Note 9 - Derivative and Hedging Transactions

12 Months Ended

Dec. 31, 2022

Notes to Financial Statements

Derivative Instruments and Hedging Activities Disclosure [Text Block]

Note 9. DERIVATIVE AND HEDGING TRANSACTIONS

Risk Management Objective of Using Derivatives

FNCB is exposed to certain risks arising from both its business operations and economic conditions.  It principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. FNCB 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, FNCB enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future unknown and uncertain cash amounts, the value of which are determined by interest rates.  Derivative financial instruments are used to manage differences in the amount, timing, and duration of known or expected cash payments primarily related to FNCB's borrowings. FNCB's existing credit derivatives result from loan participations arrangements, therefore, are not used to manage interest rate risk in FNCB's assets or liabilities.

Cash Flow Hedges of Interest Rate Risk

FNCB's objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements.  To accomplish this objective, FNCB primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for FNCB making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount, such derivatives were used to hedge the variable cash flows associated with forecasted issuances of debt in 2022 and 2021.

For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in accumulated other comprehensive income and subsequently reclassified into interest expense in the same period during which the hedged transaction affects earnings.  Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on FNCB's variable-rate debt.  During the next twelve months, it is estimated that an additional $604 thousand will be reclassified as a decrease to interest expense.

Non-designated Hedges

Derivatives not designated as hedges are not speculative and result from a service FNCB provides to certain customers.  FNCB 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 FNCB executes with a third party, such that FNCB 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. FNCB's existing credit derivatives result from participations out of interest rate swaps provided to external lenders as part of loan participation arrangements, therefor, are not used to manage interest rate risk in FNCB's assets or liabilities. Derivatives not designated as hedges are not speculative and result from a service FNCB provides to certain lenders which participate in loans.

Fair Values of Derivative Instruments on the Balance Sheet

The following table presents the fair value of FNCB's derivative financial instruments and the classification on the consolidated statements of financial condition at December 31, 2022 and December 31, 2021:

			Derivative Assets								Derivative Liabilities
			As of December 31, 2022			As of December 31, 2021					As of December 31, 2022			As of December 31, 2021
(in thousands)	Notional Amount		Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value		Notional Amount		Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments
Cash flow hedges	$	20,000	Other assets	$	1,173	Other assets	$	271	$	-	Other liabilities	$	-	Other liabilities	$	7
Total derivatives designated as hedging instruments					1,173			271					-			7
Derivatives not designated as hedging instruments
Interest rate swaps		6,922	Other assets		931	Other assets		92		6,922	Other liabilities		931	Other liabilities		92
Risk participation transaction		2,486			-			-					-			-
Total derivatives not designated as hedging instruments					931			92					931			92
Net Derivatives on the Balance Sheet					2,104			363					931			98
Gross amounts not offset in the Statement of Financial Position
Financial instruments					-			18					-			18
Cash collateral (1)					1,946			300					-			-
Net derivative amounts				$	158		$	45				$	931		$	80

(1) Other collateral represents the amount that cannot be used to offset our derivative assets and liabilities from a gross basis to a net basis in accordance with the applicable accounting guidance. The other collateral consist of securities and is exchanged under bilateral collateral and master netting agreements that allow us to offset the net derivative position with the related collateral. The application of the other collateral cannot reduce the net derivative position below zero. Therefore, excess other collateral, if any, is not reflected above.

Effect of Fair Value and Cash Flow Hedge Accounting on Accumulated Other Comprehensive Income

The following table presents the effect of fair value and cash flow hedge accounting on accumulated other comprehensive income as of December 31, 2022 and 2021. Amounts disclosed are gross and not net of taxes:

	Year Ended December 31, 2022
(in thousands)	Amount of Gain or (Loss) Recognized in OCI on Derivative		Amount of Gain or (Loss) Recognized in OCI Included Component		Amount of Gain or (Loss) Recognized in OCI Excluded Component		Location of Gain or (Loss) Recognized from Accumulated Other Comprehensive Income into Income	Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income		Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income Included Component		Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income Excluded Component
Derivatives in cash flow hedging relationships
Interest rate products	$	46	$	46	$	-	Interest expense	$	176	$	176	$	-
Total	$	46	$	46	$	-		$	176	$	176	$	-

	Year Ended December 31, 2021
(in thousands)	Amount of Gain or (Loss) Recognized in OCI on Derivative		Amount of Gain or (Loss) Recognized in OCI Included Component		Amount of Gain or (Loss) Recognized in OCI Excluded Component		Location of Gain or (Loss) Recognized from Accumulated Other Comprehensive Income into Income	Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income			Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income Included Component			Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income Excluded Component
Derivatives in cash flow hedging relationships
Interest rate products	$	168	$	168	$	-	Interest expense	$	(22	)	$	(22	)	$	-
Total	$	168	$	168	$	-		$	(22	)	$	(22	)	$	-

Effect of Fair Value and Cash Flow Hedge Accounting on the Statement of Income

The following table presents the effect of the FNCB's derivative financial instruments on the consolidated statements of income for the years ended December 31, 2022 and 2021:

	Location and Amount of Gain or (Loss) Recognized in Income on Fair Value and Cash Flow Hedging Relationships
	Year Ended
	December 31, 2022		December 31, 2021
(in thousands)	Interest Expense		Interest Expense
Total amounts of income and expense line items presented in the cash flow statement of financial performance in which the effects of fair value or hedges are recorded	$	176	$	(22	)
The effects of fair value and cash flow hedging:
Gain or (loss) on cash flow hedging relationships in Subtopic 815-20
Interest contracts:
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income	$	176	$	(22	)
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income as a result that a forecasted transaction is no longer probable of occurring	$	-	$	-
Amount of gain or (loss) reclassified from accumulated OCI into income - included component	$	176	$	(22	)
Amount of gain or (loss) reclassified from accumulated OCI into income - excluded component	$	-	$	-

Effect of Derivatives Not Designated as Hedging Instruments on the Statement of Income

Derivative financial instruments that are not designated as hedging instruments had no effect on the consolidated statements of income for the years ended  December 31, 2022 and 2021.

Credit-risk-related Contingent Features

FNCB has agreements with each of its derivative counterparties that contain a provision where if FNCB defaults or is capable of being declared in default on any of its indebtedness, then it could also be declared in its derivative obligations.  

FNCB has agreements with certain of its derivatives counterparties that contain a provision where if it fails to maintain its status as a well-capitalized institution, then it could be required to post additional collateral.

FNCB has minimum collateral posting thresholds with certain of its derivative counterparties for derivatives in a net liability position. As of December 31, 2022, FNCB had no derivatives in a net liability position and accordingly did not have to post any collateral.