DERIVATIVE FINANCIAL INSTRUMENTS

3 Months Ended

Mar. 31, 2012

DERIVATIVE FINANCIAL INSTRUMENTS

DERIVATIVE FINANCIAL INSTRUMENTS

NOTE 6 — DERIVATIVE FINANCIAL INSTRUMENTS

The following table summarizes the fair value and balance sheet classification of derivative instruments as of March 31, 2012 and December 31, 2011. The notional amount of the contract is not recorded on the condensed consolidated balance sheets, but is used as the basis for determining the amount of interest payments to be exchanged between the counterparties. If the counterparty fails to perform, the Company’s counterparty credit risk is equal to the amount reported as a derivative asset. The valuation methodology of derivative instruments is disclosed in Note 3 to the Company’s condensed consolidated financial statements presented elsewhere in this report.

	Fair Values of Derivative Instruments
	March 31, 2012						December 31, 2011
	Notional		Derivative		Derivative		Notional		Derivative		Derivative
	Amount		Assets (1)		Liabilities (1)		Amount		Assets (1)		Liabilities (1)
	(In thousands)
Derivatives designated as hedging instruments:
Interest rate swaps on certificates of deposit—fair value	$	200,000	$	766	$	1,109	$	200,000	$	998	$	639
Total derivatives designated as hedging instruments	$	200,000	$	766	$	1,109	$	200,000	$	998	$	639
Derivatives not designated as hedging instruments:
Equity swap agreements	$	22,709	$	204	$	204	$	22,709	$	202	$	204
Foreign exchange options	85,614		4,695		2,918		85,614		3,899		2,430
Interest rate swaps	533,735		17,666		17,999		485,196		19,476		19,924
Short-term foreign exchange contracts	200,898		2,045		1,561		210,295		1,403		967
Short-term call option	150,000		—		1,500		—		—		—
Total derivatives not designated as hedging instruments	$	992,956	$	24,610	$	24,182	$	803,814	$	24,980	$	23,525

(1)Derivative assets, which are a component of other assets, include the estimated  settlement of the derivative asset position. Derivative liabilities, which are a component of other liabilities and deposits, include the estimated settlement of the derivative liability position.

Derivatives Designated as Hedging Instruments

Interest Rate Swaps on Certificates of Deposit— The Company is exposed to changes in the fair value of certain of its fixed-rate certificates of deposit due to changes in the benchmark interest rate, LIBOR. During 2011, the Company entered into four $50.0 million receive-fixed, pay-variable interest rate swaps with major brokerage firms as fair value hedges of four $50.0 million fixed-rate certificates of deposit with the same maturity dates. Interest rate swaps designated as fair value 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 the exchange of the underlying notional amount. As of March 31, 2012 and December 31, 2011 the total notional amount of the interest rate swaps on the certificates of deposit was $200.0 million and $200.0 million, respectively. The fair value of the interest rate swaps amounted to a $766 thousand asset and $1.1 million liability, respectively, as of March 31, 2012. The fair value of the interest rate swaps amounted to a $998 thousand asset and $639 thousand liability, respectively, as of December 31, 2011.  During the three months ended March 31, 2012, the Company recognized an increase of $848 thousand in expense related to hedge ineffectiveness. The Company also recognized a net reduction to interest expense of $1.5 million for the three months ended March 31, 2012 related to net settlements on the derivatives.

Derivatives Not Designated as Hedging Instruments

Equity Swap Agreements—In December 2007, the Company entered into two equity swap agreements with a major investment brokerage firm to economically hedge against market fluctuations in a promotional equity index certificate of deposit product offered to bank customers which has a term of 5 years and pays interest based on the performance of the HSCEI. Under ASC 815, a certificate of deposit that pays interest based on changes in an equity index is a hybrid instrument with an embedded derivative (i.e. equity call option) that must be accounted for separately from the host contract (i.e. the certificate of deposit). In accordance with ASC 815, both the embedded equity call options on the certificates of deposit and the freestanding equity swap agreements are marked-to-market each reporting period with resulting changes in fair value recorded in the condensed consolidated statements of income. As of March 31, 2012 and December 31, 2011, the notional amounts of the equity swap agreements totaled $22.7 million and $22.7 million, respectively.

The fair values of the equity swap agreements and embedded derivative liability for these derivative contracts amounted to $204 thousand asset and $204 thousand liability, respectively, as of March 31, 2012, compared to $202 thousand asset and $204 thousand liability, respectively, as of December 31, 2011.

Foreign Exchange Options—During 2010, the Company entered into foreign exchange option contracts with major brokerage firms to economically hedge against currency exchange rate fluctuations in a certificate of deposit product available to bank customers. This product, which has a term of 5 years, pays interest based on the performance of the Chinese currency Renminbi (“RMB”) relative to the U.S. Dollar. Under ASC 815, a certificate of deposit that pays interest based on changes in currency exchange rates is a hybrid instrument with an embedded derivative that must be accounted for separately from the host contract (i.e. the certificate of deposit). In accordance with ASC 815, both the embedded derivative instruments and the freestanding foreign exchange option contracts are marked-to-market each reporting period with resulting changes in fair value reported in the condensed consolidated statements of income.

As of March 31, 2012 and December 31, 2011, the notional amount of the foreign exchange options totaled $85.6 million and $85.6 million, respectively. The fair values of the foreign exchange options and embedded derivative liability for these contracts amounted to a $4.7 million asset and a $2.9 million liability, respectively, as of March 31, 2012. The fair values of the foreign exchange options and embedded derivative liability for these contracts amounted to a $3.9 million asset and $2.4 million liability, respectively, as of December 31, 2011.

Short-term Call Option—In March 2012, the Company sold a call option to a major investment brokerage firm to buy $150.0 million of student loans with an expiration date of May 15, 2012. Due to the short-term nature of the option, its carrying value of $1.5 million liability approximates its fair value at March 31, 2012. As disclosed in Note 14 to the Company’s condensed consolidated financial statements, in April 2012, the investment brokerage firm exercised the option and the Company entered into a transaction to sell the student loans.

Interest Rate Swaps—Since the fourth quarter of 2010, the Company has entered into pay-fixed, receive-variable swap contracts with institutional counterparties to economically hedge against interest rate swap products offered to bank customers. This product allows borrowers to lock in attractive intermediate and long-term interest rates by entering into a pay-fixed, receive-variable swap contract with the Company, resulting in the customer obtaining a synthetic fixed rate loan. The Company does not assume any interest rate risk since the swap agreements mirror each other. As of March 31, 2012 and December 31, 2011 the notional amount of the interest rate swaps with the institutional counterparties totaled $533.7 million and $485.2 million, respectively. The interest rate swap agreements are marked-to-market each reporting period with resulting changes in fair value reported in the condensed consolidated statements of income.

The fair values of the interest rate swap contracts with the institutional counterparty and the bank customers amounted to a $17.7 million asset and $18.0 million liability, respectively, as of March 31, 2012. The fair values of the interest rate swap contracts with the institutional counterparty and the bank customers amounted to a $19.5 million asset and $19.9 million liability, respectively, as of December 31, 2011.

Short-term Foreign Exchange Contracts—The Company also enters into short-term forward foreign exchange contracts on a regular basis to economically hedge against foreign exchange rate fluctuations. As of March 31, 2012 and December 31, 2011 the notional amount of the foreign exchange contracts totaled $200.9 million and $210.3 million, respectively. The fair values of the foreign exchange contracts amounted to a $2.0 million asset and $1.6 million liability, respectively, as of March 31, 2012. The fair values of the foreign exchange contracts amounted to a $1.4 million asset and $967 thousand liability, respectively, as of December 31, 2011.

The table below presents the effect of the Company’s derivative financial instruments on the condensed consolidated statements of income for the three months ended March 31, 2012 and 2011:

		Three Months Ended
	Location in	March 31,
	Condensed Consolidated
	Statements of Income	2012		2011
		(In thousands)
Derivatives designated as hedging instruments
Interest rate swaps on certificates of deposit—fair value
	Interest expense	$	703	$	—
	Total net income	$	703	$	—
Derivatives not designated as hedging instruments
Equity swap agreements	Noninterest expense	$	2	$	2
Foreign exchange options	Noninterest income	253		(109		)
Foreign exchange options	Noninterest expense	55		18
Interest rate swaps	Noninterest income	115		(60		)
Short-term foreign exchange contracts	Noninterest income	48		8
Short-term call option		—		—
	Total net income (expense)	$	473	$	(141	)

Credit Risk-Related Contingent Features—The Company has agreements with some of 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.

The Company also has agreements with some of its derivative counterparties that contain a provision where 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. Similarly, the Company could be required to settle its obligations under certain of its agreements if the Company was issued a notice of prompt corrective action.

As of March 31, 2012, the termination value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $16.8 million. If the Company had breached any of these provisions at March 31, 2012, it could have been required to settle its obligations under the agreements at the termination value.