Financial Derivative Instruments

6 Months Ended

Jun. 30, 2020

Derivative Instruments and Hedging Activities Disclosure [Abstract]

The Bank uses derivative financial instruments for risk management purposes and not for trading or speculative purposes. As part of its overall asset and liability management strategy, the Bank periodically uses derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Bank’s interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets or liabilities so that changes in interest rates do not have a significant effect on net interest income.

The Bank recognizes its derivative instruments in the consolidated balance sheet at fair value. On the date the derivative instrument is entered into, the Bank designates whether the derivative is part of a hedging relationship (i.e., cash flow or fair value hedge). The Bank formally documents relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking hedge transactions. The Bank also assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting the changes in cash flows or fair values of hedged items. Changes in fair value of derivative instruments that are highly effective and qualify as cash flow hedges are recorded in other comprehensive income or loss. Any ineffective portion is recorded in earnings. The Bank discontinues hedge accounting when it is determined that the derivative is no longer highly effective in offsetting changes of the hedged risk on the hedged item, or management determines that the designation of the derivative as a hedging instrument is no longer appropriate.

The details of the interest rate swap agreements are as follows:


						June 30, 2020						December 31, 2019						June 30, 2019
Effective Date	Maturity Date	Variable Index Received	Fixed Rate Paid		Presentation on Consolidated Balance Sheet	Notional Amount		Fair Value		Notional Amount		Fair Value		Notional Amount		Fair Value
06/05/2018	12/05/2019	1-Month USD LIBOR	2.466	%	Other Liabilities	$	—	$	—	$	—	$	—	$	25,000,000	$	(45,000)
06/27/2016	06/27/2021	1-Month USD LIBOR	0.893	%	Other (Liabilities) Assets	20,000,000		(150,000)		20,000,000		199,000		20,000,000		300,000
06/28/2016	06/28/2021	1-Month USD LIBOR	0.940	%	Other (Liabilities) Assets	30,000,000		(238,000)		30,000,000		278,000		30,000,000		423,000
06/05/2018	06/05/2020	1-Month USD LIBOR	2.547	%	Other Liabilities	—		—		25,000,000		(96,000)		25,000,000		(160,000)
06/05/2018	12/05/2020	1-Month USD LIBOR	2.603	%	Other Liabilities	—		—		25,000,000		(234,000)		25,000,000		(313,000)
12/05/2019	12/05/2022	3-Month USD LIBOR	1.779	%	Other Liabilities	—		—		25,000,000		(98,000)		25,000,000		(110,000)
08/02/2019	08/02/2024	1-Month USD LIBOR	1.590	%	Other Liabilities	12,500,000		(736,000)		12,500,000		(11,000)		—		—
08/05/2019	08/05/2024	1-Month USD LIBOR	1.420	%	Other (Liabilities) Assets	12,500,000		(649,000)		12,500,000		85,000		—		—
02/12/2020	02/12/2023	3-Month USD LIBOR	1.486	%	Other Liabilities	25,000,000		(841,000)		—		—		—		—
02/12/2020	02/12/2024	3-Month USD LIBOR	1.477	%	Other Liabilities	25,000,000		(1,124,000)		—		—		—		—
06/28/2021	06/28/2026	1-Month USD LIBOR	1.158	%	Other Liabilities	50,000,000		(2,119,000)		—		—		—		—
03/13/2020	03/13/2025	3-Month USD LIBOR	0.855	%	Other Liabilities	25,000,000		(659,000)		—		—		—		—
03/13/2020	03/13/2030	3-Month USD LIBOR	1.029	%	Other Liabilities	20,000,000		(811,000)		—		—		—		—
04/07/2020	04/07/2023	3-Month USD Libor	0.599	%	Other Liabilities	20,000,000		(210,000)		—		—		—		—
04/07/2020	04/07/2024	3-Month USD Libor	0.643	%	Other Liabilities	20,000,000		(295,000)		—		—		—		—
						$	260,000,000	$	(7,832,000)	$	150,000,000	$	123,000	$	150,000,000	$	95,000

During the first quarter of 2020, the Bank took advantage of market opportunities to restructure several interest rate swap positions and extend funding at favorable interest rates; one-time charges totaling $1.76 million were incurred and expensed in the first quarter of 2020 in connection with the restructuring. The Company would reclassify unrealized gains or losses accounted for within accumulated other comprehensive income (loss) into earnings if the interest rate swaps were to become ineffective or the swaps were to terminate. In the next 12 months, the Company does not believe it will be required to reclassify any unrealized gains or losses accounted for within accumulated other comprehensive income (loss) into earnings as a result of ineffectiveness or swap termination. Amounts paid or received under the swaps are reported in interest expense in the consolidated statement of income, and in interest paid in the consolidated statement of cash flows.

Customer loan derivatives

The Bank will enter into interest rate swaps with qualified commercial customers. Through these arrangements, the Bank is able to provide a means for a loan customer to obtain a long-term fixed rate, while it simultaneously contracts with an approved, highly-rated, third-party financial institution as counterparty to swap the fixed rate for a variable rate. Such loan level arrangements are not designated as hedges for accounting purposes, and are recorded at fair value in the Company’s consolidated balance sheet.

At June 30, 2020 there were three customer loan swap arrangements in place, detailed below:


		June 30, 2020								December 31, 2019							June 30, 2019
	Presentation on Consolidated Balance Sheet	Number of Positions	Notional Amount		Fair Value		Number of Positions	Notional Amount		Fair Value		Number of Positions	Notional Amount		Fair Value
Pay Fixed, Receive Variable	Other Liabilities	3	$	24,921,000	$	(3,613,000)	2	$	16,374,000	$	(1,205,000)	1	$	12,914,000	$	991,000
Receive Fixed, Pay Variable	Other Assets	3	24,921,000		3,613,000		2	16,374,000		1,205,000		1	12,904,000		(991,000)


Total		6	$	49,842,000	$	—	4	$	32,748,000	$	—	2	$	25,818,000	$	—

Derivative collateral

The Bank has entered into a master netting arrangement with its counterparty and settles payments with the counterparty as necessary. The Bank's arrangement with its institutional counterparty requires it to post cash or other assets as collateral for its various loan swap contracts in a net liability position based on their fair values and the Bank's credit rating or receive cash collateral for contracts in a net asset position as requested. At June 30, 2020, the Bank posted to the counterparty $3,100,000 of cash and $10,000,000 in securities as collateral on its swap contracts. The required amount to be pledged was $9,322,000.

Cessation of LIBOR

The Company is aware that LIBOR may no longer be published after December 31, 2021. The Federal Reserve formed the Alternative Reference Rates Committee (ARRC) to guide the transition process in the United States. ARRC has issued a number of recommendations including the adoption of the Secured Overnight Financing Rate (SOFR) as a replacement for LIBOR. The International Swap and Derivatives Association (ISDA), the organization that oversees and guides swap and derivatives markets and participants, continues to work on transitions and replacement rates, including having replacement rates in place before the possible cessation of LIBOR at the end of 2021, and has committed to providing more definitive recommendations later in 2020. The Company has formed a working group to address the change away from LIBOR. Management intends to continue to monitor developments from ARRC and ISDA closely, and expects to pursue the steps ultimately recommended to provide for an orderly transition to a post-LIBOR environment. Of the interest rate swap contracts the Bank has in place as of June 30, 2020, two contracts carrying a total notional amount of $50 million are set to mature prior to December 31, 2021; nine contracts with a total notional amount of $210 million have maturity dates beyond December 31, 2021. The three customer loan swap contracts shown in the table immediately above have maturity dates of December 19, 2029, July 1, 2035 and October 1, 2039.