Interest Rate Swap Derivatives

9 Months Ended

Sep. 30, 2017

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Interest Rate Swap Derivatives

Note 6. Interest Rate Swap Derivatives

The Company uses interest rate swap agreements to assist in its interest rate risk management. The Company’s objective in using interest rate derivatives designated as cash flow hedges is to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company entered into forward starting interest rate swaps in April 2015 as part of its interest rate risk management strategy intended to mitigate the potential risk of rising interest rates on the Bank’s cost of funds. The notional amounts of the interest rate swaps designated as cash flow hedges do not represent amounts exchanged by the counterparties, but rather, the notional amount is used to determine, along with other terms of the derivative, the amounts to be exchanged between the counterparties. The interest rate swaps are designated as cash flow hedges and involve the receipt of variable rate amounts from two counterparties in exchange for the Company making fixed payments beginning in April 2016. The Company’s intent is to hedge its exposure to the variability in potential future interest rate conditions on existing financial instruments.

As of September 30, 2017, the Company had three forward starting designated cash flow hedge interest rate swap transactions outstanding that had an aggregate notional amount of $250 million associated with the Company’s variable rate deposits. The net unrealized gain before income tax on the swaps was $167 thousand at September 30, 2017 compared to a net unrealized loss before income tax of $692 thousand at December 31, 2016. The net unrealized gain at September 30, 2017 compared to the net unrealized loss at December 31, 2016 is due to the increase in current market expectation of short term interest rates for the remaining term of the designated cash flow hedge interest rate swap.

For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings), net of tax, and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged transactions. The Company recognized an immaterial amount in earnings due to hedge ineffectiveness during both the nine month periods ended September 30, 2017 and September 30, 2016.

Amounts reported in accumulated other comprehensive income related to designated cash flow hedge derivatives will be reclassified to interest income/expense as interest payments are made/received on the Company’s variable-rate assets/liabilities. During the quarter ended September 30, 2017, the Company reclassified $307 thousand related to designated cash flow hedge derivatives from accumulated other comprehensive income to interest expense. During the next twelve months, the Company estimates (based on existing interest rates) that $657 thousand will be reclassified as an increase in interest expense.

The Company is exposed to credit risk in the event of nonperformance by the interest rate swap counterparty. The Company minimizes this risk by entering into derivative contracts with only large, stable financial institutions, and the Company has not experienced, and does not expect, any losses from counterparty nonperformance on the interest rate swaps. The Company monitors counterparty risk in accordance with the provisions of ASC Topic 815, “Derivatives and Hedging.” In addition, the interest rate swap agreements contain language outlining collateral-pledging requirements for each counterparty. Collateral must be posted when the market value exceeds certain threshold limits.

The designated cash flow hedge interest rate swap agreements detail: 1) that collateral be posted when the market value exceeds certain threshold limits associated with the secured party’s exposure; 2) 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; 3) if the Company fails to maintain its status as a well/adequately capitalized institution then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements.

As of September 30, 2017, the aggregate fair value of all designated cash flow hedge derivative contracts with credit risk contingent features (i.e., those containing collateral posting or termination provisions based on our capital status) were in a net asset position of $167 thousand (none of these contracts were in a net liability position as of September 30, 2017). As of September 30, 2017, the Company has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral of $890 thousand against its obligations under these agreements. If the Company had breached any provisions under the agreements at September 30, 2017, it could have been required to settle its obligations under the agreements at the termination value.

The table below identifies the balance sheet category and fair values of the Company’s designated cash flow hedge derivative instruments as of September 30, 2017 and December 31, 2016.

	Swap			Notional					Balance Sheet
September 30, 2017	Number			Amount		Fair Value			Category	Receive Rate	Pay Rate			Maturity
(dollars in thousands)
Interest rate swap		(1	)	$	75,000	$	116		Other Assets	1 month USD-LIBOR-BBA w/ -1 day lookback +10 basis points		1.71	%	March 31, 2020
Interest rate swap		(2	)		100,000		(24	)	Other Liabilities	Federal Funds Effective Rate +10 basis points		1.74	%	April 15, 2021
Interest rate swap		(3	)		75,000		75		Other Assets	1 month USD-LIBOR-BBA w/ -1 day lookback +10 basis points		1.92	%	March 31, 2022
		Total		$	250,000	$	167

	Swap			Notional					Balance Sheet
December 31, 2016	Number			Amount		Fair Value			Category	Receive Rate	Pay Rate			Maturity
(dollars in thousands)
Interest rate swap		(1	)	$	75,000	$	(197	)	Other Liabilities	1 month USD-LIBOR-BBA w/ -1 day lookback +10 basis points		1.71	%	March 31, 2020
Interest rate swap		(2	)		100,000		(514	)	Other Liabilities	Federal Funds Effective Rate +10 basis points		1.74	%	April 15, 2021
Interest rate swap		(3	)		75,000		19		Other Assets	1 month USD-LIBOR-BBA w/ -1 day lookback +10 basis points		1.92	%	March 31, 2022
		Total		$	250,000	$	(692	)

The table below presents the pre-tax net gains (losses) of the Company’s cash flow hedges for the nine months ended September 30, 2017 and for the year ended December 31, 2016.

				Nine Months Ended September 30, 2017
				Effective Portion							Ineffective Portion
							Reclassified from AOCI				Recognized in Income
				Amount of			into income				on Derivatives
	Swap			Pre-tax gain (loss)				Amount of				Amount of
	Number			Recognized in OCI			Category	Gain (Loss)			Category	Gain (Loss)
(dollars in thousands)
Interest rate swap		(1	)	$	116		Interest Expense	$	(338	)	Other Expense	$	—
Interest rate swap		(2	)		(24	)	Interest Expense		(525	)	Other Expense		—
Interest rate swap		(3	)		75		Interest Expense		(458	)	Other Expense		(1	)
		Total		$	167			$	(1,321	)		$	(1	)

				Year Ended December 31, 2016
				Effective Portion							Ineffective Portion
							Reclassified from AOCI				Recognized in Income
				Amount of			into income				on Derivatives
	Swap			Pre-tax gain (loss)				Amount of				Amount of
	Number			Recognized in OCI			Category	Gain (Loss)			Category	Gain (Loss)
(dollars in thousands)
Interest rate swap		(1	)	$	(197	)	Interest Expense	$	(628	)	Other Expense	$	—
Interest rate swap		(2	)		(514	)	Interest Expense		(880	)	Other Expense		—
Interest rate swap		(3	)		19		Interest Expense		(747	)	Other Expense		1
		Total		$	(692	)		$	(2,255	)		$	1

Balance Sheet Offsetting: Our designated cash flow hedge interest rate swap derivatives are eligible for offset in the Consolidated Balance Sheets and are subject to master netting arrangements. Our derivative transactions with counterparties are generally executed under International Swaps and Derivative Association (“ISDA”) master agreements which include “right of set-off” provisions. In such cases there is generally a legally enforceable right to offset recognized amounts and there may be an intention to settle such amounts on a net basis. The Company generally offsets such financial instruments for financial reporting purposes.

Nine Months Ended September 30, 2017
Offsetting of Derivative Liabilities (dollars in thousands)
										Gross Amounts Not Offset in the Balance Sheet
	Gross Amounts of Recognized Liabilities			Gross Amounts Offset in the Balance Sheet			Net Amounts of Liabilities presented in the Balance Sheet			Financial Instruments		Cash Collateral Posted			Net Amount
Counterparty 1	$	24		$	(75	)	$	(51	)	$	—	$	(560	)	$	(611	)
Counterparty 2		(116	)		—			(116	)		—		(330	)		(446	)
	$	(92	)	$	(75	)	$	(167	)	$	—	$	(890	)	$	(1,057	)

Year Ended December 31, 2016
Offsetting of Derivative Liabilities (dollars in thousands)
								Gross Amounts Not Offset in the Balance Sheet
	Gross Amounts of Recognized Liabilities		Gross Amounts Offset in the Balance Sheet			Net Amounts of Liabilities presented in the Balance Sheet		Financial Instruments		Cash Collateral Posted			Net Amount
Counterparty 1	$	514	$	(19	)	$	495	$	—	$	(380	)	$	115
Counterparty 2		197		—			197		—		(170	)		27
	$	711	$	(19	)	$	692	$	—	$	(550	)	$	142