Derivative Instruments and Hedging Activities

9 Months Ended

Sep. 30, 2011

Derivative Instruments and Hedging Activities [Abstract]

Derivative Instruments and Hedging Activities

Note 5. Derivative Instruments and Hedging Activities

U. S. GAAP requires that all derivatives be recognized in the Consolidated Financial Statements at their fair values.  On the date that the derivative contract is entered into, the Company designates the derivative as a hedge of variable cash flows to be paid or received in conjunction with recognized assets or liabilities, or a cash-flow hedge. For a derivative treated as a cash flow hedge, the ineffective portion of changes in fair value is reported in current period earnings.  The effective portion of the cash flow hedge is recorded as an adjustment to the hedged item through other comprehensive income.

The Company formally assesses, both at the hedges' inception, and on an on-going basis, whether derivatives used in hedging transactions have been highly effective in offsetting changes in cash flows of hedged items and whether those derivatives are expected to remain highly effective in subsequent periods.  The Company discontinues hedge accounting when (a) it determines that a derivative is no longer effective in offsetting changes in cash flows of a hedged item; (b) the derivative expires or is sold, terminated or exercised; (c) probability exists that the forecasted transaction will no longer occur; or (d) management determines that designating the derivative as a hedging instrument is no longer appropriate.  In all cases in which hedge accounting is discontinued and a derivative remains outstanding, the Company will carry the derivative at fair value in the Consolidated Financial Statements, recognizing changes in fair value in current period income in the consolidated statement of income.

The Company follows generally accepted accounting principles, FASB ASU 815-10-50 “Disclosures about Derivative Instruments and Hedging Activities”, which includes the disclosure requirements for derivative instruments and hedging activities to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance and cash flows.

The Bank uses interest rate swaps to reduce interest rate risks and to manage net interest income.  The Company entered into an interest rate swap agreement on July 1, 2010 to manage the interest rate exposure on its Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036.  By entering into this agreement, the Company converts a floating rate liability priced at three-month LIBOR plus 1.70% into a fixed rate liability priced at 4.91% through 2020.  Under the terms of the agreement, the Company receives interest quarterly at the rate equivalent to three month LIBOR repricing every three months on the same date as the Company's Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036 and pays interest monthly at the fixed rate shown below.  The net interest expense on the interest rate swap was $30,122 for quarter ended September 30, 2011 and $88,623 for the nine months ended September 30, 2011.

The Company also entered into two swap agreements dated August 15, 2011 to manage the interest rate risk related to two commercial loans.  The agreements allow the Company to convert fixed rate assets priced at 5.875% through 2021 to floating rate assets priced at one-month LIBOR plus 3.55%.  The Company receives interest monthly at the rate equivalent to one-month LIBOR on the loans and pays interest at the fixed rate shown below.   The net interest income loss on the interest rate swap was $14,773 for quarter and nine months ended September 30, 2011.

Interest differentials paid or received under the swap agreements are reflected as adjustments to interest income.  These interest rate swap agreements are considered cash flow hedge derivative instruments that qualify for hedge accounting.  The notional amounts of the interest rate swaps are not exchanged and do not represent exposure to credit loss.  In the event of default by a counter party, the risk in these transactions is the cost of replacing the agreements at current market rates.

The effects of derivative instruments on the Consolidated Financial Statements for September 30, 2011 and December 31, 2010 are as follows:

(In thousands except as noted)	September 30, 2011
Derivatives designated as hedging instruments	Notional/ Contract Amount		Estimated Net Fair Value			Fair Value Balance Sheet Location	Expiration Date	Fixed Rate
Interest rate swap-10 year cash flow	$	4,000	$	(433	)	Other Liabilities	9/15/2020		3.21	%
Interest rate swap-10 year cash flow		2,219		70		Other Assets	8/15/2021		2.325	%
Interest rate swap-10 year cash flow		2,259		72		Other Assets	8/15/2021		2.325	%
	$	8,388	$	(291	)

	September 30, 2011
Derivatives in cash flow hedging relationships	Amount of Gain (Loss) Recognized in OCI on Derivatives, net of tax (Effective Portion)			Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion)	Amount of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion)
Interest rate swap-10 year cash flow	$	(298	)	Not applicable	$	-
Interest rate swap-10 year cash flow		46		Not applicable		-
Interest rate swap-10 year cash flow		48		Not applicable		-
	$	(204	)		$	-

	December 31, 2010
	Notional/ Contract Amount		Estimated Net Fair Value		Fair Value Balance Sheet Location	Expiration Date	Fixed Rate
Interest rate swap-10 year cash flow	$	4,000	$	19	Other Assets	9/15/2020		3.21	%

	December 31, 2010
Derivatives in cash flow hedging relationships	Amount of Gain (Loss) Recognized in OCI on Derivatives, net of tax (Effective Portion)		Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion)	Amount of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion)
Interest rate swap-10 year cash flow	$	12	Not applicable	$	-