In connection with the acquisition of Covenant, the Corporation became a party to derivative financial instruments. These financial instruments consist of interest rate swap agreements which contain master netting and collateral provisions designed to protect the party at risk. At July 1, 2020, the aggregate notional amount of commercial loans subject to interest rate swaps was $137,176,000, and the Corporation recorded the fair value of the derivative asset of $7,932,000 and the fair value of the derivative liability of $7,932,000.

Interest rate swaps with commercial banking customers were executed to facilitate their respective risk management strategies. Under the terms of these arrangements, the commercial banking customers effectively exchanged their floating interest rate exposures on loans from Covenant (acquired by the Corporation) into fixed interest rate exposures. Those interest rate swaps have been simultaneously economically hedged by offsetting interest rate swaps that Covenant had in place with a third party (assumed by the Corporation), such that the Corporation has effectively exchanged its fixed interest rate exposures for floating rate exposures. These derivatives are not designated as hedges and are not speculative. Rather, these derivatives result from a service provided to certain customers. As the interest rate swaps associated with this program do not meet the hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings.

At December 31, 2020, the aggregate notional amount of interest rate swaps was $135,740,000. Subsequent to the merger there were no interest rate swaps originated in 2020. There were no gross amounts of interest rate swap-related assets and liabilities not offset in the consolidated balance sheets at December 31, 2020. For the year ended December 31, 2020, the net impact on the consolidated statements of income from interest rate swaps was a reduction in interest income on loans of $698,000.

The table below presents the fair value of the Corporation’s derivative financial instruments as well as their classification on the consolidated balance sheets at December 31, 2020:

The Corporation’s agreement with its derivative counterparty provides that if the Corporation defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Corporation could also be declared in default on its derivative obligations. Further, if the Corporation were to fail to maintain its status as a well or adequately capitalized institution, then the counterparty could terminate the derivative positions and the Corporation would be required to settle its obligations under the agreements. Available-for-sale securities with a carrying value of $12,182,000 were pledged as collateral against the Corporation’s liability related to the interest rate swaps at December 31, 2020.