11. Derivatives and Hedging Activities

Risk Management Objective of Using Derivatives

The Company is exposed to certain risks 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. 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 derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and known or expected cash payments principally related to certain fixed-rate assets and liabilities. The Company also has interest rate derivatives that result from a service provided to certain qualifying customers and, therefore, are not used to manage interest rate risk of the Company’s assets or liabilities. The Company has entered into an offsetting position for each of these derivative instruments with a matching instrument from another financial institution in order to minimize its net risk exposure resulting from such transactions.

Fair Values of Derivative Instruments on the Consolidated Balance Sheets

The table below presents the fair value of the Company’s derivative financial instruments as of September 30, 2018 and December 31, 2017. The Company’s derivative assets and derivative liabilities are located within Other assets and Other liabilities, respectively, on the Company’s Consolidated Balance Sheets.

Derivatives fair values are determined using valuation techniques including discounted cash flow analysis on the expected cash flows from each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves, foreign exchange rates, and implied volatilities. The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

This table provides a summary of the fair value of the Company’s derivative assets and liabilities as of September 30, 2018 and December 31, 2017 (in thousands):

	Derivative Assets				Derivative Liabilities
	September 30,		December 31,		September 30,		December 31,
Fair Value	2018		2017		2018		2017
Interest Rate Products:
Derivatives not designated as hedging instruments	$	2,499	$	10,116	$	11,424	$	7,326
Derivatives designated as hedging instruments		—		33		41		1,580
Total	$	2,499	$	10,149	$	11,465	$	8,906

Fair Value Hedges of Interest Rate Risk

The Company is exposed to changes in the fair value of certain of its fixed-rate assets and liabilities due to changes in the benchmark interest rate, London Interbank Offered Rate (LIBOR). Interest rate swaps designated as fair value hedges involve either making fixed rate payments to a counterparty in exchange for the Company receiving variable rate payments, or making variable rate payments to a counterparty in exchange for the Company receiving fixed rate payments, over the life of the agreements without the exchange of the underlying notional amount. As of September 30, 2018, the Company had one interest rate swap with a notional amount of $5.7 million that was designated as a fair value hedge of interest rate risk associated with the Company’s fixed rate loan assets.

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 earnings.

Cash Flow Hedges of Interest Rate Risk

The Company is exposed to changes in the fair value of certain of its variable-rate liabilities due to changes in the benchmark interest rate, LIBOR. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. As of September 30, 2018, the Company had two interest rate swaps with a notional amount of $51.5 million that were designated as cash flow hedges of interest rate risk associated with the Company’s variable-rate subordinated debentures issued by Marquette Capital Trusts III and IV. For derivatives designated and that qualify as cash flow hedges, the change in fair value is recorded in AOCI and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the three and nine months ended September 30, 2018, the Company recognized net gains of $1.2 million and $4.3 million, respectively, in AOCI for the change in fair value of these cash flow hedges. During the three and nine months ended September 30, 2017, the Company recognized net losses of $169 thousand and $1.1 million, respectively, in AOCI for the change in fair value of these cash flow hedges. Amounts reported in AOCI related to derivatives will be reclassified to Interest expense as interest payments are received or paid on the Company’s derivatives. The Company expects to reclassify $40 thousand from AOCI as a reduction in Interest expense during the next 12 months. As of September 30, 2018, the Company is hedging its exposure to the variability in future cash flows for forecasted transactions over a maximum period of 17.97 years.

Non-designated Hedges

The remainder of the Company’s derivatives are not designated in qualifying hedging relationships. Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously offset by interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of September 30, 2018, the Company had 104 interest rate swaps with an aggregate notional amount of $1.3 billion related to this program. During the three and nine months ended September 30, 2018, the Company recognized net gains of $67 thousand and $538 thousand, respectively, related to changes in fair value of these swaps. During the three and nine months ended September 30, 2017, the Company recognized net losses of $140 thousand and $656 thousand, respectively, related to changes in fair value of these swaps.

Effect of Derivative Instruments on the Consolidated Statements of Income

This table provides a summary of the amount of gain or loss recognized in Other noninterest expense in the Consolidated Statements of Income related to the Company’s derivative assets and liabilities for the three and nine months ended September 30, 2018 and September 30, 2017 (in thousands):

	Amount of Gain (Loss) Recognized
	For the Three Months Ended						For the Nine Months Ended
	September 30,			September 30,			September 30,			September 30,
	2018			2017			2018			2017
Interest Rate Products
Derivatives not designated as hedging instruments	$	67		$	(140	)	$	538		$	(656	)
Total	$	67		$	(140	)	$	538		$	(656	)
Interest Rate Products
Derivatives designated as hedging instruments:
Fair value adjustments on derivatives	$	36		$	(56	)	$	170		$	(188	)
Fair value adjustments on hedged items		(37	)		55			(167	)		189
Total	$	(1	)	$	(1	)	$	3		$	1

This table provides a summary of the amount of gain or loss recognized in AOCI in the Consolidated Statements of Comprehensive Income related to the Company’s derivative assets and liabilities for the three and nine months ended September 30, 2018 and September 30, 2017 (in thousands):

	Amount of Gain Recognized in Other Comprehensive Income on Derivatives
	For the Three Months Ended					For the Nine Months Ended
	September 30,		September 30,			September 30,		September 30,
Derivatives in Cash Flow Hedging Relationships	2018		2017			2018		2017
Interest Rate Products
Derivatives designated as cash flow hedging instruments	$	1,162	$	(169	)	$	4,274	$	(1,080	)
Total	$	1,162	$	(169	)	$	4,274	$	(1,080	)

Credit-risk-related Contingent Features

The Company has agreements with certain of its derivative counterparties that contain a provision that if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations.

As of September 30, 2018, the termination value of derivatives in a net liability position, which includes accrued interest, related to these agreements was $563 thousand. The Company has minimum collateral posting thresholds with certain of its derivative counterparties. At September 30, 2018, the Company had posted $1.0 million of collateral. If the Company had breached any of these provisions at September 30, 2018, it could have been required to settle its obligations under the agreements at the termination value.