10. Derivatives

ASC 815 contains the authoritative guidance on accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. As required by ASC 815, the Company records all derivatives on the consolidated balance sheets at fair value.

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 and the use of derivative financial instruments. 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 unknown 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 its known or expected cash payments principally related to certain variable-rate loan assets and variable-rate borrowings. The Company also enters into derivative financial instruments to protect against adverse changes in fair value on fixed-rate loans.

The Company’s objective in using derivatives is to minimize the impact of interest rate fluctuations on the Company’s net interest income. To accomplish this objective, the Company uses interest-rate swaps as part of its cash flow hedging strategy. The Company also offers an interest rate hedge program that includes various derivative products, including swaps, to assist its customers in managing their interest rate risk profile. In order to eliminate the interest-rate risk associated with offering these products, the Company enters into derivative contracts with third parties to offset the customer contracts. These customer accommodation interest rate swap contracts are not designated as hedging instruments.

The Company has also expanded its product offering by adding international banking products, which exposes the Company to foreign exchange risk. The Company utilizes foreign exchange forward contracts to manage the risk associated with fluctuation in foreign exchange rates.

The Company has agreements with its derivative counterparties that contain a provision where 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. Also, the Company has agreements with certain of its derivative counterparties that contain a provision where if the Bank fails to maintain its status as a well or adequately capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements.

At December 31, 2016, the fair value of derivatives in a net liability position, including accrued interest but excluding any adjustment for nonperformance risk, related to these agreements was $9.5 million. The Company has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral of $9.7 million against its obligations under these agreements. At December 31, 2016, the Company was not in default with any of its debt or capitalization covenants.

The table below presents the fair value of the Company’s derivative financial instruments as well as the classification within the consolidated balance sheets.


	Asset derivatives					Liability derivatives
		Fair value at December 31,					Fair value at December 31,
	Balance sheet					Balance sheet
(in thousands)	classification	2016		2015		classification	2016		2015

Derivatives designated as hedging instruments under ASC 815:
Cash flow hedge interest rate swap	Other assets	$	-	$	578	Accrued interest and other liabilities	$	7,639	$	4,981
Fair value hedge interest rate swap	Other assets		476		117	Accrued interest and other liabilities		845		1,574

Derivatives not designated as hedging instruments under ASC 815:
Interest rate swap	Other assets	$	2,755	$	3,092	Accrued interest and other liabilities	$	2,736	$	3,275
Foreign exchange forward contracts	Other assets		52		109	Accrued interest and other liabilities		5		59

The tables below include information about financial instruments and collateral that are eligible for offset.


	At December 31, 2016
	Gross		Gross				Gross amounts not offset
	amounts of		amounts				Financial				Net
(in thousands)	recognized assets		offset		Net amounts		Instruments		Collateral		Amount
Derivatives designated as hedges(1)	$	476	$	-	$	476	$	(476)	$	-	$	-
Derivatives not designated as hedges(1)		2,807		-		2,807		(967)		-		1,840
Total	$	3,283	$	-	$	3,283	$	(1,443)	$	-	$	1,840


	At December 31, 2016
	Gross		Gross				Gross amounts not offset
	amounts of		amounts				Financial				Net
(in thousands)	recognized liabilities		offset		Net amounts		Instruments		Collateral		Amount
Derivatives designated as hedges(2)	$	(8,484)	$	-	$	(8,484)	$	476	$	8,008	$	-
Derivatives not designated as hedges(2)		(2,741)		-		(2,741)		967		1,668		(106)
Securities sold under agreements to repurchase(3)		(27,639)		-		(27,639)		-		27,639		-
Total	$	(38,864)	$	-	$	(38,864)	$	1,443	$	37,315	$	(106)


	At December 31, 2015
	Gross		Gross				Gross amounts not offset
	amounts of		amounts				Financial				Net
(in thousands)	recognized assets		offset		Net amounts		Instruments		Collateral		Amount
Derivatives designated as hedges(1)	$	695	$	-	$	695	$	(316)	$	-	$	379
Derivatives not designated as hedges(1)		3,201		-		3,201		(88)		-		3,113
Total	$	3,896	$	-	$	3,896	$	(404)	$	-	$	3,492


	At December 31, 2015
	Gross		Gross				Gross amounts not offset
	amounts of		amounts				Financial				Net
(in thousands)	recognized liabilities		offset		Net amounts		Instruments		Collateral		Amount
Derivatives designated as hedges(2)	$	(6,555)	$	-	$	(6,555)	$	316	$	6,239	$	-
Derivatives not designated as hedges(2)		(3,334)		-		(3,334)		88		2,935		(311)
Securities sold under agreements to repurchase(3)		(47,459)		-		(47,459)		-		47,459		-
Total	$	(57,348)	$	-	$	(57,348)	$	404	$	56,633	$	(311)

(1)

Included in other assets

(2)

Included in accrued interest and other liabilities

(3)

Separately stated in consolidated balance sheets

Cash Flow Hedges of Interest Rate Risk — For hedges of the Company’s variable-rate loan assets, interest-rate swaps designated as cash flow hedges involve the receipt of fixed-rate amounts from a counterparty in exchange for the Company making variable-rate payments over the life of the agreements without exchange of the underlying notional amount.

During the first quarter of 2016, the Company terminated five interest rate swaps with a notional value of $75.0 million that had fixed the interest rate on a portion of its 1-month LIBOR loan portfolio. Upon termination, the Company had an unrealized gain of $1.3 million in AOCI. The unrealized gain will continue to be reported in AOCI, and will be reclassified to interest income over a period of three years. In October 2016, the Company entered into two interest rate swaps to hedge the risk of changes in cash flow on its LIBOR-based loan portfolio. The interest rate swaps have a weighted average term of six years and have a combined notional value of $100.0 million. The Company will pay a variable rate based on 1-month LIBOR and receive a weighted average fixed-rate of 1.23%.

For hedges of the Company’s variable-rate borrowings, interest-rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments. The Company has executed a series of interest-rate swap transactions in order to fix the effective interest rate for payments due on its junior subordinated debentures with the objective of reducing the Company’s exposure to adverse changes in cash flows relating to payments on its LIBOR-based floating rate debt. Select critical terms of the cash flow hedges are as follows:


(in thousands)	Notional		Fixed-rate		Termination date
Hedged item - Junior subordinated debentures issued by:
CoBiz Statutory Trust I	$	20,000	4.99	%	March 17, 2022
CoBiz Capital Trust II	$	30,000	5.99	%	April 23, 2020
CoBiz Capital Trust III	$	20,000	5.02	%	March 30, 2024

Based on the Company’s ongoing assessments (including at inception of the hedging relationship), it is probable that there will be sufficient variable interest payments through the maturity date of the swaps. The Company also monitors the risk of counterparty default on an ongoing basis. The Company uses a regression analysis and the “Hypothetical Derivative” method described in ASC 815 for both prospective and retrospective assessments of hedge effectiveness on a quarterly basis. The Company also uses the Hypothetical Derivative methodology to measure hedge ineffectiveness each period. The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in AOCI and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. The Company’s derivatives did not have any hedge ineffectiveness recognized in earnings during the years ended December 31, 2016, 2015 and 2014.

Amounts reported in AOCI related to derivatives will be reclassified to interest income as interest payments are received/paid on the Company’s variable-rate assets. Payments received/paid on variable-rate liabilities will be reclassified to interest expense. During the next 12 months, the Company estimates that $0.8 million and $1.3 million will be reclassified as an increase to interest income and interest expense, respectively.

Fair Value Hedges of Fixed-Rate Assets – The Company is exposed to changes in the fair value of certain of its fixed-rate assets due to changes in benchmark interest rates based on LIBOR. The Company uses interest rate swaps to manage its exposure to changes in fair value on certain fixed-rate loans. Interest rate swaps designated as fair value hedges involve the receipt of variable-rate payments from a counterparty in exchange for the Company’s fixed-rate payments over the life of the agreements without the exchange of the underlying notional amount. Certain interest-rate swaps met the criteria to qualify for the shortcut method of accounting. Under the shortcut method of accounting no ineffectiveness is assumed. For interest-rate swaps not accounted for under the shortcut method, the Company performs ongoing retrospective and prospective effectiveness assessments (including at inception) using a regression analysis to compare periodic changes in fair value of the swaps to periodic changes in fair value of the fixed-rate loans attributable to changes in the benchmark interest rate. At December 31, 2016, the Company had interest rate swaps with a notional amount of $55.4 million used to hedge the change in the fair value of ten commercial loans. At December 31, 2015, the Company had interest rate swaps with a notional amount of $55.1 million used to hedge the change in the fair value of nine commercial loans. For derivatives that are designated and qualify as fair value hedges that are not accounted for under the shortcut method, the gain or loss on the derivative as well as the gain or loss on the hedged item attributable to the hedged risk are recognized in earnings. The net amount recognized in noninterest expense during the years ended December 31, 2016, 2015 and 2014 representing hedge ineffectiveness was immaterial.

Non-designated Hedges — Derivatives not designated as hedges are not speculative and primarily result from a service the Company provides to its customers. The Company executes interest-rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest-rate swaps are simultaneously hedged by offsetting 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. At December 31, 2016, the Company had 96 interest-rate swaps with an aggregate notional amount of $247.6 million related to this program. Gains and losses arising from changes in the fair value of these swaps are included in “Other income” in the consolidated statement of operations. During the years ending December 31, 2016, 2015 and 2014, the Company recorded immaterial gains and losses.

The Company’s product offerings also include international banking products that create foreign currency exchange-rate risk exposure. At December 31, 2016, the Company’s foreign currency held include the British pound; Euro; Swiss franc; Mexican peso; Japanese yen; and Australian, Canadian and New Zealand dollars. In order to economically reduce the risk associated with the fluctuation of foreign exchange rates, the Company utilizes short-term foreign exchange forward contracts to lock in exchange rates so the gain or loss on the forward contracts approximately offsets the transaction gain or loss. These contracts are not designated as hedging instruments. Ineffectiveness in the economic hedging relationship may occur as the foreign currency holdings are revalued based upon changes in the currency’s spot rate, while the forward contracts are revalued using the currency’s forward rates. Forward contracts in gain positions are recorded at fair value in ‘other’ assets, while contracts in loss positions are recorded in ‘other’ liabilities in the consolidated balance sheets. Net changes in the fair value of the forward contracts are recognized through earnings, and are included in “Other income” in the consolidated statement of operations. At December 31, 2016, the Company had entered into forward contracts with a notional amount of $4.5 million that mature in the first half of 2016. During the years ending December 31, 2016, 2015 and 2014, the Company recorded immaterial gains and losses.