Derivative Instruments and Hedging Activities

12 Months Ended

Dec. 31, 2011

Derivative Instruments and Hedging Activities [Abstract]

Derivative Instruments and Hedging Activities

Note 16. 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 was entered into, the Company designated the derivative as a hedge of variable cash flows to be paid in conjunction with recognized 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 the interest rate swap to reduce interest rate risks and to manage interest income.  The Company entered into an interest rate swap agreement on July 1, 2010 to manage the interest rate expense on its Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036.  By entering into this agreement, the Company converts a floating rate liability into a fixed rate liability through 2020.  Under the terms of the agreement, the Company receives interest quarterly at the rate equivalent to three month LIBOR plus 1.70% repricing every three months on the same date as the Company's Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036 and pays interest expense monthly at the fixed rate of 4.91%. The net interest expense on the interest rate swap was $117,238 for 2011 and $34,673 for 2010.

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 to floating rate through 2021.  The Company receives interest monthly at the rate equivalent to one-month LIBOR plus 3.55% repricing on the same date as the loans and pays interest at the fixed rate of 5.875%. The net interest income on the interest rate swaps was a reduction of $31,130 in 2011.

Interest differentials paid or received under the swap agreements are reflected as adjustments to interest income (commercial loan swaps) and interest expense (debentures).  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 December 31, 2011 and 2010 are as follows:

(In thousands except as noted)		December 31, 2011
Derivatives designated as hedging instruments		Notional/ Contract Amount		Estimated Net Fair Value		Fair Value Balance Sheet Location	Expiration Date
2010 Interest rate swap-10 year cash flow	$	4,000	$	(452	)	Other Liabilities	9/15/2020
2011 Interest rate swap-10 year cash flow		2,117		88		Other Assets	8/15/2021
2011 Interest rate swap-10 year cash flow		2,245		91		Other Assets	8/15/2021

	December 31, 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)
2010 Interest rate swap-10 year cash flow	$	(311	)	Not applicable	$	-
2011 Interest rate swap-10 year cash flow		58		Not applicable		-
2011 Interest rate swap-10 year cash flow		60		Not applicable		-
	$	(193	)		$	-

	December 31, 2010
Derivatives designated as hedging instruments	Notional/ Contract Amount		Estimated Net Fair Value		Fair Value Balance Sheet Location	Expiration Date
2010 Interest rate swap-10 year cash flow	$	4,000	$	19	Other Assets	9/15/2020

	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	$	-