Financial Derivative Instruments

6 Months Ended

Jun. 30, 2022

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 (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, 2022		December 31, 2021		June 30, 2021
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
08/02/2019	08/02/2024	1-Month USD Libor	1.590%	Other Liabilities	—	—	—	—	12,500,000	(425,000)
08/05/2019	08/05/2024	1-Month USD Libor	1.420%	Other Liabilities	—	—	—	—	12,500,000	(359,000)
02/12/2020	02/12/2023	3-Month USD Libor	1.486%	Other Liabilities	—	—	—	—	25,000,000	(509,000)
02/12/2020	02/12/2024	3-Month USD Libor	1.477%	Other Liabilities	—	—	—	—	25,000,000	(671,000)
06/28/2021	06/28/2026	1-Month USD Libor	1.158%	Other Liabilities	—	—	—	—	50,000,000	(820,000)
03/13/2020	03/13/2025	3-Month USD Libor	0.855%	Other Liabilities	—	—	—	—	25,000,000	(139,000)
03/13/2020	03/13/2030	3-Month USD Libor	1.029%	Other Assets	—	—	—	—	20,000,000	482,000
04/07/2020	04/07/2023	3-Month USD Libor	0.599%	Other Liabilities	—	—	—	—	20,000,000	(117,000)
04/07/2020	04/07/2024	3-Month USD Libor	0.643%	Other Liabilities	—	—	—	—	20,000,000	(79,000)
04/27/2022	10/27/2023	USD-SOFR-COMPOUND	2.498%	Other Assets	10,000,000	65,000	—	—	—	—
04/24/2022	01/27/2024	USD-SOFR-COMPOUND	2.576%	Other Assets	10,000,000	62,000	—	—	—	—
04/27/2022	04/27/2024	USD-SOFR-COMPOUND	2.619%	Other Assets	10,000,000	58,000	—	—	—	—
					$30,000,000	$185,000	$—	$—	$210,000,000	$(2,637,000)

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 fourth quarter 2021, the Bank took advantage of market opportunities to terminate its then open interest rate swap positions in order to de-lever the balance sheet and reset wholesale funding costs. A one-time gain of $336,000 was recognized in non-interest income in the fourth quarter 2021. 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, 2022 and 2021, and December 31, 2021, there were six customer loan swap arrangements in place, detailed below:


		June 30, 2022					December 31, 2021					June 30, 2021
	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 Assets	6	$	38,903,000	$	3,440,000	3	$	15,765,000	$	789,000	3	$	16,532,000	$	689,000
Pay Fixed, Receive Variable	Other Liabilities	—	—		—		3	24,604,000		(1,802,000)		3	24,927,000		(2,138,000)
		6	38,903,000		3,440,000		6	40,369,000		(1,013,000)		6	41,459,000		(1,449,000)
Receive Fixed, Pay Variable	Other Assets	—	—		—		3	24,604,000		1,802,000		3	24,927,000		2,138,000
Receive Fixed, Pay Variable	Other Liabilities	6	38,903,000		(3,440,000)		3	15,765,000		(789,000)		3	16,532,000		(689,000)
		6	38,903,000		(3,440,000)		6	40,369,000		1,013,000		6	41,459,000		1,449,000
Total		12	$	77,806,000	$	—	12	$	80,738,000	$	—	12	$	82,918,000	$	—

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, 2022, there was no collateral posted on its swap contracts or required amount to be pledged.

Cessation of LIBOR

The Company is aware that 1) certain tenors of US Dollar ("USD") denominated London Interbank Offering Rate ("LIBOR") indices ceased to be published after December 31, 2021, while other tenors are expected to continue being published until June 30, 2023, and 2) no new contracts referencing LIBOR are to be written 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 has issued a voluntary fallback protocol for market participants. The Company has adopted SOFR as its replacement reference rate index for new transactions. Each of the customer loan interest rate swap contracts the Company has in place as of June 30, 2022 is tied to a LIBOR tenor expected to be published until June 2023. The six contracts shown in the table immediately above have maturity dates of December 19, 2029, August 21, 2030, April 1, 2031, July 1, 2035, October 1, 2035 and October 1, 2039. It is anticipated that necessary actions to amend these legacy contracts and designate a replacement reference rate index will be undertaken in late 2022.