NOTE 16.DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

At year-end 2014, the Company held derivatives with a total notional amount of $1 billion. That amount included $300 million in forward starting interest rate swap derivatives that were designated as cash flow hedges for accounting purposes. The Company also had economic hedges and non-hedging derivatives totaling $695.1 million and $39.6 million, respectively, which are not designated as hedges for accounting purposes and are therefore recorded at fair value with changes in fair value recorded directly through earnings. Economic hedges included interest rate swaps totaling $606.9 million, risk participation agreements with dealer banks of $45.8 million, and $42.4 million in forward commitment contracts.

As part of the Company’s risk management strategy, the Company enters into interest rate swap agreements to mitigate the interest rate risk inherent in certain of the Company’s assets and liabilities. Interest rate swap agreements involve the risk of dealing with both Bank customers and institutional derivative counterparties and their ability to meet contractual terms. The agreements are entered into with counterparties that meet established credit standards and contain master netting and collateral provisions protecting the at-risk party. The derivatives program is overseen by the Risk Management Committee of the Company’s Board of Directors. Based on adherence to the Company’s credit standards and the presence of the netting and collateral provisions, the Company believes that the credit risk inherent in these contracts was not significant at December 31, 2014.

The Company pledged collateral to derivative counterparties in the form of cash totaling $3.4 million and securities with an amortized cost of $22.8 million and a fair value of $23.1 million at year-end 2014. The Company does not typically require its commercial customers to post cash or securities as collateral on its program of back-to-back economic hedges. However certain language is written into the International Swaps Dealers Association, Inc. (“ISDA”) and loan documents where, in default situations, the Bank is allowed to access collateral supporting the loan relationship to recover any losses suffered on the derivative asset or liability. The Company may need to post additional collateral in the future in proportion to potential increases in unrealized loss positions.

Information about interest rate swap agreements and non-hedging derivative assets and liabilities at December 31, 2014 follows:

			Weighted					Estimated
	Notional		Average	Weighted Average Rate				Fair Value
December 31, 2014	Amount		Maturity	Received		Contract pay rate		Asset (Liability)
	(In thousands)		(In years)					(In thousands)
Cash flow hedges:
Forward-starting interest rate swaps on FHLBB borrowings	300,000		4.3	—		2.29	%	(3,299		)
Total cash flow hedges	300,000							(3,299		)

Economic hedges:
Interest rate swap on tax advantaged economic development bond	12,554		14.9	0.52	%	5.09	%	(2,578		)
Interest rate swaps on loans with commercial loan customers	297,158		6.0	2.23	%	4.54	%	(12,183		)
Reverse interest rate swaps on loans with commercial loan customers	297,158		6.0	4.54	%	2.23	%	12,221
Risk participation agreements with dealer banks	45,842		16.6					(91		)
Forward sale commitments	42,366		0.2					(510		)
Total economic hedges	695,078							(3,141		)

Non-hedging derivatives:
Interest rate lock commitments	39,589		0.2					625
Total non-hedging derivatives	39,589							625

Total	$	1,034,667						$	(5,815	)

Information about interest rate swap agreements and non-hedging derivative asset and liabilities at December 31, 2013 follows:

			Weighted					Estimated
	Notional		Average	Weighted Average Rate				Fair Value
December 31, 2013	Amount		Maturity	Received		Contract pay rate		Asset (Liability)
	(In thousands)		(In years)					(In thousands)
Cash flow hedges:
Interest rate swaps on FHLBB borrowings	$	150,000	2.5	0.25	%	2.61	%	$	(3,102	)
Forward-starting interest rate swaps on FHLBB borrowings	260,000		4.5	—		1.88	%	1,015
Interest rate swaps on junior subordinated notes	15,000		0.4	2.09	%	5.54	%	(203		)
Total cash flow hedges	425,000							(2,290		)

Economic hedges:
Interest rate swap on tax advantaged economic development bond	13,095		15.9	0.54	%	5.09	%	(1,889		)
Interest rate swaps on loans with commercial loan customers	206,933		5.4	2.44	%	4.68	%	(6,278		)
Reverse interest rate swaps on loans with commercial loan customers	206,933		5.4	4.68	%	2.44	%	6,286
Forward sale commitments	32,911		0.2					261
Total economic hedges	459,872							(1,620		)

Non-hedging derivatives:
Interest rate lock commitments	20,199		0.2					258
Total non-hedging derivatives	20,199							258

Total	$	905,071						$	(3,652	)

Cash Flow Hedges

The effective portion of unrealized changes in the fair value of derivatives accounted for as cash flow hedges is reported in other comprehensive income and subsequently reclassified to earnings in the same period or periods during which the hedged forecasted transaction affects earnings. Each quarter, the Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged item or transaction. The ineffective portion of changes in the fair value of the derivatives is recognized directly in earnings.

The Company has entered into six forward-starting interest rate swaps contracts with a combined notional value of $300.0 million as of year-end 2014. The six forward-starting swaps become effective in 2016 having durations of three years. This hedge strategy converts the one month rolling FHLBB borrowings based on the FHLBB’s one month fixed interest rate to fixed interest rates, thereby protecting the Company from floating interest rate variability.

Amounts included in the Consolidated Statements of Income and in the other comprehensive income section of the Consolidated Statements of Comprehensive Income (related to interest rate derivatives designated as hedges of cash flows), were as follows:

	Years Ended December 31,
(In thousands)	2014			2013

Interest rate swaps on FHLBB borrowings:
Unrealized (loss) gain recognized in accumulated other comprehensive loss	$	(6,405	)	$	11,783

Reclassification of unrealized (loss) from accumulated other comprehensive loss to interest expense	—			(3,620		)

Reclassification of unrealized loss from accumulated other comprehensive loss to other non-interest expense for termination of swaps	8,630			943

Reclassification of unrealized deferred tax (benefit) from accumulated other comprehensive loss to tax expense for terminated swaps	(3,611		)	(489		)

Net tax benefit (expense) on items recognized in accumulated other comprehensive loss	2,583			(3,276		)

Interest rate swaps on junior subordinated notes:
Unrealized (loss) recognized in accumulated other comprehensive loss	(1		)	(18		)

Reclassification of unrealized loss from accumulated other comprehensive loss to interest expense	204			519

Net tax expense on items recognized in accumulated other comprehensive loss	(80		)	(197		)
Other comprehensive income recorded in accumulated other comprehensive loss, net of reclassification adjustments and tax effects	$	1,320		$	5,645

Net interest expense recognized in interest expense on hedged FHLBB borrowings	$	—		$	4,374
Net interest expense recognized in interest expense on junior subordinated notes	$	204		$	519

Hedge ineffectiveness on interest rate swaps designated as cash flow hedges was immaterial to the Company’s financial statements during the year-ended December 31, 2014 and 2013.

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate liabilities. During the next twelve months, the Company does not anticipate any such reclassifications.

As a result of the branch acquisition, in the first quarter of 2014, the Company initiated and subsequently terminated all of its interest rate swaps, with various institutions, associated with FHLB advances with 3-month LIBOR based floating interest rates with an aggregate notional amount of $30 million, all of its interest rate swaps associated with 90 day rolling FHLB advances issued using the FHLB’s 3-month fixed interest rate with an aggregate notional amount of $145 million and all of its forward-starting interest rate swaps associated with 90 day rolling FHLB advances issued using the FHLB’s 3-month fixed interest rate with an aggregate notional amount of $235 million. In the first quarter of 2014, the Company elected to extinguish $215 million of FHLB advances related to the terminated swaps. As a result the Company reclassified $8.6 million of losses from the effective portion of the unrealized changes in the fair value of the terminated derivatives from other comprehensive income to non-interest income as the forecasted transactions to the related FHLB advances will not occur.

Economic hedges

As of December 31, 2014 the Company has an interest rate swap with a $12.6 million notional amount to swap out the fixed rate of interest on an economic development bond bearing a fixed rate of 5.09%, currently within the Company’s trading portfolio under the fair value option, in exchange for a LIBOR-based floating rate. The intent of the economic hedge is to improve the Company’s asset sensitivity to changing interest rates in anticipation of favorable average floating rates of interest over the 21-year life of the bond. The fair value changes of the economic development bond are mostly offset by fair value changes of the related interest rate swap.

The Company also offers certain derivative products directly to qualified commercial borrowers. The Company economically hedges derivative transactions executed with commercial borrowers by entering into mirror-image, offsetting derivatives with third-party financial institutions. The transaction allows the Company’s customer to convert a variable-rate loan to a fixed rate loan. Because the Company acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts mostly offset each other in earnings. Credit valuation adjustments arising from the difference in credit worthiness of the commercial loan and financial institution counterparties totaled $37.3 thousand at year-end 2014. The interest income and expense on these mirror image swaps exactly offset each other.

The Company has risk participation agreements with dealer banks. Risk participation agreements occur when the Company participates on a loan and a swap where another bank is the lead. The Company gets paid a fee to take on the risk associated with having to make the lead bank whole on Berkshire’s portion of the pro-rated swap should the borrower default.

The Company utilizes forward sale commitments to hedge interest rate risk and the associated effects on the fair value of interest rate lock commitments and loans held for sale. The forward sale commitments are accounted for as derivatives with changes in fair value recorded in current period earnings.

The company uses the following types of forward sale commitments contracts:

Best efforts loan sales,

Mandatory delivery loan sales, and

To be announced (TBA) mortgage-backed securities sales.

A best efforts contract refers to a loan sales agreement where the Company commits to deliver an individual mortgage loan of a specified principal amount and quality to an investor if the loan to the underlying borrower closes. The Company may enter into a best efforts contract once the price is known, which is shortly after the potential borrower’s interest rate is locked.

A mandatory delivery contract is a loan sales agreement where the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. Generally, the Company may enter into mandatory delivery contracts shortly after the loan closes with a customer.

The Company may sell to-be-announced mortgage-backed securities to hedge the changes in fair value of interest rate lock commitments and held for sale loans, which do not have corresponding best efforts or mandatory delivery contracts. These security sales transactions are closed once mandatory contracts are written. On the closing date the price of the security is locked-in, and the sale is paired-off with a purchase of the same security. Settlement of the security purchase/sale transaction is done with cash on a net-basis.

Non-hedging derivatives

The Company enters into interest rate lock commitments (“IRLCs”) for residential mortgage loans, which commit the Company to lend funds to a potential borrower at a specific interest rate and within a specified period of time. IRLCs that relate to the origination of mortgage loans that will be held for sale are considered derivative financial instruments under applicable accounting guidance. Outstanding IRLCs expose the Company to the risk that the price of the mortgage loans underlying the commitments may decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan. The IRLCs are free-standing derivatives which are carried at fair value with changes recorded in noninterest income in the Company’s consolidated statements of income. Changes in the fair value of IRLCs subsequent to inception are based on changes in the fair value of the underlying loan resulting from the fulfillment of the commitment and changes in the probability that the loan will fund within the terms of the commitment, which is affected primarily by changes in interest rates and the passage of time.

Amounts included in the Consolidated Statements of Income related to economic hedges and non-hedging derivatives were as follows:

	Years Ended December 31,
(In thousands)	2014			2013

Economic hedges
Interest rate swap on industrial revenue bond:
Unrealized (loss) gain recognized in other non-interest income	$	(1,333	)	$	972

Interest rate swaps on loans with commercial loan customers:
Unrealized gain recognized in other non-interest income	(4,514		)	(6,004		)

Reverse interest rate swaps on loans with commercial loan customers:
Unrealized loss recognized in other non-interest income	4,514			6,004

Favorable change in credit valuation adjustment recognized in other non-interest income	20			450

Risk Participation Agreements:

Unrealized loss recognized in other non-interest income	(91		)	—

Forward Commitments:

Unrealized (loss) gain recognized in other non-interest income	(510		)	261
Realized (loss) gain in other non-interest income	(1,494		)	7,501

Non-hedging derivatives
Interest rate lock commitments:
Unrealized gain recognized in other non-interest income	625			258
Realized gain (loss) in other non-interest income	$	3,938		$	(2,467	)

Assets and Liabilities Subject to Enforceable Master Netting Arrangements

Interest Rate Swap Agreements (“Swap Agreements”)

The Company enters into swap agreements to facilitate the risk management strategies for commercial banking customers. The Company mitigates this risk by entering into equal and offsetting swap agreements with highly rated third party financial institutions. The swap agreements are free-standing derivatives and are recorded at fair value in the Company’s consolidated statements of condition. The Company is party to master netting arrangements with its financial institution counterparties; however, the Company does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The master netting arrangements provide for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract. Collateral generally in the form of marketable securities is received or posted by the counterparty with net liability positions, respectively, in accordance with contract thresholds. The Company had net asset positions with its commercial banking counterparties totaling $12.3 million and $7.8 million as of December 31, 2014 and December 31, 2013, respectively. The Company had net liability positions with its financial institution counterparties totaling $18.2 million and $11.2 million as of December 31, 2014 and December 31, 2013, respectively. At December 31, 2014, the Company also had a net liability position of $0.1 million with its commercial banking counterparties as compared to $720 thousand liability at December 31, 2013. The collateral posted by the Company that covered liability positions was $18.2 million and $11.2 million as of December 31, 2014 and December 31, 2013, respectively.

The following table presents the assets and liabilities subject to an enforceable master netting arrangement as of December 31, 2014 and December 31, 2013:

Offsetting of Financial Assets and Derivative Assets

					Net Amounts
	Gross		Gross Amounts		of Assets		Gross Amounts Not Offset in the Statements
	Amounts of		Offset in the		Presented in the		of Condition
	Recognized		Statements of		Statements of		Financial		Cash
(in thousands)	Assets		Condition		Condition		Instruments		Collateral Received		Net Amount
As of December 31, 2014
Interest Rate Swap Agreements:
Institutional counterparties	$	23	$	—	$	23	$	—	$	—	$	23
Commercial counterparties	12,270		—		12,270		—		—		12,270
Total	$	12,293	$	—	$	12,293	$	—	$	—	$	12,293

Offsetting of Financial Liabilities and Derivative Liaibilities

						Net Amounts
	Gross			Gross Amounts		of Liabilities			Gross Amounts Not Offset in the Statements
	Amounts of			Offset in the		Presented in the			of Condition
	Recognized			Statements of		Statements of			Financial		Cash
(in thousands)	Liabilities			Condition		Condition			Instruments		Collateral Pledged		Net Amount
As of December 31, 2014
Interest Rate Swap Agreements:
Institutional counterparties	$	(18,232	)	$	58	$	(18,174	)	$	14,984	$	3,190	$	—
Commercial counterparties	(50		)	—		(50		)	—		—		(50		)
Total	$	(18,282	)	$	58	$	(18,224	)	$	14,984	$	3,190	$	(50	)

Offsetting of Financial Assets and Derivative Assets

					Net Amounts
	Gross		Gross Amounts		of Assets		Gross Amounts Not Offset in the Statements
	Amounts of		Offset in the		Presented in the		of Condition
	Recognized		Statements of		Statements of		Financial		Cash
(in thousands)	Assets		Condition		Condition		Instruments		Collateral Received		Net Amount
As of December 31, 2013
Interest Rate Swap Agreements:
Institutional counterparties	$	—	$	—	$	—	$	—	$	—	$	—
Commercial counterparties	7,799		—		7,799		—		—		7,799
Total	$	7,799	$	—	$	7,799	$	—	$	—	$	7,799

Offsetting of Financial Liabilities and Derivative Liaibilities

						Net Amounts
	Gross			Gross Amounts		of Liabilities			Gross Amounts Not Offset in the Statements
	Amounts of			Offset in the		Presented in the			of Condition
	Recognized			Statements of		Statements of			Financial		Cash
(in thousands)	Liabilities			Condition		Condition			Instruments		Collateral Pledged		Net Amount
As of December 31, 2013
Interest Rate Swap Agreements:
Institutional counterparties	$	(13,157	)	$	1,913	$	(11,244	)	$	9,544	$	1,700	$	—
Commercial counterparties	(720		)	—		(720		)	—		—		(720		)
Total	$	(13,877	)	$	1,913	$	(11,964	)	$	9,544	$	1,700	$	(720	)