10. Derivatives

The Company enters into commercial loan interest rate swap agreements in order to provide commercial loan customers the ability to convert from variable to fixed interest rates. Under these agreements, the Company enters into a variable-rate loan agreement with a customer in addition to a swap agreement that effectively converts the customer’s variable rate loan into a fixed rate. The Company then simultaneously enters into a corresponding swap agreement with a third party financial institution (“counterparty”) in order to offset its exposure on the fixed component of our customer’s interest rate swap. The Company has an agreement with its counterparty that contains a provision that provides that if the Company fails to maintain its status as a well-capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreement. This agreement also requires that the Company and the counterparty collateralize any fair value shortfalls that exceed $250,000 with eligible collateral, which includes cash and securities backed with the full faith and credit of the federal government. Similarly, the Company could be required to settle its obligations under the agreement if specific regulatory events occur, such as if the Company were issued a prompt corrective action directive or a cease and desist order, or if certain regulatory ratios fall below specified levels.

The interest rate swap agreements with our customers and the counterparty are not designated as hedging instruments under the Derivatives and Hedging topic of the FASB ASC 815, rather they are accounted for as free standing derivatives with changes in fair value reported in income. The Company had interest rate swaps with an aggregate notional amount of $20.4 million and zero at September 30, 2013 and December 31, 2012, respectively. At September 30, 2013, the notional amount of interest rate swaps is made up of one $10.2 million variable to fixed rate swap to a commercial loan customer and one $10.2 million fixed to variable rate swap with a counterparty. Changes in fair value from these two interest rate swaps offset each other in the third quarter of 2013. Additionally, the Company recognized zero and $138,000 in fee income related to interest rate swaps in the three and nine month periods ending September 30, 2013, respectively, and did not recognize any fee income related to interest rate swaps in 2012. Interest rate swap income is recorded in other income on the Consolidated Statements of Income.

The following table presents the fair value of derivatives not designated as hedging instruments at September 30, 2013 and December 31, 2012:



(In thousands)	Asset Derivatives
		September 30, 2013		December 31, 2012
	Balance Sheet Location		Fair Value		Fair Value

Interest rate contracts	Other assets	$	123	$	-


(In thousands)	Liability Derivatives
		September 30, 2013		December 31, 2012
	Balance Sheet Location		Fair Value		Fair Value

Interest rate contracts	Other Liabilities	$	123	$	-