognized
Statements of
in the Statements
Financial
Cash Collateral
 
(in thousands)
Assets1
Condition
of Condition1
Instruments
Received
Net Amount
September 30, 2016
 
 
 
 
 
 
Derivatives by Counterparty:
 
 
 
 
 
 
None
$
—

$
—

$
—

$
—

$
—

$
—

 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
Derivatives by Counterparty:
 
 
 
 
 
 
Counterparty A
$
3

$
—

$
3

$
(3
)
$
—

$
—

1 Amounts exclude accrued interest totaling zero and $1 thousand at September 30, 2016 and December 31, 2015, respectively.

Offsetting of Financial Liabilities and Derivative Liabilities
 
 
Gross Amounts
Net Amounts of
Gross Amounts Not Offset in
 
 
Gross Amounts
Offset in the
Liabilities Presented
the Statements of Condition
 
 
of Recognized
Statements of
in the Statements
Financial
Cash Collateral
 
(in thousands)
Liabilities2
Condition
of Condition2
Instruments
Pledged
Net Amount
September 30, 2016
 
 
 
 
 
 
Derivatives by Counterparty:
 
 
 
 
 
 
Counterparty A
$
2,480

$
—

$
2,480

$
—

$
(2,480
)
$
—

 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
Derivatives by Counterparty:
 
 
 
 
 
 
Counterparty A
$
1,390

$
—

$
1,390

$
(3
)
$
(1,387
)
$
—

Counterparty B
268

—

268

—

(268
)
—

Total
$
1,658

$
—

$
1,658

$
(3
)
$
(1,655
)
$
—


2 Amounts exclude accrued interest totaling $15 thousand and $27 thousand at September 30, 2016 and December 31, 2015, respectively.