Derivative Financial Instruments and Hedging Activities

We 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.

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 December 31, 2018, 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. Our interest rate swap payments are settled monthly with counterparties. Accrued interest on the swaps totaled $3 thousand and $8 thousand as of December 31, 2018 and 2017, respectively. Information on our derivatives follows:



	Asset derivatives				Liability derivatives
(in thousands)	December 31, 2018		December 31, 2017		December 31, 2018		December 31, 2017
Fair value hedges:
Interest rate contracts notional amount	$	8,895	$	4,019	$	9,016	$	14,810
Interest rate contracts fair value¹	$	161	$	74	$	375	$	740

¹See Note 9, Fair Value of Assets and Liabilities for valuation methodology.

The following table presents the carrying amount associated cumulative basis adjustment related to the application of fair value hedge accounting that is included in the carrying amount of hedged assets as of December 31, 2018 and 2017:



	Carrying Amounts of Hedged Assets				Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Loans
(in thousands)	December 31, 2018		December 31, 2017		December 31, 2018		December 31, 2017
Loans	$	17,917	$	19,260	$	6	$	431

The following table presents the net gains (losses) recognized in interest income on loans on the consolidated statements of comprehensive income related to our derivatives designated as fair value hedges:



	Years ended December 31,
(in thousands)	2018			2017
Interest and fees on loans ¹	$	79,527		$	66,799

Increase in value of designated interest rate swaps due to LIBOR interest rate movements	$	452		$	212
Payment on interest rate swaps	(149		)	(333		)
Decrease in value of hedged loans	(425		)	(166		)
Decrease in value of yield maintenance agreement	(14		)	(15		)
Net loss on fair value hedging derivatives recognized against loan interest income ²	$	(136	)	$	(302	)

¹ Represents the income line item in the statement of comprehensive income in which the effects of fair value hedges are recorded.

² Includes hedge ineffectiveness gain of $13 thousand and $31 thousand for the years ended December 31, 2018, and 2017, 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 Not Offset in the Statements of Condition
			Gross Amounts		Net Amounts
	Gross Amounts		Offset in the		of Assets Presented
	of Recognized		Statements of		in the Statements		Financial			Cash Collateral
(in thousands)	Assets¹		Condition		of Condition¹		Instruments			Received		Net Amount
December 31, 2018
Derivatives by Counterparty:
Counterparty A	$	161	$	—	$	161	$	(161	)	$	—	$	—
Total	$	161	$	—	$	161	$	(161	)	$	—	$	—

December 31, 2017
Derivatives by Counterparty:
Counterparty A	$	74	$	—	$	74	$	(74	)	$	—	$	—
Total	$	74	$	—	$	74	$	(74	)	$	—	$	—

¹Amounts exclude accrued interest totaling less than $1 thousand both at December 31, 2018 and 2017.



Offsetting of Financial Liabilities and Derivative Liabilities
							Gross Amounts Not Offset in the Statements of Condition
			Gross Amounts		Net Amounts of
	Gross Amounts		Offset in the		Liabilities Presented
	of Recognized		Statements of		in the Statements of		Financial			Cash Collateral
(in thousands)	Liabilities²		Condition		Condition²		Instruments			Pledged			Net Amount
December 31, 2018
Derivatives by Counterparty:
Counterparty A	$	375	$	—	$	375	$	(161	)	—			$	214
Total	$	375	$	—	$	375	$	(161	)	$	—		$	214

December 31, 2017
Derivatives by Counterparty:
Counterparty A	$	740	$	—	$	740	$	(74	)	(666		)	$	—
Total	$	740	$	—	$	740	$	(74	)	$	(666	)	$	—

²Amounts exclude accrued interest totaling $3 thousand and $8 thousand at December 31, 2018 and 2017, respectively.