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DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 12 Months Ended
Dec. 31, 2016
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES [Text Block]

NOTE 31 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

One of the market risks facing the Corporation is interest rate risk, which includes the risk that changes in interest rates will result in changes in the value of the Corporation’s assets or liabilities and the risk that net interest income from its loan and investment portfolios will be adversely affected by changes in interest rates. The overall objective of the Corporation’s interest rate risk management activities is to reduce the variability of earnings caused by changes in interest rates.

The Corporation designates a derivative as a fair value hedge, cash flow hedge or economic undesignated hedge when it enters into the derivative contract. As of December 31, 2016 and 2015, all derivatives held by the Corporation were considered economic undesignated hedges. These undesignated hedges are recorded at fair value with the resulting gain or loss recognized in current earnings.

The following summarizes the principal derivative activities used by the Corporation in managing interest rate risk:

Interest rate cap agreements - Interest rate cap agreements provide the right to receive cash if a reference interest rate rises above a contractual rate. The value increases as the reference interest rate rises. The Corporation enters into interest rate cap agreements for protection from rising interest rates.

Forward Contracts - Forward contracts are sales of to-be-announced (“TBA”) mortgage-backed securities that will settle over the standard delivery date and do not qualify as “regular way” security trades. Regular-way security trades are contracts that have no net settlement provision and no market mechanism to facilitate net settlement and that provide for delivery of a security within the time frame generally established by regulations or conventions in the market place or exchange in which the transaction is being executed. The forward sales are considered derivative instruments that need to be marked to market. These securities are used to economically hedge the FHA/VA residential mortgage loan securitizations of the mortgage-banking operations. Unrealized gains (losses) are recognized as part of mortgage banking activities in the consolidated statement of income.

To satisfy the needs of its customers, the Corporation may enter into non-hedging transactions. On these transactions, the Corporation generally participates as a buyer in one of the agreements and as a seller in the other agreement under the same terms and conditions.

In addition, the Corporation enters into certain contracts with embedded derivatives that do not require separate accounting as these are clearly and closely related to the economic characteristics of the host contract. When the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, it is bifurcated, carried at fair value, and designated as a trading or non-hedging derivative instrument.

The following table summarizes the notional amounts of all derivative instruments:
Notional Amounts (1)
As of December 31,
20162015
(In thousands)
Undesignated economic hedges:
Interest rate contracts:
Written interest rate cap agreements$91,510$120,816
Purchased interest rate cap agreements91,510120,816
Forward Contracts:
Sale of TBA GNMA MBS pools33,00030,000
$216,020$271,632
(1) Notional amounts are presented on a gross basis with no netting of offsetting exposure positions.

The following table summarizes the fair value of derivative instruments and the location in the statement of financial conditions:
Asset DerivativesLiability Derivatives
Statement of Financial Condition LocationDecember 31, December 31, Statement of Financial Condition Location December 31, December 31,
2016201520162015
FairValueFairValueFairValueFairValue
(In thousands)
Undesignated economic hedges:
Interest rate contracts:
Written interest rate cap agreementsOther assets$-$-Accounts payable and other liabilities$552$798
Purchased interest rate cap agreementsOther assets554806Accounts payable and other liabilities--
Forward Contracts:
Sales of TBA GNMA MBS poolsOther assets--Accounts payable and other liabilities201123
$554$806$753$921

The following table summarizes the effect of derivative instruments on the statement of income:
Gain (or Loss)
Location of Gain (or loss)Year ended
Recognized in Income onDecember 31,
Derivatives201620152014
(In thousands)
Undesignated economic hedges:
Interest rate contracts:
Interest rate swap agreements Interest income - Loans$-$-$1,258
Written and purchased interest rate cap agreementsInterest income - Loans-139-
Forward contracts:
Sales of TBA GNMA MBS poolsMortgage Banking Activities(78)25(322)
Total (loss) gain on derivatives$(78)$164$936

Derivative instruments are subject to market risk. As is the case with investment securities, the market value of derivative instruments is largely a function of the financial market’s expectations regarding the future direction of interest rates. Accordingly, current market values are not necessarily indicative of the future impact of derivative instruments on earnings. This will depend, for the most part, on the shape of the yield curve, and the level of interest rates, as well as the expectations for rates in the future.

As of December 31, 2016, the Corporation has not entered into any derivative instrument containing credit-risk-related contingent features.

Credit and Market Risk of Derivatives

The Corporation uses derivative instruments to manage interest rate risk. By using derivative instruments, the Corporation is exposed to credit and market risk. If the counterparty fails to perform, credit risk is equal to the extent of the Corporation’s fair value gain in the derivative. When the fair value of a derivative instrument contract is positive, this generally indicates that the counterparty owes the Corporation and, therefore, creates a credit risk for the Corporation. When the fair value of a derivative instrument contract is negative, the Corporation owes the counterparty and, therefore, it has no credit risk. The Corporation minimizes its credit risk in derivative instruments by entering into transactions with reputable broker dealers (financial institutions) that are reviewed periodically by the Management Investment and Asset Liability Committee of the Corporation (“MIALCO”) and by the Board of Directors. The Corporation also maintains a policy of requiring that all derivative instrument contracts be governed by an International Swaps and Derivatives Association Master Agreement, which includes a provision for netting; most of the Corporation’s agreements with derivative counterparties include bilateral collateral arrangements. The bilateral collateral arrangement permits the counterparties to perform margin calls in the form of cash or securities in the event that the fair market value of the derivative favors either counterparty. The Corporation has a policy of diversifying derivatives counterparties to reduce the consequences of counterparty default.

The Corporation has credit risk of $0.6 million as of December 31, 2016 (2015 — $0.8 million) related to derivative instruments with positive fair values. The credit risk does not consider the value of any collateral and the effects of legally enforceable master netting agreements. There were no credit losses associated with derivative instruments recognized in 2016, 2015, or 2014.

Market risk is the adverse effect that a change in interest rates or implied volatility rates has on the value of a financial instrument. The Corporation manages the market risk associated with interest rate contracts by establishing and monitoring limits as to the types and degree of risk that may be undertaken.

The Corporation’s derivative activities are monitored by the MIALCO as part of its risk-management oversight of the Corporation’s treasury functions.