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Note 6 - Derivatives

3 Months Ended

Mar. 31, 2024

Notes to Financial Statements

Derivative Instruments and Hedging Activities Disclosure [Text Block]

NOTE 6 – DERIVATIVES

The Company is exposed to certain risk arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates.

The Company’s predominant derivative and hedging activities involve interest rate swaps related to certain borrowings, brokered deposits, investment securities, forward sales contracts, and commitments to extend credit associated with mortgage banking activities. Generally, these instruments help the Company manage exposure to market risk. Market risk represents the possibility that economic value or net interest income will be adversely affected by fluctuations in external factors such as market-driven interest rates and prices or other economic factors.

Mortgage Banking Derivatives Not Designated as Hedges

The Company regularly enters into commitments to originate and sell loans held for sale. The Company has exposure to movements in interest rates associated with written interest rate lock commitments with potential borrowers to originate one-to four-family loans that are intended to be sold and for closed one-to-four-family mortgage loans held for sale for which fair value accounting has been elected, that are awaiting sale and delivery into the secondary market. The Company economically hedges the risk of changing interest rates associated with these mortgage loan commitments by entering into forward sales contracts to sell one-to-four-family mortgage loans or into contracts to sell forward To-Be-Announced (“TBA”) mortgage-backed securities. These commitments and contracts are considered derivatives but have not been designated as hedging instruments for reporting purposes under U.S. GAAP. Rather, they are accounted for as free-standing derivatives, or economic hedges, with changes in the fair value of the derivatives reported in noninterest income or noninterest expense. The Bank recognizes all derivative instruments as either “Other assets” or “Other liabilities” on the Consolidated Balance Sheets and measures those instruments at fair value.

Customer Swaps Not Designated as Hedges

The Company also enters into derivative contracts, which consist of interest rate swaps, to facilitate the needs of clients desiring to manage interest rate risk. These swaps are not designated as accounting hedges under ASC 815, Derivatives and Hedging. To economically hedge the interest rate risk associated with offering this product, the Company simultaneously enters into derivative contracts with third parties to offset the customer contracts such that the Company minimizes its net risk exposure resulting from such transactions. The derivative contracts are structured such that the notional amounts reduce over time to generally match the expected amortization of the underlying loans. These derivatives are not speculative and arise from a service provided to clients.

Cash Flow Hedges

The Company has entered into interest rate swaps to reduce the exposure to variability in interest-related cash outflows attributable to changes in forecasted Secured Overnight Financing Rate (“SOFR”) based brokered deposits. These derivative instruments are designated as cash flow hedges. The hedged item is the SOFR portion of the series of future adjustable-rate borrowings and deposits over the term of the interest rate swap. Accordingly, changes to the amount of interest payment cash flows for the hedged transactions attributable to a change in credit risk are excluded from management’s assessment of hedge effectiveness. The Company tests for hedging effectiveness on a quarterly basis. The accumulated other comprehensive income is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The Company has not recorded any hedge ineffectiveness since inception.

The Company expects that approximately $3.7 million will be reclassified from accumulated other comprehensive loss as a decrease to interest expense over the next 12 months related to these cash flow hedges.

Fair Value Hedges

The Company is exposed to changes in the fair value of certain of its pools of prepayable fixed-rate assets due to changes in benchmark interest rates. The Company uses interest rate swaps to manage its exposure to changes in fair value on these instruments attributable to changes in the designated benchmark interest rate, the SOFR. Interest rate swaps designated as fair value hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without the exchange of the underlying notional amount. For derivatives designated and that qualify as fair value hedges, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in interest income.

The following amounts were recorded on the balance sheet related to cumulative-basis adjustment for fair value hedges for the dates indicated:

						Cumulative Amount of Fair Value
Line item in the statement of financial						Hedging Adjustment Included in
position in which the hedged Item is		Carrying Amount of the				the Carrying Amount of the
included		Hedged Assets				Hedged Assets
March 31, 2024
Investment securities ⁽¹⁾		$	55,560			$	4,440
Total		$	55,560			$	4,440

December 31, 2023
Investment securities ⁽¹⁾		$	56,785			$	3,215
Total		$	56,785			$	3,215

(1)

These amounts include the amortized cost basis of closed portfolios used in designated hedging relationships in which the hedged item is the last layer expected to be remaining at the end of the hedging relationship. At March 31, 2024, the amortized cost basis of the closed portfolios used in these hedging relationships was $184.9 million; the cumulative basis adjustments associated with these hedging relationships was $4.4 million; and the amounts of the designated hedged items was $60.0 million.

The following tables summarize the Company’s derivative instruments at the dates indicated. The Company recognizes derivative assets and liabilities in “Other assets” and “Other liabilities,” respectively, on the Consolidated Balance Sheets, as follows:

		March 31, 2024
						Fair Value
Cash flow hedges:		Notional				Asset				Liability
Interest rate swaps - brokered deposits		$	190,000			$	4,960			$	—
Fair value hedges:
Interest rate swaps - securities			60,000				4,420				—
Non-hedging derivatives:
Fallout adjusted interest rate lock commitments with customers			29,238				251				—
Mandatory and best effort forward commitments with investors			36,310				—				73
Forward TBA mortgage-backed securities			38,000				—				78
Interest rate swaps - customer swap positions			801				—				73
Interest rate swaps - dealer offsets to customer swap positions			801				73				—

		December 31, 2023
						Fair Value
Cash flow hedges:		Notional				Asset				Liability
Interest rate swaps - brokered deposits		$	250,000			$	3,233			$	375
Fair value hedges:
Interest rate swaps - securities			60,000				3,198				—
Non-hedging derivatives:
Fallout adjusted interest rate lock commitments with customers			22,334				329				—
Mandatory and best effort forward commitments with investors			10,070				—				188
Forward TBA mortgage-backed securities			33,000				—				284
Interest rate swaps - customer swap positions			801				—				63
Interest rate swaps - dealer offsets to customer swap positions			801				64				—

The following table summarizes the effect of fair value and cash flow hedge accounting on the Consolidated Statements of Income for the three months ended March 31, 2024 and 2023:

		Three Months Ended March 31,
		2024								2023
		Interest				Interest				Interest				Interest
		Expense				Income				Expense				Income
		Deposits				Securities				Deposits				Securities
Total amounts presented on the Consolidated Statements of Income		$	12,882			$	3,883			$	6,624			$	2,620
Net gains (losses) on fair value hedging relationships:
Interest rate swaps - securities
Recognized on hedged items		$	—			$	(1,225	)		$	—			$	1,495
Recognized on derivatives designated as hedging instruments			—				1,225				—				(1,495	)
Net interest income recognized on cash flows of derivatives designated as hedging instruments			—				418				—				293
Net income recognized on fair value hedges		$	—			$	418			$	—			$	293
Net gain on cash flow hedging relationships:
Interest rate swaps - brokered deposits and borrowings
Realized gains (pre-tax) reclassified from AOCI into net income		$	1,722			$	—			$	907			$	—
Net income recognized on cash flow hedges		$	1,722			$	—			$	907			$	—

Changes in the fair value of the non-hedging derivatives recognized in “Noninterest income” on the Consolidated Statements of Income and included in gain on sale of loans resulted in net gains of $201,000 and $424,000 for the three months ended March 31, 2024 and 2023, respectively.

The following tables present a summary of amounts outstanding in derivative financial instruments, including those entered into in connection with the same counter-party under master netting agreements at the dates indicated. While these agreements are typically over-collateralized, GAAP requires disclosures in this table to limit the amount of such collateral to the amount of the related asset or liability for each counter-party.

						Gross Amounts				Net Amounts of Assets				Gross Amounts Not Offset
		Gross Amounts				Offset in the				Presented in the				in the Statement of Financial Position
		of Recognized				Statement of				Statement of				Financial				Cash Collateral
Offsetting of derivative assets		Assets				Financial Position				Financial Position				Instruments				Received				Net Amount
At March 31, 2024
Interest rate swaps		$	9,628			$	175			$	9,453			$	—			$	(1,070	)		$	8,383

At December 31, 2023
Interest rate swaps		$	6,648			$	153			$	6,495			$	—			$	—			$	6,495

					Gross Amounts			Net Amounts of			Gross Amounts Not Offset
		Gross Amounts			Offset in the			Liabilities			in the Statement of Financial Position
		of Recognized			Statement of			Presented in the Statement			Financial			Cash Collateral
Offsetting of derivative liabilities		Liabilities			Financial Position			of Financial Position			Instruments			Posted			Net Amount
At March 31, 2024
Interest rate swaps		$	—		$	—		$	—		$	—		$	—		$	—

At December 31, 2023
Interest rate swaps		$	(722	)	$	(347	)	$	(375	)	$	—		$	270		$	(105	)

Credit Risk–Related Contingent Features

The Company has derivative contracts with its derivative counterparties that contain a provision to post collateral to the counterparties when these contracts are in a net liability position. At March 31, 2024, the Company had no collateral posted due to this provision. Receivables related to cash collateral that has been paid to counterparties is included in “Cash and cash equivalents” on the Consolidated Balance Sheets. In certain cases, the Company will have posted excess collateral, compared to total exposure due to initial margin requirements or day-to-day rate volatility.