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Note 5 - Derivatives
 9 Months Ended
Sep. 30, 2025
Notes to Financial Statements  
Derivative Instruments and Hedging Activities Disclosure [Text Block]

NOTE 5 – 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 effects earnings. The Company has not recorded any hedge ineffectiveness since inception.

 

The Company expects that approximately $157,000 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:

 

Line item in the Consolidated Balance Sheets in which the hedged item is included

 

Carrying Amount of the Hedged Assets

  

Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Assets

 

September 30, 2025

        

Investment securities (1)

 $57,882  $2,118 

Total

 $57,882  $2,118 
         

December 31, 2024

        

Investment securities (1)

 $55,701  $4,299 

Total

 $55,701  $4,299 

 

(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 September 30, 2025, the amortized cost basis of the closed portfolios used in these hedging relationships was $183.2 million; the cumulative basis adjustments associated with these hedging relationships was $2.1 million; and the amount of the designated hedged items was $60.0 million.  At  December 31, 2024, the amortized cost basis of the closed portfolios used in these hedging relationships was $189.0 million; the cumulative basis adjustment associated with these hedging relationships was $4.3 million; and the amount 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:

 

  

September 30, 2025

 
      

Fair Value

 

Cash flow and fair value hedges:

 

Notional

  

Asset

  

Liability

 

Interest rate swaps

 $280,000  $1,714  $665 

Non-hedging derivatives:

            

Fallout adjusted interest rate lock commitments with customers

  45,889   275   — 

Mandatory and best effort forward commitments with investors

  11,737   —   28 

Forward TBA mortgage-backed securities

  68,000   30   — 

Interest rate swaps – customer swap positions

  716   —   59 

Interest rate swaps – dealer offsets to customer swap positions

  716   59   — 

 

  

December 31, 2024

 
      

Fair Value

 

Cash flow and fair value hedges:

 

Notional

  

Asset

  

Liability

 

Interest rate swaps

 $340,000  $7,244  $— 

Non-hedging derivatives:

            

Fallout adjusted interest rate lock commitments with customers

  16,905   103   — 

Mandatory and best effort forward commitments with investors

  6,829   31   — 

Forward TBA mortgage-backed securities

  31,000   180   — 

Interest rate swaps – customer swap positions

  716   —   61 

Interest rate swaps – dealer offsets to customer swap positions

  716   62   — 

 

The following table summarizes the effect of fair value and cash flow hedge accounting on the Consolidated Statements of Income for the three and nine months ended September 30, 2025 and 2024:

 

  

Three Months Ended September 30,

 
  

2025

  

2024

 
  

Interest Expense Deposits and Borrowings

  

Interest Income Securities

  

Interest Expense Deposits and Borrowings

  

Interest Income Securities

 

Total amounts presented on the Consolidated Statements of Income

 $16,797  $4,309  $15,314  $3,243 

Net gains (losses) on fair value hedging relationships:

                

Interest rate swaps – securities

                

Recognized on hedged items

 $—  $241  $—  $2,432 

Recognized on derivatives designated as hedging instruments

  —   (241)  —   (2,432)

Net interest income recognized on cash flows of derivatives designated as hedging instruments

  —   280   —   433 

Net income recognized on fair value hedges

 $—  $280  $—  $433 

Net gain on cash flow hedging relationships:

                

Interest rate swaps – brokered deposits and borrowings

                

Realized gains, pre-tax, reclassified from accumulated other comprehensive loss into net income

 $527  $—  $1,151  $— 

Net income recognized on cash flow hedges

 $527  $—  $1,151  $— 

 

 

 

  

Nine Months Ended September 30,

 
  

2025

  

2024

 
  

Interest

      

Interest

     
  

Expense

  

Interest

  

Expense

  

Interest

 
  

Deposits and

  

Income

  

Deposits and

  

Income

 
  

Borrowings

  

Securities

  

Borrowings

  

Securities

 

Total amounts presented on the Consolidated Statements of Income

 $48,223  $11,459  $44,416  $10,660 

Net gains (losses) on fair value hedging relationships:

                

Interest rate swaps – securities

                

Recognized on hedged items

 $—  $2,181  $—  $1,044 

Recognized on derivatives designated as hedging instruments

  —   (2,181)  —   (1,044)

Net interest income recognized on cash flows of derivatives designated as hedging instruments

  —   822   —   1,272 

Net income recognized on fair value hedges

 $—  $822  $—  $1,272 

Net gain on cash flow hedging relationships:

                

Interest rate swaps – brokered deposits and borrowings

                

Realized gains, pre-tax, reclassified from accumulated other comprehensive loss into net income

 $1,812  $—  $4,021  $— 

Net income recognized on cash flow hedges

 $1,812  $—  $4,021  $— 

 

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 losses of $266,000 and $149,000 for the three months ended September 30, 2025 and 2024, and net gains of $3,000 and $201,000 for the nine months ended September 30, 2025 and 2024, respectively.

 

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

 

      

Gross Amounts

  

Net Amounts of Assets

  

Gross Amounts Not Offset

 
  

Gross Amounts

  

Offset in the

  

Presented in the

  

in the Consolidated Balance Sheets

 
  

of Recognized

  

Consolidated

  

Consolidated

  

Financial

  

Cash Collateral

     

Offsetting of derivative assets

 

Assets

  

Balance Sheets

  

Balance Sheets

  

Instruments

  

Received

  

Net Amount

 

At September 30, 2025

                        

Interest rate swaps

 $1,997  $224  $1,773  $—  $—  $1,773 
                         

At December 31, 2024

                        

Interest rate swaps

 $7,844  $538  $7,306  $—  $740  $6,566 

 

        Net Amounts of          
      

Gross Amounts

  

Liabilities

  

Gross Amounts Not Offset

 
  

Gross Amounts

  

Offset in the

  

Presented in the

  

in the Consolidated Balance Sheets

 
  

of Recognized

  

Consolidated

  

Consolidated

  

Financial

  

Cash Collateral

     

Offsetting of derivative liabilities

 

Liabilities

  

Balance Sheets

  

Balance Sheets

  

Instruments

  

Posted

  

Net Amount

 

At September 30, 2025

                        

Interest rate swaps

 $718  $53  $665  $—  $660  $5 
                         

At December 31, 2024

                        

Interest rate swaps

 $—  $—  $—  $—  $—  $— 

 

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 September 30, 2025, the Company had $660,000 of 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.