Derivative Financial Instruments

12 Months Ended

Dec. 31, 2011

Derivative Financial Instruments [Abstract]

Derivative Financial Instruments

18. Derivative Financial Instruments

The Company uses derivative financial instruments to accommodate customer needs and to assist in interest rate risk management. The Company uses interest rate exchange agreements, callable interest rate exchange agreements and interest rate floors, collars and corridors to manage the interest rate risk associated with its commercial loan portfolio, brokered CDs, cash flows related to FHLB advances and repurchase agreements, and mortgage servicing associated with Cole Taylor Mortgage. The Company also has interest rate lock commitments and forward loan commitments associated with Cole Taylor Mortgage that are considered derivatives. Periodically, the Company will sell options to a bank or dealer for the right to purchase certain securities held within the Bank's investment portfolios (covered call options).

An interest rate exchange agreement (or swap) is an agreement in which two parties agree to exchange, at specified intervals, interest payment streams calculated on an agreed-upon notional principal amount with at least one stream based on a specified floating-rate index. Under an interest rate floor agreement, in the event a specified floating-rate index decreases below a predetermined interest rate floor level, the Company will receive an amount, from the counterparty, equal to the difference between the floor level and the current floating-rate index computed based on the notional amount. In an interest rate collar agreement, a predetermined floor and ceiling interest rate level are set with the counterparty. If the specified floating-rate index decreases below the interest rate floor level, the Company will receive an amount equal to the difference between the floor level and the current floating-rate index, computed based on the notional amount. If the specified floating-rate index increases above the interest rate ceiling level, the Company will pay an amount equal to the difference between the current floating-rate index and the ceiling level, computed based on the notional amounts. An interest rate corridor is an agreement in which one party pays an upfront premium to a second party in exchange for future interest payments based on a notional principal amount and the level of a floating-rate index relative to the pre-determined lower and upper bounds of the interest rate corridor. The net effect of the interest rate corridor, when combined with a floating-rate liability, is to lock in a fixed funding cost when the floating-rate index is between the lower and upper bounds of the interest rate corridor. For all types of these agreements, the notional amount does not represent the direct credit exposure. The Company is exposed to credit-related losses in the event of non-performance by the counterparty on the interest rate exchange or floor or collar payment, but does not anticipate that any counterparty will fail to meet its payment obligation.

The following tables describe the derivative instruments outstanding as of the dates indicated (dollars in thousands):

	As of December 31, 2011
	Notional Amount		Average Strike Rates	Maturity		Balance Sheet/Income Statement Location	Fair Value
	(dollars in thousands)
Fair value hedging derivative instruments:
Brokered CD interest rate swaps – pay variable/receive fixed	$	106,920	Receive 2.27% Pay 0.430%		3.4 yrs	Other assets/ Noninterest income	$	5,027
Callable brokered CD interest rate swaps – pay variable/receive fixed		60,000	Receive 3.44% Pay 0.128%		12.6 yrs	Other assets/ Noninterest income		1,176
Total fair value hedging derivative instruments		166,920
Cash flow hedging derivative instruments:
Interest rate corridors		155,000	0.33%-1.33%		0.6 yrs	Other assets/OCI		111
Total hedging derivative instruments		321,920
Non-hedging derivative instruments:
Customer interest rate swap – pay fixed/receive variable		413,105	Pay 2.90% Receive 0.358%		Wtd. avg 3.3 yrs	Other liabilities/ Noninterest income		(19,505	)
Customer interest rate swap – receive fixed/pay variable		413,105	Receive 2.90% Pay 0.358%		Wtd. avg 3.3 yrs	Other assets/ Noninterest income		19,010
Interest rate swaps – mortgage servicing rights		22,500	Receive 2.2457% Pay 0.3705%		Wtd. avg. 9.8 yrs	Other assets/ Noninterest income		489
Interest rate lock commitments		369,961	NA		0.1 yrs	Other assets/ Noninterest income		4,706
Forward loan sale commitments		352,633	NA		0.1 yrs	Other assets/ Noninterest income		(5,296	)
Total non-hedging derivative instruments		1,571,304
Total derivative instruments	$	1,893,224

	As of December 31, 2010
	Notional Amount		Average Strike Rates	Maturity		Balance Sheet/Income Statement Location	Fair Value
	(dollars in thousands)
Fair value hedging derivative instruments:
Brokered CD interest rate swaps – pay variable/receive fixed	$	57,862	Receive 2.74% Pay 0.371%		4.5 yrs	Other assets/ Noninterest income	$	1,714
Cash flow hedging derivative instruments:
Interest rate corridors		300,000	0.29%-1.29%		1.6 yrs	Other assets/OCI		1,127
Total hedging derivative instruments		357,862
Non-hedging derivative instruments:
Customer interest rate swap – pay fixed/receive variable		232,342	Pay 3.67% Receive 0.447%		Wtd. avg 2.6 yrs	Other liabilities/ Noninterest income		(11,630	)
Customer interest rate swap – receive fixed/pay variable		232,342	Receive 3.67% Pay 0.447%		Wtd. avg 2.6 yrs	Other assets/ Noninterest income		11,404
Interest rate lock commitments		129,015	NA		0.1 yrs	Other assets/ Noninterest income		438
Forward loan sale commitments		168,758	NA		0.1 yrs	Other assets/ Noninterest income		3,611
Total non-hedging derivative instruments		762,457
Total derivative instruments	$	1,120,319

Derivative Instruments Designated as Hedges:

The Company had derivative instruments with a notional amount of $106.9 million at December 31, 2011, which were designated as fair value hedges against the interest rate risk inherent in certain of its brokered certificates of deposits ("brokered CDs"). The CD swaps are used to convert the fixed rate paid on the brokered CDs to a variable rate based upon 3-month LIBOR computed on the notional amount. The fair value of these hedging derivative instruments is reported on the Consolidated Balance Sheets in other assets and the change in fair value of the related hedged brokered CD is reported as an adjustment to the carrying value of the brokered CDs. Total ineffectiveness on the interest rate swaps was $89,000 for the year ended December 31, 2011 and was recorded in noninterest income.

The Company had derivative instruments with a notional amount of $60.0 million at December 31, 2011, which were designated as fair value hedges against the interest rate risk inherent in certain callable brokered CDs. These swaps are used to convert the fixed rate paid on the callable brokered CDs to a variable rate based on 3-month LIBOR computed on the notional amount. The fair value of these hedging derivative instruments is reported on the Consolidated Balance Sheets in other assets and the change in fair value of the related hedged callable brokered CD is reported as an adjustment to the carrying value of the callable brokered CDs. Total ineffectiveness on these interest rate swaps was $292,000 for the year ended December 31, 2011 and was recorded in noninterest income.

The Company had $155.0 million of notional amount interest rate corridors at December 31, 2011, which were designated as cash flow hedges against certain borrowings. The corridors are used to reduce the variability in the interest paid on borrowings attributable to changes in 1-month LIBOR. The fair value of these hedging derivative instruments is reported on the Consolidated Balance Sheets in other assets and the change in fair value is recorded in OCI. There was no ineffectiveness on the interest rate corridors for the year ended December 31, 2011.

Non-hedging Derivative Instruments:

In order to accommodate customer borrowing needs, the Company enters into interest rate swap agreements with customers. At the same time, in order to offset the exposure and manage interest rate risk, the Company enters into an interest rate swap with a different counterparty with offsetting terms. These derivative instruments are not designated as accounting hedges and changes in fair value of these instruments, as well as any net cash settlements and upfront customer fees, are recognized in noninterest income as other derivative income or expense. As of December 31, 2011 and 2010, the Company had notional amounts of $413.1 million and $232.3 million, respectively, of interest rate swaps with customers where the Company has agreed to receive a fixed interest rate and pay a variable interest rate. In addition, as of December 31, 2011 and 2010, the Company has offsetting interest rate swaps with other counterparties with a notional amount of $413.1 million and $232.3 million, respectively, in which the Company has agreed to receive a variable interest rate and pay a fixed interest rate.

The Company enters into interest rate swaps as a part of Cole Taylor Mortgage's servicing business in order to minimize most of the price volatility of the mortgage services rights asset. At December 31, 2011, the Company had a notional amount of $22.5 million of interest rate swaps. These non-hedging derivatives are recorded at their fair value on the Consolidated Balance Sheets in other assets with changes in fair value recorded in noninterest income.

The Company also enters into interest rate lock and forward loan sale commitments as a part of Cole Taylor Mortgage's origination business. At December 31, 2011, the Company had notional amounts of $370.0 million of interest rate lock commitments and $352.6 million of forward loan sale commitments. These non-hedging derivatives are recorded at their fair value on the Consolidated Balance Sheets in other assets with changes in fair value recorded in noninterest income.

The Company enters into covered call option transactions from time to time that are designed primarily to increase the total return associated with the investment securities portfolio. There were no covered call options outstanding as of December 31, 2011 or December 31, 2010. In 2011, $178,000 of premium related to covered call options was recognized in noninterest income. No covered call options were entered into in 2010 and, therefore, there was no impact on the Company's Statement of Operations.

Terminated Derivative Instruments:

In January 2009, the Company terminated a $100.0 million notional amount interest rate swap that was not designated as an accounting hedge. The Company discontinued hedge accounting in December 2008 when it determined that this hedge would no longer be effective. The unrealized gain of $6.4 million upon de-designation, which had accumulated in OCI (net of tax), is being amortized to loan interest income over what would have been the life of the hedge. From the date of de-designation to December 31, 2008, the change in fair value, along with net settlements attributed to this period, was recorded in other derivative income in noninterest income and totaled $394,000. This derivative was terminated in January 2009 and the Company received a cash payment $6.6 million, which represented the fair value of the swap at the date of termination. At December 31, 2011 the net settlement had been completely amortized and there is no longer any amount remaining in accumulated OCI. This compares to December 31, 2010 when the Company had $761,000 in accumulated OCI related to previously terminated cash flow hedges. The amount in accumulated OCI represented the net unamortized portion of the deferred gain that had accumulated in OCI when the hedging relationship was terminated. During 2011 and 2010, $1.2 million and $3.2 million of deferred gains from previously terminated cash flow hedges were amortized as a net increase to loan interest income.

Hedges with the notional amount of $145.0 million were terminated in 2011, with net termination fees of $896,000 recognized in noninterest income for the year ended December 31, 2011. These hedges were terminated because the transaction which they hedged was no longer forecast to occur.