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Derivative Hedging Instruments

9 Months Ended

Sep. 30, 2022

Derivative Hedging Instruments

Derivative Hedging Instruments

14. Derivative Hedging Instruments

The Company can use various interest rate contracts, such as interest rate swaps, caps, floors and swaptions to help manage interest rate and market valuation risk exposure, which is incurred in normal recurrent banking activities. The Company can use derivative instruments, primarily interest rate swaps, to manage interest rate risk and match the rates on certain assets by hedging the fair value of certain fixed rate debt, which converts the debt to variable rates and by hedging the cash flow variability associated with certain variable rate debt by converting the debt to fixed rates.

Interest Rate Swap Agreements

To accommodate the needs of our customers and support the Company’s asset/liability positioning, we may enter into interest rate swap agreements with customers and a large financial institution that specializes in these types of transactions. These arrangements involve the exchange of interest payments based on the notional amounts. The Company entered into floating rate loans and fixed rate swaps with our customers. Simultaneously, the Company entered into offsetting fixed rate swaps with this large financial institution. In connection with each swap transaction, the Company agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on the same notional amount at a fixed interest rate. At the same time, the Company agrees to pay the large financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. These transactions allow the Company’s customers to effectively convert a variable rate loan to a fixed rate. Because the Company acts as an intermediary for its customers, changes in the fair value of the underlying derivative contracts offset each other and do not significantly impact the Company’s results of operations.

These swaps are considered free-standing derivatives and are reported at fair value within other assets and other liabilities on the Consolidated Balance Sheets. Disclosures related to the fair value of the swap transactions can be found in Note 18.

The following table summarizes the interest rate swap transactions that impacted the Company’s first nine months of 2022 and 2021 performance (in thousands, except percentages).

At September 30, 2022

INCREASE

AGGREGATE

WEIGHTED

(DECREASE)

NOTIONAL

AVERAGE RATE

REPRICING

IN INTEREST

HEDGE TYPE

AMOUNT

RECEIVED/(PAID)

FREQUENCY

EXPENSE

Swap assets

N/A

$

64,624

3.54

%

Monthly

$

(306)

Swap liabilities

N/A

(64,624)

(3.54)

Monthly

306

Net exposure

—

—

—

At September 30, 2021

INCREASE

AGGREGATE

WEIGHTED

(DECREASE)

NOTIONAL

AVERAGE RATE

REPRICING

IN INTEREST

HEDGE TYPE

AMOUNT

RECEIVED/(PAID)

FREQUENCY

EXPENSE

Swap assets

N/A

$

55,061

2.59

%

Monthly

$

(602)

Swap liabilities

N/A

(55,061)

(2.59)

Monthly

602

Net exposure

—

—

—

Risk Participation Agreement

The Company entered into a risk participation agreement (RPA) with the lead bank of a commercial real estate loan arrangement. As a participating bank, the Company guarantees the performance on a borrower-related interest rate swap contract. The Company has no obligations under the RPA unless the borrower defaults on their swap transaction with the lead bank and the swap is a liability to the borrower. In that instance, the Company has agreed to pay the lead bank a pre-determined percentage of the swap’s value at the time of default. In exchange for providing the guarantee, the Company received an upfront fee from the lead bank.

RPAs are derivative financial instruments and are recorded at fair value. These derivatives are not designated as hedges and therefore, changes in fair value are recognized in earnings with a corresponding offset within other liabilities. Disclosures related to the fair value of the RPA can be found in Note 18. The notional amount of the risk participation agreement outstanding at September 30, 2022 and 2021 was $2.2 million and $2.6 million, respectively.

The Company monitors and controls all derivative products with a comprehensive Board of Directors approved Hedging Policy. This policy permits a total maximum notional amount outstanding of $500 million for interest rate swaps, interest rate caps/floors, and swaptions. All hedge transactions must be approved in advance by the Investment Asset/Liability Committee (ALCO) of the Board of Directors, unless otherwise approved, as per the terms, within the Board of Directors approved Hedging Policy. The Company had no caps or floors outstanding at September 30, 2022 and 2021. None of the Company's derivatives are designated as hedging instruments.