NOTE 6 — DERIVATIVE FINANCIAL INSTRUMENTS AND BALANCE SHEET OFFSETTING

The following table summarizes the fair value and balance sheet classification of derivative instruments as of September 30, 2013 and December 31, 2012. 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
	September 30, 2013						December 31, 2012
	Notional Amount		Derivative Assets (1)		Derivative Liabilities (1)		Notional Amount		Derivative Assets (1)		Derivative Liabilities (1)
	(In thousands)
Derivatives designated as hedging instruments:
Interest rate swaps on certificates of deposit—fair value	$	105,000	$	—	$	8,312	$	50,000	$	—	$	1,521
Total derivatives designated as hedging instruments	$	105,000	$	—	$	8,312	$	50,000	$	—	$	1,521

Derivatives not designated as hedging instruments:
Foreign exchange options	$	85,614	$	5,955	$	3,511	$	85,614	$	5,011	$	3,052
Interest rate swaps	1,496,204		25,931		24,675		1,190,793		36,943		36,799
Short-term foreign exchange contracts	291,876		4,068		2,054		112,459		896		688
Total derivatives not designated as hedging instruments	$	1,873,694	$	35,954	$	30,240	$	1,388,866	$	42,850	$	40,539

(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. In the first nine months of 2013, the Company entered into three receive-fixed, pay-variable interest rate swaps and one receive-fixed pay-variable interest rate swap -steepener, with major brokerage firms, with a total notional amount of $55.0 million. The interest rate swaps were entered into as a fair value hedge of three fixed rate certificates of deposit and one fixed/variable certificate of deposit, for a total amount of $55.0 million, 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 September 30, 2013 and December 31, 2012 the total notional amount of the interest rate swaps on the certificates of deposit was $105.0 million and $50.0 million, respectively. The fair value of the interest rate swaps amounted to an $8.3 million and $1.5 million liability, respectively, as of September 30, 2013 and December 31, 2012. During the three and nine months ended September 30, 2013, the Company recognized a net reduction of $514 thousand and $817 thousand, respectively, in expense related to hedge ineffectiveness. The Company also recognized a net reduction to interest expense of $894 thousand and $1.8 million, respectively, for the three and nine months ended September 30, 2013 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. These equity swap agreements matured during the fourth quarter of 2012.

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 September 30, 2013 and December 31, 2012, the notional amount of the foreign exchange options totaled $85.6 million. The fair values of the foreign exchange options and embedded derivative liability for these contracts amounted to a $6.0 million asset and a $3.5 million liability, as of September 30, 2013. The fair values of the foreign exchange options and embedded derivative liability for these contracts amounted to a $5.0 million asset and a $3.1 million liability, as of December 31, 2012. The Company did not deliver collateral, in the form of securities to counterparty institutions as of September 30, 2013. The Company delivered collateral, in the form of securities to counterparty institutions, valued at $940 thousand, for foreign exchange option contracts that were in a net liability position as of December 31, 2012.

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 September 30, 2013 the total notional amount of the interest rate swaps, including mirror transactions, with the institutional counterparties and the bank customers totaled $1.50 billion asset and $1.57 billion liability. In comparison, as of December 31, 2012, the total notional amount of the interest rate swaps, including mirror transactions, with the institutional counterparties and the bank customers totaled $1.19 billion asset and $1.19 billion liability. 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 counterparties and the bank customers amounted to a $25.9 million asset and a $24.7 million liability, as of September 30, 2013. The fair values of the interest rate swap contracts with the institutional counterparty and the bank customers amounted to a $36.9 million asset and a $36.8 million liability, as of December 31, 2012.

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 September 30, 2013 and December 31, 2012 the notional amount of the foreign exchange contracts totaled $291.9 million and $112.5 million, respectively. The fair values of the foreign exchange contracts amounted to a $4.1 million asset and a $2.1 million liability, as of September 30, 2013. The fair values of the foreign exchange contracts amounted to an $896 thousand asset and a $688 thousand liability, as of December 31, 2012. The gross aggregate value of the short-term foreign exchange contracts by counterparty was a asset of $1.6 million as of September 30, 2013 and an asset of $495 thousand as of December 31, 2012.

The table below presents the effect of the change in fair value for the Company’s derivative financial instruments on the condensed consolidated statements of income for the three and nine months ended September 30, 2013 and 2012:

	Location in	Three Months Ended						Nine Months Ended
	Condensed Consolidated	September 30,						September 30,
	Statements of Income	2013			2012			2013			2012
		(In thousands)
Derivatives designated as hedging instruments
Interest rate swaps on certificates of deposit—fair value	Interest expense	$	(1,481	)	$	(741	)	$	(6,196	)	$	(399	)
	Total net (expense) income	$	(1,481	)	$	(741	)	$	(6,196	)	$	(399	)
Derivatives not designated as hedging instruments
Equity swap agreements	Noninterest expense	$	—		$	—		$	—		$	2
Foreign exchange options	Noninterest income	234			(28		)	472			83
Foreign exchange options	Noninterest expense	7			16			13			90
Interest rate swaps	Noninterest income	(968		)	296			1,112			(12		)
Short-term foreign exchange contracts	Noninterest income	2,568			(20		)	1,806			131
	Total net income (expense)	$	1,841		$	264		$	3,403		$	294

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.

Balance Sheet Offsetting — The Company has entered into agreements with all counterparty financial institutions, which include master netting agreements. However, the Company elects to account for all derivatives with counterparty institutions on a gross basis, excluding the foreign exchange options which are not under agreements that include master netting terms. The Company has also entered into securities purchased under resale agreements (“resale agreements”), and securities sold under agreements to repurchase (“repurchase agreements”) which have master netting agreements that allow for the netting of collateral positions. These repurchase and resale agreements of securities are not eligible for offset in the consolidated balance sheet.

The following tables show the gross derivatives, resale agreements and repurchase agreements in the consolidated balance sheets and each the respective collateral received or pledged in the form of other financial instruments, which are generally marketable securities. The collateral amounts in these tables are limited to the outstanding balances of the related asset or liability (after netting is applied); thus instances of overcollateralization are not shown. Most of the assets and liabilities in the following tables were transacted under master netting arrangements that contain a conditional right of offset, such as close-out netting, upon default. Collateral accepted or pledged in resale and repurchase agreements with other financial institutions also may be sold or re-pledged by the secured party, but is usually delivered to and held by third party trustees.

The Company delivered collateral, in the form of securities to counterparty institutions, for derivatives that were in a net liability position as of September 30, 2013 and December 31, 2012 (refer to the table below). Under the Dodd-Frank legislation, as of June 10, 2013, the Company must clear all LIBOR interest rate swaps through a clearing house. As such the Company is required to pledge cash collateral for the margin. As of September 30, 2013 the Company posted $264 thousand of cash collateral. As of December 31, 2012, the Company did not receive or pledge cash collateral and there were no net asset positions with respect to collateral.


	As of September 30, 2013
	(In thousands)
			Gross Amounts Offset in the Condensed		Net Amounts of Assets		Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
	Gross Amounts of Recognized Assets		Consolidated Balance Sheets		Presented in the Condensed Consolidated Balance Sheets		Financial Instruments			Collateral Received			Net Amount
Assets
Derivatives	$	8,224	$	—	$	8,224	$	(5,363	)	$	(2,861	)	$	—
Resale Agreements	$	1,400,000	$	—	$	1,400,000	$	(545,000	)	$	(855,000	)	$	—

	Gross Amounts of		Gross Amounts Offset in the Condensed		Net Amounts of Liabilities		Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
	Recognized Liabilities		Consolidated Balance Sheets		Presented in the Condensed Consolidated Balance Sheets		Financial Instruments			Collateral Posted			Net Amount
Liabilities
Derivatives	$	29,722	$	—	$	29,722	$	(5,363	)	$	(24,359)		$	—
Repurchase Agreements	$	995,000	$	—	$	995,000	$	(545,000	)	$	(450,000	)	$	—

	As of December 31, 2012
	(In thousands)
			Gross Amounts Offset in the Condensed		Net Amounts of Assets		Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
	Gross Amounts of Recognized Assets		Consolidated Balance Sheets		Presented in the Condensed Consolidated Balance Sheets		Financial Instruments			Collateral Received			Net Amount
Assets
Derivatives	$	992	$	—	$	992	$	(366	)	$	(626	)	$	—
Resale Agreements	$	1,750,000	$	—	$	1,750,000	$	(545,000	)	$	(1,205,000	)	$	—

	Gross Amounts of		Gross Amounts Offset in the Condensed		Net Amounts of Liabilities		Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
	Recognized Liabilities		Consolidated Balance Sheets		Presented in the Condensed Consolidated Balance Sheets		Financial Instruments			Collateral Posted			Net Amount
Liabilities
Derivatives	$	38,513	$	—	$	38,513	$	(366	)	$	(38,147	)	$	—
Repurchase Agreements	$	995,000	$	—	$	995,000	$	(545,000	)	$	(450,000	)	$	—