DERIVATIVES AND FINANCIAL INSTRUMENTS	9 Months Ended
Sep. 30, 2019
DERIVATIVES AND FINANCIAL INSTRUMENTS
DERIVATIVES AND FINANCIAL INSTRUMENTS	11. DERIVATIVES AND FINANCIAL INSTRUMENTS As part of our overall interest rate risk management, the Company uses derivative instruments, including interest rate swaps. The notional amount does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual agreements. The notional amount of these derivative instruments was $11.7 million at September 30, 2019 and $0 at December 31, 2018. These derivative financial instruments at September 30, 2019 consisted of $11.7 million notional amount of receive-variable, pay-fixed interest rate swaps on certain mortgage loans. These hedges were entered into to manage interest rate risk. Derivative instruments are recognized in other assets and other liabilities on the balance sheet at their fair value and are not reported on a net basis. Changes to the fair value are recognized in loan interest income on the statement of income. In accordance with ASC 815-20-35-1, subsequent changes in fair value for a hedging instrument that has been designated and qualifies as part of a hedging relationship should be accounted for in the following manner: Fair value hedges: changes in fair value will be recognized concurrently in earnings. Consistent with this guidance, as long as a hedging instrument is designated and the results of the effectiveness testing support that the instrument qualifies for hedge accounting treatment, 100% of the periodic changes in fair value of the hedging instrument will be accounted for as outlined above. This is the case whether or not economic mismatches exist in the hedging relationship. As a result, there will be no periodic measurement or recognition of ineffectiveness. Rather, the full impact of hedge gains and losses will be recognized in the period in which the hedged transactions impact earnings. While separate measurement and presentation of ineffectiveness is being eliminated, paragraph 815-20-45-1A requires the change in fair value of the hedging instrument that is included in the assessment of hedge effectiveness be presented in the same income statement line item that is used to present the earnings effect of the hedged item. Commitments to fund certain mortgage loans (interest rate lock commitments) and forward commitments for the future delivery of mortgage loans to third party investors are considered derivatives. These derivative contracts do not qualify for hedge accounting. At September 30, 2019, the notional amount of the interest rate lock commitments was $9.4 million and at December 31, 2018, the notional amount of the interest rate lock commitments was $4.6 million. It is our practice to enter into forward commitments for the future delivery of residential mortgage loans to third party investors when interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates resulting from our commitment to fund the loans. Credit risk arises from the possible inability of counterparties to meet the terms of their contracts. Kentucky Bancshare’s exposure is limited to the replacement value of the contracts rather than the notional, principal, or contract amounts. There are provisions in our agreements with the counterparties that allow for certain unsecured credit exposure up to an agreed threshold. Exposures in excess of the agreed thresholds are collateralized. In addition, we minimize credit risk through credit approvals, limits, and monitoring procedures. The direct impact to earnings for the nine months and three months ended September 30, 2019 was immaterial.

11. DERIVATIVES AND FINANCIAL INSTRUMENTS

As part of our overall interest rate risk management, the Company uses derivative instruments, including interest rate swaps. The notional amount does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual agreements. The notional amount of these derivative instruments was $11.7 million at September 30, 2019 and $0 at December 31, 2018. These derivative financial instruments at September 30, 2019 consisted of $11.7 million notional amount of receive-variable, pay-fixed interest rate swaps on certain mortgage loans. These hedges were entered into to manage interest rate risk. Derivative instruments are recognized in other assets and other liabilities on the balance sheet at their fair value and are not reported on a net basis. Changes to the fair value are recognized in loan interest income on the statement of income.

In accordance with ASC 815-20-35-1, subsequent changes in fair value for a hedging instrument that has been designated and qualifies as part of a hedging relationship should be accounted for in the following manner:

Fair value hedges: changes in fair value will be recognized concurrently in earnings.

Consistent with this guidance, as long as a hedging instrument is designated and the results of the effectiveness testing support that the instrument qualifies for hedge accounting treatment, 100% of the periodic changes in fair value of the hedging instrument will be accounted for as outlined above. This is the case whether or not economic mismatches exist in the hedging relationship. As a result, there will be no periodic measurement or recognition of ineffectiveness. Rather, the full impact of hedge gains and losses will be recognized in the period in which the hedged transactions impact earnings.

While separate measurement and presentation of ineffectiveness is being eliminated, paragraph 815-20-45-1A requires the change in fair value of the hedging instrument that is included in the assessment of hedge effectiveness be presented in the same income statement line item that is used to present the earnings effect of the hedged item.

Commitments to fund certain mortgage loans (interest rate lock commitments) and forward commitments for the future delivery of mortgage loans to third party investors are considered derivatives. These derivative contracts do not qualify for hedge accounting. At September 30, 2019, the notional amount of the interest rate lock commitments was $9.4 million and at December 31, 2018, the notional amount of the interest rate lock commitments was $4.6 million. It is our practice to enter into forward commitments for the future delivery of residential mortgage loans to third party investors when interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates resulting from our commitment to fund the loans.

Credit risk arises from the possible inability of counterparties to meet the terms of their contracts. Kentucky Bancshare’s exposure is limited to the replacement value of the contracts rather than the notional, principal, or contract amounts. There are provisions in our agreements with the counterparties that allow for certain unsecured credit exposure up to an agreed threshold. Exposures in excess of the agreed thresholds are collateralized. In addition, we minimize credit risk through credit approvals, limits, and monitoring procedures.

The direct impact to earnings for the nine months and three months ended September 30, 2019 was immaterial.